PowerPoint Author: Catherine Lumbattis 7/e COPYRIGHT © 2011 South-Western/Cengage Learning 9 Current Liabilities, Contingencies, and the Time Value of Money

Starbucks Corp. Partial Balance Sheet Liabilities and shareholders' equity Current liabilities: Commercial paper and short term borrowings $ Accounts payable Accrued compensation and related costs Accrued occupancy costs Accrued taxes 76.1 Insurance reserves Other accrued expenses Deferred revenue Current portion of long term debt.7 Total current liabilities $2,189.7 (in millions) Requires payment within one year September 2008

Selected 2008 Liquidity Ratios Current Quick Industry Ratio Ratio Starbucks Food Caribou Coffee Food Green Mountain Food LO1

Accounts Payable  Amounts owed for the purchase of inventory, goods, or services on credit  Discount payment terms offered to encourage early payment

Promissory Note S.J.Devona I promise to pay $1,000 plus 12% annual interest on December 31, Date: January 1, 2011 Signed : _________ Hot Coffee Inc. Total repayment = $1,120 $1,000 + ($1,000 × 12%)

Discounted Promissory Note In exchange for $880 received today, I promise to pay $1,000 on December 31, Date: January 1, 2011 Signed : _________ Hot Coffee, Inc. Effective interest rate on note = 13.6% ($120 interest/$880 proceeds)

Balance Sheet Presentation of Discounted Notes 1/1/11 12/31/11 Notes Payable $1,000 $1,000 Less: Discount on Notes Payable Net Liability $ 880 $1,000 Discount transferred to interest expense over life of note

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

Taxes Payable Record expense when incurred, not when paid Record 2007 tax expense Taxes Paid 12/31/103/15/11 LO2

Other Accrued Liabilities Includes any amount that has been incurred dueto the passage of time but has not been paid as of the balance sheet date Examples:  Salaries and Wages  Interest Adjusting Entry: ExpenseXXX Payable XXX

IFRS and Current Liabilities The U.S. and international standards are generally similar but there are important differences. Differences:  International accounting standards require companies to present classified balance sheets with liabilities as either current or long term.  An unclassified balance sheet based on the order of liquidity is acceptable only when it provides more reliable information.  U.S. standards do not require a classified balance sheets. U.S. standards permit companies to list liabilities in order by size or by order of liquidity.

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 – LO3

Contingent Liabilities  Obligation involving existing condition  Outcome not known with certainty  Dependent upon some future event  Actual amount is estimated LO4

Contingent Liabilities  Accrue estimated amount if: Liability is probable Amount can be reasonably estimated In year criteria are met: Expense(loss)XXX Liability XXX

Typical Contingent Liabilities  Product warranties and guarantees  Premium or coupon offers  Lawsuits

Recording Contingent Liabilities Quickkey Computer sells a computer product for $5,000 with a one-year warranty. In 2010, 100 computers were sold for a total sales revenue of $500,000. Analyzing past records, Quickkey estimates that repairs will average 2% of total sales. Example:

Recording Contingent Liabilities Probable liability has been incurred? Amount reasonably estimable? Warranty Expense 10,000 Estimated Liability 10,000 (2% X $500,000 sales) YES Record in 2010:

Disclosing Contingent Liabilities IF not probable but reasonably possible OR amount not estimable Disclose in Financial Statement notes

Contingent Assets  Contingent gains and assets are not recorded but may be disclosed in financial statement notes  Conservatism principle applies

IFRS and Contingencies  International standards use the term “provision” for those items that must be reported on the balance sheet  International standards have a lower threshold for those items that must be reported so thus more items will be recorded on the balance sheet.  International standards require the amount of the recorded liability be discounted (recorded at present value).  The term “contingent liability” is only used for those items that are footnoted but not for those liabilities reported on the balance sheet.

Time Value of Money  Prefer payment at the present time rather than in the future due to the interest factor  Applicable to both personal and business decisions

Simple Interest I = P × R × T Principal Dollar amount of interest per year Time in years Interest rate as a percentage LO5

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.

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. P × R × T $3,000 ×.10 × 2 = $ 600

Compound Interest  Interest is calculated on principal plus previously accumulated interest Interest on interest  Compound interest amount always higher than simple interest due to interest on interest

Example of Interest Compounding Given following data: principal amount = $ 3,000 annual interest rate = 10% term of note = 2 years semiannual compounding of interest Calculate interest on note. LO6

Compound Interest Periods 4 5% semiannual interest Year 1Year 2 10% annually 10% annually 5% + 5% semiannually 5% + 5% semiannually

Example of Interest Compou nding Principal Amount at Beginning Interest at Accumulated Period of Year 5% per Period at End of Period 1 $3,000$150 $3, , , , , , ,647

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

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

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

Future Value of a Single Amount If you invest $2,000 10% compound interest, what will it be worth 2 years from now? Invest $2,000 Future Value = ? + 10% per year Year 1Year 2 Example:

Future Value of a Single Amount: Using Formulas FV = p(1 + i) n = $2,000(1.10) 2 = $2,420

Future Value of a Single Amount Example: Using Tables FV = Present value × table factor = $2,000 × (2 10%) FV = ?? PV = $2,000 Year 1Year 2

Future Value of $1 (n) 2% 4% 6% 8% 10% 12% 15%

Future Value of a Single Amount: Using Tables FV = Present value × table factor = $2,000 × (2 10%) = $2,000 × = $2,420 PV = $2,000 Year 1Year 2 FV = $2,420

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

Present Value of a Single Amount If you will receive $2,000 in two years, what is it worth today (assuming you could invest at 10% compound interest)? $2,000 10% Year 1Year 2 Present Value = ? Example:

Present Value of a Single Amount: Using Formulas PV = Future value × (1 + i) –n = $2,000 × (1.10) –2 = $1,652

Present Value of a Single Amount: Using Tables PV = Future value × table factor = $2,000 × (2 10%) FV = $2,000 PV = ?? Year 1 Year 2

Present Value of $1 (n) 2% 4% 6% 8% 10% 12% 15%

Present Value of a Single Amount Example – Using Tables PV = Future value × table factor = $2,000 × (2 10%) = $2,000 × = $1,652 PV = $1,652 Year 1Year 2 FV = $2,000

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

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

$0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = ?? Future Value of an Annuity FV = Payment × table factor = $3,000 × (4 10%) Example:

Future Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15%

Future Value of an Annuity PV = Payment × table factor = $3,000 × (4 10%) = $3,000 × = $13,923 $0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = $13,923 Example:

Present Value of an Annuity $0 $4,000 $4,000 $4,000 $4,000 Periods Discount Present Value = ?

Present Value of an Annuity 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? $0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = ?? Example:

$0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = ?? Present Value of an Annuity PV = Payment × table factor = $4,000 × (4 10%) Example:

Present Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15%

Present Value of an Annuity PV = Payment × table factor = $4,000 × (4 10%) = $4,000 × = $12,680 $0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = $12,680 Example:

Solving for Unknowns Example 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? LO7 Year 1 Year 2 Year 3 Year 4 Year 5 $0$4,000 $4,000 $4,000 $4,000 $4,000 Discount PV = $14,420

Solving for Unknowns Example PV = Payment × table factor Table factor = PV/payment Year 1 Year 2 Year 3 Year 4 Year 5 $0 $4,000 $4,000 $4,000 $4,000 $4,000 PV = $14,420 Rearrange equation to solve for unknown

Solving for Unknowns Example Table factor = PV/payment = $14,420/$4,000 = Year 1 Year 2 Year 3 Year 4 Year 5 $0 $4,000 $4,000 $4,000 $4,000 $4,000 PV = $14,420

Present Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15% The factor of equates to an interest rate of 12%

Appendix Accounting Tools: Using Excel for Problems Involving Interest Calculations

Using Excel Functions  Many functions built into Excel®, including PV and FV calculations  Click on the PASTE function (fx) of the Excel toolbar or the Insert command

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

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)

End of Chapter 9