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 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 6-2 Accounting and the Time Value of Money LEARNING OBJECTIVES After studying this chapter, you should be able to: 6-3 Identify accounting topics where the time value of money is relevant Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of 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 Identify accounting topics where the time value of money is relevant Applications of Time Value Concepts Present Value-Based Accounting Measurements Notes Leases Pensions and Other Postretirement Benefits Shared-Based Compensation Business Combinations Disclosures Environmental Liabilities Long-Term Assets 6-5 LO 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 Identify accounting topics where the time value of money is relevant Accounting and the Time Value of Money LEARNING OBJECTIVES After studying this chapter, you should be able to: 6-7 Identify accounting topics where the time value of money is relevant Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of problems Basic Time Value Concepts Simple Interest  Interest computed on the principal only Illustration: Barstow Electric Inc borrows $10,000 for years at a simple interest 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 6-8 LO 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 years at a simple interest 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 6-9 LO 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 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 Distinguish between simple and compound interest Present Value of Annuity Problems Computation of the Interest Rate Illustration: Assume you receive a statement from MasterCard with a balance due of $528.77 You may pay it off in 12 equal monthly payments of $50 each, with the first payment due one month from now What rate of interest would you be paying? Referring to Table 6-4 and reading across the 12-period row, you find 10.57534 in the 2% column Since 2% is a monthly rate, the nominal annual rate of interest is 12 24% (12 x 2%) The effective annual rate is 26.82413% [(1 + 02) - 1] 6-79 LO Solve present value of ordinary and annuity due problems Present Value of Annuity Problems Computation of a Periodic Rent Illustration: Norm and Jackie Remmers have saved $36,000 to finance their daughter Dawna’s college education They deposited the money in the Bloomington Savings and Loan Association, where it earns 4% interest compounded semiannually What equal amounts can their daughter withdraw at the end of every months during her college years, without exhausting the fund? 12 6-80 LO Solve present value of ordinary and annuity due problems 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 Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of problems 6-81 More Complex Situations Deferred Annuities  Rents begin after a specified number of periods  Future Value of a Deferred Annuity - Calculation same as the future value of an annuity not deferred  Present Value of a Deferred Annuity - Must recognize the interest that accrues during the deferral period Future Value Present Value 6-82 100,000 100,000 100,000 19 20 LO Solve present value problems related to deferred annuities and bonds More Complex Situations Valuation of Long-Term Bonds Two Cash Flows: Periodic interest payments (annuity) Principal paid at maturity (single-sum) 2,000,000 6-83 $140,000 140,000 140,000 140,000 140,000 140,000 10 LO Solve present value problems related to deferred annuities and bonds Valuation of Long-Term Bonds Illustration: Clancey Inc issues $2,000,000 of 7% bonds due in 10 years with interest payable at year-end The current market rate of interest for bonds of similar risk is 8% What amount will Clancey receive when it issues the bonds? Present Value 6-84 $140,000 140,000 140,000 140,000 140,000 2,140,000 10 LO Solve present value problems related to deferred annuities and bonds Valuation of Long-Term Bonds i=8% n=10 PV of Interest $140,000 x Interest Payment 6-85 6.71008 Factor = $939,411 Present Value LO Solve present value problems related to deferred annuities and bonds Valuation of Long-Term Bonds i=8% n=10 PV of Principal $2,000,000 Principal 6-86 x 46319 Factor = $926,380 Present Value LO Solve present value problems related to deferred annuities and bonds Valuation of Long-Term Bonds Illustration: Clancey Inc issues $2,000,000 of 7% bonds due in 10 years with interest payable at year-end Present value of Interest $939,411 Present value of Principal 926,380 Bond current market value $1,865,791 6-87 LO Solve present value problems related to deferred annuities and bonds Valuation of Long-Term Bonds Illustration 6-88 LO Solve present value problems related to deferred annuities and bonds 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 Solve future value of ordinary and annuity due problems Distinguish between simple and compound interest Solve present value of ordinary and annuity due problems Use appropriate compound interest tables Solve present value problems related to deferred annuities and bonds Identify variables fundamental to solving interest problems Apply expected cash flows to present value measurement Solve future and present value of problems 6-89 Present Value Measurement Concept Statement No introduces an 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: 6-90  Pure Rate  Expected Inflation Rate  Credit Risk Rate Risk-free rate of return FASB states a company should discount expected cash flows by the riskfree rate of return LO Apply expected cash flows to present value measurement Present Value Measurement Illustration: Keith Bowie is trying to determine the amount to set aside so that she will have enough money on hand in years to overhaul the engine on her vintage used car While there is some uncertainty about the cost of engine overhauls in years, by conducting some research online, Angela has developed the following estimates Instructions: How much should Keith Bowie deposit today in an account earning 6%, compounded annually, so that she will have enough money on hand in years to pay for the overhaul? 6-91 LO Apply expected cash flows to present value measurement Present Value Measurement Instructions: How much should Keith Bowie deposit today in an account earning 6%, compounded annually, so that she will have enough money on hand in years to pay for the overhaul? 6-92 LO Apply expected cash flows to present value measurement Copyright Copyright © 2013 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 6-93 ...PREVIEW OF CHAPTER Intermediate Accounting 15th Edition Kieso Weygandt Warfield 6-2 Accounting and the Time Value of Money LEARNING OBJECTIVES After studying this chapter, you should... 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 Identify accounting. .. between simple and compound interest 6 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