Liability Criteria

• Firm has little discretion to avoid claim.• Event giving rise to claim has already

occurred.• Claim can be valued with reasonable

precision. Results in “off-balance sheet” liabilities

Current Liabilities

• Due within one year.• Valued at the amount payable.• Types:

• Accounts Payable: suppliers• Accrued Expenses: salaries, interest, taxes• Short-term Debt: bank debt, commercial paper• Current maturities of long-term debt• Contingencies: warranties

Present Value

• Long-term Liabilities are valued at the present value of future payments

• PV of $1 = $1/(1+r)n

• r = discount rate• n = time to payment

• Time Value of Money: a dollar today is

worth more than a dollar in the future.

Mortgages Payable

• Borrow at agreed upon interest rate• Principal and interest paid periodically

= fixed cash payment

• Interest Expense = outstanding borrowing x interest rate

• Cash Payment - Interest Expense

= Principal Payment

Bonds Payable

• Borrow from general public: do not agree upon rate in advance of issuance of bonds

Bonds have two interest rates:• Stated (Coupon) rate: fixed issue rate • Effective rate: dynamic market rate

Bonds Payable

• Issued at Par = at face value• Issued at Discount = at less than face value• Issued at Premium = at greater than face

value

Bonds may be issued at amounts other than face value:

Bonds: Par, Premium & Discount

• Premium: When effective rate is below stated rate PV of the bond is greater than face value

• Discount: When effective rate is above stated rate PV of the bond is less than face value

• Par: When effective rate is equal to stated rate PV of the bond is equal to face value

Interest Expense v. Cash Payment: Bonds

• Interest Expense = effective rate x outstanding borrowing

• Cash Payment = stated rate x face value

• Cash Payment - Interest Expense

= reduction in Premium (Discount)