Chapter 9
Current Liabilities,
Contingencies, and the
Time Value of Money
After studying this chapter, students should be able to:
◼ Identify the components of the Current Liability category of the balance sheet (Module 1–LO1).
◼ Examine how accruals affect the Current Liability category (Module 1–LO2).
INSTRUCTOR’S MANUAL
9-2
Chapter Outline
MODULE 1 CURRENT LIABILITIES
Module 1
LO 1
Current Liabilities
The balance sheet presents two categories of liabilities: current and long term.
◼ Current liability is an obligation that will be satisfied within one year.
NOTE: Interest and present value are discussed later in the chapter in LO 5, 6, and 7.
◼ Current liability classification is closely tied to entity’s liquidity.
• Sufficient cash, or assets that can be converted to cash quickly to pay current liabilities in a
short period of time.
Accounts Payable
◼ Amounts owed for the purchase of inventory, goods, or services acquired in the normal course of
business.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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Notes Payable
◼ Amounts owed that are represented by a formal contract. Formal agreement or note that is signed
by the parties to the transaction.
• Interest paid on the due date (Example 9-1):
To record the loan, debit Cash and credit Notes Payable for the principal amount.
• This increases assets and liabilities, and has no impact on stockholders’ equity or
net income.
• Discounting a note (Example 9-2):
If a discounted note is issued, the lender deducts interest from the face value in advance,
borrower pays face amount of note on due date.
Debit Cash for the amount of the loan less interest deducted in advance, debit Discount
on Notes Payable for the amount of the interest, and credit Notes Payable for the total
amount of the loan. This entry has no impact on stockholders’ equity or net income.
Current Maturities of Long-Term Debt
◼ The principal is paid in installments over more than one year, making the note a long-term
liability.
◼ The installments due within the current year are a current liability, and are thus the “current
maturity of long-term debt.”
INSTRUCTOR’S MANUAL
9-4
Module 1
LO 2
Taxes Payable
Corporations pay a variety of taxes, including federal and state income taxes, property taxes, and other
taxes.
◼ Can be shown on the balance sheet as Accrued Taxes, or Taxes Payable.
Other Accrued Liabilities
◼ An accrued liability is an amount incurred due to the passage of time, but has not yet been paid as
of the balance sheet date. (Example 9–4)
IFRS and Current Liabilities
◼ Although widely used in the U.S., a classified balance sheet is not required under U.S. standards.
◼ IFRS requires companies to present a classified balance sheet with liabilities listed as current or
long-term.
MODULE 2 CASH FLOW EFFECTS
Module 2
LO 3
Cash Flow Effects
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
• Using the indirect method, the change in the balance of each current liability account is
reflected under Operating Activities.
Decrease in a current liability account indicates that cash has been used to pay the
liability and therefore should appear as a deduction on the statement of cash flows.
MODULE 3 CONTINGENT LIABILITIES
Module 3
LO 4
Contingent Liabilities
A contingent liability is an existing condition for which the outcome is not known with certainty because
it is dependent on some future event. Also known as a contingent loss.
◼ This potential liability raises two accounting questions:
• Should the contingent liability be recorded?
• If so, at what amount?
Contingent Liabilities That Are Recorded
A contingent liability should be accrued and presented on the balance sheet if it is probable and if the
amount can be reasonably estimated.
◼ The terms probable and reasonably estimated must be defined based on the facts of each situation.
• Users would want the company to err on the side of full disclosure.
INSTRUCTOR’S MANUAL
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• At the end of each period, the selling firm must estimate how many products sold during the
period will become defective in the future and the cost or the repair or replacement.
Estimated liability – a contingent liability that is accrued and reflected on the balance
sheet.
Conforms to the matching principle – matching expenses related to the sales.
◼ Premiums or Coupons are other contingent liabilities that are recorded.
• Examples include premiums or coupon offers that accompany many products, such as cereal
boxes.
• At end of the year, must estimate the number of premium offers that will be redeemed and the
cost involved.
Contingent liability must be set up for that amount.
◼ Some lawsuits and legal claims are contingent liabilities that must be recorded.
• Contingent liability because an event has occurred but the outcome of that event, the
resolution of the lawsuit, is not yet known.
Contingent Liabilities That Are Disclosed
◼ A contingent liability must be disclosed in the financial statement notes but not reported on the
balance sheet if the contingent liability is at least reasonably possible.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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Contingent Liabilities versus Contingent Assets
◼ Contingent asset (contingent gain) is an existing condition for which the outcome is not known,
but by which the company stands to gain.
IFRS and Contingencies
◼ Under IFRS, contingent liability is used only for those items that are not recorded on the balance
sheet but are disclosed in the footnotes.
MODULE 4 TIME VALUE OF MONEY
Module 4
LO 5
Time Value of Money Concepts
The time value of money means that people prefer a payment at the present time (immediately) rather than
in the future because of the interest factor. The amount can be invested and the resulting accumulation will
be larger than the same amount received in the future.
Simple Interest
INSTRUCTOR’S MANUAL
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◼ Simple interest is interest earned on the principal amount only.
◼ If the amount of principal is unchanged from year to year, the interest per year will remain the
same.
◼ I = P × R × T
Compound Interest
◼ Compound interest means that the interest is calculated on the principal plus previous amounts of
accumulated interest.
Module 4
LO 6
Interest Compounding
◼ For most accounting problems, assume interest is compounded annually.
◼ Compounding may occur at any time interval, not just annually.
Present Value and Future Value: Single Amounts
Future Value of a Single Amount
◼ Future amount or future value is the amount of interest plus principal that will be accumulated at a
future time from a single payment or investment.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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• Excel® can use the built-in functions to perform the calculations (see Appendix).
• Tables have been constructed using the formulae for present and future value, for future value
at a number of rate/time combinations.
Present Value of a Single Amount
◼ Represents the value today of a single amount to be received or paid at a time in the future earning
“i” rate for “n” periods. (Example 9-10)
◼ The amount at a present time that is equivalent to a payment or an investment at a future time.
◼ This process is called discounting the future payment back to the present time.
Present Value and Future Value of an Annuity
Future Value of an Annuity
An annuity is a series of payments of equal amounts.
◼ Future value of an annuity is the amount accumulated in the future when a series of payments is
invested and accrues interest.
INSTRUCTOR’S MANUAL
9-10
• Instead, can use a table for the future value of an annuity, which performs the series of
calculations, using a factor, in one step (Table 9-3).
Present Value of an Annuity
◼ The amount at the present time that is equivalent to a series of payments and interest in the future.
◼ A series of payments that will occur in the future, and we must determine a single amount today
Module 4
LO 7
Solving for Unknowns
The present or future value may be known, but the interest rate or the number of payments must be
calculated. (Examples 9-13 and 9-14)
◼ The formulas, tables, or Excel® can be used for the calculations.
Appendix
Accounting Tools: Using Excel® for Problems Involving Interest
Calculations
Excel® spreadsheets can be used to calculate future value and present value amounts. The Appendix to this
chapter is a tutorial of this process.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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• Example 9-16 Using Excel® for Annual Compounding.
• Example 9-17 Using Excel® for Quarterly Compounding.
INSTRUCTOR’S MANUAL
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Lecture Suggestions
Module 1
LO 2
Module 1
LO 2
Module 3
LO 4
Discuss the fact that the accounts a company uses can reveal many different things about that
company. For example, will all companies have corporate tax expense on their books? Recall from
previous chapters that not all companies are considered a separate legal entity. Therefore, if a
Discuss why the sales taxes that a company collects for the various taxing authorities are not
considered an expense on their books.
Discuss examples of contingent liabilities. For example in the case of a legal claim, ask students
how they would reasonably estimate the outcome. Ask students whether putting an item in the
footnotes obscures it, or serves the same purpose as locating that item on the face of the statement.
Module 4
LO 5
This example, in a number of variations, can be used throughout the chapter to show the effects of
the different ways of calculating interest.
Module 4
LO 6
In addition to using the formulas, tables, or Excel® mentioned in the text, many calculators will
do future value and present value calculations automatically, if the proper values are entered.
A simple series of examples illustrates present and future value concepts.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
Future value of an annuity: Go back to the $100 deposit. Table 9-3 assumes an ordinary annuity,
that is, the payments/deposits are made at the end of each period. We will modify the example to
accommodate that. However, you may not want to enter into this discussion with your class, and
therefore might skip this example. Let students assume this time that they will deposit $100 a year
from today, then another $100 in a year from that. How much will they have at the end of the
second year, that is, in two years from today? Again, calculate by hand, and then check the table.
The first $100 earns $5 during the second year, becoming $105. The second $100, deposited at the
end of the second year, earns no interest, so that the total will be $105 + $100 = $205. Using Table
9-3, $100 × 2.05000 = $205.
INSTRUCTOR’S MANUAL
9-14
Projects and Activities
Module 1
LO 1
Current Liabilities
In–class exercise: Current ratio: McDonald’s
◼ Using the current assets and current liabilities sections of McDonald’s 2014 and 2013 balance
sheets
1
reproduced below, calculate the current ratio for each year. Comment on this ratio.
McDonald’s Corporation ($ millions)
2014 2013
Current assets:
Cash and equivalents $ 2,077.9 $2,798.7
◼ Comment on the change in the ratio from 2013 to 2014.
Solution
◼ 2014 CA CL = 4,185.52, 747.9 = 1.52 to 1 ratio
2013 CA CL = 5,050.1/3,170.0 = 1.59 to 1 ratio
To shed some light on this rather low ratio, here is what McDonald’s has to say in the Management
Discussion of its 2014 Annual Report:
2
The Company generates significant cash from its operations and has substantial credit
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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Outside assignment: Follow-up to McDonalds’s current ratio exercise
Gather the current ratios of two or three similar companies.
◼ How do these current ratios compare to McDonald’s?
◼ Are you persuaded that these companies are “stronger” than McDonald’s? More liquid? What
other information would you want in order to make this judgment?
Solution
◼ Depending on the companies the students choose to research, there may be quite a variation of
Outside assignment: Early payment discounts
How important is it to take early payment discounts? Many companies, especially small businesses, tend to
dismiss cash discounts on invoices as trivial.
◼ Assume your small electronics store just received an invoice from a supplier for a shipment of
flash drives. The total invoice is $364.80, with terms 2/10, n/30. If you pay within 10 days, how
much will you save? Are you impressed? Is it worth paying 20 days early in order to take this
discount? What reasons might a small business person give to justify not taking these discounts?
◼ Now that you know your borrowing rate, what if you borrow the money to pay this invoice? You
would probably have to pay a full month’s interest, not just 20 days, on the loan. Based on your
research, how much interest (in $, not %) would you have to pay? Now is the discount
worthwhile?
◼ Do you think that you, as the owner of the business, would be aware of how many invoices with
similar terms your firm receives, and their total dollar amount? Do you think that would be useful
knowledge? Why or why not?
Solution
◼ Your savings: $364.80 × .02 = $7.30 Seven dollars doesn’t seem like much of a savings to most
INSTRUCTOR’S MANUAL
9-16
Module 3
LO 4
Contingent Liabilities
In-class exercise: Contingent liabilities
The Sunday papers often contain coupon supplements. Each gives the consumer the ability to purchase an
item for less (usually from $.20 to $1.00) than the store’s usual price. Why not take one of those
supplements, cut out a stack of coupons, and hand them out in class. Everyone should be interested in
saving money!
◼ Read the fine print. What is the company promising? Is this a recorded liability or a disclosure in
the footnotes? Explain.
◼ If a liability is recorded, how much does the company that issued the coupons record? Is it the
total of all the coupons they printed? Some percentage of the total? How do they calculate that
percent?
◼ Whose revenue is reduced—the store that redeems the coupon or the company that makes the
product?
◼ If the manufacturer takes the reduction, does redeeming the coupon cost the store anything? How
do you think the store accounts for coupons?
◼ Someone who has impatiently waited in line to buy bread and milk behind another customer who
has presented the clerk with 30 coupons might well grumble that coupons are more trouble to
everyone than they are worth. Are they? What is their value to the manufacturer? To the store? To
the customer? Are they worth it?
Solution
◼ For example, with a breakfast cereal coupon, a box of cereal can be bought for $1.00 less than the
grocer’s marked price if the coupon is used before the expiration date. Not more than one coupon
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
In-class discussion: Reserves for product recall costs
Automobile manufactures often have recalls, which can become expensive. General Motors lists several
recalls in their 2014 annual report, including recalls related to ignition switches, the power steering column,
non-deployment of side impact restraints, and front safety lap belt cables that could fatigue and separate
over time.
In the notes to their financial statements, General Motors states
3
: “We have historically accrued estimated
costs related to recall campaigns in GMNA (General Motors North America) when they are probable and
reasonably estimable, which typically occurs once it is determined a specific recall campaign is needed and
announced. During the three months ended June 30, 2014, following the significant increase in the number
of vehicles subject to recall in GMNA, the results of our ongoing comprehensive safety review, additional
◼ Explain, in your own words, what General Motors means in this footnote.
◼ Are these costs considered a contingent liability?
INSTRUCTOR’S MANUAL
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Solution
◼ In order for a contingent liability to be recorded, it must be probable and the amount must be
In-class discussion: Reserves for product recall costs
Volkswagen is embroiled in a scandal involving emissions testing. Volkswagen said it understated the
level of carbon-dioxide emissions to regulators. U.S. and European authorities have begun regulatory
and criminal investigations. A recent article stated “In providing an estimate of financial risk from its
Class discussion: Estimated liabilities and contingencies
The following were taken from the footnotes of Microsoft’s, June 30, 2015 financial statements:
NOTE 1 ACCOUNTING POLICIES PRODUCT WARRANTY4
We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at
the time the related revenue is recognized. For hardware warranties, we estimate the costs based on
NOTE 17 CONTINGENCIES5
We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course
of our business. Although management currently believes that resolving claims against us, individually or
in aggregate, will not have a material adverse impact on our financial statements, these matters are subject
to inherent uncertainties and management’s view of these matters may change in the future.
CHAPTER 9 CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY
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As of June 30, 2015, we had accrued aggregate liabilities of $614 million in other current liabilities and $20
million in other long-term liabilities for all of the contingent matters described in this note. While we intend
to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.6
billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to
occur, there exists the possibility of a material adverse impact on our financial statements for the period in
which the effects become reasonably estimable.
◼ Do you think Microsoft has adequately explained their policy for estimating warranty expense?
◼ How much has Microsoft recorded in contingent liabilities? Have they recorded all contingent
liabilities? If not, why not?
Solution
◼ Microsoft’s policy has estimating warranty expense is very transparent. They estimate the
LO 5
Interest Compounding
In-class exercise: Present value of winning a contest
You are Joe Joe Jones, a star pitcher in the National Baseball League. You have been offered a signing
bonus under one of the following options:
Option 1: Receive $5 million in one lump sum on December 31.
Option 2: Receive $167,000 on December 31, and on each (29) succeeding
December 31, for a total of 30 annual payments.
Option 3: Receive $14,000 on December 31, and every month thereafter
for a total of 360 months.
◼ Without making any present value calculations, which option appears to be the most attractive?
Why?
◼ Now calculate the present value of each option. Assume an interest rate of 9%. (The present value
of an annuity of $1 at 9% for 30 periods is 10.274. The present value of an annuity of $1 at .75%
(9% 12) for 360 periods is 120.738.) Which option now is more attractive? Explain.
◼ Compare and comment on your answers to the two questions above.
Solution
◼ Clearly, the more money you receive up front, the better, so Option 1—$5 million all at once—is
INSTRUCTOR’S MANUAL
LO 7
Applying Compound Interest to Common Situations
In-class assignment: Automobile leases
A car dealer advertises a lease that gives the lessee the choice of making a single lease payment of $4,628,
or paying $1,000 down, and $169 per month for 24 months. You may need a reference from the library, or
a computer database, to find a table with the values you need. You can also interpolate from an existing
table.
◼ What is the interest rate implicit in the payment arrangement? You will not find the precise
number you are looking for in your table, but if you round to the nearest rate your answer will
come out close enough.
◼ At the end of the lease, the car can be purchased for $8,811.30. What is the present value of this
amount at the interest rate you calculated above?
◼ What is the approximate cash value of the car?
◼ Look at other advertisements in your newspaper for automobile leases. What are the implied rates?
Are they higher or lower than this one? What features or terms in the leases affect the interest rate?
Why do you think this is true?
Solution
◼ PV of $169 @ I % for 24 periods = $3,628 ($4,628 less down payment of $1,000)