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CHAPTER 6
Accounting and the Time Value of Money
LEARNING OBJECTIVES
1.
Identify accounting topics where the time value of money is relevant.
2.
Distinguish between simple and compound interest.
3.
Use appropriate compound interest tables.
4.
Identify variables fundamental to solving interest problems.
5.
Solve future and present value of 1 problems.
6.
Solve future value of ordinary and annuity due problems.
7.
Solve present value of ordinary and annuity due problems.
8.
Solve present value problems related to deferred annuities and bonds.
9.
Apply expected cash flows to present value measurement.
*10.
Use a financial calculator to solve time value of money problems.
*This material is covered in an Appendix to the chapter.
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CHAPTER REVIEW
1. (S.O. 1) Chapter 6 discusses the essentials of compound interest, annuities and present
value. These techniques are being used in many areas of financial reporting where the
relative values of cash inflows and outflows are measured and analyzed. The material
presented in Chapter 6 will provide a sufficient background for application of these
techniques to topics presented in subsequent chapters.
2.
Compound interest, annuity, and present value
techniques can be applied to many of
the items found in financial statements. In accounting, these techniques can be used to
measure the relative values of cash inflows and outflows, evaluate alternative investment
opportunities, and determine periodic payments necessary to meet future obligations.
Some of the accounting items to which these techniques may be applied are: (a)
notes
receivable and payable,
(b)
leases,
(c)
pensions,
(d)
longterm assets,
(e)
sinking
funds,
(f)
business combinations,
(g)
disclosures,
and (h)
installment contracts.
Nature of Interest
3. (S.O. 2)
Interest
is the payment for the use of money. It is normally stated as a per
centage of the amount borrowed (principal), calculated on a yearly basis. For example, an
entity may borrow $5,000 from a bank at 7% interest. The yearly interest on this loan is
$350. If the loan is repaid in six months, the interest due would be 1/2 of $350, or $175.
This type of interest computation is known as
simple interest
because the interest is
computed on the amount of the principal only. The formula for simple interest can be
expressed as
p
x
i
x
n
where
p
is the principal,
i
is the rate of interest for one period, and
n
is the number of periods.
Compound Interest
4. (S.O. 2)
Compound interest
is the process of computing interest on the principal plus
any interest previously earned. Referring to the example in (2) above, if the loan was for
two years with interest compounded annually, the second year’s interest would be
$374.50 (principal plus first year’s interest multiplied by 7%). Compound interest is most
common in business situations where large amounts of capital are financed over long
periods of time. Simple interest is applied mainly to shortterm investments and debts due
in one year or less. How often interest is compounded can make a substantial difference
in the level of return achieved.
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 Spring '09
 HAYWOOD
 Accounting, Time Value Of Money, Interest

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