Chapter 8

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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 liabilityWarranty 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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