1 Chapter 9 Current Liabilities, Contingencies, and the Time Value of Money Financial Accounting, Alternate 4e by Porter and Norton

2 Liabilities and shareholders' equity Current liabilities: Notes payable $.3 Accounts payable635.8 Income taxes 16.3 Other taxes191.8 Accrued interest199.4 Accrued restructuring and restaurant closing costs328.5 Accrued payroll and other liabilities774.7 Current maturities of long-term debt Total current liabilities $2,422.3 McDonald's Corporation 2002 Consolidated Balance Sheet (partial) (in millions) Require payment within one year Listed in order of liquidity

3 Selected 2002 Liquidity Ratios Current Quick Ratio Ratio Georgia-Pacific J. C. Penney Johnson Controls McDonald's Pfizer

4 Accounts Payable  Purchase of inventory, goods or services on credit 2/10, n30  Discount payment terms offered to encourage early payment

5 Promissory Note S.J.Devona I promise to pay $1,000 plus 12% annual interest on December 31, Date: January 1, 2004 Signed:_________ Lamanski Co. Total repayment = $1,120 $1,000 + ($1,000 x 12%)

6 Discounted Promissory Note In exchange for $880 received today, I promise to pay $1,000 on December 31, Date: January 1, 2004 Signed:_________ Lamanski Co. Effective interest rate on note = 13.6% ($120 interest / $880 proceeds)

7 1/1/0412/31/04 Notes Payable$ 1,000 $ 1,000 Less: Discount on Notes Payable Net Liability$ 880 $ 1,000 Balance Sheet Presentation of Discounted Notes Discount transferred to interest expense over life of note

8 8 Current Maturities of Long-Term Debt Principal repayment on borrowings due within one year of balance sheet date Due in upcoming year

9 Taxes Payable Record expense when incurred; not when paid Record 2004 tax expense Taxes Paid 12/31/043/15/05

10 Current Liabilities on the Statement of Cash Flows Operating Activities Net income xxx Increase in current liability + Decrease in current liability – Investing Activities Financing Activities Increase in notes payable + Decrease in notes payable –

11 Contingent Liability  Obligation involving existing condition  Outcome not known with certainty  Dependent upon some future event  Actual amount is estimated

12  Accrue estimated amount if: Liability is probable Amount can be reasonably estimated Contingent Liability Record in year criteria are met: Assets = Liab. + O/E + Rev. – Exp. Est. Liab. For Warranty Exp. 10,000 Warranty 10,000 Balance Sheet Income Statement

13  Warranties  Premium or coupon offers  Lawsuits Typical Contingent Liabilities

14 Recording Contingent Liabilities Quickkey Computer sells a computer product for $5,000 with a one-year warranty. In 2004, 100 of these products were sold for a total sales revenue of $500,000. Analyzing past records, Quickkey estimates that repairs will average 2% of total sales. Example:

15 Recording Contingent Liabilities Probable liability has been incurred? Amount reasonably estimable? Estimated Liability for Warranty $100,000 Warranty Expense $100,000 YES Record in 2004:

16 Disclosing Contingent Liabilities IF not probable but reasonably possible OR amount not estimable Disclose in footnotes

17 Contingent Assets  Contingent gains and assets are not recorded but may be disclosed in footnotes  Conservatism principle applies

18 Time Value of Money  Prefer payment now vs. in future due to interest factor  Applicable to both personal and business decisions

19 Simple Interest I = P x R x T Principal amount Dollar amount of interest per year Time in years Interest rate as a percentage

20 Example of Simple Interest Given following data: principal amount = $ 3,000 annual interest rate = 10% term of note = 2 years Calculate interest on the note.

21 Example of Simple Interest Given following data: principal amount = $ 3,000 annual interest rate = 10% term of note = 2 years Calculate interest on the note. Px R x T $ 3,000 x.10 x 2 = $ 600

22 Compound Interest Interest is calculated on principal plus previously accumulated interest Compounding can occur annually, semi-annually, quarterly, etc.

23 Example of Compound Interest Given following data: principal amount = $ 3,000 annual interest rate = 10% term of note = 2 years semiannual compounding of interest Calculate interest on note.

24 Compound Interest Periods Year 1Year 2 10% annually 5% + 5% semiannually 5% + 5% semiannually 4 5% semi-annual interest

25 Example of Compound Interest Period BeginningInterest Ending Principal at 5% Balance 1 $ 3,000 $ 150 $ 3, , , , , , ,647

26 Comparing Interest Methods Simple annual interest: $3,000 x.10 x 2 = $ 600 Semiannual compounding: 1 $ Total $ 647

27 Compound Interest Computations Present value of an annuity Future value of an annuity Present value of a single amount Future value of a single amount

28 Future Value of Single Amount Known amount of single payment or deposit Future Value + Interest =

29 Future Value of a Single Amount Example If you invest $10,000 10% compound interest, what will it be worth 3 years from now? invest $10,000 Future Value? + 10% per year Yr. 1Yr. 2Yr. 3

30 Future Value of a Single Amount Example - Using Formulas n FV = p (1 + i) 3 = $10,000 (1.10) = $13,310

31 FV = Present Value x FV Factor = $ 10,000 X (3 10%) Future Value of a Single Amount Example - Using Tables FV?? $10,000 PV Yr. 1Yr. 2Yr. 3

32 (n) 2% 4% 6% 8% 10% Future Value of $1

33 FV = Present Value x FV Factor = $ 10,000 X (3 10%) = $ 10,000 X = $ 13,310 Future Value of a Single Amount Example - Using Tables FV = $13,310 $10,000 PV Yr. 1Yr. 2Yr. 3

34 Present Value of Single Amount Discount Known amount of single payment in future Present Value

35 Present Value of a Single Amount Example If you will receive $10,000 in three years, what is it worth today (assuming you could invest at 10% compound interest)? Present Value? $ 10,000 10% Yr. 1Yr. 2Yr. 3

36 Present Value of a Single Amount Example - Using Formulas -n PV = payment x (1 + i) -3 = $10,000 x (1.10) = $7,513

37 PV = Future Value x PV Factor = $ 10,000 X (3 10%) Present Value of a Single Amount Example - Using Tables FV=$10,000 PV ?? Yr. 1Yr. 2Yr. 3

38 Present Value of $1 (n) 2% 4% 6% 8% 10%

39 PV = Future Value x PV Factor = $ 10,000 X (3 10%) = $ 10,000 X.7513 = $ 7,513 Present Value of a Single Amount Example - Using Tables FV=$10,000 PV = $7,513 Yr. 1Yr. 2Yr. 3

40 Periods Future Value? +Interest Future Value of an Annuity $0 $3,000$3,000$3,000 $3,000

41 If we invest $3,000 each year for four years at 10% compound interest, what will it be worth 4 years from now? Future Value of Annuity Example $0 $3,000 $3,000 $3,000 $3,000 Yr. 1Yr. 2Yr. 3Yr. 4 FV ??

42 $0 $3,000 $3,000 $3,000 $3,000 Yr. 1Yr. 2Yr. 3Yr. 4 FV ?? FV = Payment x FV Factor = $ 3,000 x (4 10%) Future Value of Annuity Example

43 Future Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12%

44 FV = Payment x FV Factor = $ 3,000 x (4 10%) = $ 3,000 x = $ 13,923 $0 $3,000 $3,000 $3,000 $3,000 Yr. 1Yr. 2Yr. 3Yr. 4 FV = $13,923 Future Value of Annuity Example

45 Present Value of an Annuity Periods Present Value ? Discount $0 $500 $500 $500 $500

46 Present Value of an Annuity Example What is the value today of receiving $4,000 at the end of the next 4 years, assuming you can invest at 10% compound annual interest? PV ?? Yr. 1Yr. 2 Yr. 3 Yr. 4 $0 $4,000 $4,000 $4,000 $4,000

47 Present Value of an Annuity Example Yr. 1Yr. 2 Yr. 3 Yr. 4 PV ?? $0 $4,000 $4,000 $4,000 $4,000 PV = Payment x PV Factor = $ 500 x (4 10%)

48 Present Value of Annuity of $1 (n) 2% 4% 6% 8% 10%

49 Present Value of an Annuity Example Yr. 1Yr. 2 Yr. 3 Yr. 4 P.V. = $12,680 $0 $4,000$4,000 $4,000 $4,000 PV = Payment x PV Factor = $ 4,000 x (4 10%) = $ 4,000 x = $ 12,680

50 Solving for Unknowns Assume that you have just purchased a new car for $14,420. Your bank has offered you a 5-year loan, with annual payments of $4,000 due at the end of each year. What is the interest rate being charged on the loan?

51 Solving for Unknowns Yr. 1Yr. 2 Yr. 3 Yr. 4 Yr. 5 discount discount discount discount discount PV = $14,420 PV = Payment x PV factor PV factor = PV / Payment rearrange equation to solve for unknown

52 Solving for Unknowns Yr. 1Yr. 2 Yr. 3 Yr. 4 Yr. 5 discount discount discount discount discount PV = $14,420 PV factor = PV / Payment = $14,420 / $4,000 = 3.605

53 Present Value of an Annuity Table (n) 10% 11% 12% 15% PV factor of equates to an interest rate of 12%.

54 Appendix A Accounting Tools: Payroll Accounting

55 Calculation of Gross Wages  Hourly Multiply the number of hours worked times employee’s hourly rate  Salaried Paid at a flat rate per week, month, or year, regardless of hours

56 Calculation of Net Pay Gross wages - Income tax (federal, state, local) - FICA - Voluntary deductions (includes health insurance, retirement contributions, savings plans, charitable contributions, union dues) = Net pay

57 Employer Payroll Taxes  Not deducted from paycheck – employer pays taxes per employee, in addition to salary FICA – employer’s share Unemployment tax

58 Payroll Accounting Example: Gross wages for Kori Company for July are $100,000. The following amounts have been withheld from employees’ paychecks: Kori Company’s unemployment tax rate is 6%. Show the effects of these transactions on the accounting equation. Income Tax$20,000 FICA 7,650 United Way contributions 5,000 Union dues 3,000

59 Payroll Accounting Record July salary and deductions: Assets = Liab. + O/E + Rev. – Exp. Salary Pay. 64,350 Salary Exp. (100,000) Inc. Tax Pay. 20,000 FICA Pay. 7,650 United Way Pay. 5,000 Union Dues Pay. 3,000

60 Payroll Accounting Record payment of employee salaries: Assets = Liab. + O/E + Rev. – Exp. Cash (64,350) Salary Pay. (64,350) Record employer’s payroll taxes: Assets = Liab. + O/E + Rev. – Exp. FICA Pay. 7,650 Payroll Tax Exp. (13,650) Unemploy. Tax Pay. 6,000

61 Compensated Absences  Employee absences for which the employee will be paid Vacation, illness, holidays  Accrued as a liability if The services have been rendered The rights (days) accumulate Payment is probable and can be reasonably estimated

62 Appendix B Accounting Tools: Using Excel for Problems Involving Interest Calculations

63 Using Excel Functions  Many functions built into Excel, including PV and FV calculations  Click on Paste or Insert button for list

64 FV Function in Excel Find the FV of a 10% note payable for $2,000, due in 2 years and compounded annually Example: Answer: $2,420

65 PV Function in Excel How much should you invest now at 10% (compounded annually) in order to have $2,000 in 2 years? Example: Answer: $1,653 (rounded)

66 End of Chapter 9