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Chapter 6
ACCOUNTING AND THE TIME VALUE OF MONEY
In accounting the phrase “time value of money” indicates a relationship between time and
money – that a dollar received today is worth more than a dollar promised at some time
in the future.
Why?
Because of the opportunity to invest today’s dollar and receive
interest on the investment.
When deciding among investment or borrowing alternatives,
it is essential to be able to company today’s dollar and tomorrow’s dollar on the same
footing – to compare “apples to apples.”
Investors do that by using the concept of
present value, which has many applications in accounting.
Financial reporting uses different measurements in different situations – historical cost
for equipment, net realizable value for some inventories, fair value for investments.
The
FASB is increasingly requiring the use of fair values in the measurement of assets and
liabilities.
According to the FASB’s recent standard on fair value measurements, the
most useful fair value measures are based on prices established in active markets.
However, for many assets and liabilities, marketbased fair value information is not
readily available.
In these cases, fair value can be estimated based on the expected future
cash flows related to the asset or liability.
Using present value techniques, these future
cash flows then can be converted into present values.
Some Time Value of Money Applications to Accounting Topics
1.
Notes Receivable and Notes Payable
(Chapter 7, Chapter 14 ACC 372)
2.
Leases
(Chapter 21)
3.
Pensions and Other Postretirement Benefits
(Chapter 20)
4.
Longterm Assets
(Chapter 11)
5.
Sinking Funds
(Chapter 14 ACC 372)
6.
Business Combinations
(ACC 416)
7.
Disclosures
(various chapters)
8.
Installment Contracts
1
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View Full DocumentThe Nature of Interest
Interest is payment for the use of money.
It is the excess cash received or repaid over and
above the amount lent or borrowed (principal).
Interest is expressed as a percentage rate
and is usually determined based on the credit risk
Other factors being equal, the higher
the risk, the higher the interest rate.
The amount of interest involved in any financing
transaction is a function of three variables:
•
Principal
– the amount borrowed or invested
•
Interest rate
– a percentage of the outstanding principal
•
Time
– the number of years or fractional portion of a year that the principal is
outstanding
Simple interest
is computed on the amount of the principal only.
Look at the illustration
on page 266.
Simple interest usually applies only to shortterm investments and debts
that involve a time span of one year or less.
Compound interest is computed on principal and on any interest earned that not been paid
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 Spring '11
 Proscott
 Accounting

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