Intermediate accounting 12th edition kieso warfield chapter 06

Accounting Accounting and and the the Time Time Value Value of of Money Money Chapter Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Chapter 6-1 Prepared by Coby Harmon, University of California, Santa Barbara Learning Learning Objectives Objectives Identify accounting topics where the time value of money is relevant Distinguish between simple and compound interest Use appropriate compound interest tables Identify variables fundamental to solving interest problems Solve future and present value of problems Solve future value of ordinary and annuity due problems Solve present value of ordinary and annuity due problems Solve present value problems related to deferred annuities and bonds Apply expected cash flows to present value measurement Chapter 6-2 Accounting Accounting and and the the Time Time Value Value of of Money Money Basic Time Value Concepts Applications The nature of interest Simple interest Compound interest Fundamental variables Chapter 6-3 Single-Sum Problems Future value of a single sum Present value of a single sum Solving for other unknowns Annuities Future value of ordinary annuity Future value of annuity due Examples of FV of annuity Present value of ordinary annuity Present value of annuity due Examples of PV of annuity More Complex Situations Deferred annuities Valuation of long-term bonds Effectiveinterest method of bond discount/ premium amortization Present Value Measurement Expected cash flow illustration Basic Basic Time Time Value Value Concepts Concepts Time Value of Money In accounting (and finance), the term indicates that a dollar received today is worth more than a dollar promised at some time in the future Chapter 6-4 LO Identify accounting topics where the time value of money is relevant Basic Basic Time Time Value Value Concepts Concepts Applications to Accounting Topics: Notes Sinking Funds Leases Business Combinations Pensions and Other Disclosures Postretirement Benefits Installment Contracts Long-Term Assets Chapter 6-5 LO Identify accounting topics where the time value of money is relevant Basic Basic Time Time Value Value Concepts 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: Principal - Amount borrowed or invested Interest Rate - A percentage Time - The number of years or portion of a year that the principal is outstanding Chapter 6-6 LO Identify accounting topics where the time value of money is relevant Simple Simple Interest Interest Interest computed on the principal only ILLUSTRATION: On January 2, 2007, Tomalczyk borrows $20,000 for years at a rate of 7% per year Calculate the annual interest cost Principal FULL YEAR Interest rate $20,000 Annual interest x 7% $ 1,400 Federal law requires the disclosure of interest rates on an annual basis in all contracts Chapter 6-7 LO Distinguish between simple and compound interest Simple Simple Interest Interest ILLUSTRATION continued: On March 31, 2007, Tomalczyk borrows $20,000 for years at a rate of 7% per year Calculate the interest cost for the year ending December 31, 2007 PARTIAL YEAR Chapter 6-8 Principal Interest rate Annual interest $20,000 x year7% Partial $ 1,400 Interest for months x 9/12 $ 1,050 LO Distinguish between simple and compound interest Compound Compound Interest Interest Computes interest on  the principal and  on interest earned to date (assuming interest is left on deposit) Compound interest is the typical interest computation applied in business situations Chapter 6-9 LO Distinguish between simple and compound interest Compound Compound Interest Interest ILLUSTRATION: On January 2, 2007, Tomalczyk borrows $20,000 for years at a rate of 7% per year Calculate the total interest cost for all three years, assuming interest is compounded annually Date Jan 2007 2007 2008 2009 Compound Interest Calculation $20,000 x 7% $21,400 x 7% $22,898 x 7% Interest $ $ Chapter 6-10 1,400 1,498 1,603 4,501 Accumulated Balance $ 20,000 21,400 22,898 24,501 LO Distinguish between simple and compound interest Present Present Value Value of of an an Ordinary Ordinary Annuity Annuity Present Value $100,000 100,000 100,000 100,000 100,000 100,000 19 20 Jaime Yuen wins $2,000,000 in the state lottery She will be paid $100,000 at the end of each year for the next 20 years How much has she actually won? Assume an appropriate interest rate of 8% What table we use? Chapter 6-40 LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Ordinary Ordinary Annuity Annuity Table 6-4 Number of Periods 4% 6% 10 15 20 0.96154 4.45183 8.11090 11.11839 13.59033 0.94340 4.21236 7.36009 9.71225 11.46992 Discount Rate 8% 0.92593 3.99271 6.71008 8.55948 9.81815 10% 0.90900 3.79079 6.14457 7.60608 8.51356 12% 0.89286 3.60478 5.65022 6.81086 7.46944 What factor we use? Chapter 6-41 LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Ordinary Ordinary Annuity Annuity Table 6-4 Number of Periods 4% 6% 10 15 20 0.96154 4.45183 8.11090 11.11839 13.59033 0.94340 4.21236 7.36009 9.71225 11.46992 $100,000 Receipt Chapter 6-42 x Discount Rate 8% 0.92593 3.99271 6.71008 8.55948 9.81815 9.81815 Factor = 10% 0.90900 3.79079 6.14457 7.60608 8.51356 12% 0.89286 3.60478 5.65022 6.81086 7.46944 $981,815 Present Value LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Annuity Annuity Due Due 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 Chapter 6-43 100,000 100,000 100,000 100,000 19 20 LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Annuity Annuity Due Due Present Value $100,000 100,000 100,000 100,000 100,000 100,000 19 20 Jaime Yuen wins $2,000,000 in the state lottery She will be paid $100,000 at the beginning of each year for the next 20 years How much has she actually won? Assume an appropriate interest rate of 8% What table we use? Chapter 6-44 LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Annuity Annuity Due Due Table 6-5 Number of Periods 4% 6% 10 15 20 1.00000 4.62990 8.43533 11.56312 14.13394 1.00000 4.46511 7.80169 10.29498 12.15812 Discount Rate 8% 1.00000 4.31213 7.24689 9.24424 10.60360 10% 1.00000 4.16986 6.75902 8.36669 9.36492 12% 1.00000 4.03735 6.32825 7.62817 8.36578 What factor we use? Chapter 6-45 LO Solve present value of ordinary and annuity due problems Present Present Value Value of of an an Annuity Annuity Due Due Table 6-5 Number of Periods 4% 6% 10 15 20 1.00000 4.62990 8.43533 11.56312 14.13394 1.00000 4.46511 7.80169 10.29498 12.15812 $100,000 Receipt Chapter 6-46 x Discount Rate 8% 1.00000 4.31213 7.24689 9.24424 10.60360 10.60360 Factor = 10% 1.00000 4.16986 6.75902 8.36669 9.36492 12% 1.00000 4.03735 6.32825 7.62817 8.36578 $1,060,360 Present Value LO Solve present value of ordinary and annuity due problems Deferred Deferred Annuities 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 Present Value Chapter 6-47 Future Value 100,000 100,000 100,000 19 20 LO Solve present value problems related to deferred annuities and bonds Valuation Valuation of of Long-Term Long-Term Bonds Bonds Two Cash Flows: • Periodic interest payments (annuity) • Principal paid at maturity (single-sum) Bonds current market value is the combined present values of the both cash flows 1,000,000 Chapter 6-48 $70,000 70,000 70,000 70,000 70,000 70,000 10 LO Solve present value problems related to deferred annuities and bonds Valuation Valuation of of Long-Term Long-Term Bonds Bonds Present Value $70,000 70,000 70,000 70,000 70,000 1,070,000 10 BE6-15 Arcadian Inc issues $1,000,000 of 7% bonds due in 10 years with interest payable at year-end The current market rate of interest for bonds is 8% What amount will Arcadian receive when it issues the bonds? Chapter 6-49 LO Solve present value problems related to deferred annuities and bonds Valuation Valuation of of Long-Term Long-Term Bonds Bonds PV of Interest Table 6-4 Number of Periods 4% 6% 10 15 20 0.96154 4.45183 8.11090 11.11839 13.59033 0.94340 4.21236 7.36009 9.71225 11.46992 $70,000 x Interest Payment Chapter 6-50 Discount Rate 8% 0.92593 3.99271 6.71008 8.55948 9.81815 6.71008 Factor = 10% 0.90900 3.79079 6.14457 7.60608 8.51356 12% 0.89286 3.60478 5.65022 6.81086 7.46944 $469,706 Present Value LO Solve present value problems related to deferred annuities and bonds Valuation Valuation of of Long-Term Long-Term Bonds Bonds PV of Principal Table 6-2 Number of Periods 10 15 20 4% 0.96154 0.82193 0.67556 0.55526 0.45639 $1,000,000 Principal Payment Chapter 6-51 6% Discount Rate 8% 0.94340 0.74726 0.55839 0.41727 0.31180 x 0.92593 0.68058 0.46319 0.31524 0.21455 46319 Factor = 10% 0.90909 0.62092 0.38554 0.23939 0.14864 12% 0.89286 0.56743 0.32197 0.18270 0.10367 $463,190 Present Value LO Solve present value problems related to deferred annuities and bonds Valuation Valuation of of Long-Term Long-Term Bonds Bonds BE6-15 Arcadian Inc issues $1,000,000 of 7% bonds due in 10 years with interest payable at year-end Present value of Interest $469,706 Present value of Principal 463,190 Bond current market value Date Account Title Cash Discount on Bonds Bonds payable Chapter 6-52 $932,896 Debit Credit 932,896 67,104 1,000,000 LO Solve present value problems related to deferred annuities and bonds Present Present Value Value Measurement Measurement Concepts Statement No 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 6-53 Risk-free Risk-free rate rate of of return return FASB FASBstates states aacompany companyshould should discount discountexpected expected cash cashflows flowsby bythe the risk-free risk-freerate rateof of return return LO Apply expected cash flows to present value measurement Copyright Copyright Copyright © 2006 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 6-54 ... deferred annuities and bonds Apply expected cash flows to present value measurement Chapter 6-2 Accounting Accounting and and the the Time Time Value Value of of Money Money Basic Time Value... Value of Money In accounting (and finance), the term indicates that a dollar received today is worth more than a dollar promised at some time in the future Chapter 6-4 LO Identify accounting topics... to Accounting Topics: Notes Sinking Funds Leases Business Combinations Pensions and Other Disclosures Postretirement Benefits Installment Contracts Long-Term Assets Chapter 6-5 LO Identify accounting