1. Chapter 9 Current Liabilities, Contingencies, and the Time Value of Money Copyright © 2009 South-Western, a part of Cengage Learning. Using Financial Accounting Information: The Alternative to Debits and Credits, 6/e by Gary A. Porter and Curtis L. Norton

2. Liabilities and shareholders' equity Current liabilities: Accounts payable $ 340,937 Accrued compensation and related costs 288,963 Accrued occupancy costs 54,868 Accrued taxes 94,010 Short-term borrowing 700,000 Other accrued expenses 224,154 Deferred revenue 231,926 Current portion of long term debt 762 Total current liabilities $1,935,620 Starbucks Corp. Partial Balance Sheet (in thousands) Requires payment within one year 2006

3. Selected 2006 Liquidity Ratios Current Quick Industry Ratio Ratio Starbucks Food.79.39 Caribou Coffee Food.92.56 Green Mountain Food 1.74.89 LO1

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

5. Promissory Note S.J.Devona I promise to pay $1,000 plus 12% annual interest on December 31, 2008. Date: January 1, 2008 Signed: _________ Hot Coffee Inc. Total repayment = $1,120 $1,000 + ($1,000 × 12%)

6. Record issuance of note: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expenses Equity Cash 1,000 Notes Payable 1,000 Record repayment of loan: Cash 1,120 Notes Payable Interest Expense (1,000) (120) Promissory Notes

7. Discounted Promissory Note In exchange for $880 received today, I promise to pay $1,000 on December 31, 2008. Date: January 1, 2008 Signed: _________ Hot Coffee, Inc. Effective interest rate on note = 13.6% ($120 interest/$880 proceeds)

8. Record issuance of note: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expenses Equity Cash 880 Notes Payable 1,000 Discount on Notes Payable (120) Record interest and repayment of loan: Discount on Notes Interest Expense Payable 120 (120) Cash 1,000 Notes Payable (1,000) Discounted Promissory Notes

9. 1/1/08 12/31/08 Notes Payable $1,000 $1,000 Less: Discount on Notes Payable 120 - 0 - Net Liability $ 880 $1,000 Balance Sheet Presentation of Discounted Notes Discount transferred to interest expense over life of note

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

11. Taxes Payable Record expense when incurred, not when paid Record 2008 tax expense Taxes Paid 12/31/083/15/09 LO2

12. 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

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

14.  Record estimated amount if: Liability is probable Amount can be reasonably estimated Contingent Liabilities

15.  Warranties  Premium or coupon offers  Lawsuits Typical Contingent Liabilities

16. Recording Contingent Liabilities Quickkey Computer sells a computer product for $5,000 with a one-year warranty. In 2008, 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:

17. Recording Contingent Liabilities Probable liability has been incurred? Amount reasonably estimable? YES Record in 2008: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expenses Equity Estimated Expense (xxx) Liability xxx

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

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

20. 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

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

22. 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.

23. 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

24. 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

25. 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

26. Compound Interest Periods 4 periods @ 5% semiannual interest Year 1Year 2 10% annually 5% + 5% semiannually 5% + 5% semiannually

27. Example of Interest Compounding Principal Amount at Beginning Interest at Accumulated Period of Year 5% per Period at End of Period 1 $3,000$150 $3,150 2 3,150 158 3,308 3 3,308 165 3,473 4 3,473 174 3,647

28. Comparing Interest Methods Simple annual interest: $3,000 ×.10 × 2 = $600 Semiannual compounding: 1$150 2 158 3 165 4 174 Total $647

29. 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

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

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

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

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

34. (n) 2% 4% 6% 8% 10% 12% 15% 11.020 1.0401.0601.0801.1001.1201.150 21.0401.082 1.124 1.1661.2101.2541.323 31.0611.1251.1911.2601.3311.4051.521 41.0821.1701.2621.3601.4641.5741.749 51.1041.2171.3381.4701.6111.7622.011 61.1261.2651.4191.5871.7721.9742.313 71.1491.3161.5041.7141.9492.2112.660 81.1721.3691.5941.8512.1442.4763.059 Future Value of $1

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

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

37. 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 Discount @ 10% Year 1Year 2 Present Value = ? Example:

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

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

40. (n) 2% 4% 6% 8% 10% 12% 15% 10.980 0.9620.9430.9260.9090.8930.870 20.9610.925 0.890 0.8570.8260.7970.756 30.9420.8890.8400.7940.7510.7120.658 40.9240.8550.7920.7350.6830.6360.572 50.9060.8220.7470.6810.6210.5670.497 60.8880.7900.7050.6300.5640.5070.432 70.8710.7600.6650.5830.5130.4520.376 80.8530.7310.6270.5400.4670.4040.327 Present Value of $1

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

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

43. 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 an Annuity $0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = ?? Example:

44. $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 periods @ 10%) Example:

45. (n) 2% 4% 6% 8% 10% 12% 15% 11.000 1.0001.0001.0001.0001.0001.000 22.0202.040 2.060 2.0802.1002.1202.150 33.0603.1223.1843.2463.3103.3743.473 44.1224.2464.3754.5064.6414.7794.993 55.2045.4165.6375.8676.1056.3536.742 66.3086.6336.9757.3367.7168.1158.754 77.4347.8988.3948.923 9.48710.08911.067 88.5839.2149.897 10.637 11.43612.30013.727 Future Value of Annuity of $1

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

47. Present Value of an Annuity 1 2 3 4 $0 $4,000 $4,000 $4,000 $4,000 Periods Discount Present Value = ?

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

49. $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 periods @ 10%) Example:

50. (n) 2% 4% 6% 8% 10% 12% 15% 10.980 0.9620.9430.9260.9090.8930.870 21.9421.886 1.833 1.7831.7361.6901.626 32.8842.7752.6732.5772.4872.4022.283 43.8083.6303.4653.3123.1703.0372.855 54.7134.4524.2123.9933.7913.6053.352 65.6015.2424.9174.6234.3554.1113.784 76.4726.0025.5825.2064.8684.5644.160 87.3256.7336.2105.7475.3354.9684.487 Present Value of Annuity of $1

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

52. 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

53. 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

54. 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

55. (n) 2% 4% 6% 8% 10% 12% 15% 10.980 0.9620.9430.9260.9090.8930.870 21.9421.886 1.833 1.7831.7361.6901.626 32.8842.7752.6732.5772.4872.4022.283 43.8083.6303.4653.3123.1703.0372.855 54.7134.4524.2123.9933.7913.6053.352 65.6015.2424.9174.6234.3554.1113.784 76.4726.0025.5825.2064.8684.5644.160 87.3256.7336.2105.7475.3354.9684.487 Present Value of Annuity of $1 The factor of 3.605 equates to an interest rate of 12%

56. Appendix Accounting Tools: Using Excel for Problems Involving Interest Calculations

57. 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

58. 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

59. 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)

60. End of Chapter 9