Current Liabilities, Contingencies, and the Time Value of Money

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Chapter 9
Current Liabilities, Contingencies, and the Time
Value of Money
Financial Accounting 4e by Porter and Norton
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Accounts Payable

• Purchase of inventory, goods or services on credit

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Promissory Note
I promise to pay 1,000 plus 12 annual interest
on December 31, 2004. Date January 1,
2004 Signed_________
Lamanski Co.
S.J.Devona
Total repayment 1,120 1,000 (1,000 x 12)
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Current Maturities of Long-Term Debt

• Principal repayment on borrowings due within one
  year of balance sheet date

Due in upcoming year
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Taxes Payable

• Record expense when incurred not when paid

12/31/04
3/15/05
Record 2004 tax expense
Taxes Paid
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Contingent Liability

• Obligation involving existing condition
• Outcome not known with certainty
• Dependent upon some future event
• Actual amount is estimated

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Contingent Liability

• Accrue estimated amount if
• liability is probable
• amount can be reasonably estimated

In year criteria are met Expense
(loss) XXX Liability XXX
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Typical Contingent Liabilities

• Warranties
• Premium or coupon offers
• Lawsuits

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Recording Contingent Liabilities
Example

• Quickkey Computer sells a computer product for
  5,000 with a one-year warranty. In 2004, 100 of
  these products were sold for a total sales
  revenue of 500,000.
• Analyzing past records, Quickkey estimates that
  repairs will average 2 of total sales.

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Recording Contingent Liabilities
Probable liability has been incurred? Amount
reasonably estimable?
YES
YES
Record in 2004
Warranty Expense 10,000 Estimated
Liability 10,000
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Disclosing Contingent Liabilities
IF not probable but reasonably
possible OR amount not estimable
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Contingent Assets

• Contingent gains and assets are not recorded but
  may be disclosed in footnotes

• Conservatism principle applies

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Time Value of Money

• Prefer payment now vs. in future due to interest
  factor

• Applicable to both personal and business decisions

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Simple Interest
I P x R x T
Dollar amount of interest per year
Time in years
Principal amount
Interest rate as a percentage
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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.
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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. P x R
x T 3,000 x .10 x 2 600
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Compound Interest

• Interest is calculated on principal plus
  previously accumulated interest

Compounding can occur annually, semi-annually,
quarterly, etc.
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Example of Compound Interest
Given following data principal amount
3,000 annual interest rate
10 term of note 2
years semiannual compounding of interest
Calculate interest on note.
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Compound Interest Periods
Year 1 Year 2 10 annually 10
annually
5 5 semiannually
5 5 semiannually
4 periods _at_ 5 semi-annual interest
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Example of Compound Interest
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Comparing Interest Methods
Simple annual interest 3,000 x .10 x
2 600 Semiannual compounding 1
150 2 158 3 165
4 174 Total 647
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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
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Future Value of Single Amount
Known amount of single payment or deposit
Future Value
Interest
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Future Value of a Single Amount Example

• If you invest 10,000 today _at_ 10 compound
  interest, what will it be worth 3 years from now?

invest 10,000
Future Value?
Yr. 1
Yr. 2
Yr. 3
Interest _at_ 10 per year
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Future Value of a Single Amount Example - Using
Table 9-1
Yr. 1
Yr. 2
Yr. 3
10,000 PV
FV 13,310

• FV Present Value x FV Factor
• 10,000 X (3 periods _at_ 10)
• 10,000 X 1.331
• 13,310

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Present Value of Single Amount
Known amount of single payment in future
Present Value
Discount
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Present Value of a Single Amount Example

• If you will receive 10,000 in three years, what
  is it worth today (assuming you could invest at
  10 compound interest)?

Present Value?
10,000
Yr. 1
Yr. 2
Yr. 3
Discount _at_ 10
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Present Value of a Single Amount Example - Using
Table 9-2
Yr. 1
Yr. 2
Yr. 3
PV 7,513
FV10,000

• PV Future Value x PV Factor
• 10,000 X (3 periods _at_ 10)
• 10,000 X .751
• 7,510

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Future Value of 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?

Yr. 1 Yr. 2 Yr. 3 Yr. 4
0 3,000 3,000 3,000
3,000
FV ??
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Future Value of Annuity (Table 9-3)
FV 13,923

• FV Payment x FV Factor
• 3,000 x (4 periods _at_ 10)
• 3,000 x 4.641
• 13,923

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Present Value of an Annuity
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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?

PV ??
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Present Value of an Annuity Example (Table 9-4)
Yr. 1 Yr. 2 Yr. 3 Yr. 4
0 4,000 4,000 4,000 4,000
P.V. 12,680

• PV Payment x PV Factor
• 4,000 x (4 periods _at_ 10)
• 4,000 x 3.170
• 12,680

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Solving for Unknowns

• 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?

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Solving for Unknowns
Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5
discount discount discount discount
discount PV 14,420

• PV Payment x PV factor
• PV factor PV / Payment

rearrange equation to solve for unknown
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Solving for Unknowns
Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5
discount discount discount discount
discount PV 14,420

• PV factor PV / Payment
• 14,420 / 4,000
• 3.605

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Present Value of an Annuity Table

• (n) 10 11 12 15
• 1 0.909 0.901 0.893 0.870
• 2 1.736 1.713 1.690 1.626
• 3 2.487 2.444 2.402 2.283
• 4 3.170 3.102 3.037 2.855
• 5 3.791 3.696 3.605 3.352

PV factor of 3.605 equates to an interest rate of
12.
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Appendix

• Accounting Tools
• Using Excel for Problems Involving Interest
  Calculations

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Using Excel Functions

• Many functions built into Excel, including PV and
  FV calculations
• Click on Paste or Insert button for list

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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
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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)
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End of Chapter 9