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Unformatted text preview: CHAPTER 6 ACCOUNTING AND THE
ACCOUNTING
TIME VALUE OF MONEY
TIME
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
6 1 Accounting and the Time Value of Money
Accounting and the Time Value of Money Basic Time
Basic
Value
Concepts
Concepts
Applications
The nature of
The
interest
interest
Simple interest
Compound
Compound
interest
interest
Fundamental
Fundamental
variables
variables Chapter
62 SingleSum
SingleSum
Problems
Problems
Future value
Future
of a single
sum
sum
Present value
Present
of a single
sum
sum
Solving for
Solving
other
unknowns
unknowns Annuities Future value
Future
of ordinary
annuity
annuity
Future value
Future
of annuity due
of
Examples of
Examples
FV of annuity
FV
Present value
Present
of ordinary
annuity
annuity
Present value
Present
of annuity due
of
Examples of
Examples
PV of annuity
PV More
More
Complex
Situations
Situations
Deferred
Deferred
annuities
annuities
Valuation of
Valuation
longterm
bonds
bonds
Effectiveiinterest
nterest
method of
bond discount/
premium
amortization
amortization Present Value
Present
Measurement
Measurement
Choosing an
Choosing
appropriate
interest rate
interest
Expected cash
Expected
flow illustration
flow Basic Time Value Concepts
Basic Time Value Concepts
Time Value of Money
In accounting (and finance), 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? Chapter
6 3 LO 1 Identify accounting topics where the time value of money is relevant. Basic Time Value Concepts
Basic Time Value Concepts
Applications to Accounting Topics:
1. Notes 5. Sinking Funds 2. Leases 6. Business Combinations 3. Pensions and Other 7. Disclosures Postretirement Benefits 4. LongTerm Assets Chapter
6 4 8. Installment Contracts LO 1 Identify accounting topics where the time value of money is relevant. Basic Time Value Concepts
Basic Time Value Concepts
Nature of Interest
Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction:
1. Principal  Amount borrowed or invested.
2. Interest Rate A percentage. 3. Time The number of years or portion of a year that the principal is outstanding. Chapter
6 5 LO 1 Identify accounting topics where the time value of money is relevant. Basic Time Value Concepts
Basic Time Value Concepts
Simple Interest
Interest computed on the principal only. Illustration: KC borrows $20,000 for 3 years at a rate of 7% per year. Compute the total interest to be paid for the 1 year. Annual Interest Chapter
6 6 Interest = p x i x n
= $20,000 x .07 x 1
= $1,400 LO 2 Distinguish between simple and compound interest. Basic Time Value Concepts
Basic Time Value Concepts
Compound Interest
Computes interest on the principal and any interest earned that has not been paid or withdrawn. Most business situations use compound interest. Chapter
67 LO 2 Distinguish between simple and compound interest. Basic Time Value Concepts
Basic Time Value Concepts
Compound Interest Tables
Table 1 Future Value of 1
Table 2 Present Value of 1
Table 3 Future Value of an Ordinary Annuity of 1
Table 4 Present Value of an Ordinary Annuity of 1
Table 5 Present Value of an Annuity Due of 1
Number of Periods = number of years x the number of compounding periods per year.
Compounding Period Interest Rate = annual rate divided by the number of compounding periods per year.
Chapter
68 LO 3 Use appropriate compound interest tables. Basic Time Value Concepts
Basic Time Value Concepts
Compound Interest
Illustration 62 How much principal plus interest a dollar accumulates to at the end of each of five periods, at three different rates of compound interest. Chapter
6 9 LO 3 Use appropriate compound interest tables. Basic Time Value Concepts
Basic Time Value Concepts
Compound Interest
Formula to determine the future value factor (FVF) for 1: Where:
FVF n,i = future value factor for n periods at i interest
n = number of periods
i = rate of interest for a single period Chapter
610 LO 3 Use appropriate compound interest tables. Basic Time Value Concepts
Basic Time Value Concepts
Compound Interest
Determine the number of periods by multiplying the number of years involved by the number of compounding periods per year.
Illustration 64 Chapter
611 LO 3 Use appropriate compound interest tables. Basic Time Value Concepts
Basic Time Value Concepts
Fundamental Variables to Compound Interest
Rate of Interest
Number of Time Periods
Present Value
Future Value Chapter
612 Illustration 66 LO 4 Identify variables fundamental to solving interest problems. SingleSum Problems
SingleSum Problems
Future Value of a Single Sum
The value at a future date of a given amount invested, assuming compound interest. Where:
FV = future value
PV = present value (principal or single sum)
FVF n,i = future value factor for n periods at i interest Chapter
613 LO 5 Solve future and present value of 1 problems. SingleSum Problems
SingleSum Problems
Present Value of a Single Sum
The value now of a given amount to be paid or received in the future, assuming compound interest. Where:
FV = future value
PV = present value (principal or single sum)
PVF n,i = present value factor for n periods at i interest Chapter
614 LO 5 Solve future and present value of 1 problems. Annuities
Annuities
Annuity requires:
(1) Periodic payments or receipts (called rents) of the same amount, (2) Samelength interval between such rents, and (3) Compounding of interest once each interval. Two
Types
Chapter
615 Ordinary annuity rents occur at the end of each period. Annuity Due rents occur at the beginning of each period.
LO 6 Solve future value of ordinary and annuity due problems. Annuities
Annuities
Future Value of an Ordinary Annuity
Rents occur at the end of each period.
No interest during 1st period.
Future Value Present Value
$20,000 0 Chapter
616 20,000 20,000 20,000 20,000 20,000 20,000 20,000 1 2 3 4 5 6 7 8 LO 6 Solve future value of ordinary and annuity due problems. Future Value of an Ordinary Annuity
Future Value of an Ordinary Annuity
A formula provides a more efficient way of expressing the future value of an ordinary annuity of 1. Where: R=
FVFOA n,i =
i=
n=
Chapter
617 periodic rent
future value factor of an ordinary annuity
rate of interest per period
number of compounding periods LO 6 Solve future value of ordinary and annuity due problems. Future Value of an Ordinary Annuity
Future Value of an Ordinary Annuity
Illustration: What is the future value of five $5,000 deposits made at the end of each of the next 5 years, earning interest of 12%? Illustration 619 = $31,764.25 Chapter
618 LO 6 Solve future value of ordinary and annuity due problems. Annuities
Annuities
Future Value of an Annuity Due
Rents occur at the beginning of each period.
Interest will accumulate during 1st period.
Annuity Due has one more interest period than Ordinary Annuity.
Factor = multiply future value of an ordinary annuity factor by 1 plus the interest rate.
Future Value
$20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 0 1 2 3 4 5 6 7 Chapter
619 8 LO 6 Solve future value of ordinary and annuity due problems. Future Value of an Annuity Due
Future Value of an Annuity Due
Comparison of Ordinary Annuity with an Annuity Due
Illustration 621 Chapter
620 LO 6 Solve future value of ordinary and annuity due problems. Annuities
Annuities
Present Value of an Ordinary Annuity
Present value of a series of equal amounts to be withdrawn or received at equal intervals.
Periodic rents occur at the end of the period.
Present Value
$100,000 0
Chapter
621 100,000 100,000 100,000 100,000 100,000 1 2 3 4 19 20 ..... LO 7 Solve present value of ordinary and annuity due problems. Present Value of an Ordinary Annuity
Present Value of an Ordinary Annuity
Illustration: Assume that $1 is to be received at the end of each of 5 periods, as separate amounts, and earns 12% interest compounded annually. Illustration 628 Chapter
622 LO 7 Solve present value of ordinary and annuity due problems. Present Value of an Ordinary Annuity
Present Value of an Ordinary Annuity
A formula provides a more efficient way of expressing the present value of an ordinary annuity of 1. Where: Chapter
623 LO 7 Solve present value of ordinary and annuity due problems. Annuities
Annuities
Present Value of an Annuity Due
Present value of a series of equal amounts to be withdrawn or received at equal intervals.
Periodic rents occur at the beginning of the period.
Present Value
$100,000 100,000 100,000 100,000 100,000 100,000 0 1 2 3 4 19 Chapter
624 ..... 20 LO 7 Solve present value of ordinary and annuity due problems. Present Value of an Annuity Due
Present Value of an Annuity Due
Comparison of Ordinary Annuity with an Annuity Due
Illustration 631 Chapter
625 LO 7 Solve present value of ordinary and annuity due problems. More Complex Situations
More Complex Situations
Deferred Annuities
Rents begin after a specified number of periods.
Future Value Calculation same as the future value of an annuity not deferred.
Present Value Must recognize the interest that accrues during the deferral period.
Future Value Present Value 0
Chapter
626 1 100,000 2 100,000 100,000 3 4 19 ..... 20 LO 8 Solve present value problems related to deferred annuities and bonds. More Complex Situations
More Complex Situations
Valuation of LongTerm Bonds
Two Cash Flows: Periodic interest payments (annuity). Principal paid at maturity (singlesum).
2,000,000
$140,000 0
Chapter
627 140,000 140,000 140,000 140,000 140,000 1 2 3 4 9 10 ..... LO 8 Solve present value problems related to deferred annuities and bonds. Present Value Measurement
Present Value Measurement
Concepts Statement No. 7 introduces an expected cash flow approach that uses a range of cash flows and incorporates the probabilities of those cash flows. Choosing an Appropriate Interest Rate
Three Components of Interest:
Pure Rate
Expected Inflation Rate
Credit Risk Rate Chapter
628 Riskfree rate of
return. FASB states a company should discount expected cash flows by the riskfree rate of return. LO 9 Apply expected cash flows to present value measurement. ...
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This note was uploaded on 03/02/2012 for the course AICS 3115 taught by Professor Lynnalmond during the Spring '11 term at Virginia Tech.
 Spring '11
 LynnAlmond

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