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Chapter 13: Question 6Q (page 691)

How is present value related to the concept of a liability?

Short Answer

Expert verified

Interest included in payables and receivables, makes us consider future value at their current value. The present value of liability shows the debt, excluding the interest factor.

Step by step solution

01

Definition of Present Value

The present value concept in liability is an estimation of future liability at a discounted rate. It represents the amount that should be invested at present, at a particular rate of interest, to add to a future amount.

02

Relationship between present value and concept of a liability

The present value is calculated to check the fairness of the liabilities that will be availed or to compare the difference between the present value of the investment income and the nominal value of the liability.

The present value method indicates that the value of money today is greater than its future value. An amount that is not invested in an investment today may lose its value in the future due to inflation or the rate of return by applying an annualized rate. Hence, risks and uncertainties; regarding the events and situations should be considered while estimating provision.

Hence, the present value of liability considers the time value of money including interest. If the time value of money is ignored while considering liability then it will actually be wrong as a factor of inflation changes with time. Thus, it is necessary to consider the present value of liabilities.

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Most popular questions from this chapter

(a) Assuming no Fair Value Adjustment account balance at the beginning of the year, prepare the adjusting entry at the end of the year if Laura Company鈥檚 available-for-sale debt securities have a fair value of \(60,000 below cost.

(b) Assume the same information as part (a), except that Laura Company has a debit balance in its Fair Value Adjustment account of \)10,000 at the beginning of the year. Prepare the adjusting entry at year-end.

(Asset Retirement Obligation) Oil Products Company purchases an oil tanker depot on January 1, 2017, at a cost of \(600,000. Oil Products expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost \)75,000 to dismantle the depot and remove the tanks at the end of the depot鈥檚 useful life.

Instructions

  1. Prepare the journal entries to record the depot and the asset retirement obligation for the depot on January 1, 2017. Based on an effective-interest rate of 6%, the present value of the asset retirement obligation on January 1, 2017, is \(41,879.
  2. Prepare any journal entries required for the depot and the asset retirement obligation at December 31, 2017. Oil Products uses straight-line depreciation; the estimated salvage value for the depot is zero.
  3. On December 31, 2026, Oil Products pays a demolition firm to dismantle the depot and remove the tanks at a price of \)80,000. Prepare the journal entry for the settlement of the asset retirement obligation.

Question: On October 15, 2017, Oil Products Co. purchased 4,000 barrels of fuel oil with a cost of

\(240,000 (\)60 per barrel). Oil Products is holding this inventory in anticipation of the winter 2018 heating season. Oil Products

accounts for its inventory at the lower-of-FIFO-cost-or-net realizable value. To hedge against potential declines in the value of

the inventory, Oil Products also purchased a put option on the fuel oil. Oil Products paid an option premium of \(300 for the put

option, which gives Oil Products the option to sell 4,000 barrels of fuel oil at a strike price of \)60 per gallon. The option expires

on March 1, 2018. The following data are available with respect to the values of the fuel of inventory and the put option.

Date Market Price of Fuel Oil Time Value of Put Option

October 31, 2017 \(58 per gallon \)175

November 30, 2017 57 per gallon 105

December 31, 2017 54 per gallon 40

Instructions

(a) Prepare the journal entries of Oil Products for the following dates.

(1) October 15, 2017鈥擮il Products purchases fuel oil and the put option on fuel oil.

(2) October 31, 2017鈥擮il Products prepares financial statements.

(3) November 30, 2017鈥擮il Products prepares financial statements.

(4) December 31, 2017鈥擮il Products prepares financial statements.

(b) Indicate the amount(s) reported on the balance sheet and income statement related to the fuel oil inventory and the put

option on November 30, 2017.

(c) Indicate the amount(s) reported on the balance sheet and income statement related to the fuel oil and the put option on

December 31, 2017.

E13-11 (L03) (Warranties) Early in 2017, Sheryl Crow Equipment Company sold 500 Rollomatics during 2017 at \(6,000each. During 2017, Crow spent \)20,000 servicing the 2-year assurance warranties that accompany the Rollomatic. All applicabletransactions are on a cash basis.Instructions(a) Prepare 2017 entries for Crow. Assume that Crow estimates the total cost of servicing the warranties will be \(55,000 for2 years.(b) Prepare 2017 entries for Crow assuming that the warranties are not an integral part of the sale (a service-type warranty).Assume that of the sales total, \)56,000 relates to sales of warranty contracts. Crow estimates the total cost of servicingthe warranties will be $55,000 for 2 years. Estimate revenues to be recognized on a straight-line basis.

(Impairment of Debt Securities) Hagar Corporation has municipal bonds classified as a held-to-maturity at December 31, 2017. These bonds have a par value of \(800,000, an amortized cost of \)800,000, and a fair value of \(720,000. The

The company believes that impairment accounting is now appropriate for these bonds.

Instructions

(a) Prepare the journal entry to recognize the impairment.

(b) What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is \)800,000, should Hagar

Do corporations amortize the difference between the carrying amount and the maturity value over the life of the bonds?

(c) On December 31, 2018, the fair value of the municipal bonds is $760,000. Prepare the entry (if any) to record this information
See all solutions

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