Lecture Issues in financial accounting – Lecture 24: Accounting and the time value of money

Lecture 24 - Accounting and the time value of money. The contents of this chapter include all of the following: Compute interest and future values, compute present values, use a financial calculator to solve time value of money problems.

PART II: Corporate Accounting Concepts and  Issues Lecture 24 Accounting and the Time Value of Money 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 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 Single-Sum Problems Future value of a single sum Present value of a single sum Solving for other unknowns Basic Basic Time Time Value Value Concepts 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 LO Identify accounting topics where the time value of money is relevant Basic Basic Time Time Value Value Concepts Concepts Applications to Time Value Concepts: Notes Leases Pensions and Other Postretirement Benefits Shared-Based Compensation Business Combinations Disclosures Environmental Liabilities Long-Term Assets LO Identify accounting topics where the time value of money is relevant Basic Basic Time Time Value Value Concepts Concepts The Nature of Interest  Payment for the use of money  Excess cash received or repaid over the amount borrowed (principal) LO Identify accounting topics where the time value of money is relevant Basic Basic Time Time Value Value Concepts Concepts Simple Interest  Interest computed on the principal only Illustration: Barstow Electric Inc borrows $10,000 for years at a rate of 8% per year Compute the total interest to be paid for the year Annual Interest Interest = p x i x n = $10,000 x 08 x = $800 Federal law requires the disclosure of interest rates on an annual basis LO Distinguish between simple and compound interest Basic Basic Time Time Value Value Concepts Concepts Simple Interest  Interest computed on the principal only Illustration: Barstow Electric Inc borrows $10,000 for years at a rate of 8% per year Compute the total interest to be paid for the years Total Interest Interest = p x i x n = $10,000 x 08 x = $2,400 Federal law requires the disclosure of interest rates on an annual basis LO Distinguish between simple and compound interest Basic Basic Time Time Value Value Concepts Concepts Simple Interest  Interest computed on the principal only Illustration: On October 1, 2012, Barstow Electric Inc borrows $10,000 for months at a rate of 7% per year Compute the total interest to be paid for the year ended Dec 31, 2012 Interest = p x i x n Partial Year = $10,000 x 08 x 3/12 = $200 LO Distinguish between simple and compound interest Basic Basic Time Time Value Value Concepts Concepts Compound Interest   10 Computes interest on ► principal and ► interest earned that has not been paid or withdrawn Most business situations use compound interest LO Distinguish between simple and compound interest Alternate Present Value of a Single Sum Present Value of a Single Sum Calculation Illustration: What is the present value of $84,253 to be received or paid in years discounted at 11% compounded annually? What table we use? 39 LO Solve future and present value of problems Present Present Value Value of of aa Single Single Sum Sum i=11% n=5 What factor? $84,253 Future Value 40 x 59345 Factor = $50,000 Present Value LO Solve future and present value of problems Present Present Value Value of of aa Single Single Sum Sum Caroline and Clifford need $25,000 in years What amount must they invest today if their investment earns 12% compounded annually? Future Value $25,000 Present Value? What table we use? 41 LO Solve future and present value of problems Present Present Value Value of of aa Single Single Sum Sum i=12% n=4 What factor? $25,000 Future Value 42 x 63552 Factor = $15,888 Present Value LO Solve future and present value of problems Present Present Value Value of of aa Single Single Sum Sum Caroline and Clifford need $25,000 in years What amount must they invest today if their investment earns 12% compounded quarterly? Future Value $25,000 Present Value? What table we use? 43 LO Solve future and present value of problems Present Present Value Value of of aa Single Single Sum Sum i=3% n=16 $25,000 Future Value 44 x 62317 Factor = $15,579 Present Value LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Solving for Other Unknowns Example—Computation of the Number of Periods The Village of Somonauk wants to accumulate $70,000 for the construction of a veterans monument in the town square At the beginning of the current year, the Village deposited $47,811 in a memorial fund that earns 10% interest compounded annually How many years will it take to accumulate $70,000 in the memorial fund? 45 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Example—Computation of the Number of Periods Using the future value factor of 1.46410, refer to Table 6-1 and read down the 10% column to find that factor in the 4-period row 46 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Example—Computation of the Number of Periods Using the present value factor of 68301, refer to Table 6-2 and read down the 10% column to find that factor in the 4-period row 47 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Solving for Other Unknowns Example—Computation of the Number of Periods The Village of Somonauk wants to accumulate $70,000 for the construction of a veterans monument in the town square At the beginning of the current year, the Village deposited $47,811 in a memorial fund that earns 10% interest compounded annually How many years will it take to accumulate $70,000 in the memorial fund? 48 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Solving for Other Unknowns Example—Computation of the Interest Rate Advanced Design, Inc needs $1,409,870 for basic research years from now The company currently has $800,000 to invest for that purpose At what rate of interest must it invest the $800,000 to fund basic research projects of €1,409,870, years from now? 49 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Example—Computation of the Interest Rate Using the future value factor of 1.76234, refer to Table 6-1 and read across the 5-period row to find the factor 50 LO Solve future and present value of problems Single-Sum Single-Sum Problems Problems Example—Computation of the Interest Rate Using the present value factor of 56743, refer to Table 6-2 and read across the 5-period row to find the factor 51 LO Solve future and present value of problems Accounting Accounting Applications Applications of of Present Present Value Value Techniques—Single Techniques—Single Cash Cash Amount Amount Some notes not include a stated interest rate We call these notes noninterest-bearing notes Even though the agreement states it is a  noninterest­bearing note, the note  does, in fact, include interest 52 We impute an appropriate interest rate  for noninterest­bearing notes.  Expected Expected Cash Cash Flow Flow Approach Approach Statement of Financial Accounting Concepts No “Using Cash Flow Information and Present Value in Accounting Measurements” The objective of valuing an asset or liability using present value is to approximate the fair value of that asset or liability 53 Expected Cash Flow Credit-Adjusted Risk-Free × Rate of Interest Present Value ... solving interest problems Solve future and present value of problems Accounting Accounting and and the the Time Time Value Value of of Money Money Basic Time Value Concepts Applications The. .. variables needed when determining the time value of money 18 If you know any three of these, the fourth can be determined Determining Determining the the Unknown Unknown Interest Interest Rate Rate Suppose... Number of? ?Compounding  of? ?Compounding  FV  =  PV  (1 + i)n Periods Periods Future Future Value Value 12 Amount  Amount  Invested at  Invested at  the? ?Beginning  the? ?Beginning  of? ?the? ?Period of? ?the? ?Period