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ACTG 3110

ACTG 3110. Chapter 6 Time Value of Money Concepts. Time Value of Money. Importance Significance Present value calculations Accounting applications: Receivables and payables Bonds Leases Pensions Sinking Funds Asset valuations Installment Contracts. Nature of Interest.

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ACTG 3110

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  1. ACTG 3110 Chapter 6 Time Value of Money Concepts

  2. Time Value of Money • Importance • Significance • Present value calculations • Accounting applications: • Receivables and payables • Bonds • Leases • Pensions • Sinking Funds • Asset valuations • Installment Contracts

  3. Nature of Interest • Simple Interest • (Principal x Interest rate x Time period in year) • Compound Interest • Earn interest on principal AND interest • PERIODS CAN BE MORE THAN ONCE A YEAR • Divide annual interest rate by periods per year • Multiply number of compounding periods by years for total time periods

  4. Future Value • |-----|-----|-----|-----|-----|-----|-----|-----| • Year 1 Year 8 • Present value known Future • Value • ???? • Procedure called “accumulation” • Choice of interest rates affects future value amounts

  5. Present Value • |-----|-----|-----|-----|-----|-----|-----|-----| • Year 1 Year 8 • Present value Future • ?????? Value • Known • Procedure called “discounting” • Choice of interest rates affects future value amounts

  6. Lump Sum (Single Sum of $1) • Future value of one time payment • Present value of one time payment • Examples: Repayment of the entire loan balance, purchase of long-term asset, salvage value

  7. Annuities • Series of EQUAL payments/receipts occurring at equal intervals • Ordinary annuity – paid at END of period (Mortgages, car payments) • Annuity due – paid at the BEGINNING of period (Leases) • Deferred annuity – series of payments will start sometime in the future • Must get the present value of an annuity • Then discount the present value of the annuity to current time period

  8. Future Value/Present Value • These are reciprocal formulas. • FUTURE VALUE WILL ALWAYS BE GREATER THAN PRESENT VALUE. • Can determine number of periods if interest rate and present value/future value is known • Can determine interest rate if number of periods and present value/future value is known

  9. Complex Situations • Deferred Annuities • Future series of equal payments • Example: Pensions • Long-Term Bonds • Face value • Interest payments • Market value = sum of the present value of the principal payment (single sum) and the periodic interest payments (annuities) using the discount rate • Amortization tables

  10. Complex Situations • Long-term Leases • Present value of lease payments is capitalized (set up as an asset) • Must separate portion of lease payment for principal and interest

  11. Expected Cash Flow Approach • SFAC No. 7 – Measurability • Method to be used for asset retirement obligations, impairment losses, and business combinations • Determine probability of each expected cash flow • Multiply the probability times each expected cash flow, then sum • Discount the sum to present value using the risk-free rate of interest (rate for T-bills, etc.)

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