Financial accounting 3e IFRS edtion willey appendix a

WILEY

IFRS EDITION
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
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APPENDIX PREVIEW
Would you rather receive NT$1,000 today or a year from
now? You should prefer to receive the NT$1,000 today
because you can invest the NT$1,000 and earn interest on it.
As a result, you will have more than NT$1,000 a year from
now. What this example illustrates is the concept of the time
value of money. Everyone prefers to receive money today
rather than in the future because of the interest factor.

Financial Accounting
IFRS 3rd Edition
Weygandt ● Kimmel ● Kieso
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APPENDIX

E

Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Distinguish between simple and compound interest.
2. Solve for future value of a single amount.
3. Solve for future value of an annuity.
4. Identify the variables fundamental to solving present value problems.
5. Solve for present value of a single amount.
6. Solve for present value of an annuity.
7. Compute the present value of notes and bonds.
8. Compute the present values in capital budgeting situations.
9. Use a financial calculator to solve time value of money problems.
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Nature of Interest
Payment

for the use of money.

Difference

Learning Objective
1
Distinguish between
simple and compound
interest.

between amount borrowed or invested
(principal) and amount repaid or collected.

Elements involved in financing transaction:
1.Principal (p ): Amount borrowed or invested.
2.Interest Rate (i ): An annual percentage.
3.Time (n ): Number of years or portion of a year that
the principal is borrowed or invested.

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LO 1


Nature of Interest
Simple Interest
Interest

computed on the principal only.

Illustration: Assume you borrow NT$5,000 for 2 years at a
simple interest rate of 6% annually. Calculate the annual interest
cost.
Illustration E-1
Interest computations

2 FULL
YEARS

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Interest = p x i x n
= NT$5,000 x .06 x 2

= $600
LO 1


Nature of Interest
Compound Interest




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Computes interest on
►

the principal and

►

any interest earned that has not been paid or
withdrawn.

Most business situations use compound interest.

LO 1


Compound Interest
Illustration: Assume that you deposit €1,000 in Bank Two, where it
will earn simple interest of 9% per year, and you deposit another

€1,000 in Citizens Bank, where it will earn compound interest of 9%
per year compounded annually. Also assume that in both cases you
will not withdraw any cash until three years from the date of deposit.

Illustration E-2
Simple versus compound interest
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LO 1


Future Value Concepts
Future value of a single amount is the
value at a future date of a given amount
invested, assuming compound interest.

Learning Objective
2
Solve for future value of
a single amount.

Illustration E-3
Formula for future value

FV = future value of a single amount

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p

=

principal (or present value; the value today)

i

=

interest rate for one period

n

=

number of periods

LO 2


Future Value of a Single Amount
Illustration: If you want a 9% rate of return, you would
compute the future value of a €1,000 investment for three
years as follows:

Illustration E-4
Time diagram

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LO 2

Future Value of a Single Amount
Illustration: If you want a 9% rate of return, you would
compute the future value of a €1,000 investment for three
years as follows:
Illustration E-4
Time diagram

What table do we use?
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LO 2


Future Value of a Single Amount

What factor do we use?
€1,000
Present Value

E-11

x

1.29503
Factor

=

€1,295.03
Future Value
LO 2


Future Value of a Single Amount
Illustration E-5
Demonstration problem—
Using Table 1 for FV of 1

Illustration:

What table do we use?
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LO 2


Future Value of a Single Amount

£20,000
Present Value
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x

2.85434
Factor

=

£57,086.80
Future Value
LO 2


Future Value of an Annuity
Illustration: Assume that you invest
HK$2,000 at the end of each year for three
years at 5% interest compounded annually.

Learning Objective
3
Solve for future value of
an annuity.

Illustration E-6
Time diagram for a three-year annuity

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LO 3


Future Value of an Annuity
Illustration:
Invest = HK$2,000
i = 5%
n = 3 years

Illustration E-7
Future value of periodic payment computation
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LO 3


Future Value of an Annuity
When the periodic payments (receipts) are the same in each
period, the future value can be computed by using a future
value of an annuity of 1 table.

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Illustration E-8
Demonstration problem—Using Table 2 for FV of an annuity of 1

LO 3


Future Value of an Annuity

What factor do we use?
£2,500
Payment

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x

4.37462
Factor

=

£10,936.55
Future Value
LO 3


Present Value Concepts
Present Value Variables

Learning Objective
4
Identify the variables
fundamental to solving
present value problems.

The present value is the value now of a
given amount to be paid or received in the future, assuming
compound interest.
Present value variables:
1. Dollar amount to be received (future amount).

2. Length of time until amount is received (number of periods).
3. Interest rate (the discount rate).

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LO 4


Present Value of a Single Amount
Learning Objective
5
Solve for present value
of a single amount.

Present Value (PV) = Future Value ÷ (1 + i )n
p = principal (or present value)
i = interest rate for one period
n = number of periods
Illustration E-9
Formula for present value

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LO 5


Present Value of a Single Amount
Illustration: If you want a 10% rate of return, you would
compute the present value of €1,000 for one year as follows:

Illustration E-10
Finding present value if discounted for one period
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LO 5

Present Value of a Single Amount
Illustration E-10
Finding present value if discounted for one period

Illustration: If you want a 10% rate of return, you can also
compute the present value of €1,000 for one year by using a
present value table.

What table do we use?
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LO 5


Present Value of a Single Amount

What factor do we use?
€1,000
Future Value
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x

.90909
Factor

=

€909.09
Present Value
LO 5


Present Value of a Single Amount
Illustration E-11
Finding present value if discounted for two period

Illustration: If the single amount of €1,000 is to be received in
two years and discounted at 10% [PV = €1,000 ÷ (1 + .102], its
present value is €826.45 [($1,000 ÷ 1.21).

What table do we use?
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LO 5


Present Value of a Single Amount

What factor do we use?
€1,000
Future Value
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x

.82645
Factor

=

€826.45
Present Value
LO 5


Present Value of a Single Amount

Illustration: Suppose you have a winning lottery ticket. You have the
option of taking NT$100,000 three years from now or taking the present
value of NT$100,000 now. Assuming an 8% rate in discounting. How
much will you receive if you accept your winnings now?

NT$100,000
Future Value
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x

.79383
Factor

=

NT$79,383
Present Value
LO 5