5. Liabilities - 2/21/10 Liabilities Dr. Mimi Alciatore 1...

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Unformatted text preview: 2/21/10 Liabilities Dr. Mimi Alciatore 1 Current Liabilities ♦  Expected to Be Paid or Performed Within 1 Year Dr. Mimi Alciatore 2 Current Liabilities ♦ Accounts Payable (or “ Trade Accounts Payable”) ♦ Amounts Owed to Others for Goods (ODen Inventory) & Services Bought on Account 1 2/21/10 Examples of Accrued Liabilities   Wages & Salaries Payable   Payroll Taxes Payable   Interest Payable   Rent Payable ……. Examples of Accrued Liabilities   Insurance Payable   Property Taxes Payable Often Combined into One Account Called “Accrued Liabilities” Wages & Salaries Payable  Wages Earned But Not Paid as of the End of Period   The Firm Records the Expense: Wage Expense 200 ↓ Equity Wages Payable 200 ↑ Liab. Dr. Mimi Alciatore 6 2 2/21/10 Payroll Liabilities Local Pays Its Staff at the end of each month: Wages and Salaries Expense 20,000 4,600 1,000 1,530 12,870 U.S. Withholding Taxes Payable State Withholding Taxes Payable FICA (Social Security) Taxes Withheld Cash Payroll LiabiliMes FICA = Federal Insurance ContribuMons Act Payroll Liabilities ♦  The Employee Tax Rate for Social Security Is 6.2% (Amount Withheld from Paycheck) 3 2/21/10 Payroll Liabilities ♦  The Employer Tax Rate for Social Security Is Also 6.2% (12.4% Total for Social Security) Payroll LiabiliMes ♦  The Employee Tax Rate for Medicare Is 1.45% (amount withheld) ♦  The Employer Tax Rate for Medicare Tax Is also 1.45% ♦  2.9% Total for Medicare Payroll LiabiliMes ♦  The Employee Tax Rate for Medicare Is 1.45% (amount withheld) ♦  The Employer Tax Rate for Medicare Tax Is also 1.45% (2.9% total) ♦  There is No Wage Base Limit for Medicare Tax ♦  All Wages Are Subject to Medicare Tax 4 2/21/10 Payroll LiabiliMes Federal Insurance ContribuMons Act “FICA” = 7.65%: 6.2% (for old age) On Salary Up To: ♦  $51,300 in 1990 ♦  $68,000 in 1998 ♦  $72,600 in 1999 ♦  $84,900 in 2002……. Payroll LiabiliMes ♦ 2005 Wage Base Limit Was $90,000 ♦ 2006 Wage Base Limit Was $94,200 ♦ 2007, the Limit in 2007 Was $97,500 ♦ Thus, There Was a 90% Increase in the Wage Base Limit from 1990 to 2007 Per IRS Publica7on 15: Payroll LiabiliMes ♦ For 2008, the Limit Is $102,000 ♦ $97,500 in ’07 ♦ This is an Increase of 4.6% Over 2007 5 2/21/10 Payroll LiabiliMes ♦ For 2009, the Limit Is $106,800 ♦ $102,000 in ’08 ♦ This is an Increase of 4.7% Payroll LiabiliMes ♦ For 2010, the Limit Was Set to be $111,600 Which is a 4.5% Increase ♦ However, the Limit Was Kept at $106,800 in 2010 Payroll LiabiliMes The Limit, known as the Social Security Wage Base, goes up each Year Based on Average NaMonal Wages and, in general, at a faster rate than the Consumer Price Index Wikipedia 6 2/21/10 Payroll LiabiliMes Local Also Pays Payroll Taxes: Payroll Tax Expense 2,056 FICA Taxes Payable* 1,530 Federal Unemployment Tax Payable 126 State Unemployment Tax Payable 400 * Matches Employees' ContribuMon = 7.65% Other Current LiabiliMes ♦  Short ­term Debts or Short ­term Borrowings Such as Short ­term Bank Loans & Current MaturiMes of Long ­term Debt Other Current LiabiliMes ♦  Dividends Payable: ♦  They Become a Liability When Board of Directors Declares the Dividend 7 2/21/10 Other Current LiabiliMes ! ♦  Deferred Revenues: Services To Be Performed Later for Which the firm has already Been Paid Such as Magazine SubscripMons Dr. Mimi Alciatore 22 Other Current LiabiliMes ! ♦  Short ­Term Notes Payable Dr. Mimi Alciatore 23 Other Current LiabiliMes ! ♦  Current MaturiMes of Long ­Term Debt ♦  Part of Long-term Debt due Within 1 Year ♦  “Reclassify” as Current Dr. Mimi Alciatore 24 8 2/21/10 WarranMes Music Inc. EsMmates that One out of Every 1,000 Radios Sold Will Require Repair Under Warranty and the Average Warranty Claim Will Cost $15. It Sold 50,000 Radios This Year. 50 radios x $15 Warranty Expense $750 EsMmated Warranty Liability $750 WarranMes ♦ In 19X2, Music Incurred Costs of $800 to Repair 40 Radios Under Warranty: EsMmated Warranty Liability $800 Cash $800 WarranMes ♦  WarranMes Can Be Current LiabiliMes Or Long ­Term LiabiliMes ♦  WarranMes Can Affect Deferred Taxes 9 2/21/10 Deferred Taxes ♦  Significant for Oil Firms: In 2007 & 2006, Exxon Mobil had $30 Billion & $28 billion In Deferred Tax Liabilities, which Represented 19% of Total Liabilities and 20% of Long-Term Liabilities Dr. Mimi Alciatore 28 Deferred Taxes ♦  Deferred Taxes Are Due to Temporary Differences between The Financial Books & the Tax Return Dr. Mimi Alciatore 29 Deferred Taxes ♦ Example: Simple Inc. uses Straight ­Line DepreciaMon for its Financial AccounMng And Double Declining Balance for its Taxes ♦ In Year 1, it bought a truck for $30,000 ($5,000 residual value, and a 5 ­year life). Dr. Mimi Alciatore 30 10 2/21/10 Straight ­Line DepreciaMon = (30,000  ­ 5,000)/ 5 = $5,000 DDB DepreciaMon Year 1 = 2 /5 (30,000) = $12,000 Simple's DepreciaMon on its Income Statement and Tax Return for Years 1  ­ 3 are Shown Below: Financial Tax Year Deprec. Book Deprec. Tax Book Expense Value DeducMon Value 1 $5,000 25,000 $12,000 $18,000 2 5,000 20,000 7,200 10,800 3 5,000 15,000 4,320 6,480 Dr. Mimi Alciatore 31 Year 1 Revenues Operating Expenses Income Statement $200,000 -75,000 -5,000 $120,000 -30,000 Tax Return $200,000 -75,000 DDB -12,000 $113,000 -28,250 Depreciation Straight-line Income Before Taxes Income Tax Expense (25%) Income Tax Expense $30,000 Income Taxes Payable $28,250 Deferred Tax Liability $1,750 Dr. Mimi Alciatore 32 Year 3 Revenues Operating Expenses Income Statement Tax Return $200,000 - 75,000 - 5,000 $120,000 - 30,000 $200,000 - 75,000 DDB - 4,320 $120,680 - 30,170 Depreciation Straight-line Income Before Taxes Income Tax Expense (25%) Income Tax Expense $30,000 Deferred Tax Liability $170 Income Taxes Payable $30,170 Dr. Mimi Alciatore 33 11 2/21/10 Deferred Taxes ♦  One can also have a Deferred Tax Asset if a firm Recognizes an Expense Earlier for financial reporting than for tax reporting. ♦ For example, a firm records the cost of Warranties at the time of sale, but May Not Deduct the costs for taxes until it spends Money to make a repair Dr. Mimi Alciatore 34 Assume a firm expenses the cost of warranties given this period and has a 30% tax rate: P&L Income before warranty expense $100 Warranty expense 20 Income before tax 80 Income taxes (at 30%) 24 Income tax expense 24 Deferred tax asset 6 Income taxes payable Dr. Mimi Alciatore Tax Return 100 0 100 30 30 35 The Firm Makes All the Repairs in the Next Year: P&L Income before warranty expense Warranty expense Income before tax Income taxes (at 30%) $100 0 100 30 Tax Return $100 20 80 24 Income tax expense 30 Deferred tax asset 6 Income taxes payable 24 Dr. Mimi Alciatore 36 12 2/21/10 Accounting for Contingent Losses Contingent Loss Probability of Occurrence High (“Probable”) Reasonable Remote Estimable? Yes Accounting Treatment No Accrue Disclose Disclose Ignore Accounting For Contingent Losses   If It Is “Probable” that Events Have Impaired an Asset or Created a Liability,   But the Estimated Effect Is a Range of Amounts,   Then Use the Lowest Amount In that Range Dr. Mimi Alciatore 38 Accounting For Contingent Losses Example: If the Firm Has an Obligation to Remediate (Clean Up) A Given Area, And It Estimates the Remediation Could Cost Between $2 Million and $4 Million, It Would Record a Liability of $2 Million. Dr. Mimi Alciatore 39 13 2/21/10 Accounting for Contingent Gains: More Conservative than for Losses Contingent Gain Probability of Occurrence High Reasonable Remote Accounting Treatment Disclose Ignore Ignore Long-Term Liabilities: Debt   Long-Term Notes Payable, Bonds Payable  Valued at the Present Value of the Required Payments Using the Interest Rate For the Debt when it was Issued. Dr. Mimi Alciatore 41 Other Long-Term Liabilities   Under-Funded Pension Plans   Non-Pension Post-Retirement Benefits (such as Medical)   Environmental Liabilities Dr. Mimi Alciatore 42 14 2/21/10 Alciatore, Dee and Easton (2004) Study   34 Publicly Traded U.S. Oil & Gas Firms   Examined 1998 and 1989 Form 10-Ks and Annual Reports   Market Value of Firms Ranged from $187 Million to $178 Billion, with an Average Size of $13 Billion Dr. Mimi Alciatore 43 Remediation Liabilities Average (Median) Remediation Liability in 1998 was 21% (13%) of the Total of: Dismantlement & Remediation Obligations, Capital and Operating Environmental Costs Dr. Mimi Alciatore 44 Dismantlement Obligations The Average Dismantlement Liability In 1998 was $475 million - - - 5.3% of total liabilities versus 2.4% for remediation liabilities Dr. Mimi Alciatore 45 15 2/21/10 Dismantlement Obligations The Median Dismantlement Amount Was 5.5% of Liabilities -- Five Times the Size of the Median Remediation Liability Dr. Mimi Alciatore 46 Environmental Capital Expenditures 1998 Environmental Capital Expenditures Averaged about 4% of Firms’ Total Capital Expenditures for the year Dr. Mimi Alciatore 47 Environmental Operating Expenditures / Expenses  The average amounts for environmental operating costs were Triple that of Environmental Capital Expenditures  The Maximum Amount in 1998 was Nearly $900 million Dr. Mimi Alciatore 48 16 2/21/10 Environmental Operating Expenditures / Expenses  On average, environmental operating expenditures Represented 1.4% of Total Revenues in 1998  Earnings divided by total revenue (return on sales or profit margin) for our Firms for 1993-1997 Averaged 5.2% Dr. Mimi Alciatore 49 Environmental Operating Expenditures / Expenses   Return on Sales Without the Environmental Operating Expenditures Would Have Been 6.6%   That Decreases the Return on Sales by 21% Dr. Mimi Alciatore 50 Bonds and Leases 17 2/21/10 4 Basic Time Value of Money Problems Future Value (FV) of a Single Cash Flow Ex. 1: FV of $1 at 10% for 1 Period = $1 x Cash Flow 1.10 FV Multiplier = $1.10 Ex. 2: Invest $10,000 at 10% Annual Rate Compounded Annually for 3 Years Future Value of $10,000 at 10% Rate for 3 Years Day 1 Balance in Account Interest for 1st Year Balance at End of 1st Year Interest for 2nd Year (11,000 x 10%) Balance at End of 2nd Year Interest for 3rd Year (12,100 x 10%) Balance at End of 3rd Year $10,000 1,000 11,000 1,100 12,100 1,210 $13,310 Using a Future Value of $1 Multiplier from Appendix A in Back of Text: $10,000 x Cash Flow 1.331 = $13, 310 FV Multiplier for 3 Periods, 10% The FV Multiplier is Calculated as : (1 +.10) (1 +.10) (1 +.10) = (1 +.10) 3 = 1.331 This Multiplier is for $1. For $10,000, Multiply by 10,000 18 2/21/10 Present Value of a Single Cash Flow Ex. 1: PV of $1.10 One Year from now at 10% = $1.00 $1.10 Cash Flow x 0.90909 PV Multiplier = $1.00 PV Multiplier Is Calculated as : 1 (1 + .10) If the future value of $1 is: $1 (PV) x (1 + .10) = $1.10 (FV) The PV of $1.10 Is: $1.10 (FV) x 1 = $1 (1 +.10) (PV) An "Annuity"   Specified Number of EQUAL Cash Flows, Occurring One Interest Period Apart   Examples of Types of Annuities: 1. Semi-annual Bond Coupon (Interest) Payments 2. Annual payments to Lottery Winners 3. Annual Lease Payments 4. Monthly Retirement Payments Terminology 1. An "Annuity in Arrears" or an "Ordinary Annuity" Is an Annuity with Payments at the End of each Period. $10,000 / 10,000 / 10,000 / Timeline 0 Now 1 2 3 2.  An "Annuity in Advance" or an "Annuity Due” Is an Annuity with Payments Made at the Beginning of Each Period (like Rent). 19 2/21/10 FV of Ordinary Annuity of 3 $10,000 Cash Flows at 10% Rate Compounded Annually Day 1 (Now) Interest for 1st Year First Cash Flow Balance at end of 1st Year 10% Interest for 2nd Year Second Cash Flow Balance at end of 2nd Year 10% Interest for 3rd Year Third Cash Flow $ 0 0 10,000 10,000 1,000 10,000 21,000 2,100 10,000 Balance at end of 3rd Year $ 33,100 Future Value of Annuity of 3 $10,000 Cash Flows at 10% Rate Compounded Annually Future Value = $10,000 Amount of Repeating Cash Flow x 3.31 = $33,100 ↓ Multiplier (Table 4, A-3 Easton) 3 Periods, 10% The Number of Periods in the Annuity Tables Equals the Number of Annuity Cash Flows NOTE:   When Using the Tables, Adjust the Interest Rate to the Interest Period   For a 12% Annual Rate for 5 Years Compounded Quarterly Use 3% & 20 Periods   For a 12% Annual Rate for 5 Years Compounded Monthly, Use 1% & 60 periods 20 2/21/10 Present Value of Ordinary Annuity of 2 $10,000 Cash Flows at 10% Rate Present Value = $10,000 x 1.73554 ~ $17,355 ↓ Amount of Multiplier Repeating (Table 2, A-2 Easton) Cash Flow 2 Periods, 10% $10,000 PV $17,355 / 1 10,000 / 2 Present Value of Ordinary Annuity of Two $10,000 Cash Flows at 10% Rate Check: Car Loan: Date of Purchase $17,355 Interest for 1st Year at 10% Balance Owe by End of 1st Year Make First Payment Balance at End of 1st Year 10% Interest for 2nd Year Balance Owe by End of 2nd Year Balance Owe at End of 2nd Year + 1,736 19,091 - 10,000 9,091 + 909 10,000 Make Second Payment - 10,000 0 Long-Term Liabilities: Debt  Long-Term Notes Payable  Bonds Payable  Valued at the Present Value of the Required Payments Using the Interest Rate For the Debt when it was Issued. Dr. Mimi Alciatore 63 21 2/21/10 Long-Term Liabilities: Debt 
 ♦  Capital Leases: ♦  Record an Asset (“Leasehold”) & ♦ A Lease Liability ♦  If any of the following are Met: Dr. Mimi Alciatore 64 Capital Leases 
 1.  The Lease Extends for at Least 75% of the Asset's Life 2.  It Transfers Ownership to Lessee at End of Lease Term Dr. Mimi Alciatore 65 Capital Leases 
 3.  A Bargain Purchase Option Exists 4.  The Present Value of the Lease Payments Equals or Exceeds 90% of the Asset’s Fair Market Value Dr. Mimi Alciatore 66 22 2/21/10 Operating Leases  Do Not Record a Liability  Record Lease Payments as Rent Expense Dr. Mimi Alciatore 67 Other Long ­Term LiabiliMes   Under ­Funded Pension Plans   Non ­Pension Post ­ReMrement Benefits (such as Medical)   Environmental LiabiliMes Dr. Mimi Alciatore 68 Leases Wall Street Journal July 2006: “AccounMng Bodies on both sides of the AtlanMc are expected tomorrow to begin a formal overhaul of rules on leases, potenMally forcing companies to recognize billions of dollars in liabiliMes currently kept off their books.” Dr. Mimi Alciatore 69 23 2/21/10 Leases The joint effort by the FASB in the U.S. & the InternaMonal AccounMng Standards Board in London to Create New rules for Leases comes aDer….. Dr. Mimi Alciatore 70 Leases The SEC Called last year for a revamp in a report criMcal of off ­the ­books arrangements like those that were instrumental in The implosion of Enron Corp Dr. Mimi Alciatore 71 Leases Today's lease accounMng lets firms in the Standard & Poor's 500 ­stock Index, for example, keep about $400 billion in liabiliMes off their books, according to Credit Suisse research. Dr. Mimi Alciatore 72 24 2/21/10 Leasing Is Also Big Business While a large porMon of leases relate to real estate, equipment leasing is a more than $200 billion ­a ­year industry In the U.S., according to the Equipment Leasing AssociaMon, an industry group. Dr. Mimi Alciatore 73 Leases: Wall Street Journal July 2006 Among S&P 500 companies, More than 90% of leases have Been Kept off balance sheets, said David Zion, an accounMng analyst at Credit Suisse Dr. Mimi Alciatore 74 In re ­examining lease rules, FASB is planning to put aside the idea of who is effecMvely taking ownership of a leased asset, said Robert Herz, the board's chairman. Instead, the board will Likely look at ways to account for the Right to Use An Asset. Dr. Mimi Alciatore 75 25 2/21/10 Leases: Wall Street Journal July 2006 “We’re going to look at the Lease Terms & Account for Those,” Mr. Herz said. "We're not going to ask people, “Who should have the equipment on the books?” Dr. Mimi Alciatore 76 IASB: Leases  The aim of the project is to develop a new common approach to lease accounMng that would ensure that all assets and liabiliMes arising under Lease Contracts are  Recognised in the Statement of Financial PosiMon (Balance Sheet). Dr. Mimi Alciatore 77 IASB: Leases   The project was added on the IASB’s agenda in July 2006.   In March 2009 the IASB issued a Discussion Paper on Lease AccounMng jointly with the FASB.   The discussion paper is open for public comment unMl 17 July 2009. Dr. Mimi Alciatore 78 26 2/21/10 ASSETS Current Assets: Cash and Short ­term Investments $ 19,784 Accounts Receivable 218,361 Inventories 23,954 Other Current Assets 14,572 276,671 Oil and Gas ProperMes 5,027,312 Other ProperMes 540,342 5,567,654 Accumulated DepreciaMon, DepleMon &AmorMzaMon 1,631,941 ProperMes – Net 3,935,713 Other Assets 235,336 Total Assets $4,447,720 Dr. Mimi Alciatore 79 BURLINGTON RESOURCES INC. CONSOLIDATED BALANCE SHEET DECEMBER 31, 1993 (IN THOUSANDS) LIABILITIES Current LiabiliMes: Accounts Payable $ 202,565 Taxes Payable 58,372 Other Current LiabiliMes 38,680 299,617 Long ­term Debt 819,071 Deferred Income Taxes 566,758 Other LiabiliMes and Deferred Credits 154,216 STOCKHOLDERS' EQUITY Common Stock, Par Value $.01 Per Share (Authorized 325,000,000 Shares; Issued 150,000,000 Shares) 1,500 Paid ­in Capital 2,936,934 Retained Earnings 467,667 3,406,101 Cost of Treasury Stock (1993, 20,316,521 Shares) 798,043 Common Stockholders' Equity 2,608,058 Total LiabiliMes & Common Stockholders' Equity $4,447,720 Dr. Mimi Alciatore 80 27 ...
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