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Ch.9 Current Liabilities and Time Value of Money

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Part I: Current Liabilities Current liabilities: –Require payment within one year (or one operating cycle whichever is longer)

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Liabilities and shareholders' equity Current liabilities: Notes payable$ 21.1 Current maturities of long-term debt 3.9 Trade accounts payable123.7 Income taxes payable18.3 Accrued expenses and other current liabilities 134.4 Total current liabilities $301.4 Jacuzzi Brands Partial Balance Sheet – 2004 (in millions) Requires payment within one year

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Selected 2004 Liquidity Ratios Current Ratio Jacuzzi Brands 1.79 Sara Lee 1.06 Tommy Hilfiger 3.87 Boeing 0.72 Nike 2.50 123 45678910 11121314151617 18192021222324 25262829303127 LO1

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1. Accounts Payable Amounts owed for the purchase of inventory, goods, or services on credit

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2. Note Payable (Short term) S.J.Devona I promise to pay $1,000 plus 12% annual interest on December 31, 2007. Date: January 1, 2007 Signed:_________ Lamanski Co. Total repayment = $1,120 $1,000 + ($1,000 × 12%)

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Discounted Promissory Note Discounted Promissory Note In exchange for $880 received today, I promise to pay $1,000 on December 31, 2007. Date: January 1, 2007 Signed:_________ Lamanski Co. Effective interest rate on note = 13.6% ($120 interest/$880 proceeds)

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3. Current Maturities of Long-Term Debt Principal repayment on borrowings due within one year of balance sheet date Due in upcoming year 123 45678910 11121314151617 18192021222324 25262829303127 123 45678910 11121314151617 18192021222324 25262829303127 123 45678910 11121314151617 18192021222324 25262829303127

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4. Income Taxes Payable Record expense when incurred, not when paid Record 2007 tax expense Taxes Paid 12/31/073/15/08 LO2

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5. Contingent Liabilities Obligation involving existing condition Outcome not known with certainty Dependent upon some future event Actual amount is estimated LO4

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Accrue estimated amount if: Liability is probable Amount can be reasonably estimated Contingent Liabilities In year criteria are met: Expense(loss)XXX Liability XXX

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Warranties Premium or coupon offers Lawsuits Typical Contingent Liabilities

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Recording Contingent Liabilities Quickkey Computer sells a computer product for $5,000 with a one-year warranty. In 2007, 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. Example:

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Recording Contingent Liabilities Probable liability has been incurred? Amount reasonably estimable? Warranty Expense 10,000 Estimated Liability 10,000 YES Record in 2007:

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Disclosing Contingent Liabilities IF not probable but reasonably possible OR amount not estimable Disclose in financial statement notes

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Contingent Assets Contingent gains and assets are not recorded but may be disclosed in financial statement notes Conservatism principle applies

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Part II: Time Value of Money Prefer payment at the present time rather than in the future due to the interest factor Present and future value concepts allow people to compare the value of money at different point in time Applicable to both personal and business decisions

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If you invest $100 now at 10% annual return. How much money would you have in your account after 100 years?

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Simple v. compounding interest Simple interest: earn interest only on the principal Compounding interest: earn interest on both principal and the interest earned in previous periods

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Simple Interest I = P × R × T Principal Dollar amount of interest per year Time in years Interest rate as a percentage LO5

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Simple Interest principal amount = $ 100 annual interest rate = 10% term of note = 100 years P × R × T Interest = $100 ×.10 × 100 = $ 1,000 Total = $100 + $1,000 = $1,100

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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

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Interest Compounding principal amount = $ 100 annual interest rate = 10% term of note = 100 years Annual compounding of interest LO6

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Total amount after $100 years: 100(1+.1)(1+.1)(1+.1)(1+.1)(1+.1)…

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Compound Interest Computations Present value of an annuity Future value of an annuity Present value of a single amount Future value of a single amount

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1. Future Value of Single Amount Known amount of single payment or investment Future Value + Interest =

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Future Value of a Single Amount Example If you invest $10,000 today @ 10% compound interest, what will it be worth 3 years from now? invest $10,000 Future Value = ? + Interest @ 10% per year Year 1Year 2Year 3

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Future Value of a Single Amount Example – Using Formulas FV = p(1 + i) n = $10,000(1.10) 3 = $13,310

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FV = Present value × table factor = $10,000 × (3 periods @ 10%) Future Value of a Single Amount Example – Using Tables FV = ?? PV = $10,000 Year 1Year 2Year 3

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(n) 2% 4% 6% 8% 10% 12% 15% 11.020 1.0401.0601.0801.1001.1201.150 21.0401.082 1.124 1.1661.2101.2541.323 31.0611.1251.1911.2601.3311.4051.521 41.0821.1701.2621.3601.4641.5741.749 51.1041.2171.3381.4701.6111.7622.011 61.1261.2651.4191.5871.7721.9742.313 71.1491.3161.5041.7141.9492.2112.660 81.1721.3691.5941.8512.1442.4763.059 Future Value of $1

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FV = Present value × table factor = $10,000 × (3 periods @ 10%) = $10,000 × 1.331 = $13,310 Future Value of a Single Amount Example – Using Tables PV = $10,000 Yr. 1Yr. 2Yr. 3 FV = $13,310

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2. Present Value of Single Amount Discount Known amount of single payment in future Present Value

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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)? $10,000 Discount @ 10% Year 1Year 2Year 3 Present Value = ?

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Present Value of a Single Amount Example – Using Formulas PV = Future value × (1 + i) –n = $10,000 × (1.10) –3 = $7,513

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PV = Future value × table factor = $10,000 × (3 periods @ 10%) Present Value of a Single Amount Example – Using Tables FV = $10,000 PV = ?? Year 1Year 2Year 3

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(n) 2% 4% 6% 8% 10% 12% 15% 10.980 0.9620.9430.9260.9090.8930.870 20.9610.925 0.890 0.8570.8260.7970.756 30.9420.8890.8400.7940.7510.7120.658 40.9240.8550.7920.7350.6830.6360.572 50.9060.8220.7470.6810.6210.5670.497 60.8880.7900.7050.6300.5640.5070.432 70.8710.7600.6650.5830.5130.4520.376 80.8530.7310.6270.5400.4670.4040.327 Present Value of $1

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PV = Future value × table factor = $10,000 × (3 periods @ 10%) = $10,000 × 0.751 = $7,510 Present Value of a Single Amount Example – Using Tables PV = $7,510 Yr. 1Yr. 2Yr. 3 FV = $10,000

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Practice If Johnson Company promises to pay you $10,000,000 eight years from now, how much that promised payment worth now if the appropriate interest rate is 12%?

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Periods Future Value = ? + Interest 3. Future Value of an Annuity 1 2 3 4 $0 $3,000 $3,000$3,000 $3,000

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If we invest $3,000 each year for four years at 10% compound interest, what will it be worth 4 years from now? Future Value of an Annuity Example $0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = ??

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$0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = ?? Future Value of an Annuity Example FV = Payment × table factor = $3,000 × (4 periods @ 10%)

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(n) 2% 4% 6% 8% 10% 12% 15% 11.000 1.0001.0001.0001.0001.0001.000 22.0202.040 2.060 2.0802.1002.1202.150 33.0603.1223.1843.2463.3103.3743.473 44.1224.2464.3754.5064.6414.7794.993 55.2045.4165.6375.8676.1056.3536.742 66.3086.6336.9757.3367.7168.1158.754 77.4347.8988.3948.923 9.48710.08911.067 88.5839.2149.897 10.637 11.43612.30013.727 Future Value of Annuity of $1

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Future Value of an Annuity Example $0 $3,000 $3,000 $3,000 $3,000 Year 1 Year 2 Year 3 Year 4 FV = $13,923 PV = Payment × table factor = $3,000 × (4 periods @ 10%) = $3,000 × 4.641 = $13,923

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4. Present Value of an Annuity 1 2 3 4 $0 $500 $500 $500 $500 Periods Discount Present Value = ?

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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? Present Value of an Annuity Example $0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = ??

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$0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = ?? Present Value of an Annuity Example PV = Payment × table factor = $4,000 × (4 periods @ 10%)

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(n) 2% 4% 6% 8% 10% 12% 15% 10.980 0.9620.9430.9260.9090.8930.870 21.9421.886 1.833 1.7831.7361.6901.626 32.8842.7752.6732.5772.4872.4022.283 43.8083.6303.4653.3123.1703.0372.855 54.7134.4524.2123.9933.7913.6053.352 65.6015.2424.9174.6234.3554.1113.784 76.4726.0025.5825.2064.8684.5644.160 87.3256.7336.2105.7475.3354.9684.487 Present Value of Annuity of $1

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Present Value of an Annuity Example $0 $4,000 $4,000 $4,000 $4,000 Year 1 Year 2 Year 3 Year 4 PV = $12,680 PV = Payment × table factor = $4,000 × (4 periods @ 10%) = $4,000 × 3.170 = $12,680

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Practice If Johnson Company promises to pay you $1,000,000 each and every year for eight years, how much that promised payments worth now if the appropriate interest rate is 12%?

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Practice If Johnson Company promises to pay you $10,000,000 eight years from now and $1,000,000 each year for eight years, how much would you be willing to pay for those promises if the appropriate interest rate is 12%?

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Appendix A (FYI only) Appendix A (FYI only) Accounting Tools: Payroll Accounting

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Calculation of Gross Wages Hourly Multiply the number of hours worked times employee’s hourly rate Salaried Paid at a flat rate per week, month, or year, regardless of hours LO8

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Calculation of Net Pay Calculation of Net Pay Gross wages Less:Income tax (federal, state, local) FICA—Employee’s share Voluntary deductions (includes health insurance, retirement contributions, savings plans, charitable contributions, union dues, etc.) = Net pay

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Payroll Accounting Example: Gross wages for Kori Company for July are $100,000. The following amounts have been withheld from employees’ paychecks: Income Tax$20,000 FICA 7,650 United Way Contributions 5,000 Union Dues 3,000

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Payroll Accounting Journal entry: July 31Salary Expense100,000 Income Tax Payable 20,000 FICA Payable 7,650 United Way Payable 5,000 Union Dues Payable 3,000 Salary Payable 64,350 To record July salary and deductions.

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Employer Payroll Taxes Not deducted from paycheck – employer pays taxes per employee, in addition to salary FICA—Employer’s share Unemployment tax Assuming Kori Company’s unemployment tax rate is 3%.

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Employer payroll taxes July 31Payroll Tax Expense 10,650 FICA Payable 7,650 Unemployment Tax Payable 3,000 To record employer’s payroll taxes.

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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Liabilities Chapter 9.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Liabilities Chapter 9.

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