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Chapter 6: Accounting and the Time Value of Money

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

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Chapter 6: Accounting and the Time Value of Money

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

  2. 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

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

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

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

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 Compound Interest • Computed on • Principal balance, plus • Accumulated interest not withdrawn

  7. 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

  8. 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%

  9. 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

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

  11. 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

  12. 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

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