Chapter 6: Accounting and the Time Value of

Money

Sid Glandon, DBA, CPAAssistant 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Principal balance, plus Accumulated interest not withdrawn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