Financial accounting the impact on decision makers 9e chapter 9

Example 9.2—Discounting a Note continued  The original balance in the Discount on Notes Payable account represents interest that must be transferred to interest expense over the life of

Chapter 9

Current Liabilities, Contingencies,

and the Time Value of Money

Current Liabilities

 Obligation that will be satisfied within one year or within current operating cycle

 Normally recorded at face value and are important

because they are indications of a company’s liquidity

Accounts Payable

 Amounts owed for inventory, goods, or services acquired in the normal course of business

 Usually do not require the payment of interest, but terms may be

given to encourage early payment

 Example: 2/10, n/30

 A 2% discount is available if payment occurs within the first ten days

 If payment is not made within ten days, the full

amount must be paid within 30 days

Notes Payable

 Amounts owed that are represented by a formal contract

 Formal agreement is signed by the parties to the

Example 9.1—Recording the Interest on

Example 9.1—Recording the Interest on

Notes Payable (continued)

 The company could identify and analyze the effect of the repayment as follows:

Example 9.2—Discounting a Note

 Suppose that on January 1, 2014, First National Bank granted to Hot Coffee a $1,000 loan, due on December 31, 2014, but deducted the interest in advance and gave Hot Coffee the remaining amount of $880 ($1,000 face amount of the note less interest of $120)

Example 9.2—Discounting a Note

(continued)

 The Discount on Notes Payable account should be treated as a

reduction of Notes Payable If a balance sheet was developed

immediately after the January 1 loan, the note would appear in the Current Liability category as follows:

Example 9.2—Discounting a Note

(continued)

 The original balance in the Discount on Notes Payable account

represents interest that must be transferred to interest expense over the life of the note Refer to Example 9-2 Before Hot Coffee presents its year-end financial statements, it must make an adjustment to

transfer the discount to interest expense

Example 9.2—Discounting a Note

(continued)

 Thus, the balance of the Discount on Notes Payable account is zero and $120 has been transferred to interest expense When the note is repaid on December 31, 2014, Hot Coffee must repay the full amount

of the note

Recording Current Maturities of

Long-Term Debt

 The portion of a long-term liability that will be paid within one year

Example 9.3—Recording Current Maturities of Long-Term Debt

 Assume that on January 1, 2014, your firm obtained a $10,000 loan from the bank The terms of the loan require you to make payments in the amount of $1,000 per year for ten years

payable each January 1 beginning January 1, 2015 On

December 31, 2014, an entry should be made to classify a

portion of the balance as a current liability

Recording Current Maturities of

Long-Term Debt

 Refer to the information in Example 9-3 On January 1, 2015, the company must pay $1,000

Current Liabilities—Other Accrued

Liabilities

 Include any amount that has been incurred but has not yet been paid

Example 9.4—Recording Accrued

Liabilities

 Suppose that your firm has a payroll of $1,000 per day Monday through Friday and that employees are paid at the close of work each Friday Also, suppose that December 31 is the end of your accounting year and that it falls on a Tuesday

Recording Accrued Liabilities

 Assume that you received a one-year loan of $10,000 on

December 1 The loan carries a 12% interest rate On December

31, an accounting entry must be made to record interest even though the money may not actually be due.

IFRS and Current Liabilities

 International accounting standards require companies to present classified balance sheets with liabilities classified as either current or long term

 U.S standards do not require a classified balance sheet

Exhibit 9.2—Current Liabilities on the

Statement of Cash Flows

LO 3

Exhibit 9.3—Starbucks Corporation Partial Consolidated

Statement of Cash Flows (In millions)

Contingent Liabilities

 Existing condition for which the outcome is not

known but depends on some future event

 Recorded if the liability is probable and the amount can be reasonably estimated

 Accrued and reflected on the balance sheet if it is

probable and if the amount can be reasonably

estimated

 Examples:

 Premiums or coupons

 Lawsuits and legal claims

 Warranties and guarantees

LO 4

Example 9.5—Recording a Liability for

Warranties

 Assume that Quickkey Computer sells a computer product for

$5,000 with a one-year warranty in case the product must be repaired Assume that in 2014, Quickkey sold 100 computers for

a total sales revenue of $500,000 Using an analysis of past

warranty records, Quickkey estimates that repairs will average 2% of total sales

Exhibit 9.4—Note Disclosure of Contingencies for Burger King Corporation

Contingent Liabilities versus

Contingent Assets

IFRS and Contingencies

likely than not’’ to occur

– Require the amount

– Has a higher threshold than this

– Do not have a similar requirement

Time Value of Money:

Compounding of Interest

 An immediate amount should be preferred over an amount in the

future because of the interest factor

 The amount can be invested, and the resulting accumulation will be

larger than the amount received in the future

LO 5

Exhibit 9.5—Importance of the Time

Value of Money

Simple Interest

 Calculated on the principal amount only

Compound Interest

 Calculated on the principal plus previous amounts of interest

 Assume a $3,000 note payable for which interest and principal are due

in two years with interest compounded annually at 10% per year

Interest Compounding

 Future value of a single amount

 Present value of a single amount

 Future value of an annuity

 Present value of an annuity

LO 6

Future Value of a Single Amount

 Amount accumulated at a future time from a single payment or investment

 The future amount is always larger than the principal amount

(payment) because of the interest that accumulates

Future Value of a Single Amount

(continued)

Present Value of a Single Amount

 The amount at a present time that is equivalent to a payment or an investment at a future time

Future Value of an Annuity

 The amount accumulated in the future when a series of payments is invested and accrues interest

 Annuity: series of payments of equal amounts

Using Future Value of Annuity of $1 Table

Future Value of an Annuity

(continued)

Using future value of $1 table:

Present Value of an Annuity

 The amount at a present time that is equivalent to a series of payments and interest in the future

Using Present Value of Annuity of $1 Table

Present Value of an Annuity

(continued)

Using present value of $1 table:

Example 9.13—Solving for an Interest

Rate

 Assume that you have just purchased an automobile for $14,419 and must decide how to pay for it Your local bank has graciously granted you a five-year loan Because you are a good credit risk, the bank will allow you to make annual payments on the loan at the end of each

year The amount of the loan payments, which include principal and

interest, is $4,000 per year You are concerned that your total

payments will be $20,000 ($4,000 per year for five years) and want to calculate the interest rate that is being charged on the loan

 Because the market or present value of the car, as well as the loan, is

$14,419, a time diagram of the example would appear as follows:

LO 7

Example 9.13—Solving for an Interest

Rate (Continued)

 The interest rate we must solve for represents the discount rate that was applied to the $4,000 payments to result in a present value of

$14,419 Therefore, the applicable formula is the following:

 In this case, PV is known, so the formula can be rearranged as follows:

Table 9.4— Present Value of Annuity of

$1

Example 9.14—Solving for the Number

of Years

 Assume that you want to accumulate $12,000 as a down payment on a home You believe that you can save $1,000 per semiannual period, and your bank will pay interest of 8% per year, or 4% per semiannual period How long will it take you to accumulate the desired amount?

 The future value is known to be $12,000, and we must solve for the interest factor or table factor Therefore, we can rearrange the formula

as follows:

Table 9.3—Future Value of Annuity of

$1

End of Chapter 9