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Chapter 8 Outline (pages 368 – 390) Current Liabilities and (Appendix C at end of text) Time Value of Money PART A: CURRENT LIABILITIES Liabilities 1) Probable future sacrifices of economic benefits 2) Arising from present obligations to other entities 3) As a result of past transactions or events Current liabilities are short-term obligations that will be paid within the current operating cycle or one year, whichever is longer (normally one year). Current liabilities are recorded at face value because the time to maturity is short. Non-current liabilities include all other liabilities that are not current liabilities. Non-current liabilities are recorded at their cash equivalent amount (present value). Cash equivalent- (the cash amount that the creditor would accept to settle the liability today) -Does not include interest until interest is accrued Order of Liabilities on Balance Sheet -Current Liabilities go first, then -Long term (non-current) Liabilities CURRENT LIABILITIES Notes Payable -Evidenced by a contract -Includes interest Interest Calculation (Revisited) PxRxT P = Principal (FACE Value) is the amount borrowed R = Annual interest rate T = length of time the money was used this accounting period (fraction of year). Chapter 8 Fall 2011 Page 8-1 Accrued interest—(interest incurred; earned but not paid/received yet) -current liability (if payments are made periodically and interest is due within the year) -non-current liability (if interest is added to the liability and the liability is non-current) Practice On December 1, Casino Cruise Lines borrows $1,000,000 from Bank of America signing a 6 month, 5% (simple interest) note. Principal and interest is payable at maturity. Record the entry for Casino Cruise Lines on December 1: Record the adjusting entry for Casino Cruise Lines at year-end December 31: How would Casino Cruise Lines treat the note on their Balance Sheet? What affect does the note have on Casino Cruise Line’s Income Statement? Record the entry for Casino Cruise Lines on May 31 when the note matures: Line of Credit—an arrangement with a lending institution that allows the company to continuously borrow up to prearranged limit. Commercial Paper—when a company borrows from another company, the note is referred as commercial paper; usually matures from 30 – 270 days. Accounts Payable (A/P) trade accounts payable—arise through the normal course of business (purchase inventory, goods or services on credit) PAYROLL LIABILITIES—examples include: salaries and wages, taxes, and fringe benefits. Federal Income taxes—amount withheld depends on income and exemptions Chapter 8 Fall 2011 Page 8-2 FICA Taxes --Social security: 6.2% up to a maximum amount (increases each year) --Medicare: 1.45% Employer portion—7.65% Employee portion—7.65% Self employed—15.3% FUTA/SUTA (Federal/State Unemployment taxes—only employer pays) -6.2% -assessed on the first $7,000 of earnings per employee Fringe Benefits -Health/Dental/Vision insurance premiums -Life insurance premiums -Retirement/savings programs Practice Greg works at Break Ski Resorts working 40 hours per week earning $20 per hour. Greg gets paid every two weeks. The company does not pay any health or retirement benefits. 15% of Greg’s income is withheld for federal income taxes and 5% for state taxes. Calculate the amount Greg expects to get direct deposited into his account for his first paycheck: Wages $ Less: Withholdings Federal Income Taxes $ State Income Taxes FICA Taxes Total Withholdings Actual Direct Deposit $ Calculate the total cost to Break Ski Resort for Greg’s paycheck being deposited Wages $ Plus taxes FICA Taxes $ Unemployment taxes (FUTA) Total taxes Actual Payroll costs $ Chapter 8 Fall 2011 Page 8-3 How much should Break Ski Resort send to Government Agencies for Greg’s paycheck? Employee amount withheld $ Employer amount Total amount due IRS, etc. $ Unearned Revenue—cash received before it is earned Sales taxes payable Current Portion of Long-Term Debt -the principal amount of the debt coming due within a year of the balance sheet date Practice United Supply has a $25 million liability at December 31, 20C, of which $5 million of the principal is payable in each of the next five years. How should the liability be shown on the balance sheet at December 31, 20C? Current: Long-term: What about interest on the loan? PART B: LOSS CONTINGENCIES AND ANALYSIS Loss Contingency-an existing uncertain situation that might result in a loss A contingent liability is a “potential” liability that has arisen from a past event or transaction. -contingent liabilities are reported on the financial statements if they are probable and the liability can be estimated. -contingent liabilities are disclosed in the notes if they are probable and cannot be estimated; OR if they are reasonably possible (regardless if they can be estimated or not). Estimable Within a Range -use the more likely amount -no “more likely amount” use lower loss amount and disclose the potential additional loss. Lawsuits Chapter 8 Fall 2011 Page 8-4 Product Warranties and Guarantees (estimated liability) Warranty liabilityWarranty expense (based on estimated amounts)—matching principle -current liability if warranty period is for a year or less -noncurrent liability if warranty period is more than a year. Premiums or Coupons (estimate amount that will be redeemed) GAIN CONTINGENCIES -not recorded until gain is certain - Conservatism LIQUIDITY ANALYSIS Working Capital = CA - CL Current Ratio = CA/CL Acid-test Ratio aka Quick Ratio = (Cash + Current investments +A/R)/CL --does not include inventory or prepaid-assets --uses assets that can be easily converted to cash Practice Under Armour shows the following partial balance sheet; IDENTIFY the CURRENT assets & liabilities: Assets Liabilities Cash $63,000 Note payable due in six months $3,000 Accounts receivable 60,000 Accounts payable 41,000 Short term investments 30,000 Payroll taxes payable 15,000 PPE, net 245,000 Note payable due in 18 months 55,000 Inventory 54,000 Current portion of Long Term Debt 4,000 Other current 5,000 Long Term Debt 50,000 Determine total Determine Total CURRENT Assets: CURRENT Liabilities: Calculate working capital: Calculate the current ratio: Calculate the acid-test ratio: Chapter 8 Fall 2011 Page 8-5 APPENDIX C, TIME VALUE OF MONEY (“TVM”) (end of text, pages C-1 to C-13) “A dollar today is worth more than a dollar in the future.” Assumptions: 1. The dollar is invested today 2. The dollar is earning a positive return Simple interest: P x R x T Compound interest -Discounting -Compounding -Cash flows -Single sum -Annuity PV and FV Tables (Located on last pages of textbook) & included herewith on pages 8-9, 8-10 (or BAII Plus Financial Calculator) Future Value of a Single Amount (FV$1) Equation: (1 + i)n Where i is the interest rate and n is the number of compounding periods. Present Value of a Single Amount (PV$1) Equation: 1/(1 + i)n [the is the reciprocal of (FV$1)] Future Value of an Ordinary Annuity (FVA) Equation: (1+i)n – 1 i Present Value of an Ordinary Annuity (PVA) Equation: 1 – (1/(1 + i)n ) i Interest rates are stated in annual terms (one year, 12 months, 365 days…sometimes 360 days) Chapter 8 Fall 2011 Page 8-6 If compounding occurs more than once a year, the interest rate i needs to be adjusted to reflect the number of compounding periods in a year. And “n” needs to reflect the total number of compounding periods. Example: An investment pays 12% interest annually for 5 years: (12%, 5n) An investment pays 12% interest semiannually for 5 years: (6%, 10n) interest is cut in half, compounding periods are doubled. An investment pays 12% interest quarterly for 5 years: (3%, 20n) interest is cut in fourth, compounding periods are quadrupled. ACCOUNTING APPLICATIONS OF FUTURE AND PRESENT VALUES Use PV and FV Tables (Located on last pages in text or pages 8-9 and 8-10) or BAII Plus Calculator Identify: 1. Type of cash flow: Single sum or Annuity (Payment) 2. Present Value or Future Value 3. Number of compounding periods (n) 4. Interest rate (i) For BAII Plus: Set P/Y to 1 by pressing the 2ND key and then the (I/Y) key. Type in 1 and press enter. Then press the 2ND key and then the CPT key. N = number of compounding periods I/Y = interest rate PV = present value PMT = annuity cash flow (payment) FV = Future Value CPT = compute key To quit/clear, press 2ND then CPT and then 2ND then FV. (Note: turning off the calculator will not clear the TVM items). PRACTICE: 1. Joe invests $3,000 today, how much will Joe’s investment be worth at the end of five years if a 12% rate of return could be earned? N 1/Y PV PMT FV CASH FLOW X FACTOR = x = Chapter 8 Fall 2011 Page 8-7 2. How much would John pay today for an investment where he receives $1,000 at the end of 10 years if John wants to earn a 12% rate of return? N 1/Y PV PMT FV CASH FLOW X FACTOR = x = 3. Joan invests $200 every year for the next 8 years, how much will her investment be worth at the end of 8 years if she can earn 12% interest each year? N 1/Y PV PMT FV CASH FLOW X FACTOR = x = 4. How much could Jill borrow today if she promised to make annual payments of $120 for 10 years at a 12% interest rate? N 1/Y PV PMT FV CASH FLOW X FACTOR = x = 5. How much could Jill borrow today if she promised to make semi-annual payments of $60 ($120 per year) for 10 years at a 12% interest rate? N 1/Y PV PMT FV CASH FLOW X FACTOR = x = Assets and Liabilities are recorded at PRESENT VALUE (cash equivalent) 6. On January 1st, BB Company acquired a truck that had a purchase price of $38,000. The seller agreed to allow BB to pay for the truck over a four-year period (12 payments per year, 48 payments in total) at 6% interest. Determine the amount of each payment: N 1/Y PV PMT FV CASH FLOW X FACTOR = PV x = Chapter 8 Fall 2011 Page 8-8 INSERT FACTOR TABLES found at http://ruby.fgcu.edu/courses/jconreco/core1 Chapter 8 Fall 2011 Page 8-9 INSERT FACTOR TABLES Chapter 8 Fall 2011 Page 8-10 Chapter 8 Homework Submit your answers in Angel before it is due Use the following to answer questions 1 – 5 Select the correct reporting method for each of the items listed below: Reporting Method A. Current Liability 1. _____ Notes payable due in nine months. B. Long term liability C. Disclosure note only 2. _____ Current portion of long-term debt. D. Not reported 3. _____ A loss contingency that is probable of occurring within the next year and can be estimated. 4. _____ Bond Payable. 5. _____ A loss contingency that is reasonably possible of occurring within the next year and can be estimated. Use the following to answer questions 6 – 10 st On October 1 , TLC Technologies, an aeronautic electronics company, borrows $300,000 cash from FirstBanc Corp., to expand operations. TLC signs a six-month, 8% promissory note. Interest is payable at maturity. TLC’s year-end is December 31. st 6. How is the loan classified on TLC’s December 31 balance sheet? A. Current liability B. Long term liability C. Note disclosure only D. Stockholders’ Equity st 7. How is the loan classified on TLC’s December 31 statement of cash flows? A. Operating activity B. Investing activity C. Financing activity D. Not shown on the statement of cash flows 8. $___________How much interest should be accrued on December 31 (assume no previous entry was recorded for interest on the loan)? 9. $___________When the note is paid at maturity how much cash is paid to FirstBanc Corp.? 10. $___________When the note is paid at maturity how much does net income decrease? Use the following to answer questions 11 – 13 OS Environmental provides cost effective solutions for managing regulatory requirements and environmental needs specific to the airlines industry. Assume that on July 1st, the company issues a one-year note for the amount of $500,000. Interest is payable at maturity. 11. $___________Determine the amount of interest expense that should be recorded in a year-end adjusting entry assuming a 9% interest rate and a fiscal year-end September 30. Chapter 8 Fall 2011 Page 8-11 12. $___________Determine the amount of interest expense that should be recorded in a year-end adjusting entry assuming a 6% interest rate and a fiscal year-end December 31. 13. $___________Determine the amount of interest expense that should be recorded in a year-end adjusting entry assuming an 8% interest rate and a fiscal year-end March 31. Use the following to answer questions 14 – 18 You have been working at a local distributor for the past couple of years. Your average salary is $70,200 per year paid bi-weekly at $2,700 per pay. (Your average income tax rate is 23% plus FICA taxes). Your employer provides health insurance to you which costs your employer $380.00 per pay and costs you $40 per pay. Determine the following based on your pay for the last full paycheck of the year. 14. $___________How much will your employer withhold from your paycheck for federal income taxes? 15. $______.__ __How much will your employer withhold from your paycheck for FICA taxes? 16. $______.__ __How much will your employer direct deposit into your bank account for your pay? 17. $______.__ __What is the total cost to your employer for your pay for the bi-weekly pay period? 18. $__ __.__ __ If you work 80 hours bi-weekly, what is the average hourly cost to your employer for your services? (round to two decimal places) Use the following to answer questions 19 – 24 The following balance sheet items, listed in alphabetical order, are available from the records of SSP Corporation at December 31, 20C: Accounts payable $12,400 Inventory $87,500 Accounts receivable 24,300 Land 120,000 Automobiles, net 123,600 Long-term investment 68,400 Bonds payable 300,000 Notes payable, due 7 months 25,000 Buildings, net 357,000 Office supplies 300 Common Stock 175,000 Patents 98,000 Cash 19,500 Prepaid rent 6,500 Income taxes payable 48,500 Retained earnings 318,850 Interest payable 17,850 Payroll taxes payable 7,500 19. $________. How much are SSP’s current assets? Chapter 8 Fall 2011 Page 8-12 20. $________. How much are SSP’s total assets? 21. $________. How much are SSP’s current liabilities? 22. $________. How much are SSP’s total liabilities? 23. $________. How much is SSP’s total stockholders’ equity? 24. ___.___ ___ What is SSP’s current ratio, (round to two decimal places)? USE THE PV and FV Tables (located on last pages of textbook & included herewith on pages 8-9 and 8-10) or BAII Plus Financial Calculator to answer the remaining questions Use the following to answer questions 25 – 27 (round to nearest whole dollar) Each of the four people below has invested the following amounts and will keep the money invested for the next five years. Determine the amount the investment will accumulate over the five year period. Original Investment Interest amount rate Compounding BA $22,500 8% Quarterly JM 23,000 8% Annually ST 21,500 10% Annually KM 21,000 10% Semi-annually 25. $__________ How much will BA accumulate over the 5 year period (round to nearest dollar)? 26. $___________How much will KM accumulate over the 5 year period (round to nearest dollar)? 27. $__________Of the four investments, the future value of the greatest investment accumulation in 5 years (round to the nearest dollar) is: Use the following to answer questions 28 – 29 (round to nearest whole dollar) The four actors below have just signed a contract to star in a comedy. Each person signs independent contracts with the following terms: Contract How contract is paid amount Actor 1 $840,000 Lump sum in two years Actor 2 900,000 Lump sum in three years Actor 3 283,000 Every year for three years Actor 4 220,000 Every year for four years Assume an annual discount rate of 8% (compounded annually). 28. $_________What is the value of the lowest value contract today (round to nearest dollar)? 29. $_________What is the value of the highest paid contract today (round to nearest dollar)? Chapter 8 Fall 2011 Page 8-13 30. $___________You would like to start saving for retirement. Assuming you are now 25 years old and you want to retire at age 55, you have 30 years to watch your investment grow. You decide to invest in the stock market, which you expect it to earn about 10% per year into the future. You decide to invest $5,000 at the end of each year for the next 30 years. Calculate your accumulated investment at the end of 30 years. (Round to nearest whole dollar) Use the following to answer questions 31 – 33 You want a new car. At the dealership, you find a car that you like. The dealership gives you two payment options: 1. Pay $25,000 in cash for the car today…OR 2. Pay $438.33 at the end of each month for six years at 8% (0.66667% monthly for 72n). 31. $__________.__ __How much CASH (in total) will you end up paying if you choose to make monthly payments for the car? 32. $__________.__ __How much interest (in total) will you pay if you choose to make payments instead of paying cash for the car today? 33. $_____. __ __How much interest has accrued by the time the first car payment is due (round to two decimal places)? Use the following to answer questions 34 – 39 KMC reports the following income statement results: Sales $512,500 Operating exp 124,200 Net income 39,500 Sales returns & allowances 12,500 Gross profit 180,000 Interest expense 4,500 34. $____________Calculate Net sales: 35. $____________Calculate Cost of Goods Sold 36. $____________Calculate operating income 37. $_____________Calculate Income before Income tax (IBT) 38. ___ ___%. Calculate the gross profit margin: 39. ___.___%. Calculate the net profit margin: Chapter 8 Fall 2011 Page 8-14

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