Prepared by Coby Harmon University of California, Santa Barbara Westmont College 6-1 Accounting and the Time Value of Money CHAPTER LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 6-2 Describe the fundamental concepts related to the time value of money Solve present value of ordinary and annuity due problems Solve future and present value of problems Solve future value of ordinary and annuity due problems Solve present value problems related to deferred annuities, bonds, and expected cash flows PREVIEW OF CHAPTER 6-3 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield Basic Basic Time Time Value Value Concepts Concepts LEARNING OBJECTIVE Describe the fundamental concepts r elated to the time value of money 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—to footing—to “compare “compare apples apples to to apples.” apples.” 6-4 LO Basic Time Value Concepts Applications of Time Value Concepts: Notes Leases Pensions and Other Postretirement Benefits Shared-Based Compensation Business Combinations Disclosures Environmental Liabilities Non-Current Assets 6-5 LO Basic Time Value Concepts The Nature of Interest Payment for the use of money Excess cash received or repaid over the amount lent or borrowed (principal) Variables in Interest Computation Principal The amount borrowed or invested Interest Rate A percentage of the outstanding principal Time The number of years or fractional portion of a year that the principal is outstanding 6-6 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 year Interest = p x i x n Annual Interest = $10,000 x 08 x = $800 6-7 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 6-8 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 Partial Year Interest = p x i x n = $10,000 x 08 x 3/12 = $200 6-9 LO Basic Time Value Concepts Compound Interest 6-10 Computes interest on ► principal and ► interest earned that has not been paid or withdrawn Typical interest computation applied in business situations LO Other Time Value of Money Issues LEARNING OBJECTIVE Solve present value problems related to deferred annuities, bonds, and expected cash flows Deferred Annuities Rents begin after a specified number of periods Future Value of a Deferred Annuity - Calculation same as the future value of an annuity not deferred Present Value of a Deferred Annuity - Must recognize the interest that accrues during the deferral period Present Value Future Value 100,000 100,000 100,000 6-70 19 20 LO Deferred Annuities Future Value of Deferred Annuity Illustration: Sutton Corporation plans to purchase a land site in six 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 6-71 LO Deferred Annuities Present Value of Deferred Annuity Illustration: Bob Boyd has developed and copyrighted tutorial software for students in advanced accounting He agrees to sell the copyright to Campus Micro Systems for six annual payments of $5,000 each The payments will begin five years from today Given an annual interest rate of 8%, what is the present value of the six payments? Two options are available to solve this problem 6-72 LO Present Value of Deferred Annuity ILLUSTRATION 6.38 Use Table 6.4 6-73 ILLUSTRATION 6.39 LO Present Value of Deferred Annuity Use Table 6.2 and 6.4 6-74 LO Other Time Value of Money Issues 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 6-75 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? 6-76 LO Valuation of Long-Term Bonds PV of Interest HK$140,000 Interest Payment 6-77 i=8% n=10 TABLE 6.4 PRESENT VALUE OF AN ORDINARY ANNUITY OF x 6.71008 Factor = HK$939,411 Present Value LO Valuation of Long-Term Bonds TABLE 6.2 PRESENT VALUE OF PV of Principal HK$2,000,000 Principal 6-78 i=8% n=10 x 46319 Factor = HK$926,380 Present Value LO Valuation of Long-Term Bonds BE6-15: Wong Inc issues HK$2,000,000 of 7% bonds due in 10 years with interest payable at year-end Present value of Interest Present value of Principal Bond current market value 6-79 HK$ 939,411 926,380 HK$1,865,791 LO Effective-Interest Method of Amortization BE6-15: Year 10 6-80 LO 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: 6-81 Pure Rate Expected Inflation Rate Credit Risk Rate Risk-free rate of return IASB states a company should discount expected cash flows by the riskfree rate of return 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? 6-82 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? 6-83 LO COPYRIGHT Copyright © 2018 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 6-84 ... related to deferred annuities, bonds, and expected cash flows PREVIEW OF CHAPTER 6-3 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield Basic Basic Time Time Value Value Concepts.. .Accounting and the Time Value of Money CHAPTER LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying