Question

Morten Co. is experiencing a slowdown in their operations. The Board of Directors believe it is reasonably possibly that they will have to terminate the current Chief Executive Officer (CEO) as a result. If that comes to pass, the company will be required to pay a severance package per the CEO’s employment contract including:

• $60,000 cash upon termination;
• Another $30,000 to be paid one year following termination;
• Cash payments of $18,000 to be paid each year for 5 years.

Required:

1. Using the present value factors, compute the present value of the complete package assuming an interest rate of 7 percent assuming the termination takes effect today.
   1. Annuity tables
   2. Single payment table
2. Given the information above, describe how the severance package would be reported in the company's financial statements.

Answer 1

Calculation the present value of complete severance package

Present value interest factor at 7% for year 1- 5 as per annuity table

year 1 = 0.935

year 2 = 0.873

year 3 = 0.816

year 4 = 0.763

year 5 = 0.713

Present value = Present value interest factor * Amount

Cash at termination has the same present value = $60000

Present value of $30000 at year 1 = $30000*0.935 which is $28050

Present value of $18000 paid each for 5 years

present value of 18000 at year 1 = 18000* 0.935 which is $16830

present value of of 18000 at year 2 = 18000* 0.873 which is $15714

present value of 18000 at year 3 = 18000 * 0.816 which is $14688

present value of 18000 at year 4 = 18000 * 0.763 which is $13734

present value of 18000 at year 5 = 18000 * 0.713 which is $12834

Total present value of severance package = $60000 + $28050 + $16830 + $15714 + $14688 + $13734 + $12834

which is $161850

Journal to record severance package expense of CFO

Dr. Termination Expense Account 180000

Cr. Cash Account $60000

Cr. Termination expense payable $120000