Intermediate accounting 15e kieso warfield chapter 06

INTERMEDIATE

Intermediate
ACCOUNTING
Intermediate
Accounting
Accounting
F I F T E E N T H

6-1

E D I T I O N

Prepared
by
Prepared
by
Coby Harmon
Prepared by
Coby Harmon
Coby Harmon
University
of California
Santa Barbara
University
of California,
Santa Barbara
University of California, Santa Barbara
Westmont
College
Westmont

College

kieso
weygandt
warfield
team for success


PREVIEW OF CHAPTER

6

Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
6-2


6

Accounting and the
Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

6-3

1.

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

6.

Solve future value of ordinary and annuity
due problems.

2.

Distinguish between simple and
compound interest.

7.

Solve present value of ordinary and
annuity due problems.

3.

Use appropriate compound interest
tables.

8.

Solve present value problems related to
deferred annuities and bonds.

4.

Identify variables fundamental to solving
interest problems.

9.

Apply expected cash flows to present
value measurement.

5.

Solve future and present value of 1
problems.


Basic Time Value 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.
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 1 Identify accounting topics where the time value of money is relevant.

Applications of Time Value Concepts
Present Value-Based Accounting
Measurements
1. Notes
2. Leases
3. Pensions and Other

Postretirement
Benefits

5. Shared-Based
Compensation
6. Business Combinations
7. Disclosures
8. Environmental Liabilities

4. Long-Term Assets

6-5

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


Basic Time Value Concepts
The Nature of Interest

6-6



Payment for the use of money.



Excess cash received or repaid over the amount lent
or borrowed (principal).

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


6

Accounting and the
Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

6-7

1.

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

6.

Solve future value of ordinary and annuity

due problems.

2.

Distinguish between simple and
compound interest.

7.

Solve present value of ordinary and
annuity due problems.

3.

Use appropriate compound interest
tables.

8.

Solve present value problems related to
deferred annuities and bonds.

4.

Identify variables fundamental to solving
interest problems.

9.

Apply expected cash flows to present

value measurement.

5.

Solve future and present value of 1
problems.


Basic Time Value Concepts
Simple Interest


Interest 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 the 1 year.

Annual
Interest

Interest = p x i x n
= $10,000 x .08 x 1
= $800

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

LO 2 Distinguish between simple and compound interest.

Basic Time Value Concepts
Simple Interest


Interest 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 the 3 years.

Total
Interest

Interest = p x i x n
= $10,000 x .08 x 3
= $2,400

6-9

LO 2 Distinguish between simple and compound interest.


Basic Time Value Concepts
Simple Interest


Interest 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 2 Distinguish between simple and compound interest.


6

Accounting and the
Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.

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

6.

Solve future value of ordinary and annuity
due problems.

2.

Distinguish between simple and
compound interest.

7.

Solve present value of ordinary and
annuity due problems.

3.

Use appropriate compound interest
tables.

8.

Solve present value problems related to
deferred annuities and bonds.

4.

Identify variables fundamental to solving
interest problems.

9.

Apply expected cash flows to present
value measurement.

5.

Solve future and present value of 1
problems.

6-11


Basic Time Value Concepts
Compound Interest




6-12

Computes interest on
►

principal and

►

interest earned that has not been paid or
withdrawn.

Typical interest computation applied in business
situations.

LO 3 Use appropriate compound interest tables.


Compound Interest
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, Tomalczyk will not
withdraw any interest until 3 years from the date of deposit.
Illustration 6-1
Simple vs. Compound Interest

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%

6-13

$1,069.29 $ 12,950.29

LO 3


A PRETTYYOUR
GOOD START
WHAT’S
PRINCIPLE

The continuing debate on Social
Security reform provides a great
context to illustrate the power of
compounding. One proposed idea is
for the government to give $1,000 to
every citizen at birth. This gift would
be deposited in an account that would
earn interest tax-free until the citizen
retires. Assuming the account earns a
modest 5% annual return until
retirement at age 65, the $1,000 would
grow to $23,839. With monthly
compounding, the $1,000 deposited at
birth would grow to $25,617.

6-14

Why start so early? If the government
waited until age 18 to deposit the
money, it would grow to only $9,906
with annual compounding. That is,
reducing the time invested by a

third results in more than a 50%
reduction in retirement money. This
example illustrates the importance of
starting early when the power of
compounding is involved.

LO 3 Use appropriate compound interest tables.


Basic Time Value Concepts
Compound Interest Tables
Table 6-1 - Future Value of 1
Table 6-2 - Present Value of 1
Table 6-3 - Future Value of an Ordinary Annuity of 1
Table 6-4 - Present Value of an Ordinary Annuity of 1
Table 6-5 - 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.
6-15

LO 3 Use appropriate compound interest tables.


Basic Time Value Concepts
Compound Interest Tables

Illustration 6-2
Excerpt from Table 6-1

FUTURE VALUE OF 1 AT COMPOUND INTEREST
(Excerpt From Table 6-1, Page 1

How much principal plus interest a dollar accumulates to at the end of
each of five periods, at three different rates of compound interest.
6-16

LO 3 Use appropriate compound interest tables.


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

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

6-17

LO 3 Use appropriate compound interest tables.


Basic Time Value Concepts
Compound Interest Tables
Determine the number of periods by multiplying the number
of years involved by the number of compounding periods
per year.

Illustration 6-4
Frequency of Compounding

6-18

LO 3 Use appropriate compound interest tables.


Basic Time Value Concepts
Compound Interest Tables
A 9% annual interest compounded daily provides a 9.42%
yield.
Effective Yield for a $10,000 investment.

6-19

Illustration 6-5
Comparison of Different
Compounding Periods

LO 3 Use appropriate compound interest tables.


6

Accounting and the
Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1.

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

6.

Solve future value of ordinary and annuity
due problems.

2.

Distinguish between simple and
compound interest.

7.

Solve present value of ordinary and
annuity due problems.

3.

Use appropriate compound interest
tables.

8.

Solve present value problems related to
deferred annuities and bonds.

4.

Identify variables fundamental to solving
interest problems.

9.

Apply expected cash flows to present
value measurement.

5.

Solve future and present value of 1
problems.

6-20


Basic Time Value Concepts
Fundamental Variables


Rate of Interest



Future Value



Number of Time Periods



Present Value
Illustration 6-6

6-21

LO 4 Identify variables fundamental to solving interest problems.


6

Accounting and the
Time Value of Money

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.

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

6.

Solve future value of ordinary and annuity
due problems.

2.

Distinguish between simple and
compound interest.

7.

Solve present value of ordinary and
annuity due problems.

3.

Use appropriate compound interest
tables.

8.

Solve present value problems related to
deferred annuities and bonds.

4.

Identify variables fundamental to solving
interest problems.

9.

Apply expected cash flows to present
value measurement.

5.

Solve future and present value of 1
problems.

6-22


Single-Sum Problems
Two Categories
Unknown Present Value

Unknown Future Value

Illustration 6-6

6-23

LO 5 Solve future and present value of 1 problems.


Single-Sum Problems
Future Value of a Single Sum
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

6-24

LO 5 Solve future and present value of 1 problems.


Future Value of a Single 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

Illustration 6-7

6-25

LO 5 Solve future and present value of 1 problems.