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CHAPTER 6
Accounting and the Time Value of Money
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
1.
Present value concepts.
1, 2, 3, 4, 5,
9, 17, 19
2.
Use of tables.
13, 14
8
1
3.
Present and future value
problems:
a. Unknown future amount.
7, 19
1, 5, 13
2, 3, 4, 6
4.
Value of a series of irregular
deposits; changing interest
rates.
3, 5, 8
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises
Exercises
Problems
1. Describe the fundamental concepts
related to the time value of money.
8
1
4. Solve present value of ordinary and
annuity due problems.
10, 11, 12,
14, 16, 17
1, 3, 4, 5, 6,
11, 12, 17,
18, 19
1, 3, 4, 5,
7, 8, 9, 10,
13, 14
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E6.1
Using interest tables.
Simple
5–10
E6.2
Simple and compound interest computations.
Simple
5–10
E6.3
Computation of future values and present values.
Simple
10–15
E6.8
Computations for a retirement fund.
Simple
10–15
E6.9
Unknown rate.
Moderate
5–10
E6.10
Unknown periods and unknown interest rate.
Simple
10–15
E6.11
Evaluation of purchase options.
Moderate
10–15
E6.12
Analysis of alternatives.
Simple
10–15
E6.13
Computation of bond liability.
Moderate
15–20
E6.14
Computation of pension liability.
Moderate
15–20
P6.1
Various time value situations.
Moderate
15–20
P6.2
Various time value situations.
Moderate
15–20
P6.3
Analysis of alternatives.
Moderate
20–30
P6.4
Evaluating payment alternatives.
Moderate
20–30
P6.5
Analysis of alternatives.
Moderate
20–25
P6.6
Purchase price of a business.
Moderate
25–30
P6.7
Time value concepts applied to solve business problems.
Complex
30–35
ANSWERS TO QUESTIONS
1. Money has value because with it one can acquire assets and services and discharge obligations.
The holding, borrowing or lending of money can result in costs or earnings. And the longer the
time period involved, the greater the costs or the earnings. The cost or earning of money as a
function of time is the time value of money. A dollar received today is worth more than a dollar
promised at some time in the future because of the opportunity to invest today’s dollar and receive
interest on the investment.
2. Some situations in which present value measures are used in accounting include:
(a) Notes receivable and payable—these involve single sums (the face amounts) and may involve
annuities, if there are periodic interest payments.
(b) Leases—involve measurement of assets and obligations, which are based on the present value
of annuities (lease payments) and single sums (if there are residual values to be paid at the
conclusion of the lease).
3. Interest is the payment for the use of money. It may represent a cost or earnings depending upon
whether the money is being borrowed or loaned. The earning or incurring of interest is a function
4. The interest rate generally has three components:
(a) Pure rate of interest—This would be the amount a lender would charge if there were no
possibilities of default and no expectation of inflation.
(b) Expected inflation rate of interest—Lenders recognize that in an inflationary economy, they
Questions Chapter 6 (Continued)
5. (a) Present value of an ordinary annuity at 8% for 10 periods (Table 6-4).
(b) Future value of 1 at 8% for 10 periods (Table 6-1).
6. He should choose quarterly compounding, because the balance in the account on which interest
will be earned will be increased more frequently, thereby resulting in more interest earned on the
investment. This is shown in the following calculation:
Semiannual compounding, assuming the amount is invested for 2 years:
7. $26,897.80 = $20,000 X 1.34489 (future value of 1 at 21/2% (10% ÷ 4) for 12 (3 x 4) periods).
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: Critical Thinking, AICPA FC: Reporting, AICPA PC: Problem Solving
8. $44,671.20 = $80,000 X .55839 (present value of 1 at 6% (12% ÷ 2) for 10 (5 x 2) periods).
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: Critical Thinking, AICPA FC: Reporting, AICPA PC: Problem Solving
10.
Amount paid each year =
€40,000
(present value of an ordinary annuity at 12% for 4 years).
3.03735
Questions Chapter 6 (Continued)
12.
Amount deposited each year =
¥20,000,000
[future value of an annuity due at 10% for 4 years
(4.64100 X 1.10)].
5.10510
13. The process for computing the future value of an annuity due using the future value of an ordinary
annuity interest table is to multiply the corresponding future value of the ordinary annuity by one
14. The basis for converting the present value of an ordinary annuity table to the present value of an
15. Present value = present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
$245,000 = present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
LO: 1,4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: Critical Thinking, AICPA FC: Reporting, AICPA PC: Problem Solving
16. 4.96764 Present value of ordinary annuity at 12% for eight periods.
17. (a) Present value of an annuity due.
(b) Present value of 1.
18. R$27,600 = PV of an ordinary annuity of $6,900 for five periods at ? percent.
19. The taxing authority argues that the future reserves should be discounted to present value. The
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6.1
8% annual interest
i = 8%
PV = $15,000 FV = ?
8% annual interest, compounded semiannually
i = 4%
PV = $15,000 FV = ?
BRIEF EXERCISE 6.2
12% annual interest
i = 12%
PV = ? FV = R$25,000
12% annual interest, compounded quarterly
i = 3%
PV = ? FV = R$25,000
BRIEF EXERCISE 6.3
i = ?
PV = €30,000 FV = €150,000
BRIEF EXERCISE 6.4
i = 5%
PV = $10,000 FV = $17,100
BRIEF EXERCISE 6.5
First payment at year-end (Ordinary Annuity)
i = 6%
FV – OA =
?
€8,000 €8,000 €8,000 €8,000 €8,000
First payment today (Annuity Due)
i = 6%
R = FV – AD =
€8,000 €8,000 €8,000 €8,000 €8,000 ?
BRIEF EXERCISE 6.6
i = 5%
FV – OA =
R = ? ? ? ? $250,000
BRIEF EXERCISE 6.7
8% annual interest
i = 8%
PV = ? FV = $300,000
BRIEF EXERCISE 6.8
With quarterly compounding, there will be 20 (5 x 4 ) quarterly compounding
BRIEF EXERCISE 6.9
i = 5%
FV – OA =
R = $100,000
$9,069 $9,069 $9,069
BRIEF EXERCISE 6.10
First withdrawal at year-end
i = 8%
PV – OA = R =
? £30,000 £30,000 £30,000 £30,000 £30,000
First withdrawal immediately
i = 8%
PV – AD =
?
R =
BRIEF EXERCISE 6.11
i = ?
PV = R =
$793.15 $75 $75 $75 $75 $75
BRIEF EXERCISE 6.12
i = 4%
PV =
$300,000 R = ? ? ? ? ?
BRIEF EXERCISE 6.13
i = 6%
R =
$30,000 $30,000 $30,000 $30,000 $30,000
BRIEF EXERCISE 6.14
i = 8%
PV – OA = R =
? R$25,000 R$25,000 R$25,000 R$25,000
BRIEF EXERCISE 6.15
i = 8%
PV = ?
PV – OA = R = HK$2,000,000
? HK$140,000* HK$140,000 HK$140,000 HK$140,000
BRIEF EXERCISE 6.16
PV – OA = £20,000
£4,727.53 £4,727.53 £4,727.53 £4,727.53
0
1
2
5 6
BRIEF EXERCISE 6.17
PV – AD = £20,000
£? £? £? £?
0
1
2
5 6
SOLUTIONS TO EXERCISES
EXERCISE 6.1 (5–10 minutes)
(a)
(b)
Rate of Interest
Number of Periods
1.
a.
9%
9
b.
2% (8% ÷ 4)
20 (5 x 4)
c.
5% (10% ÷ 2)
30 (15 x 2)
2.
a.
9%
25
EXERCISE 6.2 (5–10 minutes)
(a)
Simple interest of HK$2,400 (HK$30,000 X 8%)
per year X 8 ..................................................................
HK$19,200
Principal .............................................................................
30,000
Total withdrawn ........................................................
HK$49,200
EXERCISE 6.3 (10–15 minutes)
(a)
€9,000 X (FVF5, 8%) 1.46933 = €13,224.
EXERCISE 6.4 (15–20 minutes)
(a)
Future value of an ordinary
due of $5,000 a period at 8%
(b)
Present value of an ordinary
annuity of $2,500 for 30
periods at 10%
$23,567.28
($2,500 X 9.42691)
Factor (1 + .10)
X 1.10
Present value of annuity
due of $2,500 for 30 periods
(Or see Table 6-5 $23,567 x 10.369
EXERCISE 6.5 (10–15 minutes)
(a)
£50,000 X (PVF–OA8, 12%) 4.96764 = £248,382.
EXERCISE 6.6 (15–20 minutes)
(a)
Future value of ¥1,200,000 @ 10% for 10 years
(¥1,200,000 X 2.59374) =
¥ 3,112,488
(b)
Future value of an ordinary annuity of W620,000
EXERCISE 6.7 (12–17 minutes)
(a)
$100,000 X (PVF15,8%) .31524
=
$ 31,524
+ $10,000 X (PVF–OA15,8%) 8.55948
=
85,595
$117,119
