6-1 PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 6-2 6 Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Solve future value of ordinary and annuity due problems relevant Solve present value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value problems related to deferred annuities and bonds Use appropriate compound interest tables Apply expected cash flows to present value measurement Identify variables fundamental to solving interest problems Solve future and present value of problems 6-3 Identify accounting topics where the time value of money is BASIC BASICTIME TIMEVALUE VALUECONCEPTS CONCEPTS Time Value of Money A relationship between time and money A dollar received today is worth more than a dollar promised at some time in the future When When deciding deciding among among investment investment or or borrowing borrowing alternatives, alternatives, itit is is essential essential to to be be able able to to compare compare today’s today’s dollar dollar and and tomorrow’s tomorrow’s dollar dollar on on the the same same footing footing —to —to “compare “compare apples apples to to apples.” apples.” 6-4 LO BASIC TIME VALUE CONCEPTS Applications of Time Value Concepts: Notes Shared-Based Compensation Leases Business Combinations Pensions and Other Postretirement Disclosures Environmental Liabilities Benefits 6-5 Long-Term Assets LO BASIC TIME VALUE CONCEPTS The Nature of Interest 6-6 Payment for the use of money Excess cash received or repaid over the amount lent or borrowed (principal) LO Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 6-7 Identify accounting topics where the time value of money is relevant Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of problems BASIC TIME VALUE CONCEPTS Simple Interest Interest computed on the principal only Illustration: Barstow Electric Inc borrows $10,000 for years at a simple interest rate of 8% per year Compute the total interest to be paid for year Interest = p x i x n Annual Interest = $10,000 x 08 x = $800 6-8 LO BASIC TIME VALUE CONCEPTS Simple Interest Interest computed on the principal only Illustration: Barstow Electric Inc borrows $10,000 for years at a simple interest rate of 8% per year Compute the total interest to be paid for years Interest = p x i x n Total Interest = $10,000 x 08 x = $2,400 6-9 LO BASIC TIME VALUE CONCEPTS Simple Interest Interest computed on the principal only Illustration: If Barstow borrows $10,000 for months at a 8% per year, the interest is computed as follows Interest = p x i x n Partial Year = $10,000 x 08 x 3/12 = $200 6-10 LO MORE COMPLEX SITUATIONS Future Value of Deferred Annuity Illustration: Sutton Corporation plans to purchase a land site in years for the construction of its new corporate headquarters Sutton budgets deposits of $80,000 on which it expects to earn 5% annually, only at the end of the fourth, fifth, and sixth periods What future value will Sutton have accumulated at the end of the sixth year? ILLUSTRATION 6-37 6-82 LO MORE COMPLEX SITUATIONS Present Value of Deferred Annuity Illustration: Bob Bender has developed and copyrighted tutorial software for students in advanced accounting He agrees to sell the copyright to Campus Micro Systems for annual payments of $5,000 each The payments will begin years from today Given an annual interest rate of 8%, what is the present value of the payments? Two options are available to solve this problem 6-83 LO Present Value of Deferred Annuity ILLUSTRATION 6-38 Use Table 6-4 6-84 ILLUSTRATION 6-39 LO Present Value of Deferred Annuity Use Table 6-2 and 6-4 6-85 LO MORE COMPLEX SITUATIONS Valuation of Long-Term Bonds Two Cash Flows: Periodic interest payments (annuity) Principal paid at maturity (single-sum) 2,000,000 $140,000 140,000 140,000 140,000 140,000 140,000 6-86 10 LO Valuation of Long-Term Bonds Present Value HK$140,000 140,000 140,000 140,000 140,000 2,140,000 10 BE6-15: Wong Inc issues HK$2,000,000 of 7% bonds due in 10 years with interest payable at year-end The current market rate of interest for bonds of similar risk is 8% What amount will Wong receive when it issues the bonds? 6-87 LO Valuation of Long-Term Bonds i=8% n=10 PV of Interest HK$140,000 Interest Payment 6-88 x 6.71008 = HK$939,411 Factor Present Value LO Valuation of Long-Term Bonds i=8% n=10 PV of Principal HK$2,000,000 Principal 6-89 x 46319 = HK$926,380 Factor Present Value LO Valuation of Long-Term Bonds BE6-15: Wong Inc issues HK$2,000,000 of 7% bonds due in 10 years with interest payable at year-end Present value of Interest Present value of Principal Bond current market value 6-90 HK$ 939,411 926,380 HK$1,865,791 LO Valuation of Long-Term Bonds BE6-15: 6-91 LO Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 6-92 Identify accounting topics where the time value of money is relevant Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of problems PRESENT VALUE MEASUREMENT IFRS 13 explains the 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: 6-93 Pure Rate Risk-free rate of return IASB states a company should discount expected Expected Inflation Rate cash flows by the risk-free rate of return Credit Risk Rate LO PRESENT VALUE MEASUREMENT E6-21: Angela Contreras is trying to determine the amount to set aside so that she will have enough money on hand in years to overhaul the engine on her vintage used car While there is some uncertainty about the cost of engine overhauls in years, by conducting some research online, Angela has developed the following estimates Instructions: How much should Angela Contreras deposit today in an account earning 6%, compounded annually, so that she will have enough money on hand in years to pay for the overhaul? 6-94 LO PRESENT VALUE MEASUREMENT Instructions: How much should Angela Contreras deposit today in an account earning 6%, compounded annually, so that she will have enough money on hand in years to pay for the overhaul? 6-95 LO COPYRIGHT Copyright © 2014 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 6-96 ...PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 6-2 6 Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, ... borrowed (principal) LO Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 6-7 Identify accounting topics where... 08 x 3/12 = $200 6-10 LO Accounting and the Time Value of Money LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 6-11 Identify accounting topics where