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Chapter9

VIEWS: 7 PAGES: 68

									          Chapter 9

                              FEDERAL RESERVE NOTE

                   THE UNITED STATES OF AMERICA
                   THE UNITED STATES OF AMERICA
               H OE       E A E DR
              T IS NT IS L GL T NE

             O L E T , UL N R AE
            F RAL DBS P BICADP IVT
                                                     L70744629F

    12                                               WASHINGT ON, D.C.   12
            A
                                                                              H 293

         L70744629F
    12                                               SR S
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                                                      95
                                                      18




                                     ONE DOLLAR
                                     ONE DOLLAR




Current Liabilities,
Contingent Liabilities & the
Time Value of Money
                                                                                      1
      Objectives & Key Concepts
 Review   Current Liabilities
 Introduce concept of Contingent
  Liabilities
 Compare Simple vs. Compound Interest
 Discuss Time Value of Money
   Future amount of a single payment
   Present value of a single payment

   Future amount of an annuity

   Present value of an annuity
                                        2
Balance Sheet Classifications: REVIEW
  Current Liabilities:

        DEFN: due within one year of
           the balance sheet date                                     1    2    3

                                                  4    5    6    7    8    9    10

                                                  11   12   13   14   15   16   17


                                                  18   19   20   21   22   23   24


                                                  25   26   27   28   29   30   31




  Long-term Liabilities:

                        1    2    3


    4    5    6    7    8    9    10




                                       DEFN: due beyond one year
    11   12   13   14   15   16   17


    18   19   20   21   22   23   24


    25   26   27   28   29   30   31




                                                                                     3
Current Liability Accounts: REVIEW

  Accounts Payable
  Notes Payable
  Current Portion of                 Listed in
     Long-Term Debt                   order of
  Taxes Payable                      liquidity
  Unearned Revenues
  Other Accrued Liabilities
      (Warranties, Legal claims, etc.)
                                                  4
Accounts Payable: REVIEW
 DEFN:   Purchase of
  inventory, goods or
  services on credit
 Cash Implications:
  Discount payment      2%/10,
  terms offered to      net 30
  encourage early
  payment
                                 5
Note Payable: REVIEW

I promise to pay $1,000 plus 12% annual
interest on December 31, 2002.

Date: January 1, 2002

       Tony Soprano
Signed:_________


       Total repayment = $1,120
        $1,000 + ($1,000 x 12%)
                                          6
Discounted Note Payable: REVIEW

In exchange for $880 received today, I
promise to pay $1,000 on December 31,
2002.
Date: January 1, 2002
        Vito Corleone
Signed:_________


   Effective interest rate on note = 13.6%
       ($120 interest / $880 proceeds)
                                             7
     Balance Sheet Presentation of
       Discounted Note Payable

                         1/1/02       12/31/02
Notes Payable            $ 1,000      $ 1,000
Less: Discount on
Notes Payable              120          - 0 -
                         $ 880        $ 1,000

 Discount transferred to Interest Expense
  over life of note  Liability and O/E
                                                 8
     Balance Sheet Presentation of
       Discounted Note Payable

                         1/1/02       12/31/02
Notes Payable            $ 1,000      $ 1,000
Less: Discount on
Notes Payable              120          - 0 -
                         $ 880        $ 1,000

 Discount transferred to Interest Expense
  over life of note  Liability and O/E
                                                 9
                                Current Maturities of
                                  Long-term Debt
DEFN: Principal repayment on portion
 of long-term borrowing (e.g., Bonds
 Payable) due within one year of
 balance sheet date
                                                                                           1    2    3
                                     1        2        3
                                                                       4    5    6    7    8    9    10
      4   5        6        7210 3   8    19
                           1    2   3                                  11   12   13   14   15   16   17
     11 412 513 614 715 816 9 17 10
        11 412 513 614 715 816 9 17 10
                                                                       18   19   20   21   22   23   24

     18 19 20 21 22 23 24
                                                                       25   26   27   28   29   30   31
           11 12 13 14 15 16 17
        18 19 20 21 22 23 24
     25 26 27 28 29 30 31
           18 19 20 21 22 23 24
        25 26 27 28 29 30 31
              25       26       27       28       29       30   31




  Current Liability                                                  Long-term Liability
     $500,000                                                           $15,000,000
                                                                                                          10
Income Taxes Payable: REVIEW
Record expense when incurred; not
 when paid
          12/31/01     4/15/02


           Record      Taxes
           2001 tax     Paid
           expense

 To follow the MATCHING PRINCIPLE….
                                      11
Contingent Liability

 DEFN: Future obligation
  involving existing
  condition
 Circumstances:
   Outcome not known with
    certainty
   Dependent upon some
    future event
Should this be in the F/S?
                             12
     Contingent Liability: CRITERIA
        Accrue estimated amount if:
            liability is probable, AND
            amount can be reasonably estimated

-----------Balance Sheet-------------   --Income Statement--
 Assets       = Liabilities + OE        + Rev.   - Expenses
                 Accrued                           Accrued
                 Liability                       Expense/Loss
                  $XXX                             ($XXX)

                                                          13
Typical Contingent Liabilities

   Warranties/Guarantees

   Premium or Coupon offers

   Lawsuits


                                 14
Recording Contingent Liabilities

Example:
Ford Motor Company’s total auto sales for
 January 2002 were $1,000,000,000. Based
 upon historical experience, estimated
 warranty work (parts and labor) over the
 36 months of the warrantee average 1% of
 sales value.

                Warranty

                                            15
Recording Contingent Liabilities

Probable liability has   YES
been incurred?                   Warrantee

Amount reasonably        YES
estimable?


Record   Loss & Liability in January

                                             16
    Recording Contingent Liabilities

-----------Balance Sheet-------------     --Income Statement--
  Assets       = Liabilities + OE         + Rev.     - Expenses
January 31, 2002    Accrued
                   Warranty                      Warranty
                    Liability                     Expense
                   $10,000,000                   ($10,000,000)

    At the end of January 2002, record the expected liability and
    recognize the warrantee expense, per the Matching concept

                                                                    17
 Recording actual Warrantee Work
     EXAMPLE: Illustrates reimbursement by Ford Motor
     Company to a local dealer for warranty work of $750
     performed by that dealer in March 2003 on behalf of Ford

-----------Balance Sheet-------------   --Income Statement--
  Assets      = Liabilities + OE        + Rev.     - Expenses
March 2003
     Cash     Accrued              NOTE: NO
    ($750)    Warrantee             expense is
                                   recorded in
              Liability            2003 when
               ($750)                work is
L: Warranty Liability                actually      A: Cash
             $10,000,000 1/31/02   performed.            $750
     $750
                                                                18
  Disclosing Contingent Liabilities
   when both criteria are not met

SITUATION:
 Event is not         TREATMENT:
probable but            Disclose in
 “reasonably             footnotes
  possible”
    - or -
amount is not
  estimable
                                      19
  Disclosing Contingent Liabilities
             Case Study

 SITUATION:              TREATMENT:
    Your lawyer             Disclose suit in
  determines that       footnotes only (nature
you’ll probably lose     and amount of suit).
   a lawsuit filed
  against you if it        If you record a
  goes to jury. He      contingent liability in
gives you a range of    the B/S, the litigant’s
dollar amounts the       attorney would use
 jury might award.       that as Exhibit A !
                                           16
                                              20
Contingent Assets
GAAP:
   Contingent  gains and assets are
   not recognized nor recorded.
  May be disclosed in footnotes to
   financial statements,
Conservatism principle applies –
 “Don’t count your chickens before they’re
 hatched!”
                                             21
 Time Value of Money

 CONCEPT:     Prefer payment now vs.
  sometime in the future – e.g., a dollar today
  is worth more than a dollar a year from now.
  Why?
 Approach: Incorporates interest factor
  (return on investment) to make a decision.
 Where used? Applicable to both personal
  and business decisions.

                                                  22
Simple Interest: A REVIEW

       I = PX R         X   T




                            23
  Example of Simple Interest

 Given following data:
     Principal amount        = $ 10,000
     Annual interest rate =       10%
     Term of Note Payable = 2 years
 Required:
 Calculate interest on the note.

     P   x R x T = Interest
$ 10,000 x .10 x 2 = $ 2,000              20
                                               24
25
26
27
28
29
30
31
 Comparing Interest Methods

Simple annual interest:
    $10,000 x .10 x 2 = $ 2,000
Semi-annual compounding:
     1                           $ 500
                  Compounding
     2 NOTE: is $155 more
           effect
                                     525
     3    earned if investing or     551
     4        more owed if           579
               borrowing!
   Total                         $ 2,155
                                           32
Compound Interest Applications:
  TIME VALUE OF MONEY
                      Present
Future value
                     value of a
 of a single
                       single
  amount
                      amount


   Future            Present
 value of an        value of an
  annuity            annuity
                                  33
      TIME VALUE OF MONEY
            Questions
 Future  Value of a Single Amount (FV)
   How much will I have in the future (FV) if

    I invest a single amount (P) today at a
    compound annual interest rate (i%) for a
    certain time period (n) ?
 Present Value of a Single Amount (PV)

 Future Value of an Annuity (FVA)

 Present Value of an Annuity (PVA)
                                           34
Future Value of Single Amount



Known amount of
single payment (P)
or deposit             Future Value (FV)



             + Interest (i%) =
                                     35
 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?


   $10,000                   Future Value?

             Yr. 1   Yr. 2   Yr. 3

             + Interest @ 10%
                                             36
Future Value of a Single Amount Example
         Using FV Formula

                           n
       FV =    p (1 + i)
                               3
          = $10,000 (1.10)
          = $13,310




                                     37
Future Value of a Single Amount Example
 Using Time Value of Money Tables

          Yr. 1    Yr. 2     Yr. 3


 $10,000 P.V.                        F.V.??


 F.V. =     Present Value x F.V. Factor
      = $ 10,000 X (3 periods @ 10%)
                                              38
          Future Value of a Single
               Amount Table
    (n)      2% 4% 6%                8%    10%
     1      1.020 1.040 1.060       1.080 1.10
     2      1.040 1.082 1.124       1.166 1.210
    3       1.061   1.125   1.191   1.260   1.331
    4       1.082   1.170   1.262   1.360   1.464
    5       1.104   1.217   1.338   1.470   1.611
    6       1.126   1.265   1.419   1.587   1.772
    7       1.149   1.316   1.504   1.714   1.949
    8       1.172   1.369   1.594   1.851   2.144
                        Why are all the values > 1.0 ?

Table 9-1                                                39
Future Value of a Single Amount Example
 Using Time Value of Money Tables

           Yr. 1    Yr. 2      Yr. 3


  $10,000 P.V.                     F.V. = ?
                                F.V. = $13,310

  F.V. =     Present Value x F.V. Factor
       = $ 10,000 X (3 periods @ 10%)
        = $ 10,000 X        1.331
           = $ 13,310
                                             40
      TIME VALUE OF MONEY
          Four Questions
 Future  Value of a Single Amount (FV)
 Present Value of a Single Amount (PV)

   How much (PV) must I invest today at a

    given compound annual interest rate (i%)
    for a specified time period (n) if I want to
    have a certain amount (P) in the future?
 Future Value of an Annuity (FVA)

 Present Value of an Annuity (PVA)
                                              41
Present Value of Single Amount


                      Known amount
                      of single
                      payment (FV)
Present Value (PV)    in the future



           - Discount (i%)            42
 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 @ 10%
                                              43
Present Value of a Single Amount Example
           Using Formulas


                             -n
       PV = payment x (1 + i)
                             -3
          = $10,000 x (1.10)
           = $7,513




                                      44
Present Value of a Single Amount Example
                    Using Tables

            Yr. 1      Yr. 2       Yr. 3


  P.V. ??                          F.V.=$10,000

   P.V. =      Future Value x P.V. Factor

       = $ 10,000 X (3 periods @ 10%)

                                              45
          Present Value of $1

 (n)    2%    4%    6%        8%      10%

 1     .9804 .9615 .9434    .9259    .9090
 2     .9612 .9246 .8900    .8573    .8265
 3     .9423 .8890 .8396    .7938    .7513
 4     .9238 .8548 .7921    .7350    .6830
 5     .9057 .8219 .7473    .6806    .6209
                 Why are all the values < 1.0 ?
Table 9-2        NOTE: These are the inverse of Table 9-1
                                                     46
Present Value of a Single Amount Example
                  Using Tables

          Yr. 1       Yr. 2      Yr. 3


  P.V. = $7,513
    P.V. = $?                    F.V.=$10,000

   P.V. =    Future Value x P.V. Factor

        = $ 10,000 X (3 periods @ 10%)
        = $ 10,000 X     .7513
        = $7,513                            47
      TIME VALUE OF MONEY
            Questions
 Future   Value of a Single Amount (FV)
 Present Value of a Single Amount (PV)

 Future Value of an Annuity (FVA)

   How much will I have in the future (FVA)

    if I invest a series of equal amounts (P)
    each year at a compound interest rate (i%)
    for a certain time (n) ?
 Present Value of an Annuity (PVA)
                                           48
 Future Value of an Annuity
NOTE: First investment
is at end of Year #1         Periods
      1                  2             3        4

$0          $2,000            $2,000       $2,000    $2,000
                             +Interest
                                                    Future
                                                    Value?

                                                         49
Future Value of Annuity Example
If we invest $2,000 each year for four years @
  10% compound interest, what will it be
  worth 4 years from now?


     Yr. 1     Yr. 2        Yr. 3    Yr. 4

$0       $2,000    $2,000       $2,000    $2,000
                                         F.V.(a)??

                                               50
 Future Value of Annuity Example
          Using Tables

     Yr. 1      Yr. 2        Yr. 3    Yr. 4

$0       $2,000     $2,000       $2,000    $2,000
                                          F.V.(a)??

 F.V. (a) = Payment x F.V. (a) Factor
             = $ 2,000 X (4 periods @ 10%)

                                                  51
  Future Value of an Annuity Table

(n) 2% 4% 6%            8%     10%       12%
 1 1.000 1.000 1.000   1.000   1.000   1.000
 2 2.020 2.040 2.060   2.080   2.100   2.120
 3 3.060 3.122 3.184   3.246   3.310   3.374
 4 4.122 4.246 4.375   4.506   4.641   4.779
 5 5.204 5.416 5.637   5.867   6.105   6.353

                 Note the pattern of the values
    Table 9-3
                                                  52
  Future Value of Annuity Example
           Using Tables

     Yr. 1    Yr. 2        Yr. 3    Yr. 4

$0       $2,000   $2,000       $2,000   $2,000
                                        F.V.(a)
                                         F.V.(a)
                                        = $9,282
                                          =?
F.V. (a) =   Payment x F.V. (a) Factor

        = $ 2,000 X (4 periods @ 10%)
        = $ 2,000 X 4.641
        = $ 9,282                              53
      TIME VALUE OF MONEY
            Questions
 Future   Value of a Single Amount (FV)
 Present Value of a Single Amount (PV)
 Future Value of an Annuity (FVA)
 Present Value of an Annuity (PVA)
   How much (PVA) must I invest today if I
    want to withdraw a series of equal amounts
    (P) each year for a specified time period (n)
    if I earn at a given compound annual
    interest rate (i%) on any balance ?
                                             54
 Present Value of an Annuity

                 Periods
      1          2                                                         3                                                                                       4

 $0       $500       $500                                                                                $500                                                          $500
                 Discount
Present                            H OE
                                                  FEDERAL RESERVE NOTE

                                       THE UNITED STATES OF AMERICA
                                       THE UNITED STATES OF AMERICA
                                  T IS NT IS L GL T NE
                                              E A E DR
                                                                FEDERAL RESERVE NOTE

                                                     THE UNITED STATES OF AMERICA


Value ?
                                 O L E T , UL N R AE
                                                     THE UNITED STATES OF AMERICA
                                F RAL DBS P BICADP IVT
                                                                         L70744629F
                                                                              FEDERAL RESERVE NOTE
                                                 H OE       E A E DR
                                                T IS NT IS L GL T NE
                      12                                                                          12
                                              O L E T , UL N R AE
                                             F RAL DBS P BICADP IVT
                                                                   THE UNITED STATES OFAMERICA
                                                                   THE UNITED STATES OFON, D.C.
                                                                                   WASHINGT
                                                                                            AMERICA
                                                                                          L70744629F
                                A                                                           FEDERAL RESERVE NOTE
                                                               H OE       E A E DR
                                                              T IS NT IS L GL T NE
                           12                                                                                   12
                                                            O L E T , UL N R AE
                                                           F RAL DBS P BICADP IVT
                                                                                 THE UNITED STATES OFAMERICA
                                                                                 THE UNITED STATES OFON, D.C. H 293
                                                                                                 WASHINGT
                                                                                                          AMERICA
                                                                                                        L70744629F
                                             A
                           L70744629F                                        H OE       E A E DR
                                                                            T IS NT IS L GL T NE
                                   12                                                                                  WASHINGT ON, D.C.12
                                                                          O L E T , UL N R AE
                                                                         F RAL DBS P BICADP IVT
                      12                                                                                 E IE
                                                                                                         SR S                 12L70744629F
                                                                                                                                       H 293
                                                           A                                             95
                                                                                                         18

                                   L70744629F
                                                 12                                                                                                12
                           12                                           ONE DOLLAR
                                                                        ONE DOLLAR
                                                                        A
                                                                                                                SR S
                                                                                                                E IE
                                                                                                                95
                                                                                                                18
                                                                                                                               WASHINGT ON, D.C.
                                                                                                                                      12           H 293

                                                 L70744629F
                                   12                                                 ONE DOLLAR
                                                                                      ONE DOLLAR                       SR S
                                                                                                                       E IE
                                                                                                                        95
                                                                                                                        18
                                                                                                                                             12            H 293

                                                               L70744629F
                                                 12                                                ONE DOLLAR
                                                                                                   ONE DOLLAR                  SR S
                                                                                                                               E IE
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                                                                                                                                95
                                                                                                                                                   12



                                                                                                     ONE DOLLAR
                                                                                                     ONE DOLLAR


                                                                                                                                                                          55
       Present Value of an Annuity
                Example
What is the value today of receiving $500 at
 the end of the each of the next 4 years,
 assuming you can invest at 10% compound
 annual interest?

        Yr. 1      Yr. 2          Yr. 3          Yr. 4

  $0        $500           $500           $500       $500

P.V.(a)??
                                                            56
    Present Value of an Annuity
             Example
        Yr. 1      Yr. 2          Yr. 3          Yr. 4

  $0        $500           $500           $500       $500

P.V.(a)??



  P.V. (a) = Payment x P.V. (a) Factor
           = $ 500 X (4 periods @ 10%)

                                                            57
Present Value of an Annuity Table

 (n)    2%   4%      6%       8%    10%

 1     .9804 .9615   .9434   .92593 .90909
 2     1.942 1.886   1.833   1.783 1.735
 3     2.884 2.775   2.673   2.577 2.487
 4     3.808 3.630   3.465   3.312 3.170
 5     4.713 4.452   4.212   3.992 3.791


 Table 9-4
                                             58
          Present Value of an Annuity
                   Example
              Yr. 1      Yr. 2          Yr. 3          Yr. 4

        $0        $500           $500           $500       $500

P.V. = P.V. = ?
       $1,585

    P.V. (a) = Payment x P.V. (a) Factor

              = $ 500 X (4 periods @ 10%)
              = $ 500 X 3.170
              = $ 1,585                                        49
                                                                    59
Solving for Unknowns:
An Application of Time Value Concepts
  Remember that each of our Time Value
     equations had 4 parameters:
  (1) Payment,
  (2) interest (i%) rate,
  (3) Time (n) period, and
  (4) Future Value or Present Value.
  Given any three of the parameters, we can
     solve for the fourth.
                                              60
Solving for Unknowns:
An Application
You wish to purchase the car of your dreams
 for $40,000 total cost, after your trade-in
 of $10,000.
The dealer is (generously! ) offering 24%
 annual financing over 24 months.
Compute the amount of your monthly
 payment.


The unknown is the amount of the annuity.
                                            61
Solving for Unknowns
         Mo. 1       Mo. 2          Mo. 24

$40,000        ???           ???   ???      ???
loan = P.V.(a)


    P.V. (a)   = Payment x P.V. (a) Factor
   rearrange equation to solve for unknown
       Payment = P.V.(a) / P.V.(a) factor
                                                  51
                                                       62
Solving for Unknowns
         Mo. 1       Mo. 2          Mo. 24

$40,000        ???           ???   ???   ???
loan = P.V.(a)
    P.V. (a)   = Payment x P.V. (a) Factor
    rearrange equation to solve for unknown
        Payment = $40,000 / (24 @ 2%)

     24% annual rate / 12
      monthly payments                         63
Present Value of an Annuity Table

 (n)    2%      4%     6%     8%

 1     .9804   .9615 .9434 .929
 2     1.942    1.886 1.833 1.783
 3     2.884    2.775 2.673 2.577

 :
 24 18.914 15.247 12.550 10.529


                            Table 9-4   64
Solving for Unknowns
         Mo. 1    Mo. 2         Mo. 24

$40,000       $2,115   $2,115            $2,115
loan = P.V.(a)


 Payment = P.V.(a) / P.V.(a) factor
         = $40,000 / (24 months @ 2%)
         = $40,000 / 18.914
         = $2,115
                                             65
   Solving for Unknowns
            Mo. 1      Mo. 2                 Mo. 24

   $40,000       $2,115      $2,115                    $2,115
   loan = P.V.(a)
Total Payments = Monthly Payment          x # months
 $50760         =     $2,115              x      24
Total Interest Paid = Total Payments       - $ Borrowed
  $10,760           = $50,760              - $40,000
Effective Interest Rate Paid = Interest Paid/ $ Borrowed
      26.9%                  =   $10,760 / $40,000
      The more often you compound, the more you pay!       66
                   Summary
 Reviewed    Current Liabilities
 Introduced concept of Contingent
  Liabilities
 Compared Simple vs. Compound
  Interest
 Discussed Time Value of Money
     Future amount of a single payment
     Present value of a single payment
     Future amount of an annuity
     Present value of an annuity         67
Exhibit 9-3    Current Liabilities on the
               Statement of Cash Flows

Operating Activities
Net income                        xxxx
 Increase in current liability     +
 Decrease in current liability     -
Investing Activities
Financing Activities
 Increase in notes payable         +
 Decrease in notes payable         -
                                            68

								
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