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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