1. Fair Value of Accounting
Chapter 8
Fair Value of Accounting

2. Valuation Approaches to Fair Value Accounting
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3. Does Time Affect Money? Time Value of Money
Effects of the passage of time on
holding or not holding money
Interest
Measures these effects for a given period of time
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4. Interest Simple Interest Compound Interest
return on principal for one or more periods
principal sum stays the same from period to period
return on principal for two or more periods
computed by adding the interest earned in one period to the amount on which interest is computed in future periods
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5. Simple Interest Illustrated
Willy Wang accepts an 8 percent, $15,000 note due in 90 days. What total amount will Sanchez receive?
The total that Sanchez will receive is $15,
($15, principal + $ interest)
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6. Compound Interest Illustrated
Terry Soma deposits $10,000 in an account that pays 6 percent interest. She expects to leave the principal and accumulated interest in the account for three years. Interest is paid at the end of each year. What total amount will be in the account at the end of three years?
Soma will have $11, at the end of three years.
Note that the annual amount of interest increases each year by the interest rate times the interest of the previous year.
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7. Present Value
Sample Question Concerning Present Value and Future Value:
You need $500 one year from now for tuition. How much do you need to invest today to generate that amount if the interest rate is 3 percent?
Way of valuing future cash flows
Amount that must be invested today at a given rate to produce a given future value
Present value and future value are closely related
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8. Present Value It depends upon... the amount of the future receipt.
the length of time to the future receipt.
interest rate for the period.

9. The present value (PV) is the PRESENT VALUE
amount that would have to be invested now to accumulate to some specified future amount.
Present Value = Future Value * Factor
The process of computing present value is called discounting.

10. CALCULATING PRESENT VALUE
The present value of a single sum can be computed using The Present Value of $1 table
Find the factor in the table that corresponds with the number of interest periods and the interest rate.
Multiply that factor by the future value.

12. Present Value of a Single Sum Due in the Future
Ron More wants to have $8,000 at the end of three years. How much must he invest today in a 5 percent savings account to achieve this goal?
Year 3
Future value $8,000
Year 2
Year 1
Present value $6,910
Using tables (Table 1), the calculation is:
Future Value × Factor = Present Value
$8, × = $6,910
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13. Present Value of an Annuity
An annuity is a stream of payments of equal amounts at equal time intervals.
The Present Value of an Annuity:
PVa = Payment (pmt) * Factor (f)

14. Present Value of an Annuity
The present value of an annuity is determined by using the factors in the Present Value of an Annuity table.
To compute the present value of an annuity, find the factor in the table that corresponds with the number of periods and the interest rate.
Multiply that factor by the amount of the periodic payment (receipt).

16. Present Value of an Ordinary Annuity
Vickie Long sold a piece of property and is to receive $18,000 in three equal payments of $6,000 beginning one year from today. What is the present value of this sale if the current interest rate is 5 percent?
Year 3
$6,000
Year 2
Year 1
Present value $16,338
Using the table factor (Table 2), the calculation is:
Periodic payment × Factor = Present Value
$6, × = $16,338
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17. Time Periods When using tables, the left-hand column refers to periods
Interest can, of course, be paid on a quarterly or semiannual basis
To use the tables in these cases, it is necessary to (1) divide the annual interest rate by the number of periods in the year, and (2) multiply the number of periods in one year by the number of years
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18. Stop & Apply
Example SE7-8, hwk E13
Q. Each year Kevin Spelling deposits $1,000 in a savings account that pays 3 percent interest. He expects to leave all funds in the account for four years. Interest is paid at the end of each year. What amount has accumulated in the account if the interest compounds annually? A.
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19. Applications Using Present Values
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20. How Is the Time Value of Money Used in Accounting?
Valuing an asset
Differed payment
Investment of idle cash
Accumulation of a fund for loan repayment
Other applications
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21. Valuing an Asset
An asset is something that will provide future benefits to the company that owns it
The purchase price of an asset represents the present value of these future benefits
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The proposed purchase price can be evaluated by comparing it with the present value of the asset to the company
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22. Evaluating the Proposed Purchase Price of an Asset
Mike Yeboah is thinking about buying a new machine that will reduce his annual labor cost by $1,400 per year. The machine will last for 8 years. The interest rate used for management decisions is 10 percent. What is the maximum amount Yeboah should pay for the machine?
The present value of the machine is equal to the present value of an ordinary annuity of $1,400 per year for 8 years at compound interest of 10 percent
Using Table 2, the factor for 10 percent and 8 periods is 5.335
Yeboah should not pay more than $7, for the new machine.
This amount equals the present value of the benefits that he will receive from owning the machine.
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23. Determining the Sales Price When Payment Is Deferred
Field Helpers Corporation sells a tractor to Sasha Ptak for $100,000 on February 1, agreeing to take payment ten months later on December 1. The prevailing annual interest rate is 12 percent. What is the actual price of the tractor?
The actual price of the tractor is equal to the present value of the future payment
Using Table 1, the factor for 1 percent and 10 periods is .905
12% annual rate ÷ 12 months per year = 1 percent per month
12 months per year x 10/12 of a year = 10 months
The sale price of the tractor is $90,500
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24. Recording Deferred Sales
The transaction is recorded in both the seller’s and purchaser’s books at the present value, $90,500.
Ptak’s Journal (Purchaser)
Helpers’ Journal (Seller)
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25. Recording Deferred Sales
When Ptak pays for the tractor, the entries are as follows:
Ptak’s Journal (Purchaser)
Helpers’ Journal (Seller)
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26. Recording Investment of Idle Cash
Example SE9, hwk E14
When the investment is made, the following entry is recorded:
After the first month, the interest is recorded by increasing the Short-Term Investments account:
After the second month, the interest is earned on the new balance of the Short-Term Investments account:
Entries would continue in a similar manner for four more months
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