Intermediate accounting 13th kieso warfield chapter 06

Chapter
6-1


CHAPTER

6

ACCOUNTING AND THE
TIME VALUE OF MONEY

Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
6-2


Learning
Learning Objectives
Objectives
1.

Identify accounting topics where the time value of money is
relevant.

2.

Distinguish between simple and compound interest.

3.

Use appropriate compound interest tables.

4.

Identify variables fundamental to solving interest problems.

5.

Solve future and present value of 1 problems.

6.

Solve future value of ordinary and annuity due problems.

7.

Solve present value of ordinary and annuity due problems.

8.

Solve present value problems related to deferred annuities
and bonds.

9.

Apply expected cash flows to present value measurement.

Chapter
6-3

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
6-4

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
Choosing an
appropriate
interest rate
Expected cash
flow illustration


Basic
Basic Time
Time Value
Value Concepts
Concepts
Time Value of Money
In accounting (and finance), the phrase time value
of money indicates a relationship between time and
money—that a dollar received today is worth more
than a dollar promised at some time in the future.
Why?

Chapter

6-5

LO 1 Identify accounting topics where the time value of money is relevant.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Applications to Accounting Topics:
1. Notes

5. Sinking Funds

2. Leases

6. Business Combinations

3. Pensions and Other

7. Disclosures

Postretirement
Benefits

8. Installment Contracts

4. Long-Term Assets

Chapter
6-6

LO 1 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:
1. Principal - Amount borrowed or invested.
2. Interest Rate - A percentage.
3. Time - The number of years or portion of a year

that the principal is outstanding.

Chapter
6-7

LO 1 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: KC borrows $20,000 for 3 years at a rate of
7% per year. Compute the total interest to be paid for the
3 years.

Total
Interest

Interest = p x i x n
= $20,000 x .07 x 3
= $4,200

Federal law requires the disclosure of interest rates on an annual basis in all contracts.
Chapter
6-8

LO 2 Distinguish between simple and compound interest.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Simple Interest

Interest computed on the principal only.
Illustration: KC borrows $20,000 for 3 years at a rate of
7% per year. Compute the total interest to be paid for the
1 year.

Annual
Interest

Chapter
6-9

Interest = p x i x n
= $20,000 x .07 x 1
= $1,400

LO 2 Distinguish between simple and compound interest.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Simple Interest
Interest computed on the principal only.
Illustration: On March 31, 2011, KC borrows $20,000 for
3 years at a rate of 7% per year. Compute the total interest
to be paid for the year ended Dec. 31, 2011.

Partial

Year

Interest = p x i x n
= $20,000 x .07 x 9/12
= $1,050

Chapter
6-10

LO 2 Distinguish between simple and compound interest.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest
Computes interest on
 the principal and
 any interest earned that has not been paid or

withdrawn.

Most business situations use compound interest.

Chapter
6-11

LO 2 Distinguish between simple and compound interest.

Basic
Basic Time
Time Value
Value Concepts
Concepts
Illustration: Tomalczyk Company deposits $10,000 in the Last
National Bank, where it will earn simple interest of 9% per year.
It deposits another $10,000 in the First State Bank, where it will
earn compound interest of 9% per year compounded annually. In
both cases, Vasquez will not withdraw any interest until 3 years
Illustration 6-1
from the date of deposit.
Simple versus compound interest

Chapter
6-12

Year 1 $10,000.00 x 9%

$ 900.00

$ 10,900.00

Year 2 $10,900.00 x 9%

$ 981.00

$ 11,881.00

Year 3 $11,881.00 x 9%

$1,069.29

$ 12,950.29

LO 2 Distinguish between simple and compound interest.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest Tables
Table 1 - Future Value of 1
Table 2 - Present Value of 1
Table 3 - Future Value of an Ordinary Annuity of 1
Table 4 - Present Value of an Ordinary Annuity of 1
Table 5 - Present Value of an Annuity Due of 1
Number of Periods = number of years x the number of
compounding periods per year.
Compounding Period Interest Rate = annual rate divided by
the number of compounding periods per year.
Chapter
6-13

LO 3 Use appropriate compound interest tables.

Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest
Illustration 6-2

How much principal plus interest a dollar accumulates to at the
end of each of five periods, at three different rates of compound
interest.
Chapter
6-14

LO 3 Use appropriate compound interest tables.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest
Formula to determine the future value factor (FVF) for 1:

Where:
FVF n,i = future value factor for n periods at i interest
n = number of periods
i = rate of interest for a single period

Chapter
6-15

LO 3 Use appropriate compound interest tables.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest
Determine the number of periods by multiplying the
number of years involved by the number of compounding
periods per year.
Illustration 6-4

Chapter
6-16

LO 3 Use appropriate compound interest tables.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Compound Interest

A 9% annual interest compounded daily provides a
9.42% yield.
Effective Yield for a $10,000 investment.

Chapter
6-17

Illustration 6-5

LO 3 Use appropriate compound interest tables.


Basic
Basic Time
Time Value
Value Concepts
Concepts
Fundamental Variables to Compound Interest
Rate of Interest
Number of Time Periods
Present Value
Future Value

Chapter
6-18

Illustration 6-6

LO 4 Identify variables fundamental to solving interest problems.

Single-Sum
Single-Sum Problems
Problems
Two Categories
Unknown Present Value

Chapter
6-19

Unknown Future Value

LO 5 Solve future and present value of 1 problems.


Single-Sum
Single-Sum Problems
Problems
Future Value of a Single Sum
The value at a future date of a given amount invested,
assuming compound interest.

Where:
FV = future value
PV = present value (principal or single sum)
FVF n,i = future value factor for n periods at i interest

Chapter
6-20

LO 5 Solve future and present value of 1 problems.


Future
Future Value
Value of
of aa Single
Single Sum
Sum
Illustration: Bruegger Co. wants to determine the future
value of $50,000 invested for 5 years compounded annually
at an interest rate of 11%.

= $84,253

Chapter
6-21

LO 5 Solve future and present value of 1 problems.


Future
Future Value
Value of
of aa Single
Single Sum
Sum

Alternate
Calculation

Illustration: Bruegger Co. wants to determine the future
value of $50,000 invested for 5 years compounded annually
at an interest rate of 11%.

What table
do we use?

Chapter
6-22

LO 5 Solve future and present value of 1 problems.


Future
Future Value
Value of
of aa Single
Single Sum
Sum

Alternate
Calculation

i=11%
n=5

What factor do we use?
$50,000
Present Value

Chapter
6-23

x

1.68506
Factor

=

$84,253
Future Value

LO 5 Solve future and present value of 1 problems.


Future
Future Value
Value of
of aa Single
Single Sum
Sum
BE6-1: Chris Spear invested $15,000 today in a fund that
earns 8% compounded annually. To what amount will the
investment grow in 3 years?
Present Value
$15,000

0

1

Future Value?

2

3

4

5

6

What table do we use?
Chapter
6-24

LO 5 Solve future and present value of 1 problems.


Future
Future Value
Value of
of aa Single
Single Sum
Sum
i=8%
n=3

$15,000
Present Value

Chapter
6-25

x

1.25971
Factor

=

$18,896
Future Value

LO 5 Solve future and present value of 1 problems.