ACCT 101, Session 7: Liabilities; Sustainability Reporting

Dr. Richard M. Crowley
rcrowley@smu.edu.sg

https://rmc.link/

Front matter

Learning objectives

Current liabilities (Chapter 8)

  1. Account for current liabilities
  2. Become familiar with “time value of money”
    • We’ll need this for Bonds

Sustainability reporting

  1. Understand the components of a sustainability report
  2. Recognize challenges and benefits of sustainability reports
  3. Identify sustainability as a core business value

Current Liabilities

Review of liabilities

Obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. (FRS 37:10)

  • Current liability: Something you owe within the span of one year (the current accounting term)
  • Non-Current liability: Something you owe after the current accounting term

Example current liabilities: Accounts payable, Unearned revenue, Salaries payable, Taxes payable, Notes payable, Interest payable, ________ payable

Sales tax payable

  • Also known as GST
  • Generally paid quarterly
    • Can pay monthly as well
  • Retailers collect this from customers to pass to tax authorities (IRAS)

Notes payable

  • Notes payable is a small, short-term loan
  • Similar to A/P, but:
    • More formal
    • Has a stated interest rate
  • Can be provided by any party
    • Banks
    • Suppliers

This is included in Chapter 5 in the book

Notes payable terms

  • Creditor: the lender
  • Debtor: the party that owes money
  • Term: length of time of the note
  • Maturity date: when the note is due
  • Principal: amount of money borrowed
    • We’ll record this at the start
  • Interest: additional payments for borrowing
    • We’ll record these as they occur
      • Or when doing adjusting entries
  • Maturity value: amount owed at maturity
  • Interest is usually all paid at the end
    • The interest rate will be given as the annual rate

Notes payable debtor

Received a $2,000 note payable with 9% interest due in 3 months payable to our supplier.

The other side: Notes receivable

Gave $2,000 with 9% interest due in 3 months payable to our customer as a note receivable.

Current long term debt

  • We consider any payment owed in the coming fiscal year as a current liability
    • This includes payments on long term debt
  • We shift these payments to short term debt when we do our balance sheet
    • Call it “current portion of long term debt”

Check

Coffee Co. gives $1,000 to Latte Inc. on November 1st, 20X8 as a note with 6% interest over 6 months. Record the journal entries for both companies, i.e., the note receivable and the note payable. Assume December 31st is both companies’ fiscal year end.

  • Hints:
    • Money changes hands on November 1
    • Interest accrues on December 31
    • The note is paid back on April 30th

Time value of money

Source

This section is based on:

Corporate Finance: An Introduction

by Ivo Welch

Pearson: Boston, MA. 2009.

It’s a good finance textbook!

The perfect market

  • No taxes
  • No transaction costs
    • Can find buyers/sellers costlessly
    • Can deliver costlessly
  • Everyone has identical beliefs
  • Many buyers and sellers (liquid)

We’ll use these assumptions in this class

Basic perspectives: Why we have time value of money

  1. You can earn interest on $1 today, so it’s worth more than $1 tomorrow.
  2. Inflation means that $1 tomorrow can buy less than $1 today.
  3. $1 today gives me the option to spend today or tomorrow, but $1 tomorrow can only be spent tomorrow. If that option to use the $1 today is valuable to me, $1 today is worth more than $1 tomorrow.

All three of these are equivalent: a dollar today is worth more than a dollar tomorrow

Consequences

  • When we talk about returns, we’ll talk about compounded returns
    • If $1 today is $1.10 next year…
      • then $1.00 in two years is $1.21, not $1.20
        • Return scales with capital
  • More explicitly: if the interest rate, \(r\) is 10%, and the principal, \(P_0\) is $1, then:
    • Tomorrow \(P_0\) is worth \(P_1=P_0\cdot (1+r) = 1\cdot 1.10 = 1.10\)
    • Flipping the equation implies: \(P_0 = \frac{P_1}{(1+r)} = \frac{1.10}{1.1} = 1\)

Extension: Going forward

  • What is $1 worth in two years? Three years? …
    • \(P_2 = \left(1\cdot 1.1\right)\cdot 1.1 = 1.21\)
    • \(P_3 = \left(\left(1\cdot 1.1\right)\cdot 1.1\right)\cdot 1.1 = 1.331\)
    • \(\ldots\)
    • \(P_{50} = \left(\ldots \left(1\cdot 1.1\right)\cdot 1.1\ldots\right)\cdot 1.1 \approx 106.72\)
    • \(\ldots\)
    • \(P_n = P_0\cdot (1+r)^n\)

Extension: Going forward

Extension: Going backward

  • What is the current value of $1 in two years? Three years? …
    • \(P_0'' = \left(1/1.1\right)/1.1 = 0.83\)
    • \(P_0''' = \left(\left(1/1.1\right)/1.1\right)/1.1 = 0.75\)
    • \(\ldots\)
    • \(P_0^{(50)} = \left(\ldots\left(1/ 1.1\right)/ 1.1\ldots\right)/ 1.1 \approx 0.0085\)
    • \(\ldots\)
    • \(P_0^{(n)} = \frac{P_n}{(1+r)^n}\)

Extension: Going backward

Check

  1. What is $10 worth in 20 years, if the interest rate is 5%?
  2. What is $10 received 20 years from now worth today, if the interest rate is 5%?

Answers:

  1. \(10\times (1+0.05)^{20}=\$26.53\)
  2. \(\frac{10}{(1+0.05)^{20}}=\$3.76\)

Net Present Value

What is Net Present Value? (NPV)

  • What we just did!
  • Determine the price today of some future (expected) cash flows
  • Numerator is the future cash flow, \(CF\)
  • Denominator is the discount factor, \(R\)
    • That is, we discount cash flows by the return to get today’s value

\[ NPV_0 = CF / R \]

  • What if there are multiple cash flows?

\(NPV_0 = \sum_{i=0}^{n} \frac{CF_i}{R_i}\)

NPV at time 0 (today) is the sum of all discounted cash flows

Discount factors

  • The discount factor is the amount of cumulated return or interest you would expect to receive between two period of time.
  • We often assume a fixed discount rate for each year of \(1+r\)
  • Let \(R_i\) denote the discount factor from time \(0\) to time \(i\)
    • \(R_1=1+r\)
    • \(R_2=(1+r)\cdot(1+r)\)
    • \(R_3=(1+r)\cdot(1+r)\cdot(1+r)\)
    • \(\ldots\)
    • \(R_n=(1+r)^n\)

Simple Example

  • A project costs $500 today, and is expected to pay out the following:
    • $100 in one year
    • $600 in two years.
  • If the interest rate is 10%, what is the NPV of the project?

  • \(NPV = \frac{-500}{(1+0.1)^0} + \frac{100}{(1+0.1)^1} + \frac{600}{(1+0.1)^2}\)
  • \(NPV = -500 + 90.91 + 495.87\)
  • \(NPV = 86.78\)
  • What if the interest rate was 5%?
  • \(NPV = \frac{-500}{(1+0.05)^0} + \frac{100}{(1+0.05)^1} + \frac{600}{(1+0.05)^2}\)
  • \(NPV = -500 + 95.24 + 544.22\)
  • \(NPV = 139.46\)

Calculating

  • Easy to do a few cash flows with a calculator
  • Easy to do any number of cash flows with spreadsheets
  • What is the NPV of a project that pays out $100 each year for 100 years, assuming the interest rate is 1%?
    • Value is 6302.8878767

What about for…

  • 10 years? 100 years? 1,000 years? 10,000 years?
  • Pretty hard by hand
  • Trivial to brute force on a computer
NPV <- data.frame(Years=c(10, 100, 1000, 10000),
                  NPVs=c(sum(c(100/1.01^(1:10))),
                         sum(c(100/1.01^(1:100))),
                         sum(c(100/1.01^(1:1000))),
                         sum(c(100/1.01^(1:10000)))))
html_df(NPV)
Years NPVs
10 947.1305
100 6302.8879
1000 9999.5229
10000 10000.0000

What about by hand?

Formulas!

  • Perpetuity: The same cash flow and discount rate forever:
    • \(Perpetuity~NPV = \frac{CF}{r}\)
  • Growing perpetuity: perpetuity but with a growth in cash flows of \(g\):
    • \(GP~NPV = \frac{CF}{r-g}, g<r\)
  • Annuity: same cash and discount rate for only \(T\) periods
    • \(Annuity~NPV = \frac{CF}{r}\left[1-\frac{1}{(1+r)^T}\right]\)

We’ll need this annuity NPV formula next class

Revisiting the 10,000 figures

\[\begin{align*} NPV &= \frac{100}{0.01} \cdot \left[1-\frac{1}{(1+0.01)^{10,000}}\right] \\ &\approx 10,000 \cdot 1 \\ &\approx 10,000 \\ \end{align*}\]

  • What about for 70 periods?
    • \(NPV = \frac{100}{0.01} \cdot \left[1-\frac{1}{(1+0.01)^{70}}\right]\)
    • \(NPV = 5,016.85\)

The last formula…

A note to those in finance, from the textbook: “I am not a fan of memorization, but you must remember the growing perpetuity formula. It would likely be useful if you could also remember the annuity formula. These formulas are used in many different contexts. There is also a fourth formula, which nobody remembers, but which you should know to look up if you need it.” (p53)

  • Growing annuity

\(PV = \frac{C}{r-g} \left[1 - \frac{(1+g)^T}{(1+r)^T}\right], g<r\)

Derivation – for those interested in the math

You can derive the other 3 formulas from the fourth:

  • Growing perpetuity:
    • \(\lim_{T\rightarrow\infty} \frac{CF}{r-g} \left[1 - \frac{(1+g)^T}{(1+r)^T}\right] = \frac{CF}{r-g} \left[1 - 0\right] = \frac{CF}{r-g}\)
  • Annuity:
    • \(\left.\frac{C}{r-g} \left[1 - \frac{(1+g)^T}{(1+r)^T}\right]\right|_{g=0} = \frac{C}{r} \left[1 - \frac{1}{(1+r)^T}\right]\)
  • Perpetuity
    • \(\left.\lim_{T\rightarrow\infty} \frac{CF}{r-g} \left[1 - \frac{(1+g)^T}{(1+r)^T}\right]\right|_{g=0} = \frac{CF}{r-0} \left[1 - 0\right] = \frac{CF}{r}\)

You don’t need to know this for this class

In class work

  1. An investment costs $100 today, and pays out $10 per year for the next 10 years. In the 10th year, it also pays back the original $100. If the interest rate is 10%, what is the NPV?
  2. What if the interest rate was 8% instead of 10% in #1?

Stock markets

  • Are stock prices NPVs?

Sustainability

CSR or ESG?

CSR

  • Corporate Social Responsibility
  • The precursor to ESG

ESG

  • Environmental, Social, & Governance
  • Blends governance, CSR, and a broader focus on climate and its risks

ESD

  • Education for Sustainable Development
  • [Up]Skilling future leaders

ESD: UNESCO

ESD is a lifelong learning process and an integral part of quality education. It enhances the cognitive, socio-emotional and behavioural dimensions of learning and encompasses learning content and outcomes, pedagogy and the learning environment itself.

The three pillars of ESG

Environmental

  • Climate change, effluents and waste, clean energy, energy consumption, carbon emissions, biodiversity degradation, water, …

Social

  • Diversity, human rights, everyone’s health & safety, child & enforced labour, product responsibility, anti-corruption, …

Governance

  • Management structure, employee relations, executive compensation, Board diversity, ethical culture, Board and management competence

TCFD

The above comes from the Task Force on Climate-related Financial Disclosures (TCFD)

Can ESG disclosure mislead?

Can ESG disclosure mislead?

Before the video

After the video

How firms should act

  1. Guided by strong moral and ethical standards in daily interactions with all stakeholders
  2. Carefully balance shareholders’ needs with the needs of other stakeholders
  3. Constantly consider the environmental impact of its business operations

U.N. SGDs

U.N. SDGs

Sustainability reporting

What must be reported?

Factors to consider

What needs to be reported often varies by jurisdiction, company size, ownership structure, and industry. In Singapore, rules are determined by SGX

  • In Singapore, the following must be reported by public companies:
    • Starting FY 2025: Greenhouse gas emissions from their own or controlled operations (Scope 1)
    • Starting FY 2026: Greenhouse gas emissions from purchasing electricity, heat, or steam (Scope 2)
    • Starting FY 2027: Greenhouse gas emissions from the rest of their supply chain (Scope 3)
    • Starting FY 2027: Scope 1 and 2 need an audit
  • For large private firms:
    • Scope 1 and 2 disclosure by 2027, Scope 3 by 2029
    • Audit of scope 1 and 2 by 2029

Material risks must be disclosed already

Materiality and ESG

Materiality goes two ways

Company \(\Rightarrow\) World

  • What is the impact of the firm on…
    • The local environment
    • Climate
    • Nearby communities
  • What risks does the company’s actions pose on the environment and local communities?

World \(\Rightarrow\) Company

What environmental risks does the company face? Does climate change pose a risk for the company’s operations?

Reporting frameworks

Singapore

SGX’ reporting choices are generally in line with TCFD

TCFD reporting

Risks and Opportunities: Company to World

  • Consider the following companies:
    1. A Norwegian lumber producer
    2. A Singaporean airline

Risks and Opportunities: World to Company

  • Consider the following companies:
    1. A Norwegian lumber producer
    2. A Singaporean airline

TCFD: The Game

  • We will divide into 9 groups
  • Each group needs to pick 1 of the 6 provided company cards

The task

  1. Determine the key risks this firm faces (top 6)
  2. Determine the best solution for each of the risks (choose 6 of 16 actions)
  3. I will pull 6 event cards, and we will see how your company performs

Additional information for Singapore

End matter

Wrap up

  • For next week
    1. Recap the reading for this week
    2. Read the pages for next week
      • Liabilities (Chapter 9)
    3. Submit last week’s homework
      • Available on eLearn
      • Submit on eLearn
    4. Practice on eLearn
      • Practice on Time value of money
      • Automatic feedback provided
  • Survey on the class session at rmc.link/101survey7

Packages used for these slides