Chapter 9Current 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

Liabilities and shareholders' equityCurrent liabilities:

Accounts payable $ 340,937 Accrued compensation and related costs 288,963

Accrued occupancy costs 54,868Accrued taxes 94,010Short-term borrowing 700,000

Other accrued expenses 224,154 Deferred revenue 231,926

Current portion of long term debt 762Total current liabilities $1,935,620

Starbucks Corp.Partial Balance Sheet

(in thousands)

Requires payment within

one year

2006

Selected 2006 Liquidity Ratios

Current Quick Industry Ratio Ratio

Starbucks Food .79 .39Caribou Coffee Food .92 .56Green Mountain Food 1.74 .89

LO1

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

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%)

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

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)

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

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

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 2008 taxexpense

Taxes Paid

12/31/08 3/15/09

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

Record estimated amount if:

• Liability is probable

• Amount can be reasonably estimated

Contingent Liabilities

Warranties

Premium or coupon offers

Lawsuits

Typical Contingent Liabilities

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:

Recording Contingent LiabilitiesProbable liability has been incurred?

Amount reasonably estimable?

YES

YES

Record in 2008:

Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expenses Equity Estimated Expense (xxx) Liability xxx

Disclosing Contingent Liabilities

IF not probable

but reasonably possible

ORamount 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

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

Princip

al

Dollar

amou

nt of

inter

est p

er ye

ar

Time i

n year

s

Inter

est r

ate a

s a p

erce

ntage

LO5

Example of Simple Interest

Given following data:principal amount = $ 3,000annual interest rate = 10%term of note = 2 years

Calculate interest on the note.

Example of Simple InterestGiven following data:

principal amount = $ 3,000annual 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 CompoundingGiven 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 periods @ 5% semiannual interest

Year 1 Year 2

10% annually 10% annually

5% + 5%semiannually

5% + 5%semiannually

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

Comparing Interest MethodsSimple annual interest: $3,000 × .10 × 2 = $600

Semiannual compounding: 1 $150 2 158 3 165 4 174Total $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 today @ 10% compound interest, what will it be worth 2 years from now?

invest$2,000

Future Value = ?

+ Interest @ 10% per year

Year 1 Year 2

Example:

Future Value of a Single Amount Example – Using Formulas

FV = p(1 + i)n

= $2,000(1.10)2

= $2,420

FV = Present value × table factor = $2,000 × (2 periods @ 10%)

Future Value of a Single Amount Example – Using Tables

FV = ??PV = $2,000

Year 1 Year 2

(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

Future Value of $1

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 1 Year 2

FV = $2,420

Present Value of Single Amount

Discount

Known amount of single

payment in futurePresent 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

Discount @ 10%

Year 1 Year 2

Present Value = ?

Example:

Present Value of a Single Amount Example – Using Formulas

PV = Future value × (1 + i)–n

= $2,000 × (1.10)–2

= $1,652

PV = Future value × table factor = $2,000 × (2 periods @ 10%)

Present Value of a Single Amount Example – Using Tables

FV = $2,000PV = ??

Year 1 Year 2

(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

Present Value of $1

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 1 Year 2

FV = $2,000

Periods

FutureValue = ?

+ Interest

Future Value of an Annuity

1 2 3 4

$0 $3,000 $3,000 $3,000 $3,000

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:

$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:

(n) 2% 4% 6% 8% 10% 12% 15% 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

Future Value of Annuity of $1

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:

Present Value of an Annuity

1 2 3 4

$0 $4,000 $4,000 $4,000 $4,000

Periods

Discount

PresentValue = ?

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:

$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:

(n) 2% 4% 6% 8% 10% 12% 15% 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

Present Value of Annuity of $1

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:

Solving for Unknowns ExampleAssume 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 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

(n) 2% 4% 6% 8% 10% 12% 15% 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

Present Value of Annuity of $1

The factor of 3.605 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