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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.

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actg 3110

ACTG 3110

Chapter 6

Time Value of Money Concepts

time value of money
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
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
Future Value
  • |-----|-----|-----|-----|-----|-----|-----|-----|
  • Year 1 Year 8
  • Present value known Future
  • Value
  • ????
  • Procedure called “accumulation”
  • Choice of interest rates affects future value amounts
present value
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
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
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
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
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 situations1
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
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.)