Chapter 9
Current Liabilities, Contingencies,
and the Time Value of Money
Using Financial Accounting Information:
The Alternative to Debits and Credits, 6/e
by
Gary A. Porter and Curtis L. Norton
Copyright © 2009 South-Western, a part of Cengage Learning.
Starbucks Corp.
Partial Balance Sheet
(in thousands)
Liabilities and shareholders' equity
2006
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
Requires
Current portion of long term debt
762
Total current liabilities
payment within $1,935,620
one year
Selected 2006 Liquidity Ratios
Industry
Starbucks
Caribou Coffee
Green Mountain
Food
Food
Food
Current
Ratio
.79
.92
1.74
Quick
Ratio
.39
.56
.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
I promise to pay $1,000 plus 12% annual interest on
December 31, 2008.
Date: January 1, 2008
Hot Coffee Inc.
Signed: _________
S.J.Devona
Total repayment = $1,120
$1,000 + ($1,000 × 12%)
Promissory Notes
Record issuance of note:
Balance Sheet
Assets =
Liabilities + Stockholders’ +
Equity
Cash 1,000 Notes Payable
1,000
Income Statement
Revenues – Expenses
Record repayment of loan:
Cash 1,120
Notes Payable
(1,000)
Interest Expense
(120)
Discounted Promissory Note
In exchange for $880 received today, I promise
to pay $1,000 on December 31, 2008.
Date: January 1, 2008
Coffee, Inc.
Signed: Hot
_________
Effective interest rate on note = 13.6%
($120 interest/$880 proceeds)
Discounted Promissory Notes
Record issuance of note:
Assets =
Cash 880
Balance Sheet
Liabilities + Stockholders’ +
Equity
Notes Payable
1,000
Discount on Notes
Payable (120)
Income Statement
Revenues – Expenses
Record interest and repayment of loan:
Cash 1,000
Discount on Notes
Payable 120
Notes Payable (1,000)
Interest Expense
(120)
Balance Sheet Presentation of
Discounted Notes
Discount transferred
to interest expense
over life of note
1/1/08
12/31/08
Notes Payable
$1,000
Less: Discount on Notes Payable
120
Net Liability
$ 880
$1,000
- 0 $1,000
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
12/31/08
3/15/09
Record
2008 tax
expense
Taxes
Paid
LO2
Current Liabilities on the
Statement of Cash Flows
Operating Activities
Net income
Increase in current liability
Decrease in current liability
Investing Activities
Financing Activities
Increase in notes payable
Decrease in notes payable
xxx
+
–
+
–
LO3
Contingent Liabilities
 Obligation involving existing condition
 Outcome not known with certainty
 Dependent upon some future event
 Actual amount is estimated
LO4
Contingent Liabilities
 Record estimated amount if:
• Liability is probable
• Amount can be reasonably estimated
Typical Contingent Liabilities
 Warranties

Premium or coupon offers

Lawsuits
Recording Contingent Liabilities
Example:
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.
Recording Contingent Liabilities
Probable liability has been
incurred?
YES
Amount reasonably estimable?
YES
Record in 2008:
Assets =
Balance Sheet
Liabilities + Stockholders’ +
Equity
Estimated
Liability xxx
Income Statement
Revenues – Expenses
Expense (xxx)
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
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
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
annual interest rate
term of note
= $ 3,000
=
10%
= 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
=
term of note
= 2 years
10%
semiannual compounding of interest
Calculate interest on note.
LO6
Compound Interest Periods
Year 1
5% + 5%
semiannually
10% annually
Year 2
5% + 5%
semiannually
10% annually
4 periods @ 5% semiannual interest
Example of Interest Compounding
Period
Principal Amount
at Beginning
of Year
1
$3,000
$150
$3,150
2
3,150
158
3,308
3
3,308
165
3,473
4
3,473
174
3,647
Interest at
Accumulated
5% per Period at End of Period
Comparing Interest Methods
Simple annual interest:
$3,000 × .10 × 2 =
$600
Semiannual compounding:
1
$150
2
158
3
165
4
174
Total
$647
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
Future Value of Single Amount
Known amount of
single payment or
investment
Future Value
+ Interest =
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
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
PV = $2,000
FV = Present value × table factor
= $2,000 × (2 periods @ 10%)
FV = ??
Future Value of $1
(n)
1
2
3
4
5
6
7
8
2%
1.020
1.040
1.061
1.082
1.104
1.126
1.149
1.172
4%
1.040
1.082
1.125
1.170
1.217
1.265
1.316
1.369
6%
1.060
1.124
1.191
1.262
1.338
1.419
1.504
1.594
8%
1.080
1.166
1.260
1.360
1.470
1.587
1.714
1.851
10%
1.100
1.210
1.331
1.464
1.611
1.772
1.949
2.144
12%
1.120
1.254
1.405
1.574
1.762
1.974
2.211
2.476
15%
1.150
1.323
1.521
1.749
2.011
2.313
2.660
3.059
Future Value of a Single Amount
Example – Using Tables
Year 1
PV = $2,000
Year 2
FV = $2,420
FV = Present value × table factor
= $2,000 × (2 periods @ 10%)
= $2,000 × 1.210
= $2,420
Present Value of Single Amount
Present Value
Discount
Known amount
of single
payment in
future
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%
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
PV = ??
Year 2
FV = $2,000
PV = Future value × table factor
= $2,000 × (2 periods @ 10%)
Present Value of $1
(n)
1
2
3
4
5
6
7
8
2%
0.980
0.961
0.942
0.924
0.906
0.888
0.871
0.853
4%
0.962
0.925
0.889
0.855
0.822
0.790
0.760
0.731
6%
0.943
0.890
0.840
0.792
0.747
0.705
0.665
0.627
8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
10%
0.909
0.826
0.751
0.683
0.621
0.564
0.513
0.467
12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
15%
0.870
0.756
0.658
0.572
0.497
0.432
0.376
0.327
Present Value of a Single
Amount Example – Using Tables
Year 1
PV = $1,652
Year 2
FV = $2,000
PV = Future value × table factor
= $2,000 × (2 periods @ 10%)
= $2,000 × 0.826
= $1,652
Future Value of an Annuity
Periods
1
$0
2
$3,000
3
$3,000
4
$3,000
$3,000
+ Interest
Future
Value = ?
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?
Year 1
Year 2
Year 3
Year 4
$0
$3,000
$3,000
$3,000
$3,000
FV = ??
Future Value of an Annuity
Example:
Year 1
Year 2
$0
$3,000
Year 3
$3,000
Year 4
$3,000
$3,000
FV = ??
FV = Payment × table factor
= $3,000 × (4 periods @ 10%)
Future Value of Annuity of $1
(n)
1
2
3
4
5
6
7
8
2%
1.000
2.020
3.060
4.122
5.204
6.308
7.434
8.583
4%
1.000
2.040
3.122
4.246
5.416
6.633
7.898
9.214
6%
1.000
2.060
3.184
4.375
5.637
6.975
8.394
9.897
8%
1.000
2.080
3.246
4.506
5.867
7.336
8.923
10.637
10%
1.000
2.100
3.310
4.641
6.105
7.716
9.487
11.436
12%
1.000
2.120
3.374
4.779
6.353
8.115
10.089
12.300
15%
1.000
2.150
3.473
4.993
6.742
8.754
11.067
13.727
Future Value of an Annuity
Example:
Year 1
Year 2
$0
$3,000
Year 3
$3,000
Year 4
$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
$0
2
$4,000
3
$4,000
Discount
Present
Value = ?
4
$4,000
$4,000
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
$0
Year 2
$4,000
PV = ??
Year 3
$4,000
Year 4
$4,000
$4,000
Present Value of an Annuity
Example:
Year 1
$0
Year 2
$4,000
Year 3
$4,000
Year 4
$4,000
PV = ??
PV = Payment × table factor
= $4,000 × (4 periods @ 10%)
$4,000
Present Value of Annuity of $1
(n)
1
2
3
4
5
6
7
8
2%
0.980
1.942
2.884
3.808
4.713
5.601
6.472
7.325
4%
0.962
1.886
2.775
3.630
4.452
5.242
6.002
6.733
6%
0.943
1.833
2.673
3.465
4.212
4.917
5.582
6.210
8%
0.926
1.783
2.577
3.312
3.993
4.623
5.206
5.747
10%
0.909
1.736
2.487
3.170
3.791
4.355
4.868
5.335
12%
0.893
1.690
2.402
3.037
3.605
4.111
4.564
4.968
15%
0.870
1.626
2.283
2.855
3.352
3.784
4.160
4.487
Present Value of an Annuity
Example:
Year 1
$0
Year 2
$4,000
Year 3
$4,000
Year 4
$4,000
PV = $12,680
PV = Payment × table factor
= $4,000 × (4 periods @ 10%)
= $4,000 × 3.170
= $12,680
$4,000
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
$0
Year 2
$4,000
Year 3
$4,000
Year 4
$4,000
Year 5
$4,000
$4,000
Discount
PV = $14,420
LO7
Solving for Unknowns Example
Year 1
$0
Year 2
$4,000
Year 3
Year 4
$4,000 $4,000
$4,000
Year 5
$4,000
PV = $14,420
PV = Payment × table factor
Rearrange equation to solve for unknown
Table factor = PV/payment
Solving for Unknowns Example
Year 1
$0
Year 2
$4,000
Year 3
$4,000
Year 4
$4,000
Year 5
$4,000
PV = $14,420
Table factor = PV/payment
= $14,420/$4,000
= 3.605
$4,000
Present Value of Annuity of $1
(n)
1
2
3
4
5
6
7
8
2%
0.980
1.942
2.884
3.808
4.713
5.601
6.472
7.325
4%
0.962
1.886
2.775
3.630
4.452
5.242
6.002
6.733
6%
0.943
1.833
2.673
3.465
4.212
4.917
5.582
6.210
8%
0.926
1.783
2.577
3.312
3.993
4.623
5.206
5.747
10%
0.909
1.736
2.487
3.170
3.791
4.355
4.868
5.335
12%
0.893
1.690
2.402
3.037
3.605
4.111
4.564
4.968
15%
0.870
1.626
2.283
2.855
3.352
3.784
4.160
4.487
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
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