Exam 2 Study Guide - MGMT 200 (Financial Accounting)
Exam 2 Study Guide - MGMT 200 (Financial Accounting) MGMT 200
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This 26 page Study Guide was uploaded by boilermaker2016 on Thursday March 3, 2016. The Study Guide belongs to MGMT 200 at Purdue University taught by Kimberly Fatten in Summer 2015. Since its upload, it has received 50 views. For similar materials see Introductory Accounting in Economcs at Purdue University.
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MGMT 200 Exam 2 Study Guide CHAPTER 5 – Receivables and Sales Credit Sales • Transfer products and services to a customer today and collecting payment in the future • Also known as sales on account or services on account • Common for large business transactions Accounts Receivable • Cash owed to the company by its customers from sales on account • Recorded at the time of the credit sale • Also called trade receivables Recording of Credit Sales • Link’s Dental charges $500 for teeth whitening. Dee Kay decides to have her teeth whitened on March 1 but doesn’t pay cash at the time of service. She promises to pay the $500 whitening fee to Link by March 31. • No written document, just an invoice after the service that tells Dee Kay to pay $500. Net Revenues or Net Sales • Net Revenues/Net Sales • A company’s total revenues less any discounts, returns, and allowances • Also referred to as net sales Net Revenues = Sales – Sales Discounts – Sales Returns and Allowances Income Statement Presentation Brody Co Income Statement For the Year Ended Dec. 31, 2015 Sales or Revenues $1,000,000 Less: Sales Discounts 2,500 Less: Sales Returns & Allowances 7,500 Net Sales or Net Revenues $ 990,000 Trade Discount • Reduced from the list price of a product or service • Not recognized directly • Nothing “extra” in the journal entry • We put our product on sale before a customer ever offers to buy it • We just record the smaller price because that is what we charged (Not) Recording Trade Discount • Link’s Dental, which typically charges $500 for teeth whi tening. Assume that in order to entice more customers, Dr. Link offers a 20% discount on teeth whitening to any of his regular patients. MGMT 200 Exam 2 Study Guide Sales Returns and Allowances • Sales Return o Seller issues a full refund o Customer returns the product • Sales Allowances o Seller reduces the customer’s balance owed partially o Customer does not return the product § We reduce the price to keep a good customer Recording Sales Allowances • Dee notifies Dr. Link that another dentist is offering the same procedure for $350 • Dr. Link reduces Dee’s account balance by $50 Estimating Uncollectible Accounts • Percentage-of-receivables method • Based on the percentage of receivables expected not to be collected • Also called the Balance Sheet method (because receivables are on the Balance Sheet!) • Balance sheet accounts are permanent • When we make the estimate, we include the existing balance of the uncollectable accounts • Percentage-of-credit-sales method • Based on a percentage of net credit sales expected not to be collected • Also called the Income St atement method (because sales are on the income statement!) • Income statement accounts are temporary • When we make the estimate, we do NOT include the existing balance of uncollectable accounts But why? • Balance sheet accounts (like Accounts Receivable) are p ermanent • When we make our estimate, each time we are considering accounts that may have been included in the previous estimate • So some old accounts may have been included in the last estimate we did and are still in the Allowance account • So we have to include the old Allowance account amount! • Income Statement accounts (like Sales) are temporary • Each year, when we make our estimate, we are looking at totally new accounts because we CLOSE income statement accounts • So anything still remaining in the Allowance account belonged to accounts from a previous period, we can ignore them when making our new estimate Estimating Uncollectible Accounts • Bad Debt Expense: uncollectible accounts expense or provision for doubtful accounts MGMT 200 Exam 2 Study Guide • Takes the estimate directly to the in come statement • Allowance For Uncollectible Accounts : contra asset account representing the amount of accounts receivable that we do not expect to collect • Shows our A/R at its net realizable value Aging of Accounts Receivable • More accurate than using single percentage • Considers the age of receivables • Using a higher percentage for older accounts • The percentages will be given to you on the exam • The longer a customer has gone without paying his/her account the less likely it will be that it gets paid. Accounts Receivable Aging Schedule Writing Off Accounts Receivable Entry is our best ESTIMATE (we know there are bad debts, but we don’t know which customers yet) ▯ Estimate Entry: Debit: Bad Debt Expense Credit: Allowance for Uncollectable Accounts Write Off Entry (we have identified a specific customer, get them off our books!) • Write-off has no effect on total amounts reported • Negative effects (reduction of Net Income) recorded with estimate Write-Off Entry: Debit: Allowance for Uncollectable Accounts Credit: Accounts Receivable Direct Write-Off Method • Records bad debt expense when uncollectible account is known • Used: • When uncollectible accounts are not anticipated or are immaterial (we have one or two small accounts receivable, everyone else pays cash) • When it’s not possible to reliably estimate uncollectible accounts (new companies) • For tax purposes only Notes Receivable • Similar to accounts receivable but are more formal • Evidenced by a written debt instrument, or note • Classified as either current or no ncurrent asset MGMT 200 Exam 2 Study Guide Recording Notes Receivable • Kimzey provided $10,000 of services to Justin Payne, who is not able to pay immediately Recording Notes Receivable • Kimzey provided $10,000 of services to Justin Payne and recorded it as a typical account receivable • Later, Justin discovers he won’t be able to pay quickly and Kimzey requires Justin signs a six - month, 12% promissory note Interest Calculation • Kimzey issued a $10,000 six-month, 12% promissory note Collection of Notes Receivable & Accrued Interest • What happens when the time period goes over the end of the accounting period? Accrued Interest • We make the adjusting entry to recognize the revenue in the period it was earned • Corrects our income statement and balance sheet MGMT 200 Exam 2 Study Guide Percentage-of-Credit-Sales Method • Estimates uncollectible accounts based on the percentage of credit sales • Income statement method – sales are on the income statement • Records allowance for doubtful accounts • But we don’t care about the existing balance , the previous estimate was on last period’s net credit sales and those sales where closed during the closing process (Revenues are a temporary account) AR vs Net Credit Sales BAP Corporation has a $1,000 credit balance in their Allowance for Uncollectable Accounts account. Using the Aging of Accounts Receivable Method, they come up with $15,000 in their estimate of uncollectable accounts, recorded as follows Debit: Bad Debt Expense $14,000 Credit: Allowance for Uncollectable Accounts $14,000 The total balance in the Al lowance account is now $15,000, because some of the $1,000 still there could be accounts we have already included in our estimate Using the Percentage of Net Credit Sales method they come up with an $15,000 in their estimate of uncollectable accounts Debit: Bad Debt Expense $15,000 Credit: Allowance for Uncollectable Accounts $15,000 The total balance in the Allowance account is now $16,000 because we are estimating only on this year’s accounts. The $1,000 is from last year and should still be included CHAPTER 6 – Inventory and Cost of Goods Sold Inventory • Includes items a company intends for sale to customers • Also includes items that are not yet finished products • Reported as a current asset • Cost of Goods Available for Sale: Cost of everything that we made that is finished and can be sold to customers • Cost of goods sold: Cost of the inventory that is sold during the period • Ending Inventory: Everything we fully produced but did not sell by the end of the period. • All of our finished goods ( Goods Available for Sale) are either Cost of Goods Sold (units sold to customers) or Ending Inventory (units we have that are unsold Illustration 6.4—Multiple-Step Income Statement MGMT 200 Exam 2 Study Guide Inventory Cost Methods • Specific identification – car dealerships • Each inventory item may have a different cost and is specifically tracked • First-in, first-out (FIFO) • CGS is made up from the FIRST items available, beginning inventory is the first products sold • Cans of Chicken Noodle Soup at the grocery store • Last-in, first-out (LIFO) • CGS is made up from the LAST items available, the last items we made were the first products sold • Six ton aluminum ingots • Weighted-average cost • CGS & EI are an AVERAGE of what came in • Total the costs, total the item numbers and divide Weighted-Average Cost • Under this method, we assume: • Both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale • Each unit of inventory has a cost equal to the weighted -average unit cost of all inventory items • Calculated as: • Cost of Goods available for sale / Number of units available for sale Example p. 272-273 NASCAR Unlimited sells remote -controlled cars. For 2015, the company has the following beginning inventory and purchases: The company sold a total of 280 units and had 20 units at the end of the period. WAC per Unit = Cost/Number = $5,100 / 300 = $17 Cost of Goods Sold = $17*280 units sold = $4,760 MGMT 200 Exam 2 Study Guide Ending Inventory = $17 * 20 units in EI = $340 First-In First Out • FIFO method • Matches physical flow for most com panies • Ending inventory reflects today’s costs • Balance-sheet approach Look at products sold for the period and use: 1. Costs for beginning inventory first 2. Then the earlier purchases 3. Ending inventory has the latest purchase costs Example p. 272-273 NASCAR Unlimited sells remote-controlled cars. For 2015, the company has the following beginning inventory and purchases: The company sold a total of 280 units and had 20 units at the end of the period. FIFO CGS: 280 sold = 120@ $20 = $2400 (Jan 1) + 160@ $15 = $2,400(Aug 15) = $4,800 FIFO EI: all 20 are from Aug 15, 20 units * $15 unit cost = $300 Last-In First Out • LIFO method • Cost of goods sold reflects today’s costs • Income-statement approach • LIFO conformity rule: requires companies that use LIFO for tax reporting must also use LIFO for financial reporting Look at products sold for the period and use: 1. Use the cost of last purchase first, 2. Work your way backward through the period 3. Ending inventory has the EARLIEST costs in it Example p. 272-273 NASCAR Unlimited sells remote-controlled cars. For 2015, the company has the following beginning inventory and purchases: MGMT 200 Exam 2 Study Guide The company sold a total of 280 units and had 20 units at the end of the period. LIFO CGS: 280 sold = 180 units @ $15 = $2,700 (Aug 15) + 100 units @ $20 = $2,000( Jan 1) = $4,700 Cost of Goods Sold LIFO EI: all 20 are from Jan 1st, 20 units * $20 cost per unit = $400 Inventory Summary Sample Problem • As our product costs decrease when we purchase inventory our inventory methods gave us the following costs: As our product costs increase when we purchase them, our inventory methods would give us the opposite result (higher EI with FIFO, higher CGS with LIFO) Perpetual Inventory System and Periodic Inventory System Purchase of Inventory: Perpetual System On April 25 Mario purchased inventory on account, $9 per unit, 300 units: April 25 Inventory $2,700 Accounts Payable $2,700 To record purchase of inventory on account Inventory is adjusted with a journal entry every time we receive new items to sell or sell items! Sales of Goods: Perpetual System On July 17 , sold 300 units of inventory on account for $15 each (Mario uses FIFO). th July 17 Accounts Receivable $4,500 Sales Revenue $4,500 To record Sale of 300 units on Account ( 300 units * $15 sale price per unit) AND MGMT 200 Exam 2 Study Guide Cost of Goods Sold $2,500 Inventory $2,500 To record cost of inventory sold (100 units at $7 per unit and 200 units at $9 per unit) Periodic Inventory System • Does not continually modify inventory amounts • Use “Purchases” and just track Sales • Periodically adjust for purchases and sales of inventory • At the end of the reporting period • Based on a physical count of inventory on hand • We DO NOT make regular entries to Inventory • Inventory is only debited or credited based on the physical count Inventory Purchases and Sales Side-by-Side Comparisons Between the Perpetual System and Periodic System • Purchase inventory on account • Sell inventory on account Freight Charges, Purchase Discounts and Returns side-by-side Comparisons Between the Perpetual System and Periodic System • Pay freight-in charges • Pay on account with a 2% purchase discount of $54; Return inventory previously purchased on account Period-End Adjustment • Needed only under the periodic system Illustration 6.15—Shipping Terms MGMT 200 Exam 2 Study Guide Lower-of-Cost-or-Market (LCM) Method • Reports inventory in the balance sheet at the lower of cost or market value • Replacement cost • Cost to replace an inventory item in its identical form Il. 6.20—Calculating the Lower-of-Cost-or-Market Gross Profit Ratio • Indicator of the company’s successful management of inventory • Measures the amount by which the sale price of inventory exceeds its cost per dollar of sales • Gross Profit Ratio = Gross profit / Net sales Illustration 6.26—Effects in the Current Year • Ending Inventory – effect on Balance Sheet • CGS – effect on the income statement, which ripples all the way through to Net Income Illustration 6.27—Effects in the Next Year • If we misstate EI in Year 1, our Beginning Inventory is m isstated in Year 2 • Everything is off in Year 2 in reverse! YEAR 1 MGMT 200 Exam 2 Study Guide YEAR 2 Inventory Error Ending Inventory Cost of Goods Sold Gross Profit Overstate EI in Year 1 Correct Count Y2 Overstate Y2 Unde rstate Y2 Understate EI in Year 1 Correct Count Y2Understate Y2 Overstate Y2 CHAPTER 7 Long-Term Assets Property, Plant, and Equipment • Capitalize: recording an expenditure as an asset • Recorded at: • Cost of Asset + All expenditures necessary to get it ready for use • Includes commissions paid, delivery charges and sales tax • Includes property taxes in arrears (not current!) set up, testing, demolition, sale of salvaged material (but that reduces the cost!)! Basket Purchases—Example • Purchase of more than one asset for one purchase price • Allocate total purchase price based on individual fair values Types of Cost Allocation • Depreciation: the allocation of the cost of a tangible asset over its service life • Land is never depreciated • Land Improvements (landscaping, fences), Buildings, Equipment are Property, Plant & Equipment that is depreciated • Amortization: the allocation of the cost of an intangible asset over its useful life • Internal vs Acquired, Patents, Copyrights, Trademarks, Franchises, Goodwill • Depletion: allocation of the cost of a natural resource over its service life • Coal, oil, copper, gold, timber Expenditures After Acquisition • Repairs and maintenance • Additions • Improvements MGMT 200 Exam 2 Study Guide • Legal defense of intangible assets • Capitalize à If it increases future benefits • Expense à If it benefits only the current period Common Terms • Accumulated depreciation: contra asset account to record the total depreciation taken to date • Book value: Original Cost – Current balance in accumulated depreciation • Service life: how long the company expects to receive benefits from the asset before disposing of it • Residual value: salvage value or the amount the company expects to receive from selling the asset at the end of its service life Three Types of Depreciation • Straight Line Depreciation • Declining Balance • Units of Production (Activity-Based Depreciation) Little King Sandwich Delivery Truck • Our Company bought a heavy-duty truck costing $40,000 in 2015. At the end of its service life, we can probably sell it for $5,000. We think we can drive the truck a total of 100,000 miles over its service life. It costs $450 twice a year to change the oil and $800 once per year to put new tires on the truck. We drove the truck 30,000 miles in 2015 and 22,000 miles in 2016. Calculating Depreciation Under Straight-line method Calculating Depreciation Under Declining-Balance Method Calculating Depreciation Under Activity-Based Method MGMT 200 Exam 2 Study Guide DO NOT DEPRECIATE BELOW RESIDUAL (SALVAGE) VALUE USING ANY DEPRECIATION METHOD Amortization of Intangible Assets • Allocating the cost of intangible assets to expense is called amortization • Intangible assets include patents, trademarks, copyright, goodwill • Remember with goodwill, it’s only PURCHASED goodwill • Every other intangible is internally developed OR purchased • Do not amortize if the asset has an indefinite useful life • Trademarks & Goodwill Amortization Example LKS acquires franchise rights from UH for $800,000. The franchise agreement is for a period of 20 years. LKS also purchases a patent on a special process for $72,000 that had an original legal life of 20 years and there are 12 years remaining. Due to rapid technological advancements, the company estimates the useful life is only 9 more years. Three Methods of Asset Disposal • Sale – Can result in either a gain or a loss • Retirement – Occurs when a long-term asset is no longer useful but cannot be sold • Exchange – Occurs when two companies trade assets Sale of Long-Term Assets—Gain MGMT 200 Exam 2 Study Guide Retirement of Long-Term Assets—Loss Return on Assets • Indicates the amount of net income generated for each dollar invested in assets • Profit margin: indicates the earnings per dollar of sales • Asset turnover: measures the sales per dollar of assets invested CHAPTER 8 – Current Liabilities Current Liabilities • Liability: a present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past • Current Liability - we will have to fulfill that responsibility within 1 year or 1 operating cycle (usually 1 year) • Long-Term Liabilities – will be payable MORE than one year or operating cycle in the future • They are shown separately on the Balance Sheet Payroll Liabilities • A company will have three types of liabilities • Taxes & Benefits withheld from an employ ees’ salaries and wages • Taxes paid by the company • Benefits paid by the company #1 Withheld from the Employee (Individual) • Federal Income Taxes • State Income Taxes • FICA (7.65%) Taxes • Employee’s share of benefits • Health Insurance • Retirement Contributions • The employee earned his/her gross wages, and these amounts are withheld from those wages by the company and paid to the appropriate entities (state & federal government, insurance companies, investment companies) #2 Taxes on the Employer (Company) MGMT 200 Exam 2 Study Guide • ADDITIONAL FICA (7.65%) • Half is withheld from the employees’ earnings (7.65%) • Half is taxed to the company (7.65%) • Federal & State Unemployment Taxes • FUTA & SUTA (percentages vary by company) #3 Benefits Paid by the Employer (Company) • Benefits paid by the Company on b ehalf of the employee • Part or all of their health insurance • Retirement match • Other benefits (known as “fringe benefits”) Illustration 8.4—Payroll Example • Hawaiian Travel Agency has a total payroll for the month of January of $100,000 for its 20 th employees. The payment for payroll will be made on Feb 15 . Withholdings are shown below: #1 Withheld from the Employee #2 Taxes on the Employer • Record the Employer (Company) Payroll Taxes • Employer’s share of FICA • Applicable FUTA & SUTA #3 Benefits Paid by the Employer • Record the employer (company) provided fringe benefits given in the problem (Health Ins premiums to Blue Cross of $5,000) and the company contribution to the employees’ retirement plan of $10,000): Notes Payable • Note signed by a firm promising to repay the amount borrowed plus interest • Interest on notes is calculated as: • Interest = Face Value x Annual interest rate x Fraction of the year Notes Payable • Southwest Airlines borrows $100,000 from Bank of America on September 1, 2015, signing a 6%, six-month note for the amount borrowed plus accrued interest due six months later on March 1, 2016. On September 1, 2015, Southwest will receive $100,000 in cash and record this entry MGMT 200 Exam 2 Study Guide Accruing Interest at Year End • Just like with Notes Receivable, we need to accrue the amount that we owe at the end of the year so that our balance sheet and income statement have the appropriate amounts Repayment of the Note Payable • On March 1 , when Southwest repays the note, they have completely cleared their obligation to Bank of America. We must take everything off of our books related to the note when we make payment. • Note: The $2,000 Interest Expense from the Year End Accrual was closed when we did the closing entries in December. Only the Payable remains, so we m ust remove it when we make the payment. Line of Credit & Commercial Paper • Line of credit: • Informal agreement • Permits a company to borrow up to a prearranged limit • No formal loan procedures and paperwork • Commercial paper: • Company borrows from another compan y rather than from a bank • Sold with maturities normally ranging from 30 to 270 days • Interest rate is usually lower than on a bank loan Accounts Payable • Amounts owed to suppliers of merchandise or services • Sometimes called trade accounts payable Other Current Liabilities • Unearned revenues: liability account used to record cash received in advance of the sale or service • Sales tax payable: collected from customers by the seller • Current portion of long-term debt: debt that will be paid within the next year • Debt that will be paid within the next year • Provides information about a company’s bankruptcy risk • Separate out the current portion of long-term debt on the balance sheet • The remainder is reported as a Long-Term Liability (Chapter 9) Illustration 8.6—Current Portion of▯Long-Term Debt MGMT 200 Exam 2 Study Guide Illustration 8.8—Accounting Treatment of Contingent Liabilities • Contingency: An existing uncertain situation that might result in a loss • If the estimate of the loss is a range, record the low amount of the range and disclose t he rest of the range in the notes to financial statement • Gain contingencies • Sometimes disclosed when the gain is certain • Not recorded with a journal entry – disclosed in the notes to the financials Warranties • An example of a contingent liability • Helps a company increase sales – gives some assurance about the product • Warranty expense is recorded in the same accounting period as the sale • It should be probable and the amount can be reasonably estimated Record the Warranty Expense • Assume Dell introduces a new laptop computer in December that carries a one-year warranty against manufacturer’s defects. Based on industry experience with similar product introductions, Dell expects warranty costs will be an amount equal to approximately 3% of sales. New laptop sales for the month of December are $1.5 million. • Record the warranty expense (done in the month of sale) Record Customer Claims on the Warranty • If customers make claims costing $12,000 in December, we record the warranty expenditures as shown in this entry: Liquidity Analysis MGMT 200 Exam 2 Study Guide • Liquidity: refers to having sufficient cash or other current assets to pay currently maturing debts • Lack of liquidity can result in financial difficulties or even bankruptcy • Three liquidity measures: • Working capital (Current Assets minus Current Liabilities) • Current ratio (Current Assets divided by Current Liabilities) • Acid-test ratio (Cash+Current Investments+Accounts Recivable divided by Current Liabilities) Liquidity Management • Management can influence the ratios that measure liquidity • Debt covenant: agreement between a borrower and a lender that requires certain minimum financial measures be met or the lender can r ecall the debt • (Chapter 9 Preview) This is why companies might incur a loss on early extinguishment of debt • If they are out of compliance (or going to be out of compliance) with their debt covenants, they may wish to retire (pay off) a bond issue so that they can continue to meet (or qualify for new debt financing) the debt covenants with their lenders CHAPTER 9 – Long-Term Liabilities Financing Alternatives • Capital structure: mixture of liabilities and stockholders’ equity a business uses • Debt financing: borrowing money • Equity financing: obtaining additional investment from stockholders What Are Bonds? • Formal debt instrument • Usually issued to many lenders, corporate or individual • Borrower repays the principal or face amount, at a specified maturity date and pays interest over the life of the bond • Private placement: selling debt securities directly to a single investor Illustration 9.1—Summary of Bond Characteristics Illustration 9.2—Timeline of a Bond Issue Illustration 9.5—Pricing Bonds Issued at Face Amount (Issued at PAR) Using Present Value Tables MGMT 200 Exam 2 Study Guide Recording Bonds Payable—Issued at Face Value • Bonds issue for exactly $100,000, assuming a 7% market interest rate • First semiannual interest payment: Bonds Issuing At A Premium or Discount • The market rate for bonds similar to our bonds may change over time • If the Market Rate is LOWER than the stated rate on the bond • Our bond will issue at a PREMIUM. We can get more money for our bond because it has a better interest rate than the market • Investors are essentially pre-paying some of the extra interest they are getting back • If the Market Rate is HIGHER than the stated rate on the bond • Our bond will issue at a DISCOUNT so that our bon d is competitive with the other bonds • We are essentially giving our investors a little bit more interest up front by lowering the price of the bond Example Premium Problem • $100,000 Bond Issue (Face Amount is $100,000) • The Stated Rate on the bond is 9%, pays interest semiannually • The Market Rate is 8% - so the rate being paid in the market for similar bonds is LESS than our 9% bond is paying. • Our bond will sell for more; it will sell at a PREMIUM Calculating the Issue Price – Bond Sells at a PREMIUM • We use the market interest rate to find the price of a bond • Face Amount: $100,000 * PV factor at 20 periods (10 * 2 interest payments), 4% (8% market rate / 2 interest payments) • $100,000 * 0.45639 = $45,639 • Interest Payment Amount: $4,500 * PV Annuity factor at 20 periods and 4% • $4,500 * 13.59033 = $61,156 • Bond Issue Price = $45,639 + 61,156 = $106,795 Our bond interest rate is HIGHER than the market rate so we are able to issue it at a HIGHER price Bond Amortization Tables MGMT 200 Exam 2 Study Guide Recording Bonds Issued @ Premium • On the issue date: 1/1 Cash $106,795 Bonds Payable $106,795 • First Interest Payment 6/30 Interest Expense $ 4,272 Bonds Payable 228 Cash $4,500 • The Second Interest Payment would look just like the first ones, but with the amounts from the 2 payment on the amortization table (see previous slide Example Discount Problem • $100,000 Bond Issue (Face Amount is $100,000) • The Stated Rate on the bond is 9%, pays interest semiannually • The Market Rate is 10% - so the rate being paid in the market for similar bonds is MORE than our 9% bond is paying. • Our bond will sell for less; it will sell at a DISCOUNT Calculating the Issue Price – Bond Sells at a DISCOUNT • We use the market interest rate to find the price of a bond • Face Amount: $100,000 * PV factor at 20 periods (10 * 2 interest payments), 5% (10% market rate / 2 interest payments) • $100,000 * 0.37689 = $37,689 • Interest Payment Amount: $4,500 * PV Annuity factor at 20 periods and 5% • $4,500 * 12.46221 = $56,080 • Bond Issue Price = $37,689 + 56,080 = $93,769 • Our bond interest rate is LOWER than the market rate so we are able to issue it at a LOWER price Bond Amortization Tables MGMT 200 Exam 2 Study Guide Recording Bonds Issued @ Discount • On the Issue Date 1/1 Cash $93,769 Bonds Payable $93,769 • First Interest Payment 6/30Interest Expense $ 4,688 Bonds Payable $ 188 Cash 4,500 Illustration 9.15—Changes in Carrying Value over Time Recording Bond Retirements—At Maturity • Retired: buy back of bonds from the investors • By the time the bonds mature, any premium or discount has been completely amortized and Bonds Payable equals maturity value Installment Notes • Requires installment payments • Installment payment: payment includes interest and outstanding balance • Car loans • Home mortgages • Example: $25,000 installment note at 6% interest with monthly payments of $587.13 Illustration 9.16—Amortization Schedule for an Installment Note MGMT 200 Exam 2 Study Guide Recording Installment Payments of Note • For first two months Leases • Contractual arrangement between lessor (owner) and lessee (user) to provide the right to use an asset for a specified period of time • PLEASE NOTE: FASB has issued Proposed Accounting Standards that GREATLY change accounting for Leases in the US. Final standard expected to be issued in Q4 of 2015. • For now, know there are two types of leases: • Operating leases: lessor owns the asset, and the lessee simply uses the asset temporarily (renting from Enterprise Rent -a-Car) • Capital leases: lessee buys an asset and borrows the money through a lease to pay for the asset (financing the purchase, leasing a car through Ford Motor Credit) Debt Analysis • Business decisions include risk • Failure to properly consider risk could prove costly • Long-term debt management is crucial • Measuring a company’s risk: • Debt to equity ratio • Measures financial leverage • = Total Liabilities / Stockholder ’s equity • Times interest earned ratio • Compares interest expense with the income available to pay interest • = Net Income + Interest Expense + Tax Expense / Interest Expense Appendix C – Time Value of Money Time Value of Money • Decrease in value of money due to passage of time • $1 today is worth $1 • $1 ten years from now will not have the buying power of $1 today MGMT 200 Exam 2 Study Guide • Essential in solving many business decisions Simple versus Compound Interest • Simple interest: interest earned on the initial investment only • Compound interest: interest earned on the initial investment and on previous interest Illustration C.1—Calculation of Simple Interest Illustration C.2—Calculation of Compound Interest Using TVM to Solve Problems • Table Recognition • What will we need in some future date? • Future Value • What do we need today for a specific dollar amount (that we know)? • Present value • Am I dealing with one lump -sum dollar amount? • PV or FV of $1 (PV or FV of a Lump Sum) • Am I dealing with a series of equal payments over equal time periods? • PVA or FVA Illustration C.3—Future Value of a Single Amount FV = I(1+i)^n Illustration C.4—Future Value of $1 (excerpt from Table 1) • I have $1000 now, what will it grow to at 10% compounded annually in three years? • $1000 * 1.33100 = $1,331.00 Illustration C.7—Present Value of a Single Amount MGMT 200 Exam 2 Study Guide Illustration C.8—Present Value of $1 (excerpt from Table 2) • I need $1,331.00 three years from now, compounded annually for 3 years. How much do I invest now? • $1,331 * .75131 = $999.99361 or about $1,000 Time Value of an Annuity • Annuity: Cash payments of equal amounts over equal time intervals • Used for a series of receipts and payments of cash • EQUAL Payments or Receipts • EQUAL Time Period Illustration C.11—Future Value of an Annuity Illustration C.12—Future Value of an Annuity of $1 (excerpt from Table 3) • What is the value of $1,000 invested each year for three years, compounded annually at 10%? • $1,000 * 3.31000 = $3,310.00 • REMEMBER! USE THE PAYMENT, NOT THE TOTAL INVESTMENT Illustration C.15—Present Value of an Annuity MGMT 200 Exam 2 Study Guide Illustration C.16—Present Value of an Annuity of $1 (excerpt from Table 4) • What is the value today of three $1,000 pa yments received at the end of each year for 3 years, compounded at 10% • $1,000 * 2.48685 = $2,486.85 = $2487.00 Compounding other than Annually • Annual compounding means we just compound once at the end of the year • Many companies and b anks compound much more often • Semiannually – twice per year • Quarterly – four times per year • Monthly – 12 times per year • Must adjust the tables if we compound other than annually • Divide the interest rate by the number of times per year compounded • Multiply the number of periods times the number of times per year compounded Example Table Adjustment • Jerry has invested $25,000 at 12% interest, compoun ded quarterly. What will the amount of Jerry’s investment be in five years? • Future Value or Present Value? • Future value – we HAVE $25,000 today, what is it worth in 5 years? • Lump Sum or Annuity? • Lump Sum – there is just the one amount, no stream o f equal payments over an equal time period • CAUTION – if you have unequal payments OR an unequal time period – treat the payments/receipts as a LUMP SUM! Illustration C.4—Future Value of $1 MGMT 200 Exam 2 Study Guide Period 1% 2% 3% 4% 1 1.010 1.020 1.030 1.040 2 1.020 1.040 1.061 1.082 3 1.030 1.061 1.093 1.125 4 1.041 1.082 1.126 1.170 5 1.051 1.104 1.159 1.217 6 1.062 1.126 1.194 1.265 7 1.072 1.149 1.230 1.316 8 1.083 1.172 1.267 1.369 9 1.094 1.195 1.305 1.423 10 1.105 1.219 1.344 1.480 11 1.116 1.243 1.384 1.539 12 1.127 1.268 1.426 1.601 13 1.138 1.294 1.469 1.665 14 1.149 1.319 1.513 1.732 15 1.161 1.346 1.558 1.801 16 1.173 1.373 1.605 1.873 17 1.184 1.400 1.653 1.948 18 1.196 1.428 1.702 2.026 19 1.208 1.457 1.754 2.107 20 1.220 1.486 1.806 2.191 Example Table Adjustment • Jerry has invested $25,000 at 12% interest, compounded quarterly. What will the amount of Jerry’s investment be in five years? • $25,000 x 1.806 = $45,150
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