Gary A. Porter and Curtis L. Norton Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Jacuzzi Brands Partial Balance Sheet – 2004 (in millions) Liabilities and shareholders' equity Current liabilities: Notes payable $ 21.1 Current maturities of long-term debt 3.9 Trade accounts payable 123.7 Income taxes payable 18.3 Accrued expenses and other current liabilities 134.4 Total current liabilities $301.4 Requires payment within one year

Selected 2004 Liquidity Ratios Current Quick Ratio Ratio Jacuzzi Brands 1.79 1.04 Sara Lee 1.06 0.55 Tommy Hilfiger 3.87 2.77 Boeing 0.72 0.42 Nike 2.50 1.67 LO1

Accounts Payable Amounts owed for the purchase of inventory, goods, or services on credit Discount payment terms offered to encourage early payment Example: 2/10, n30

Promissory Note I promise to pay $1,000 plus 12% annual interest on December 31, 2007. Date: January 1, 2007 Signed:_________ Lamanski Co. S.J.Devona Total repayment = $1,120 $1,000 + ($1,000 × 12%) 5

Discounted Promissory Note In exchange for $880 received today, I promise to pay $1,000 on December 31, 2007. Date: January 1, 2007 Signed:_________ Lamanski Co. Effective interest rate on note = 13.6% ($120 interest/$880 proceeds)

Balance Sheet Presentation of Discounted Notes Discount transferred to interest expense over life of note 1/1/07 12/31/07 Notes Payable $1,000 $1,000 Less: Discount on Notes Payable 120 - 0 - Net Liability $ 880 $1,000 7

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 12/31/07 3/15/08 Record 2007 tax expense Taxes Paid LO2

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 11

Contingent Liabilities Accrue estimated amount if: Liability is probable Amount can be reasonably estimated In Year criteria are met: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity increase increase 12

Typical Contingent Liabilities Warranties Premium or coupon offers Lawsuits 13

Recording Contingent Liabilities Example: Quickkey Computer sells a computer product for $5,000 with a one-year warranty. In 2007, 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.

Recording Contingent Liabilities Probable liability has been incurred? Amount reasonably estimable? YES YES Record in 2007: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Warranty Warranty Expense Liability 10,000 (10,000)

Disclosing Contingent Liabilities Disclose in financial statement notes IF not probable but reasonably possible OR amount not estimable 16

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

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

I = P × R × T Simple Interest Dollar amount of Time in years Principal interest per year Principal Time in years Interest rate as a percentage LO5 19

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. 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. P × R × T $3,000 × .10 × 2 = $ 600 21

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 22

Example of Interest Compounding Given following data: principal amount = $ 3,000 annual interest rate = 10% term of note = 2 years annual compounding of interest Calculate interest on note. LO6 23

Compound Interest Periods Year 1 Year 2 10% annually 2 periods @ 10% annual interest 24

Example of Interest Compounding Principal Amount at Beginning Interest at Accumulated Year of Year 10% per Year at End of Year 1 $3,000 $300 $3,300 2 3,300 330 3,630 25

Comparing Interest Methods Simple annual interest: $3,000 × .10 × 2 = $600 Annual compounding: 1 $300 2 330 Total $630 26

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

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

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

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

Future Value of a Single Amount Example – Using Tables Year 1 Year 2 FV = ?? PV = $2,000 FV = Present value × table factor = $2,000 × (2 periods @ 10%) 31

Future Value of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 1.020 1.040 1.060 1.080 1.100 1.120 1.150 2 1.040 1.082 1.124 1.166 1.210 1.254 1.323 3 1.061 1.125 1.191 1.260 1.331 1.405 1.521 4 1.082 1.170 1.262 1.360 1.464 1.574 1.749 5 1.104 1.217 1.338 1.470 1.611 1.762 2.011 6 1.126 1.265 1.419 1.587 1.772 1.974 2.313 7 1.149 1.316 1.504 1.714 1.949 2.211 2.660 8 1.172 1.369 1.594 1.851 2.144 2.476 3.059 32

Future Value of a Single Amount Example – Using Tables Yr. 1 Yr. 2 PV = $2,000 FV = $2,420 FV = Present value × table factor = $2,000 × (2 periods @ 10%) = $2,000 × 1.210 = $2,420 33

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

Present Value of a Single Amount Example If you will receive $2,000 in two years, what is it worth today (assuming you could invest at 10% compound interest)? Present Value = ? $2,000 Year 1 Year 2 Discount @ 10% 29

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

Present Value of a Single Amount Example – Using Tables Year 1 Year 2 PV = ?? FV = $2,000 PV = Future value × table factor = $2,000 × (2 periods @ 10%) 31

Present Value of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 0.961 0.925 0.890 0.857 0.826 0.797 0.756 3 0.942 0.889 0.840 0.794 0.751 0.712 0.658 4 0.924 0.855 0.792 0.735 0.683 0.636 0.572 5 0.906 0.822 0.747 0.681 0.621 0.567 0.497 6 0.888 0.790 0.705 0.630 0.564 0.507 0.432 7 0.871 0.760 0.665 0.583 0.513 0.452 0.376 8 0.853 0.731 0.627 0.540 0.467 0.404 0.327 32

Present Value of a Single Amount Example – Using Tables Year 1 Year 2 PV = $1,652 FV = $2,000 PV = Future value × table factor = $2,000 × (2 periods @ 10%) = $10,000 × 0.826 = $1,652 33

Future Value of an Annuity Periods 1 2 3 4 $0 $3,000 $3,000 $3,000 $3,000 + Interest Future Value = ? 40

Future Value of an Annuity Example 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 = ?? 41

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

Future Value of Annuity of $1 1 1.000 1.000 1.000 1.000 1.000 1.000 1.000 2 2.020 2.040 2.060 2.080 2.100 2.120 2.150 3 3.060 3.122 3.184 3.246 3.310 3.374 3.473 4 4.122 4.246 4.375 4.506 4.641 4.779 4.993 5 5.204 5.416 5.637 5.867 6.105 6.353 6.742 6 6.308 6.633 6.975 7.336 7.716 8.115 8.754 7 7.434 7.898 8.394 8.923 9.487 10.089 11.067 8 8.583 9.214 9.897 10.637 11.436 12.300 13.727 32

Future Value of an Annuity Example Year 1 Year 2 Year 3 Year 4 $0 $3,000 $3,000 $3,000 $3,000 FV = $13,923 PV = Payment × table factor = $3,000 × (4 periods @ 10%) = $3,000 × 4.641 = $13,923

Present Value of an Annuity Periods 1 2 3 4 $0 $500 $500 $500 $500 Discount Present Value = ?

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? Year 1 Year 2 Year 3 Year 4 $0 $4,000 $4,000 $4,000 $4,000 PV = ?? 41

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

Present Value of Annuity of $1 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 1.942 1.886 1.833 1.783 1.736 1.690 1.626 3 2.884 2.775 2.673 2.577 2.487 2.402 2.283 4 3.808 3.630 3.465 3.312 3.170 3.037 2.855 5 4.713 4.452 4.212 3.993 3.791 3.605 3.352 6 5.601 5.242 4.917 4.623 4.355 4.111 3.784 7 6.472 6.002 5.582 5.206 4.868 4.564 4.160 8 7.325 6.733 6.210 5.747 5.335 4.968 4.487 32

Present Value of an Annuity Example Year 1 Year 2 Year 3 Year 4 $0 $4,000 $4,000 $4,000 $4,000 PV = $12,680 PV = Payment × table factor = $4,000 × (4 periods @ 10%) = $4,000 × 3.170 = $12,680

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? 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 LO7

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

Solving for Unknowns Example Year 1 Year 2 Year 3 Year 4 Year 5 $0 $4,000 $4,000 $4,000 $4,000 $4,000 PV = $14,420 Table factor = PV/payment = $14,420/$4,000 = 3.605

Present Value of Annuity of $1 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 1.942 1.886 1.833 1.783 1.736 1.690 1.626 3 2.884 2.775 2.673 2.577 2.487 2.402 2.283 4 3.808 3.630 3.465 3.312 3.170 3.037 2.855 5 4.713 4.452 4.212 3.993 3.791 3.605 3.352 6 5.601 5.242 4.917 4.623 4.355 4.111 3.784 7 6.472 6.002 5.582 5.206 4.868 4.564 4.160 8 7.325 6.733 6.210 5.747 5.335 4.968 4.487 The factor of 3.605 equates to an interest rate of 12% 32

Accounting Tools: Payroll Accounting Appendix A Accounting Tools: Payroll Accounting

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 LO8

Calculation of Net Pay Gross wages Less: Income tax (federal, state, local) FICA—Employee’s share Voluntary deductions (includes health insurance, retirement contributions, savings plans, charitable contributions, union dues, etc.) = Net pay

Employer Payroll Taxes Not deducted from paycheck – employer pays taxes for each employee, in addition to salary FICA—Employer’s share Unemployment tax

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 3%. Make the appropriate payroll entries. Income Tax $20,000 FICA 7,650 United Way Contributions 5,000 Union Dues 3,000

Payroll Accounting To record July salary and deductions: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Salaries Payable 64,350 Salaries Expense (100,000) Income Taxes Payable 20,000 FICA Taxes Payable 7,650 United Way Payable 5,000 Union Dues Payable 3,000

Payroll Accounting To record payment of employee salaries Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash = Salaries Payable (64,350) (64,350) To record employer’s payroll taxes FICA Taxes Payable Payroll Tax Expense 7,650 (10,650) Unemployment Taxes Payable 3,000

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 LO9

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

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

End of Chapter 9