7/e
9
Current Liabilities,
Contingencies, and the
Time Value of Money
PowerPoint Author: Catherine Lumbattis
COPYRIGHT © 2011 South-Western/Cengage Learning
Starbucks Corp.
Partial Balance Sheet
(in millions)
Liabilities and shareholders' equity
September 2008
Current liabilities:
Commercial paper and short term borrowings
$ 713.0
Accounts payable
324.9
Accrued compensation and related costs
253.6
Accrued occupancy costs
136.1
Accrued taxes
76.1
Insurance reserves
152.5
Other accrued expenses
164.4
Requires
Deferred revenue
368.4
Current portion of long term
debt within
.7
payment
Total current liabilities
$2,189.7
one year
Selected 2008 Liquidity Ratios
Starbucks
Caribou Coffee
Green Mountain
Industry
Current
Ratio
Quick
Ratio
Food
Food
Food
.80
.88
2.09
.30
.56
.76
LO1
Accounts Payable
 Amounts owed for the purchase of
inventory, goods, or services on credit
 Discount payment terms offered to
encourage early payment
Promissory Note
I promise to pay $1,000 plus 12% annual
interest on December 31, 2011.
Date: January 1, 2011
Coffee Inc.
Signed: Hot
_________
S.J.Devona
Total repayment = $1,120
$1,000 + ($1,000 × 12%)
Discounted Promissory Note
In exchange for $880 received today, I promise
to pay $1,000 on December 31, 2011.
Date: January 1, 2011
Coffee, Inc.
Signed: Hot
_________
Effective interest rate on note = 13.6%
($120 interest/$880 proceeds)
Balance Sheet Presentation of
Discounted Notes
Discount transferred
to interest expense
over life of note
1/1/11
Notes Payable
$1,000
Less: Discount on Notes Payable
120
Net Liability
$ 880
12/31/11
$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
12/31/10
Record
2007 tax
expense
3/15/11
Taxes
Paid
LO2
Other Accrued Liabilities
Includes any amount that has been incurred dueto
the passage of time but has not been paid as of
the balance sheet date
Examples:
 Salaries and Wages
 Interest
Adjusting Entry:
Expense
Payable
XXX
XXX
IFRS and Current Liabilities
The U.S. and international standards are generally
similar but there are important differences.
Differences:
 International accounting standards require companies
to present classified balance sheets with liabilities as
either current or long term.
 An unclassified balance sheet based on the order of
liquidity is acceptable only when it provides more
reliable information.
 U.S. standards do not require a classified balance
sheets. U.S. standards permit companies to list
liabilities in order by size or by order of liquidity.
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
 Accrue estimated amount if:
• Liability is probable
• Amount can be reasonably estimated
In year criteria are met:
Expense (loss)
XXX
Liability
XXX
Typical Contingent Liabilities
 Product warranties and guarantees

Premium or coupon offers

Lawsuits
Recording Contingent
Liabilities
Example:
Quickkey Computer sells a computer product for
$5,000 with a one-year warranty. In 2010, 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 2010:
Warranty Expense
Estimated Liability
(2% X $500,000 sales)
10,000
10,000
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
IFRS and Contingencies
 International standards use the term “provision” for
those items that must be reported on the balance sheet
 International standards have a lower threshold for those
items that must be reported so thus more items will be
recorded on the balance sheet.
 International standards require the amount of the
recorded liability be discounted (recorded at present
value).
 The term “contingent liability” is only used for those
items that are footnoted but not for those liabilities
reported on the balance sheet.
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
+ Interest =
Future Value
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
Year 1
Future Value = ?
Year 2
+ Interest @ 10% per year
Future Value of a Single
Amount:
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:
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
Known amount
of single
payment in
future
Present Value
Discount
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: Using Formulas
PV = Future value × (1 + i)–n
= $2,000 × (1.10)–2
= $1,652
Present Value of a Single
Amount: Using Tables
PV = ??
Year 1
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
PV = $1,652
Year 1
Year 2
PV = Future value × table factor
= $2,000 × (2 periods @ 10%)
= $2,000 × 0.826
= $1,652
FV = $2,000
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
$0
Year 2
$3,000
Year 3
$3,000
$3,000
Year 4
$3,000
FV = ??
Future Value of an Annuity
Example:
Year 1
$0
Year 2
$3,000
$3,000
Year 3
$3,000
Year 4
$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%
12%
15%
1.000 1.000 1.000
2.100 2.120 2.150
3.310 3.374 3.473
4.641 4.779 4.993
6.105 6.353 6.742
7.716 8.115 8.754
9.487 10.089 11.067
11.436 12.300 13.727
Future Value of an Annuity
Example:
Year 1
$0
Year 2
$3,000
Year 3
$3,000
Year 4
$3,000
PV = Payment × table factor
= $3,000 × (4 periods @ 10%)
= $3,000 × 4.641
= $13,923
$3,000
FV = $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
PV = ??
Year 2
$4,000
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
PV = $12,680
PV = Payment × table factor
= $4,000 × (4 periods @ 10%)
= $4,000 × 3.170
= $12,680
Year 4
$4,000
$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 Year 2
Year 3
Year 4
Year 5
$0
$4,000
$4,000
$4,000
$4,000
$4,000
Discount
PV = $14,420
LO7
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
PV = Payment × table factor
Rearrange equation to solve for unknown
Table factor = PV/payment
$4,000
Solving for Unknowns Example
Year 1
$0
Year 2 Year 3
$4,000
$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%
10%
0.926 0.909
1.783 1.736
2.577 2.487
3.312 3.170
3.993 3.791
4.623 4.355
5.206 4.868
5.747 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