1. Current Liabilities, Contingencies, and the Time Value of Money
Chapter 9
Current Liabilities, Contingencies, and the Time Value of Money

2. Current Liabilities
Obligation that will be satisfied within one year or within current operating cycle
Normally recorded at face value and are important because they are indications of a company’s liquidity
Examples:
Accounts payable
Notes payable
Current portion of long-term debt
Taxes payable
Other accrued liabilities
LO 1

3. Accounts Payable
Amounts owed for inventory, goods, or services acquired in the normal course of business
Usually do not require the payment of interest, but terms may be given to encourage early payment
Example: 2/10, n/30
A 2% discount is available if payment occurs within the first ten days
If payment is not made within ten days, the full amount must be paid within 30 days

4. Notes Payable Amounts owed that are represented by a formal contract
Formal agreement is signed by the parties to the transaction
Arise from dealing with a supplier or acquiring a cash loan from a bank or creditor
The accounting for notes depends on whether the interest is paid on the note’s due date or is deducted before the borrower receives the loan proceeds

5. Example 9.1—Recording the Interest on Notes Payable
Assume that Hot Coffee Inc. receives a one-year loan from First National Bank on January 1. The face amount of the note of $1,000 must be repaid on December 31 along with interest at the rate of 12%

6. Example 9.1—Recording the Interest on Notes Payable (continued)
The company could identify and analyze the effect of the repayment as follows:

7. Example 9.2—Discounting a Note
Suppose that on January 1, 2014, First National Bank granted to Hot Coffee a $1,000 loan, due on December 31, 2014, but deducted the interest in advance and gave Hot Coffee the remaining amount of $880 ($1,000 face amount of the note less interest of $120)

8. Example 9.2—Discounting a Note (continued)
The Discount on Notes Payable account should be treated as a reduction of Notes Payable. If a balance sheet was developed immediately after the January 1 loan, the note would appear in the Current Liability category as follows:

9. Example 9.2—Discounting a Note (continued)
The original balance in the Discount on Notes Payable account represents interest that must be transferred to interest expense over the life of the note. Refer to Example 9-2. Before Hot Coffee presents its year-end financial statements, it must make an adjustment to transfer the discount to interest expense

10. Example 9.2—Discounting a Note (continued)
Thus, the balance of the Discount on Notes Payable account is zero and $120 has been transferred to interest expense. When the note is repaid on December 31, 2014, Hot Coffee must repay the full amount of the note

11. Recording Current Maturities of Long-Term Debt
The portion of a long-term liability that will be paid within one year

12. Example 9.3—Recording Current Maturities of Long-Term Debt
Assume that on January 1, 2014, your firm obtained a $10,000 loan from the bank. The terms of the loan require you to make payments in the amount of $1,000 per year for ten years payable each January 1 beginning January 1, On December 31, 2014, an entry should be made to classify a portion of the balance as a current liability

13. Recording Current Maturities of Long-Term Debt
Refer to the information in Example 9-3. On January 1, 2015, the company must pay $1,000

14. Current Liabilities—Accruals
Taxes Payable: business make an accounting entry, usually as one of the year-end adjusting entries, to record the amount of tax that has been incurred but is unpaid
LO 2

15. Current Liabilities—Other Accrued Liabilities
Include any amount that has been incurred but has not yet been paid

16. Example 9.4—Recording Accrued Liabilities
Suppose that your firm has a payroll of $1,000 per day Monday through Friday and that employees are paid at the close of work each Friday. Also, suppose that December 31 is the end of your accounting year and that it falls on a Tuesday

17. Recording Accrued Liabilities
Assume that you received a one-year loan of $10,000 on December 1. The loan carries a 12% interest rate. On December 31, an accounting entry must be made to record interest even though the money may not actually be due.

18. IFRS and Current Liabilities
International accounting standards require companies to present classified balance sheets with liabilities classified as either current or long term
U.S. standards do not require a classified balance sheet

19. Exhibit 9.2—Current Liabilities on the Statement of Cash Flows

20. Exhibit 9.3—Starbucks Corporation Partial Consolidated Statement of Cash Flows (In millions)

21. Contingent Liabilities
Existing condition for which the outcome is not known but depends on some future event
Recorded if the liability is probable and the amount can be reasonably estimated
Accrued and reflected on the balance sheet if it is probable and if the amount can be reasonably estimated
Examples:
Premiums or coupons
Lawsuits and legal claims
Warranties and guarantees
LO 4

22. Example 9.5—Recording a Liability for Warranties
Assume that Quickkey Computer sells a computer product for $5,000 with a one-year warranty in case the product must be repaired. Assume that in 2014, Quickkey sold 100 computers for a total sales revenue of $500,000 Using an analysis of past warranty records, Quickkey estimates that repairs will average 2% of total sales

23. Exhibit 9.4—Note Disclosure of Contingencies for Burger King Corporation

24. Contingent Liabilities versus Contingent Assets
Recorded in the balance sheet if probable and can be reasonably estimated
May be accrued
Contingent Assets
Not recorded in the balance sheet
Not accrued

25. IFRS and Contingencies
International standards
Not recorded in the balance sheet—only provision is recorded
Probable means—‘‘more likely than not’’ to occur
Require the amount recorded as a liability to be ‘‘discounted’’ or recorded as a present value amount
U.S. standards
Recorded in the balance sheet if it is probable and can be reasonably estimated
Has a higher threshold than this
Do not have a similar requirement

26. Time Value of Money: Compounding of Interest
An immediate amount should be preferred over an amount in the future because of the interest factor
The amount can be invested, and the resulting accumulation will be larger than the amount received in the future
LO 5

27. Exhibit 9.5—Importance of the Time Value of Money

28. Simple Interest
Calculated on the principal amount only

29. Compound Interest
Calculated on the principal plus previous amounts of interest
Assume a $3,000 note payable for which interest and principal are due in two years with interest compounded annually at 10% per year

30. Interest Compounding Future value of a single amount
Present value of a single amount
Future value of an annuity
Present value of an annuity
LO 6

31. Future Value of a Single Amount
Amount accumulated at a future time from a single payment or investment
The future amount is always larger than the principal amount (payment) because of the interest that accumulates

32. Future Value of a Single Amount (continued)

33. Present Value of a Single Amount
The amount at a present time that is equivalent to a payment or an investment at a future time

34. Future Value of an Annuity
The amount accumulated in the future when a series of payments is invested and accrues interest
Annuity: series of payments of equal amounts
Using Future Value of Annuity of $1 Table

35. Future Value of an Annuity (continued)
Using future value of $1 table:

36. Present Value of an Annuity
The amount at a present time that is equivalent to a series of payments and interest in the future
Using Present Value of Annuity of $1 Table

37. Present Value of an Annuity (continued)
Using present value of $1 table:

38. Example 9.13—Solving for an Interest Rate
Assume that you have just purchased an automobile for $14,419 and must decide how to pay for it. Your local bank has graciously granted you a five-year loan. Because you are a good credit risk, the bank will allow you to make annual payments on the loan at the end of each year. The amount of the loan payments, which include principal and interest, is $4,000 per year. You are concerned that your total payments will be $20,000 ($4,000 per year for five years) and want to calculate the interest rate that is being charged on the loan
Because the market or present value of the car, as well as the loan, is $14,419, a time diagram of the example would appear as follows:
LO 7

39. Example 9.13—Solving for an Interest Rate (Continued)
The interest rate we must solve for represents the discount rate that was applied to the $4,000 payments to result in a present value of $14,419. Therefore, the applicable formula is the following:
In this case, PV is known, so the formula can be rearranged as follows:

40. Table 9.4— Present Value of Annuity of $1

41. Example 9.14—Solving for the Number of Years
Assume that you want to accumulate $12,000 as a down payment on a home. You believe that you can save $1,000 per semiannual period, and your bank will pay interest of 8% per year, or 4% per semiannual period. How long will it take you to accumulate the desired amount?
The future value is known to be $12,000, and we must solve for the interest factor or table factor. Therefore, we can rearrange the formula as follows:

42. Table 9.3—Future Value of Annuity of $1

43. End of Chapter 9