Accounting: The Language of Business - Vol. 2 (Intermediate: Part 112)

“When you find an idea that you just can’t stop thinking about, that’s probably a good one to pursue.”

— Josh James, CEO and co-founder of Omniture

Accounting and the Time Value of Money (Part V)

by

Charles Lamson

In the past, a common application of the time value of money (TVM) in the sports industry was for deferred compensation (Part 110) built into player and staff (e.g., general manager, coach) contracts, using a relatively straightforward net present value calculation to compare the costs and benefits of alternative payment plans. We now rarely enter into deferred payment or front-loaded agreements with other players or our team executives, both by our choice and that of the athlete/staff member. For our teams, collective bargaining agreements and salary cap restrictions have significantly reduced the appeal of such arrangements. Most players and staff realize that tying future payments to a team introduces an element of credit risk (for example, the significant amount the Pittsburgh Penguins owed Mario Lemieux under a deferred compensation agreement and the team's later bankruptcy). Most players now have relatively sophisticated financial advisors and can arrange a “ deferred” payment plan through other means.

The current exception is signing bonuses (up-front payments) with certain athletes. These tend to be relatively small compared to the overall size of the player contract; other considerations such as the players cash flow needs and commitment to the player take precedence. An athlete might defer the receipt of a payment for several reasons, including if the team agreed to make a sufficiently larger payment or series of payments at a later date or if there were tax advantages (i.e., deferring the payment of taxes to a later date) to doing so. Both of these use time value of money calculations. We also consider time value issues in multi-year business agreements with our state tenants, corporate sponsors, and media partners.

The judgments considered depend on and vary dramatically based on the type of agreement we are entering into. For example, when negotiating a player contract, we compare the upfront payment versus the net present value of the deferred payments and the expected player performance in later years. While not time value of money related, we also consider the payments' impact on the team's current and future salary cap position.

With a capital investment, judgment factors include the potential for increased revenues and the payback period (how long it takes to recover our investment) compared to alternative investments or other requirements. For alternative investments, we modify the discount rate depending on the risk of our target investment and the alternatives. Typically, these investments would include either future revenue generation upside (the possible rise in value, gauged in cash or percentage of a given investment) or cost savings. For business agreements, we factor the amount of royalties for merchandising, endorsements, and broadcast revenues into our future revenues and outflows.

Often a capital investment will generate returns to us (increased revenues and/or decreased costs). For example, if we want to increase ticket revenues by adding luxury boxes or upgrade the food concession facilities, we weigh the expected amounts and timing of the returns (higher ticket revenues or concession commissions) against the initial capital outlay for the renovation to determine the attractiveness of the investment. Using time value of money calculations, we compare the costs and benefits to find the difference between the cash inflows and cash outflows for the potential investment. In addition, in an even modestly inflationary environment, we must consider the potential for rising costs if we advance or defer an investment and factor that risk into our analysis by modifying the discount rate (the interest rate the Federal Reserve charges commercial banks and other financial institutions for short-term loans).

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., P. 354*

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