ACTG 3110

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ACTG 3110 - PowerPoint PPT Presentation

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

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