Chapter 6: Accounting and the Time Value of Money Sid Glandon, DBA, CPA Assistant Professor of Accounting

Present Value-Based Accounting Measurements Notes Leases Amortization of premiums and discounts Pensions and other postretirement benefits Long-term assets Sinking funds Business combinations Disclosures Installment contracts

Variables in Interest Computation Principal Amount borrowed or invested Interest rate Percentage of outstanding principal Time Number of periods that principal is outstanding

Components of Interest Pure (risk free) rate (2%-4%) Credit risk rate (0%-5%) Expected inflation (0%-?)

Simple Interest Interest = p * i * n p=principal i=rate of interest for a single period n=number of periods

Compound Interest Computed on Principal balance, plus Accumulated interest not withdrawn

Compound Interest Tables Future value of $1 Present value of $1 Future value of ordinary annuity of $1 Present value of ordinary annuity of $1 Present value of annuity due of $1

Interest Rates and Frequency of Compounding Interest rate of 12% per year: Annual Compounded once per year at 12% Semi-annual Compounded twice per year at 6% Quarterly Compounded four times per year at 3% Monthly Compounded twelve times per year at 1%

Annuity Computations Requires that Periodic payments or receipts always be of the same amount Interval between payments or receipts be the same Interest be compounded once each interval

Ordinary Annuities Payments or receipts are always made at the end of the period Use the FVOA or PVOA tables

Annuity Due Payments or receipts are always made at the beginning of the period Multiply 1 plus the interest rate times the table value of an ordinary annuity

Issue Price of Bonds PV of Principle Using market rate of interest PV of Annuity Annuity = Principal times stated interest rate Using market rate of interest Equals Issue Price of Bonds