Lecture Intermediate accounting (IFRS 2nd edition): Chapter 6 - Kieso, Weygandt, Warfield

Chapter 6 - Accounting and the time value of money. After studying this chapter, you should be able to: 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 1 problems.

6-1 PREVIEW OF CHAPTER 6-2 Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield  Accounting and the  Time Value of Money  LEARNING OBJECTIVES After studying this chapter, you should be able to: 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 6-3 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 BASIC TIME VALUE CONCEPTS Time Value of Money uA relationship between time and money uA dollar received today is worth more than a dollar  promised at some time in the future.  When deciding among investment or  borrowing alternatives, it is essential to be  able to compare today’s dollar and  tomorrow’s dollar on the same footing—to  “compare apples to apples.” 6-4 LO BASIC TIME VALUE CONCEPTS Applications of Time Value Concepts: 1.Notes  5.Shared­Based Compensation 2.Leases  6.Business Combinations 3.Pensions and Other  Postretirement  Benefits  7.Disclosures 8.Environmental Liabilities 4.Long­Term Assets 6-5 LO BASIC TIME VALUE CONCEPTS The Nature of Interest uPayment for the use of money.  uExcess cash received or repaid over the amount lent or   borrowed (principal) 6-6 LO Accounting and the  Time Value of Money  LEARNING OBJECTIVES After studying this chapter, you should be able to: 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 6-7 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 BASIC TIME VALUE CONCEPTS Simple Interest uInterest computed on the principal only.  Illustration:  Barstow Electric Inc. borrows $10,000 for 3 years  at a simple interest rate of 8% per year.  Compute the total  interest to be paid for 1 year Annual  Interest Interest = p x i x n = $10,000  x  .08  x  1 = $800 6-8 LO BASIC TIME VALUE CONCEPTS Simple Interest uInterest computed on the principal only.  Illustration:  Barstow Electric Inc. borrows $10,000 for 3 years  at a simple interest rate of 8% per year.  Compute the total  interest to be paid for 3 years Total  Interest Interest = p x i x n = $10,000  x  .08  x  3 = $2,400 6-9 LO BASIC TIME VALUE CONCEPTS Simple Interest uInterest computed on the principal only.  Illustration:  If Barstow borrows $10,000 for 3 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 6-10 LO MORE COMPLEX SITUATIONS Future Value of Deferred Annuity Illustration:  Sutton Corporation plans to purchase a land site in 6  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 6­37 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 6 annual payments of $5,000  each. The payments will begin 5 years from today. Given an annual  interest rate of 8%, what is the present value of the 6 payments? Two options are available to solve this problem 6-83 LO Present Value of Deferred Annuity ILLUSTRATION 6­38 Use Table 6­4 6-84 ILLUSTRATION 6­39 LO Present Value of Deferred Annuity Use Table 6­2 and 6­4 6-85 LO MORE COMPLEX SITUATIONS Valuation of Long­Term Bonds Two Cash Flows: u Periodic interest payments (annuity).  u Principal paid at maturity (single­sum) 2,000,000 $140,000 6-86 140,000 140,000 140,000 140,000  . . .  140,000 10 LO Valuation of Long­Term Bonds Present Value HK$140,000 140,000 140,000 140,000 140,000 2,140,000  . . .  10 BE6­15:  Wong Inc. issues HK$2,000,000 of 7% bonds due in  10 years with interest payable at year­end.  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 Long­Term Bonds i=8% n=10 PV of Interest       HK$140,000     x     6.71008      =      HK$939,411 Interest Payment 6-88 Factor Present Value LO Valuation of Long­Term Bonds i=8% n=10 PV of Principal      HK$2,000,000      x    .46319      =      HK$926,380 Principal 6-89 Factor Present Value LO Valuation of Long­Term Bonds BE6­15:   Wong Inc. issues HK$2,000,000 of 7% bonds due in  10 years with interest payable at year­end.  Present value of Interest  HK$   939,411 Present value of Principal  Bond current market value  Date Account Title Cash Bonds payable 6-90 926,380 HK$1,865,791  Debit Credit 1,865,791 1,865,791 LO Valuation of Long­Term Bonds Schedule of Bond Discount Amortization 10-Year, 7% Bonds Sold to Yield 8% BE6­15: Cash Interest Paid Date 1/1/12 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 12/31/20 12/31/21 140,000 140,000 140,000 140,000 140,000 140,000 140,000 140,000 140,000 140,000 * 6-91 Interest Expense Bond Discount Amortization 149,263 150,004 150,805 151,669 152,603 153,611 154,700 155,876 157,146 158,533 * 9,263 10,004 10,805 11,669 12,603 13,611 14,700 15,876 17,146 18,533 Carrying Value of Bonds 1,865,791 1,875,054 1,885,059 1,895,863 1,907,532 1,920,135 1,933,746 1,948,445 1,964,321 1,981,467 2,000,000 rounding LO Accounting and the  Time Value of Money  LEARNING OBJECTIVES After studying this chapter, you should be able to: 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 6-92 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 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: uPure Rate uExpected Inflation Rate uCredit Risk Rate 6-93 Risk­free rate of  return.  IASB states a  company should  discount expected  cash flows by the risk­ free rate of return LO PRESENT VALUE MEASUREMENT E6­21: Angela Contreras is trying to determine the amount to set aside so that she will have enough money on hand in 2 years to  overhaul the engine on her vintage used car. While there is some  uncertainty about the cost of engine overhauls in 2 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 2 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 2 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 6- 2 Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield Accounting and the  Time Value of Money  LEARNING OBJECTIVES After studying this chapter,  you should be able to:... ILLUSTRATION 6 8 Future Value Time Diagram (n = 8, i = 5%) 6- 29 What table do we use? LO Future Value of a Single Sum i=5% n=8 ¥250,000,000 Present Value 6- 30 x    1.477 46 Factor =    ¥ 369 , 365 ,000... uPresent Value ILLUSTRATION 6 6 Basic Time Diagram 6- 22 LO Accounting and the  Time Value of Money  LEARNING OBJECTIVES After studying this chapter,  you should be able to: Identify accounting topics where