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Chapter 6 PP Slides - CHAPTER 6 ACCOUNTING AND THE ACCOUNTING TIME VALUE OF MONEY TIME Intermediate Accounting 13th Edition Kieso Weygandt and

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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 6-2 Single-Sum Single-Sum 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 long-term 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 6-7 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 6-8 LO 3 Use appropriate compound interest tables. Basic Time Value Concepts Basic Time Value Concepts Compound Interest Illustration 6-2 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 6-10 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 6-4 Chapter 6-11 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 6-12 Illustration 6-6 LO 4 Identify variables fundamental to solving interest problems. Single-Sum Problems Single-Sum 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 6-13 LO 5 Solve future and present value of 1 problems. Single-Sum Problems Single-Sum 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 6-14 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 6-15 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 6-16 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= FVF-OA n,i = i= n= Chapter 6-17 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 6-19 = $31,764.25 Chapter 6-18 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 6-19 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 6-21 Chapter 6-20 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 6-21 100,000 100,000 100,000 100,000 100,000 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 6-28 Chapter 6-22 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 6-23 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 6-24 ..... 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 6-31 Chapter 6-25 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 6-26 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 Long-Term Bonds Two Cash Flows: Periodic interest payments (annuity). Principal paid at maturity (single­sum). 2,000,000 $140,000 0 Chapter 6-27 140,000 140,000 140,000 140,000 140,000 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 6-28 Risk-free 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.

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