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CHAPTER 6
ACCOUNTING AND THE
TIME VALUE OF MONEY

Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield

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 Accounting and the Time Value of Money

Basic Time More

Single-Sum Present Value
Value Annuities Complex
Problems Measurement
Concepts Situations

Applications Future value Future value Deferred Choosing an

The nature of of a single of ordinary annuities appropriate
interest sum annuity Valuation of interest rate
Simple interest Present value Future value long-term Example of
of a single of annuity due bonds expected cash
Compound
sum Examples of Effective- flow
interest
Solving for FV of annuity interest
Fundamental
other Present value method of
variables
unknowns of ordinary bond discount/
annuity premium
amortization
Present value
of annuity due
Examples of
6-3 PV of annuity
 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.

6-4 LO 1 Identify accounting topics where the time value of money is relevant.
 Basic Time Value Concepts

Applications to Accounting Topics:

1. Notes 5. Shared-Based
Compensation
2. Leases
6. Business Combinations
3. Pensions and Other
Postretirement 7. Disclosures
Benefits
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

Payment for the use of money.
Excess cash received or repaid over the amount
borrowed (principal).

6-6 LO 1 Identify accounting topics where the time value of money is relevant.
 Basic Time Value Concepts

Simple Interest
Interest computed on the principal only.

Illustration: KC borrows $20,000 for 3 years at a rate of 7%

per year. Compute the total interest to be paid for the 3 years.

Interest = p x i x n
Total
= $20,000 x .07 x 3
Interest
= $4,200

Many regulatory frameworks require disclosure of interest rates on an annual basis.

6-7 LO 2 Distinguish between simple and compound interest.

 Basic Time Value Concepts

Simple Interest
Interest computed on the principal only.

Illustration: KC borrows $20,000 for 3 years at a rate of 7%

per year. Compute the total interest to be paid for the 1 year.

Interest = p x i x n
Annual
= $20,000 x .07 x 1
Interest
= $1,400

6-8 LO 2 Distinguish between simple and compound interest.

 Basic Time Value Concepts

Simple Interest
Interest computed on the principal only.

Illustration: On March 31, 2011, KC borrows $20,000 for 3

years at a rate of 7% per year. Compute the total interest to be
paid for the year ended Dec. 31, 2011.

Interest = p x i x n
Partial
Year = $20,000 x .07 x 9/12

= $1,050

6-9 LO 2 Distinguish between simple and compound interest.

 Basic Time Value Concepts

Compound Interest
Computes interest on
➢ principal and

➢ interest earned that has not been paid or

withdrawn.

Most business situations use compound interest.

6-10 LO 2 Distinguish between simple and compound interest.

 Basic Time Value Concepts
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% $1,069.29 $ 12,950.29

6-11 LO 2 Distinguish between simple and compound interest.

 Basic Time Value Concepts

Fundamental Variables
Rate of Interest
Number of Time Periods
Future Value
Present Value
Illustration 6-6

6-12 LO 4 Identify variables fundamental to solving interest problems.

 Single-Sum Problems

Two Categories

Unknown Present Value Unknown Future Value

Illustration 6-6

6-13 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

6-14 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

6-15 LO 5 Solve future and present value of 1 problems.

 Single-Sum Problems

Present Value of a Single Sum

Value now of a given amount to be paid or received in
the future, assuming compound interest.

Where:

FV = future value
PV = present value (principal or single sum)
PVF n,i = present value factor for n periods at i interest

6-16 LO 5 Solve future and present value of 1 problems.

 Present Value of a Single Sum

Illustration: What is the present value of $84,253 to be

received or paid in 5 years discounted at 11% compounded
annually?

= $50,000

Illustration 6-11

6-17 LO 5 Solve future and present value of 1 problems.

 Annuities

Annuity requires:
(1) Periodic payments or receipts (called rents) of the
same amount,

(2) Same-length interval between such rents, and

(3) Compounding of interest once each interval.

Two Ordinary Annuity - rents occur at the end of each period.

Types Annuity Due - rents occur at the beginning of each period.

6-18 LO 6 Solve future value of ordinary and annuity due problems.

 Annuities

Future Value of an Ordinary Annuity

Rents occur at the end of each period.
No interest during 1st period.

Present Value Future Value

$20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000

0 1 2 3 4 5 6 7 8

6-19 LO 6 Solve future value of ordinary and annuity due problems.

 Future Value of an Ordinary Annuity

Illustration: Assume that $1 is deposited at the end of

each of 5 years (an ordinary annuity) and earns 12%
interest compounded annually. Following is the
computation of the future value, using the “future value of 1”
table (Table 6-1) for each of the five $1 rents.

Illustration 6-17

6-20 LO 6 Solve future value of ordinary and annuity due problems.

 Future Value of an Ordinary Annuity

A formula provides a more efficient way of expressing the

future value of an ordinary annuity of 1.

Where:

R = periodic rent
FVF-OA n,i = future value factor of an ordinary annuity
i = rate of interest per period
n= number of compounding periods

6-21 LO 6 Solve future value of ordinary and annuity due problems.

 Future Value of an Ordinary Annuity

Illustration: What is the future value of five $5,000 deposits

made at the end of each of the next 5 years, earning interest
of 12%?

= $31,764.25

Illustration 6-19

6-22 LO 6 Solve future value of ordinary and annuity due problems.

 Annuities

Present Value of an Ordinary Annuity

Present value of a series of equal amounts to be
withdrawn or received at equal intervals.
Periodic rents occur at the end of the period.

Present Value

$100,000 100,000 100,000 100,000 100,000 100,000

.....
0 1 2 3 4 19 20

6-23 LO 7 Solve present value of ordinary and annuity due problems.

 Present Value of an Ordinary Annuity

Illustration: Assume that $1 is to be received at the end of

each of 5 periods, as separate amounts, and earns 12%
interest compounded annually.
Illustration 6-28

6-24 LO 7 Solve present value of ordinary and annuity due problems.

 Present Value of an Ordinary Annuity

A formula provides a more efficient way of expressing the

present value of an ordinary annuity of 1.

Where:

6-25 LO 7 Solve present value of ordinary and annuity due problems.

 Present Value of an Ordinary Annuity

Illustration: What is the present value of rental receipts of

$6,000 each, to be received at the end of each of the next 5
years when discounted at 12%?

Illustration 6-30

6-26 LO 7 Solve present value of ordinary and annuity due problems.

 More Complex Situations

Deferred Annuities
Rents begin after a specified number of periods.
Future Value - Calculation same as the future value of an
annuity not deferred.
Present Value - Must recognize the interest that accrues
during the deferral period.

Future Value
Present Value
100,000 100,000 100,000
.....
0 1 2 3 4 19 20

6-27 LO 8 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

$140,000 140,000 140,000 140,000 140,000 140,000

.....
0 1 2 3 4 9 10

6-28 LO 8 Solve present value problems related to deferred annuities and bonds.
 Valuation of Long-Term Bonds

Present Value

$140,000 140,000 140,000 140,000 140,000 2,140,000

.....
0 1 2 3 4 9 10

BE6-15: Wong Inc. issues HK$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 Wong
receive when it issues the bonds?

6-29 LO 8 Solve present value problems related to deferred annuities and bonds.
 i=8%
Valuation of Long-Term Bonds
n=10

PV of Interest

$140,000 x 6.71008 = $939,411

Interest Payment Factor Present Value

6-30 LO 8 Solve present value problems related to deferred annuities and bonds.
 i=8%
Valuation of Long-Term Bonds
n=10

PV of Principal

$2,000,000 x .46319 = $926,380

Principal Factor Present Value

6-31 LO 8 Solve present value problems related to deferred annuities and bonds.
 Valuation of Long-Term Bonds

BE6-15: Wong 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

Date Account Title Debit Credit

Cash 1,865,791
Bonds payable 1,865,791

6-32 LO 8 Solve present value problems related to deferred annuities and bonds.
 Valuation of Long-Term Bonds

BE6-15: Schedule of Bond Discount Amortization

10-Year, 7% Bonds Sold to Yield 8%

Cash Bond Carrying

Interest Interest Discount Value
Date Paid Expense Amortization of Bonds
1/1/10 1,865,791
12/31/10 140,000 149,263 9,263 1,875,054
12/31/11 140,000 150,004 10,004 1,885,059
12/31/12 140,000 150,805 10,805 1,895,863
12/31/13 140,000 151,669 11,669 1,907,532
12/31/14 140,000 152,603 12,603 1,920,135
12/31/15 140,000 153,611 13,611 1,933,746
12/31/16 140,000 154,700 14,700 1,948,445
12/31/17 140,000 155,876 15,876 1,964,321
12/31/18 140,000 157,146 17,146 1,981,467
12/31/19 140,000 158,533 * 18,533 2,000,000

* rounding

6-33 LO 8 Solve present value problems related to deferred annuities and bonds.
 Present Value Measurement

International Accounting Standard No. 36 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:
Pure Rate Risk-free rate of
return. IASB states a
Expected Inflation Rate company should
discount expected
Credit Risk Rate
cash flows by the risk-
free rate of return.

6-34 LO 9 Apply expected cash flows to present value measurement.

 Present Value Measurement
E6-21: Angela Contreras is trying to determine the amount
to set aside so that she will have enough money on hand in 2 years to
overhaul the engine on her vintage used car. While there is some
uncertainty about the cost of engine overhauls in 2 years, by conducting
some research online, Angela has developed the following estimates.

Instructions: How much should Angela Contreras deposit today in an

account earning 6%, compounded annually, so that she will have enough
money on hand in 2 years to pay for the overhaul?

6-35 LO 9 Apply expected cash flows to present value measurement.

 Present Value Measurement
Instructions: How much should Angela Contreras deposit today in an
account earning 6%, compounded annually, so that she will have enough
money on hand in 2 years to pay for the overhaul?

6-36 LO 9 Apply expected cash flows to present value measurement.

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