Lecture16 Spring 2009 v2

Lecture16 Spring 2009 v2 - Lecture16 Spring2009...

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Lecture 16 Spring 2009 Time Value of Money Accounting for Long Term Debt  Issuance of Bonds
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Today’s Outline Overview of Liabilities Time value of money Present value of $1 Present value of $1 annuity What is a bond? Terminology Effective interest rate method for accounting for a bond issued at: a premium par a discount
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Overview of Liabilities
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Does this definition leave some “gray areas” regarding whether certain transactions  should be recorded as liabilities on the balance sheet? Why does it matter whether we reflect liabilities on the balance sheet?
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Contingent Liabilities Should firms have to recognize, in the balance sheet, a liability for a future  payment that is uncertain?
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Contingent Liabilities Should firms have to recognize, in the balance sheet, a liability for a future  payment that is uncertain? Potential lawsuit damages Potential environmental cleanup costs Potential warranty service costs Potential rebate redemption
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Contingent Liabilities Primary guidance: record liability when loss contingency is probable, estimable (and  material)
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Contingent Liabilities Primary guidance: record liability when loss contingency is probable, estimable (and  material)
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Contingent Liabilities Primary guidance: record liability when loss contingency is probable, estimable (and  material)
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Time Value of Money You are given the choice of $1 today or $1 a year from now. What do you prefer? Why? Simple interest formula FV = PV(1+r) t FV is Future Value PV is Present Value R is the interest rate per period t is the number of periods over which interest is compounded Note that r and t have to be in same units
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Present Value What is the value to you today of obtaining $100 at the end of one year? Receive $100 Today Depends on the interest rate at which you could invest the money  Assuming 5%, then the value today is $100 / 1.05 =  $95.24 Why?  Because you could have invested $95.24 today, earned 5% interest  over the course of the year, and have ended up with $100 at the end $95.24 x 0.05 = $4.76  $100 The Present Value of an amount is always lower than the amount itself Why?  Because waiting makes you forego consumption at today’s purchasing  power or it makes you forego investment at your earning capacity 
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Present Value: How to Compute Plot the cash flows out over the periods in which they will be obtained Divide the cash flows by (1 + discount rate), exponentiated by the number of  compounding periods away For example, 3 periods away and 5% rate: denominator = 1.05 3 $100 / 1.05 2 Obtain $100 at the end of 2 periods; rate is 5% Receive $100 Today $90.70 Why does this work?
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Present Value: How to Compute It works because $90.70 would compound up to $100 if invested over 2  periods at 5% Today $90.70 $95.24 x   0.05  $4.54  x   0.05  $4.76 $100
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This note was uploaded on 02/02/2012 for the course ACCT 101 taught by Professor Armstrong during the Spring '09 term at UPenn.

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Lecture16 Spring 2009 v2 - Lecture16 Spring2009...

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