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Current Liabilities and the Time Value of Money

Current Liabilities and the Time Value of Money. Chapter 9. Current Liabilities. Current liability is debt with two key features: Company expects to pay the debt from existing current assets or through the creation of other current liabilities .

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Current Liabilities and the Time Value of Money

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  1. Current Liabilities and the Time Value of Money Chapter 9

  2. Current Liabilities • Current liability is debt with two key features: • Company expects to pay the debt from existing current assets or through the creation of other current liabilities. • Company will pay the debt within one year or the operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. SO 1 Explain a current liability and identify the major types of current liabilities.

  3. Current Liabilities Question To be classified as a current liability, a debt must be expected to be paid: • out of existing current assets. • by creating other current liabilities. • within 2 years. • both (a) and (b). SO 1 Explain a current liability, and identify the major types of current liabilities.

  4. Current Liabilities Notes Payable • Written promissory note. • Require the borrower to pay interest. • Those due within one year of the balance sheet date are usually classified as current liabilities. SO 2 Describe the accounting for notes payable.

  5. Current Liabilities Illustration: First National Bank agrees to lend $100,000 on September 1, 2010, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. When a company issues an interest-bearing note, the amount of assets it receives generally equals the note’s face value. Sept. 1 SO 2 Describe the accounting for notes payable.

  6. Current Liabilities Illustration: If Cole Williams Co. prepares financial statements annually, it makes an adjusting entry at December 31 to recognize interest. Dec. 31 * $100,000 x 12% x 4/12 = 4,000 SO 2 Describe the accounting for notes payable.

  7. Current Liabilities Illustration: At maturity (January 1), Cole Williams Co. must pay the face value of the note plus interest. It records payment as follows. Jan. 1 SO 2 Describe the accounting for notes payable.

  8. Current Liabilities Sales Tax Payable • Sales taxes are expressed as a stated percentage of the sales price. • Retailer collects tax from the customer. • Retailer remits the collections to the state’s department of revenue. SO 3 Explain the accounting for other current liabilities.

  9. Current Liabilities Illustration: March 25, cash register readings for Cooley Grocery show sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Mar. 25 SO 3 Explain the accounting for other current liabilities.

  10. Current Liabilities Sometimes companies do not ring up sales taxes separately on the cash register. Illustration: Cooley Grocery rings up total receipts of $10,600. Because the amount received from the sale is equal to the sales price 100% plus 6% of sales, (sales tax rate of 6%), the journal entry is: Mar. 25 SO 3 Explain the accounting for other current liabilities.

  11. Current Liabilities Unearned Revenue • Revenues that are received before the company delivers goods or provides services. • Company debits Cash, and credits a current liability account (unearned revenue). • When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account. SO 3 Explain the accounting for other current liabilities.

  12. Current Liabilities Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The entry for the sales of season tickets is: Aug. 6 Superior records the earning of revenue with the following entry. Sept. 7 SO 3 Explain the accounting for other current liabilities.

  13. Current Liabilities Current Portion of Long-Term Debt • Portion of long-term debt that comes due in the current year. • No adjusting entry required. • Illustration: Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, 2009. This note specifies that each January 1, starting January 1, 2010, Wendy should pay $5,000 of the note. When the company prepares financial statements on December 31, 2009, • What amount should be reported as a current liability? _________ • What amount should be reported as a long-term liability? _______ SO 3 Explain the accounting for other current liabilities.

  14. Current Liabilities Payroll and Payroll Taxes Payable The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. SO 3 Explain the accounting for other current liabilities.

  15. Current Liabilities Illustration: Assume Cargo Corporation records its payroll for the week of March 7 as follows: Mar. 7 Salaries and wages expense 100,000 FICA tax payable 7,650 Federal tax payable 21,864 State tax payable 2,922 Salaries and wages payable 67,564 Record the payment of this payroll on March 7. Mar. 7 Salaries and wages payable 67,564 Cash 67,564 SO 3 Explain the accounting for other current liabilities.

  16. Current Liabilities Payroll tax expense results from three taxes that governmental agencies levy on employers. • These taxes are: • FICA tax • Federal unemployment tax • State unemployment tax SO 3 Explain the accounting for other current liabilities.

  17. Current Liabilities Illustration: Based on Cargo Corp.’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows. Payroll tax expense 13,850 FICA tax payable 7,650 State unemployment tax payable 800 Federal unemployment tax payable 5,400 SO 3 Explain the accounting for other current liabilities.

  18. Current Liabilities Question Employer payroll taxes do not include: • Federal unemployment taxes. • State unemployment taxes. • Federal income taxes. • FICA taxes. SO 3 Explain the accounting for other current liabilities.

  19. Basic Time Value Concepts Time Value of Money Would you rather receive $1,000 today or a year from now? Today! Because of the interest factor.

  20. Nature of Interest • Payment for the use of money. • Excess cash received or repaid over the amount borrowed (principal). • Variables involved in financing transaction: • Principal (p)- Amount borrowed or invested. • Interest Rate (i) – An annual percentage. • Time (n) - The number of years or portion of a year that the principal is borrowed or invested. SO 1 Distinguish between simple and compound interest.

  21. Nature of Interest Simple Interest • Interest computed on the principal only. Illustration: On January 2, 2010, assume you borrow $5,000 for 2 years at a simple interest of 12% annually. Calculate the annual interest cost. Illustration C-1 Interest = p x i x n FULL YEAR = $5,000 x .12 x 2 = $1,200 SO 1 Distinguish between simple and compound interest.

  22. Nature of Interest Compound Interest • Computes interest on • the principal and • any interest earned that has not been paid or withdrawn. • Most business situations use compound interest. SO 1 Distinguish between simple and compound interest.

  23. Nature of Interest - Compound Interest Illustration: Assume that you deposit $1,000 in Bank Two, where it will earn simple interest of 9% per year, and you deposit another $1,000 in Citizens Bank, where it will earn compound interest of 9% per year compounded annually. Also assume that in both cases you will not withdraw any interest until three years from the date of deposit. Illustration C-2 Simple versus compound interest Year 1 $1,000.00 x 9% $ 90.00 $ 1,090.00 Year 2 $1,090.00 x 9% $ 98.10 $ 1,188.10 Year 3 $1,188.10 x 9% $106.93 $ 1,295.03 SO 1 Distinguish between simple and compound interest.

  24. Future Value of a Single Amount Illustration: If you want a 9% rate of return, you would compute the future value of a $1,000 investment for three years as follows: Illustration C-4 What table do we use? SO 2 Solve for a future value of a single amount.

  25. Future Value of a Single Amount What factor do we use? Present Value Factor Future Value SO 2 Solve for a future value of a single amount.

  26. Future Value of a Single Amount Illustration: What table do we use? SO 2 Solve for a future value of a single amount.

  27. Future Value of a Single Amount Present Value Factor Future Value SO 2 Solve for a future value of a single amount.

  28. Future Value of an Annuity • Future value of an annuity is the sum of all the payments (receipts) plus the accumulated compound interest on them. • Necessary to know • the interest rate, • the number of compounding periods, and • the amount of the periodic payments or receipts. SO 3 Solve for a future value of an annuity.

  29. Future Value of an Annuity Illustration: Assume that you invest $2,000 at the end of each year for three years at 5% interest compounded annually. Illustration C-6 SO 3 Solve for a future value of an annuity.

  30. Future Value of an Annuity Illustration: Invest = $2,000 i = 5% n = 3 years Illustration C-7 Solution on notes page SO 3 Solve for a future value of an annuity.

  31. Future Value of an Annuity When the periodic payments (receipts) are the same in each period, the future value can be computed by using a future value of an annuity of 1 table. Illustration: Illustration C-8 SO 3 Solve for a future value of an annuity.

  32. Future Value of an Annuity What factor do we use? Payment Factor Future Value SO 3 Solve for a future value of an annuity.

  33. Present Value Concepts • The present valueis the value now of a given amount to be paid or received in the future, assuming compound interest. • Present value variables: • Dollar amount to be received in the future, • Length of time until amount is received, and • Interest rate (the discount rate). SO 4 Identify the variables fundamental to solving present value problems.

  34. Present Value of a Single Amount Illustration C-10 Illustration: If you want a 10% rate of return, you can also compute the present value of $1,000 for one year by using a present value table. What table do we use? SO 5 Solve for present value of a single amount.

  35. Present Value of a Single Amount What factor do we use? Future Value Factor Present Value SO 5 Solve for present value of a single amount.

  36. Present Value of a Single Amount Illustration C-11 Illustration: If you receive the single amount of $1,000 in two years, discounted at 10%, the present value of your $1,000 is $826.45. What table do we use? SO 5 Solve for present value of a single amount.

  37. Present Value of a Single Amount What factor do we use? Future Value Factor Present Value SO 5 Solve for present value of a single amount.

  38. Present Value of a Single Amount Illustration: Suppose you have a winning lottery ticket and the state gives you the option of taking $10,000 three years from now or taking the present value of $10,000 now. The state uses an 8% rate in discounting. How much will you receive if you accept your winnings now? Future Value Factor Present Value SO 5 Solve for present value of a single amount.

  39. Present Value of a Single Amount Illustration: Determine the amount you must deposit now in a bond investment, paying 9% interest, in order to accumulate $5,000 for a down payment 4 years from now on a new Toyota Prius. Future Value Factor Present Value SO 5 Solve for present value of a single amount.

  40. Present Value of an Annuity • The value now of a series of future receipts or payments, discounted assuming compound interest. • Necessary to know • the discount rate, • The number of discount periods, and • the amount of the periodic receipts or payments. SO 6 Solve for present value of an annuity.

  41. Present Value of an Annuity Illustration C-14 Illustration: Assume that you will receive $1,000 cash annually for three years at a time when the discount rate is 10%. What table do we use? SO 6 Solve for present value of an annuity.

  42. Present Value of an Annuity What factor do we use? Future Value Factor Present Value SO 6 Solve for present value of an annuity.

  43. Present Value of an Annuity Illustration: Kildare Company has just signed a capitalizable lease contract for equipment that requires rental payments of $6,000 each, to be paid at the end of each of the next 5 years. The appropriate discount rate is 12%. What is the amount used to capitalize the leased equipment? SO 6 Solve for present value of an annuity.

  44. Time Periods and Discounting Illustration: Assume that the investor received $500 semiannually for three years instead of $1,000 annually when the discount rate was 10%. Calculate the present value of this annuity. SO 6 Solve for present value of an annuity.

  45. Present Value of a Long-term Note or Bond • Two Cash Flows: • Periodic interest payments (annuity). • Principal paid at maturity (single-sum). 100,000 $5,000 5,000 5,000 5,000 5,000 5,000 . . . . . 0 1 2 3 4 9 10 SO 7 Compute the present value of notes and bonds.

  46. Present Value of a Long-term Note or Bond Illustration: Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Calculate the present value of the principal and interest payments. 100,000 $5,000 5,000 5,000 5,000 5,000 5,000 . . . . . 0 1 2 3 4 9 10 SO 7 Compute the present value of notes and bonds.

  47. Present Value of a Long-term Note or Bond PV of Principal Factor Present Value Principal SO 7 Compute the present value of notes and bonds.

  48. Present Value of a Long-term Note or Bond PV of Interest Factor Present Value Principal SO 7 Compute the present value of notes and bonds.

  49. Present Value of a Long-term Note or Bond Illustration: Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Present value of Principal $61,391 Present value of Interest 38,609 Bond current market value $100,000 SO 7 Compute the present value of notes and bonds.

  50. Present Value of a Long-term Note or Bond Illustration: Now assume that the investor’s required rate of return is 12%, not 10%. The future amounts are again $100,000 and $5,000, respectively, but now a discount rate of 6% (12% / 2) must be used. Calculate the present value of the principal and interest payments. Illustration C-20 SO 7 Compute the present value of notes and bonds.

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