121_08 - LIABILITIES Chapter 8 Time value of money appendix ESTIMATED LIABILITIES Exact amount of expense and liability cannot be determined Show

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LIABILITIES ± Chapter 8 ± Time value of money appendix ESTIMATED LIABILITIES ± Exact amount of expense and liability cannot be determined ± Show all liabilities on balance sheet ± Match expenses to revenue ESTIMATED LIABILITIES “Repair or replace free” warranty offered on all products sold ± Sales $200,000,000 ± Estimated warranty cost: 3% of sales ± Warranty expense $6,000,000 ($200,000,000 x 0.03 = $6,000,000) ESTIMATED LIABILITIES AJE Warranty expense $6,000,000 6,000,000 Warranty payable 6,000,000 Warranty expense 12/31 Credit Debit Description Date Defective items replaced, $5,800,000 5,800,000 Cash (labor and parts) 5,800,000 Warranty payable Credit Debit Description Date ESTIMATED LIABILITIES Warranty Payable Estimated Actual AJE Warranty expense (Estimated) Defective items replaced (Actual) PRACTICE QUESTIONS Question 1, 2
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CONTINGENT LIABILITIES ± A potential liability ± Depends on a future event ± Arising out of past events ± Conservatism principal CONTINGENT LIABILITIES If loss or expense is ± Probable, record on balance sheet ± Possible, record in notes ± Remote, do not disclose INTEREST FORMULA ± Interest rate coupon per period ± Time is number of periods ± Rate and time must be same periods ± Year, semi-annual, quarter, month Interest = Principal × Rate × Time INTEREST ± Compensation to lender ± Use of money ± Risk of default ± To lender, interest revenue ± To borrower, interest expense COMPUTE INTEREST ± Borrow $100,000 ± For 2 months ± Annual interest rate of 12% Interest = Principal × Rate × Time Interest = $100,000 × 12% × 2/12 Interest = $2,000 COMPUTE INTEREST ± Borrow $100,000 ± For 2 months ± Annual interest rate of 12% Interest = Principal × Rate × Time Interest = $100,000 × 1% × 2 Interest = $2,000
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Borrowed cash, issued note on Oct. 1 ± Principal $8,000 ± Interest rate 10% ± Term One year NOTE PAYABLE 8,000 Note payable 8,000 Cash 10/01 Credit Debit Description Date ACCRUE INTEREST At year end AJE to accrue three month’s interest Interest = $8,000 x 0.10 x 3/12 Interest = $200 200 Interest payable 200 Interest expense 12/31 Credit Debit Description Date PAY NOTE AT MATURITY 8,800 Cash 600 Interest expense 200 Interest payable 8,000 Note payable 9/30 Credit Debit Description Date On maturity date accrue nine month’s interest Interest = $8,000 x 0.10 x 9/12 Interest = $600 PRACTICE QUESTIONS Question 3 BUSINESS BACKGROUND Cash to finance assets, operations Debt - funds from creditors Equity - funds from owners FINANCE ASSETS Equity ± Issuing stock ± Retained earnings Debt ± Accounts payable ± Debt securities
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FINANCIAL LEVERAGE Borrow at low rate invest at higher rate If we borrow $1,000,000 at 8% and invest it at 10%, we will clear $20,000 profit each year! ADVANTAGES OF DEBT ± Positive leverage increases profits ± Interest expense < rate of return ± Does not dilute stock ownership ± Increases earning per share ± Interest expense tax deductible DISADVANTAGES OF DEBT ± Risk negative financial leverage ± Interest expense > rate of return ± Payments are legal obligations ± Interest paid each period ± Principal paid on maturity date ± Bankruptcy ± Cannot pay debt obligation when due BONDS VS. STOCKS ± Current net income, $300,000 ±
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This note was uploaded on 10/24/2010 for the course ACCOUNTING 31609 taught by Professor R.ambrose during the Fall '09 term at San Mateo Colleges.

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121_08 - LIABILITIES Chapter 8 Time value of money appendix ESTIMATED LIABILITIES Exact amount of expense and liability cannot be determined Show

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