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Chapter 9
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  1. Chapter 9 Reporting and Interpreting Liabilities

  2. Equity - funds from owners Debt - funds from creditors Business Background The acquisition of assets is financed from two sources:

  3. Business Background The mix of debt and equity for a company is called the capital structure: Equity - funds from owners Debt - funds from creditors

  4. Business Background Debt is considered riskier than equity. Creditors can forcebankruptcy. Interest is alegal obligation.

  5. Business Background Financial Leverage - Borrowing at one rate and investing at a higher rate. If we borrow $1,000,000 at 8% and invest it at 10%, we will clear $20,000 profit!

  6. Current Liabilities Noncurrent Liabilities Liabilities Defined and Classified Defined as probable future sacrifices of economic benefits as a result of past transactions or events. Maturity = 1 year or less Maturity > 1 year

  7. Current Ratio = Current Assets÷ Current Liabilities Working Capital = Current Assets- Current Liabilities Liabilities Defined and Classified An important indicator of a company’s ability to meet its current obligations. Two commonly used measures:

  8. Current Ratio(Compare to page 488) General Mills has current liabilities of $1,443.7 and current assets of $1,035.3. The current ratio is . . .

  9. Net Working Capital • Working capital is the dollar difference between total current assets and total current liabilities • A positive amount indicates that the firm has enough current assets to cover their current liabilities and vice versa

  10. Current Liabilities

  11. Accrued Liabilities • Liabilities incurred but not billed to company yet, I.e., utilities, phone, etc • Property and payroll taxes • Income taxes • Reserves for contingencies, etc.

  12. Deferred Revenues and Service Obligations Cash is collected from the customer before the revenue is actually earned. As the earnings process is completed. . . Cash is received in advance. Deferred revenue is recorded. Earned revenue is recorded.

  13. Interest Interest is the compensation to the lender for giving up the use of their money for a period of time. • To the lender, interest is a revenue. • To the borrower, interest is an expense.

  14. Interest The interest formula includes three variables that must be considered when computing interest: Interest = Principal × Interest Rate × Time When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction.

  15. Interest General Mills borrows $100,000 for 2 months at an annual interest rate of 12%. Compute the interest on the note for the loan period.

  16. Current Liabilities Long-term Liabilities Long-Term Liabilities Creditors often require the borrower to pledge specific assets as security for the long-term liability. Maturity = 1 year or less Maturity > 1 year

  17. Sources for Long-Term Loans Relatively small debt needs can be filled from single sources. or or Insurance Companies Pension Plans Banks

  18. Sources for Publicly Issued Debt Significant debt needs are often filled by issuing bonds to the public. Bonds Cash

  19. Deferred Taxes GAAP is the set of rules for preparing financial statements. The Internal Revenue Code is the set of rules for preparing tax returns. Results in . . . Usually. . . Results in . . . Financial statement income tax expense. IRS income taxes payable. The difference between tax expense and tax payable is recorded in an account called deferred taxes.

  20. Deferred Taxes Here is the December 31, 2001, financial information for General Mills. The company uses straight-line depreciation for financial reporting and accelerated depreciation for income tax reporting. The company has a 30% tax rate.

  21. Deferred Taxes Compute General Mill’s income tax expense and income tax payable. The income tax amount computed based on financial statement income is income tax expense for the period.

  22. Deferred Taxes Compute General Mill’s income tax expense and income tax payable. Income taxes based on tax return income are the taxes payable for the period.

  23. Deferred Taxes Compute General Mill’s income tax expense and income tax payable. The deferred tax for the period of $36,000 is the difference between income tax expense of $45,000 and income tax payable of $9,000.

  24. Contingent Liabilities Potential liabilities that arise because of events or transactions that have already occurred.

  25. $1,000 invested today at 10%. In 5 years it will be worth $1,610.51. In 25 years it will be worth $10,834.71! Present and Future Value Concepts Money can grow over time, because it can earn interest.

  26. Present and Future Value Concepts The growth is a mathematical function of four variables: • The value today. • The value in the future. • The interest rate. • The time period.

  27. Present and Future Value Concepts Two types of cash flows can be involved: Periodic payments called annuities. Today Single payment

  28. Time Value Tables (See Tables A-1 to A-4 in appendix A) Present and future value tables are available for: • Future value, single amount. • Present value, single amount. • Future value, annuity. • Present value, annuity.

  29. Future Value of a Single Amount How much will an amount today be worth in the future? Present Value FutureValue Interest compounding periods Today

  30. Future Value of a Single Amount (Formula: FV = PV(FVIF i, n) If we invest $1,000 today earning 10% interest, compounded annually, how much will it be worth in three (3) years? (Go to table A-1, Appendix A, p.780 for factor) a. $1,000 b. $1,010 c. $1,100 d. $1,331

  31. Future Value of a Single Amount If we invest $1,000 today earning 10% interest, compounded annually, how much will it be worth in three (3) years? a. $1,000 b. $1,010 c. $1,100 d. $1,331 The invested amount is $1,000. i = 10% & n = 3 years Using the future value of a single amount table, the factor is 1.331. $1,000 × 1.331 = $1,331

  32. Present Value of a Single Amt (Formula: PV = FV(PVIF i, n) How much is a future amount worth today? Present Value FutureValue Interest compounding periods Today

  33. Present Value of a Single Amt(Go to table A-2 for factor) How much do we need to invest today at 10% interest, compounded annually, if we need $1,331 in three (3) years? a. $1,000.00 b. $ 990.00 c. $ 751.30 d. $ 970.00

  34. Present Value of a Single Amt. How much do we need to invest today at 10% interest, compounded annually, if we need $1,331 in three (3) years? a. $1,000.00 b. $ 990.00 c. $ 751.30 d. $ 970.00 The required future amount is $1,331. i = 10% & n = 3 years Using the present value of a single amount table, the factor is .7513. $1,331 × .7513 = $1,000.00 (rounded)

  35. Future Value of an Annuity Formula: FV = Pmt(FVIFA i, n) • Equal payments(pmt) are made each period. • The payments and interest accumulate over time. Accumulation Present Value FutureValue Interest compounding periods Today Payment 1 Payment 2 Payment 3 + +

  36. Future Value of an Annuity (Go to table A-3 for factor) If we invest $1,000 each year at interest of 10%, compounded annually, how much will we have at the end of three years? a. $3,000 b. $3,090 c. $3,300 d. $3,310

  37. Future Value of an Annuity If we invest $1,000 each year at interest of 10%, compounded annually, how much will we have at the end of three years? a. $3,000 b. $3,090 c. $3,300 d. $3,310 The annual investment amount is $1,000. i = 10% & n = 3 years Using the future value of an annuity table, the factor is 3.3100. $1,000 × 3.3100 = $3,310

  38. Present Value of an Annuity Formula: PV = Pmt(PVIFA i, n) What is the value today of a series of payments to be received or paid out in the future? Present Value FutureValue Interest compounding periods Today Payment 1 Payment 2 Payment 3

  39. Present Value of an Annuity Go to table A-4 for factor) What is the present value of receiving $1,000 each year for three years at interest of 10%, compounded annually? a. $3,000.00 b. $2,910.00 c. $2,700.00 d. $2,486.90

  40. Present Value of an Annuity What is the present value of receiving $1,000 each year for three years at interest of 10%, compounded annually? a. $3,000.00 b. $2,910.00 c. $2,700.00 d. $2,486.90 The annual receipt amount is $1,000. i = 10% & n = 3 years Using the present value of an annuity table, the factor is 2.4869. $1,000 × 2.4869 = $2,486.90

  41. End of Chapter 9