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Coby Harmon
University of California, Santa Barbara
Westmont College
6-1
Accounting and the CHAPTER 6
Time Value of Money
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the fundamental 4. Solve present value of
concepts related to the time ordinary and annuity due
value of money. problems.
2. Solve future and present value 5. Solve present value
of 1 problems. problems related to deferred
annuities, bonds, and
3. Solve future value of ordinary
expected cash flows.
and annuity due problems.
6-2
PREVIEW OF CHAPTER 6
Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
6-3
Basic Time LEARNING OBJECTIVE 1
Describe the fundamental
Value Concepts concepts r elated to the time
value of money.
6-4 LO 1
Basic Time Value Concepts
6-5 LO 1
Basic Time Value Concepts
6-6 LO 1
Basic Time Value Concepts
Simple Interest
Interest computed on the principal only.
Interest = p x i x n
Annual
Interest = $10,000 x .08 x 1
= $800
6-7 LO 1
Basic Time Value Concepts
Simple Interest
Interest computed on the principal only.
Interest = p x i x n
Total
Interest = $10,000 x .08 x 3
= $2,400
6-8 LO 1
Basic Time Value Concepts
Simple Interest
Interest computed on the principal only.
Interest = p x i x n
Partial
Year = $10,000 x .08 x 3/12
= $200
6-9 LO 1
Basic Time Value Concepts
Compound Interest
Computes interest on
► principal and
► interest earned that has not been paid or
withdrawn.
6-10 LO 1
Compound Interest
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
6-11 LO 1
Basic Time Value Concepts
6-12 LO 1
Basic Time Value Concepts
6-13 LO 1
Basic Time Value Concepts
Where:
6-14 LO 1
Basic Time Value Concepts
6-15 LO 1
Basic Time Value Concepts
ILLUSTRATION 6.4
Frequency of Compounding
6-16 LO 1
Basic Time Value Concepts
ILLUSTRATION 6.5
Comparison of Different Compounding Periods
6-17 LO 1
Basic Time Value Concepts
Fundamental Variables
Rate of Interest Future Value
Number of Time Periods Present Value
ILLUSTRATION 6.6
Basic Time Diagram
6-18 LO 1
LEARNING OBJECTIVE 2
Single-Sum Problems Solve future and present value
of 1 problems.
Two Categories
ILLUSTRATION 6.6
Basic Time Diagram
6-19 LO 2
Single-Sum Problems
Where:
FV = future value
PV = present value (principal or single sum)
FVF n,i = future value factor for n periods at i interest
6-20 LO 2
Future Value of a Single Sum
ILLUSTRATION 6.7
Future Value Time
Diagram (n = 5, i = 6%)
= €66,912
6-21 LO 2
Future Value of a Single Sum Alternate
Calculation
ILLUSTRATION 6.7
Future Value Time
Diagram (n = 5, i = 11%)
What table do
we use?
6-22 LO 2
Future Value of a Single Sum Alternate
Calculation
6-23 LO 2
Future Value of a Single Sum
ILLUSTRATION 6.8
Future Value Time
Diagram (n = 8, i = 5%)
What table do we use?
6-24 LO 2
Future Value of a Single Sum
TABLE 6.1 FUTURE VALUE OF 1 (FUTURE VALUE OF A SINGLE SUM) i=5%
n=8
6-25 LO 2
Single-Sum Problems
Where:
PVFn,i = present value factor for n periods at i interest
n = number of periods
i = rate of interest for a single period
6-26 LO 2
Present Value of a Single Sum
6-27 LO 2
Present Value of a Single Sum
ILLUSTRATION 6.9
Excerpt from Table 6.2
6-28 LO 2
Present Value of a Single Sum
Where:
FV = future value
PV = present value
PVF n,i = present value factor for n periods at i interest
6-29 LO 2
Present Value of a Single Sum
ILLUSTRATION 6.11
Present Value Time
Diagram (n = 5, i = 8%)
= €50,000
(rounded by €.51)
6-30 LO 2
Present Value of a Single Sum
ILLUSTRATION 6.11
Present Value Time
Diagram (n = 5, i = 8%)
6-31 LO 2
Present Value of a Single Sum
i=8% TABLE 6.2 PRESENT VALUE OF 1
n=5
What factor?
6-32 LO 2
Present Value of a Single Sum
Illustration: Assume that your rich uncle decides to give you $2,000
for a vacation when you graduate from college 3 years from now.
He proposes to finance the trip by investing a sum of money now at
8% compound interest that will provide you with $2,000 upon your
graduation. The only conditions are that you graduate and that you
tell him how much to invest now.
ILLUSTRATION 6.12
Present Value Time
Diagram (n = 3, i = 8%) What table do we use?
6-33 LO 2
Present Value of a Single Sum
i=8% TABLE 6.2 PRESENT VALUE OF 1
n=3
What factor?
6-34 LO 2
Single-Sum Problems
6-35 LO 2
Solving for Other Unknowns
6-36 LO 2
Solving for Other Unknowns
6-37 LO 2
Solving for Other Unknowns
ILLUSTRATION 6.15
6-38 LO 2
Solving for Other Unknowns
6-39 LO 2
Solving for Other Unknowns
6-40 LO 2
LEARNING OBJECTIVE 3
Annuities Solve future value of ordinary
and annuity due problems.
Annuity requires:
6-41 LO 3
Annuities (Future Value)
0 1 2 3 4 5 6 7 8
6-42 LO 3
Future Value of an Ordinary Annuity
*Note that this annuity table factor is the same as the sum
of the future values of 1 factors shown in Illustration 6.17.
6-44 LO 3
Future Value of an Ordinary Annuity
Where:
R = periodic rent
FVF-OA n,i = future value factor of an ordinary annuity
factor for n periods at i interest
6-45 LO 3
Future Value of an Ordinary Annuity
= $28,185.45
ILLUSTRATION 6.19
Time Diagram for Future Value of Ordinary Annuity (n = 5, i = 6%)
6-46 LO 3
Future Value of an Ordinary Annuity
Alternate
Calculation
What factor?
6-48 LO 3
Future Value of an Ordinary Annuity
6-50 LO 3
Annuities
0 1 2 3 4 5 6 7 8
6-51 LO 3
Future Value of an Annuity Due
6-52 LO 3
Future Value of Annuity Problems
Computation of Rent
Illustration: Assume that you plan to accumulate CHF14,000 for a
down payment on a condominium apartment 5 years from now. For
the next 5 years, you earn an annual return of 8% compounded
semiannually. How much should you deposit at the end of each 6-
month period?
ILLUSTRATION 6.24
R = CHF1,166.07
6-53 LO 3
Future Value of Annuity Problems Alternate
Calculation
ILLUSTRATION 6.24
Computation of Rent
CHF14,000
= CHF1,166.07
12.00611
TABLE 6.3 FUTURE VALUE OF AN ORDINARY ANNUITY OF 1
6-54 LO 3
Future Value of Annuity Problems
ILLUSTRATION 6.25
5.86660
6-55 LO 3
Future Value of Annuity Problems
6-56 LO 3
LEARNING OBJECTIVE 4
Annuities (Present Value) Solve present value of ordinary
and annuity due problems.
Present Value
6-57 LO 4
Present Value of an Ordinary Annuity
ILLUSTRATION 6.28
Solving for the Present Value of an Ordinary Annuity
6-58 LO 4
Present Value of an Ordinary Annuity
Where:
6-59 LO 4
Present Value of an Ordinary Annuity
6-60 LO 4
Present Value of an Ordinary Annuity
Present Value
6-61 LO 4
Present Value of an Ordinary Annuity
i=8%
n=20 TABLE 6.4 PRESENT VALUE OF AN ORDINARY ANNUITY OF 1
6-62 LO 4
Annuities (Present Value)
Present Value
6-63 LO 4
Present Value of an Annuity Due
6-64 LO 4
Present Value of an Annuity Due
ILLUSTRATION 6.33
Computation of Present Value of an Annuity Due
6-65 LO 4
Present Value of Annuity Problems
Present Value
6-66 LO 4
Present Value of Annuity Problems
i=8%
n=20 TABLE 6.5 PRESENT VALUE OF AN ANNUITY DUE OF 1
6-67 LO 4
Present Value of Annuity Problems
Referring to Table 6.4 and reading across the 12-period row, you find 10.57534 in the
2% column. Since 2% is a monthly rate, the nominal annual rate of interest is 24% (12
12
x 2%). The effective annual rate is 26.82413% [(1 + .02) - 1].
6-68 LO 4
Present Value of Annuity Problems
12
6-69 LO 4
Other Time Value LEARNING OBJECTIVE 5
Solve present value problems
of Money Issues related to deferred annuities,
bonds, and expected cash
flows.
Deferred Annuities
Rents begin after a specified number of periods.
Future Value of a Deferred Annuity - Calculation same as
the future value of an annuity not deferred.
Present Value of a Deferred Annuity - 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
6-70 LO 5
Deferred Annuities
ILLUSTRATION 6.37
6-71 LO 5
Deferred Annuities
6-72 LO 5
Present Value of Deferred Annuity
ILLUSTRATION 6.38
6-73 LO 5
Present Value of Deferred Annuity
6-74 LO 5
Other Time Value of Money Issues
2,000,000
6-75 LO 5
Valuation of Long-Term Bonds
Present Value
6-76 LO 5
Valuation of Long-Term Bonds i=8%
n=10
6-77 LO 5
Valuation of Long-Term Bonds i=8%
n=10
6-78 LO 5
Valuation of Long-Term Bonds
6-79 LO 5
Effective-Interest Method of Amortization
* rounding
6-80 LO 5
Present Value Measurement
6-81 LO 5
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.
6-82 LO 5
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?
6-83 LO 5
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6-84