21-22 Liabilities

Principal

The amount originally borrowed

Interest

The cost of borrowing money, determined as a % of outstanding principal

Time Value of Money

help us value and compare cash flows properly

Why is money today more valuable?

Opportunity Cost- money today could be invested for returns

Inflation- future dollar will have less purchasing power

Rish- future payments are less certain

Future Value (TVM)

Value an amount today will grow to in the future, assuming given rate of return

Present Value (TMV)

Value today of a future amount, assuming a given rate of return 

Rate (TVM)

rate used to compute future or present value 

When adjusting the rate more frequently, the adjustment is: 

Annual Rate/ Number of Compounding Periods per Year 

Annuity (TVM) 

Series of equal cash flows that occur at regular intervals over a specified period (subscriptions) 

Future Value of Single Sum

PV * (1+r)^n

Present Value of Single Sum

FV/ (1+r)^n

Present Value of Ordinary Annuity

Payment/r *(1-1/(1+r)^n)

operating activities

cyclical operating cash needs, such as inventory (everyday expenses/money flows)

Long Term growth Activities

Large Amounts of cash needed for R&D, CAPEX, or mergers

Financing Activities

Refinance previous debt , funds to pay dividends or repurchase stock

Debt Capital

Funds a company raises by borrowing money from external sources

Sources of debt capital

Banks and Private lenders

Public debt (commercial and paper bonds)

Notes Payable and Bonds Payable (most common)

Note Payable

A liability resulting from borrowing money and signing a promissory note to repay (car loan, student loan) Payments include both interest and partial repayment of principal

Accounting for Notes Payable

Effective interest method (allocate loan payment between interest and principal)

Effective Interest Method (Accounting Notes Payables)

Interest Expense= Interest Rate * Note Payable balance

Remainder of loan payment is applied to principal, thus decreasing the balance of the note payable

A company borrows $80,000 to purchase a building

5 year mortgage

4% interest rate

Make one payment per year, payment = $17970

Interest Expense= rate*note payable balance

4%*80000=3200

Principal Reduction= Payment- Interest Expense

17970-3200=14770

Note Payable Journal Entries

Borrow Money

Debit Cash 80 Credit Note Payable 80

Y1 Loan Payment

Debit Interest Expense 32 debit Note Payable 14 Credit Cash 46

Y2 loan Payment

Debit interest Expense 26 Debit Note Payable 15 credit Cash 41

Bonds

Formal certificates of debt that promise to pay interest periodically and then repay the principal at maturity

issuer

company that borrows the money

bondholders

issued to multiple lenders

Stated rate/ coupon rate

Annual interest rate printed on the bond

Coupon payments

payments made on a bond semi-annually (typically)

Face value, maturity value, par value

Printed on face of the bond, when company pays back the principal at maturity

Coupon Payment formula

Face value * coupon rate * ½

For a bond with a $1000 face value and 10% coupon rate, how much will each coupon payment be?

$50

Pricing Bonds: Market Interest

the rate that investors demand for loaning their money

reflects firm risk, features of the bond, monetary policies and economic conditions

Effective Interest rate

The market interest rate on the day the bonds are issued is the true cost of debt to the company

Pricing a Bond (PAB)

Rate

Periods
Payments

Future Value

PAB Rate

Usually the market rate, because bonds pay semi-annually, you need to halve the annual rate

PAB Periods

How long until the bond matures? Because bonds pay semi-annually, you will need to double the number of years

PAB Payments

This is based on coupon rate and face value; because bonds pay semi-annually you will need to halve the coupon rate to compute payment

PAB Future Value

Face Value (maturity value)

Estimated Warranty Payable

When a company warranties its product

recorded in the same period that the company recognizes revenue (because warranties presumably make products more attractive to customers)

May also be called accrued warranty

Warranty Expense Journal Entry

Debit Warranty Expense Credit Warranty Payable (initial)

Debit Warranty Payable Credit Cash or Inventory (resolved)

Contingencies

a potential liability arising from a past event that depends on a future event (warranties and lawsuits)

When a liability is PROBABLE

record liability on balance sheet and an expense on income statement

When liability is REASONABLY POSSIBLE

disclose in footnotes, no estimate

When a liability is REMOTE

nothing is recorded, it is unlikely anything will happen

Covenants

terms and conditions designed to protect lender

Insurance, audited statements