Financial 2007: Chapter 08A —1
Chapter 8
Current Liabilities and the Time Value of Money
Chapter Review
Review of Learning Objectives
LO1Identify the management issues related to current liabilities.
Current liabilities are an important consideration in managing a company’s liquidity and cash flows. Key measures of liquidity are working capital, payables turnover, and days’ payable. Liabilities result from past transactions and should be recognized at the time a transaction obligates a company to make future payments. They are valued at the amount of money necessary to satisfy the obligation or at the fair value of the goods or services to be delivered. Liabilities are classified as current or long term. Supplemental disclosure is required when the nature or details of the obligations would help in understanding the liability.
LO2Identify, compute, and record definitely determinable and estimated current liabilities.
The two major categories of current liabilities are definitely determinable liabilities and estimated liabilities. Definitely determinable liabilities can be measured exactly. They include accounts payable, bank loans and commercial paper, notes payable, accrued liabilities, dividends payable, sales and excise taxes payable, the current portion of long-term debt, payroll liabilities, and unearned revenues.
Estimated liabilities definitely exist, but their amounts are uncertain and must be estimated. They include liabilities for income taxes, property taxes, promotional costs, product warranties, and vacation pay.
LO3Distinguish contingent liabilities from commitments.
A contingent liability is a potential liability that arises from a past transaction and is dependent on a future event. Contingent liabilities often involve lawsuits, income tax disputes, discounted notes receivable, guarantees of debt, and failure to follow government regulations. A commitment is a legal obligation, such as a purchase agreement, that is not recorded as a liability.
LO4Define the time value of money, and apply it to future and present values.
The time value of money refers to the costs or benefits derived from holding or not holding money over time. Interest is the cost of using money for a specific period. In computing simple interest, the amount on which the interest is computed stays the same from period to period. In computing compound interest, the interest for a period is added to the principal amount before the interest for the next period is computed.
Future value is the amount an investment will be worth at a future date if invested at compound interest. An ordinary annuity is a series of equal payments made at the end of equal intervals of time, with compound interest on the payments. Present value is the amount that must be invested today at a given rate of interest to produce a given future value. The present value of an ordinary annuity is the present value of a series of payments. Calculations of future and present values are simplified by using the appropriate tables, which appear in an appendix to the book.
LO5Apply the time value of money to simple accounting situations.
Present value may be used in evaluating the proposed purchase price of an asset, in computing the present value of deferred payments, in determining the future value of an investment of idle cash, in establishing a fund for loan repayment, and in numerous other accounting situations in which time is a factor.