Accounting Ch 6 Time Value of Money A relationship between time and money Present value based measurement o A dollar today is worth more than a dollar tomorrow o Notes o Leases o Pensions o Share based compensations Basic Concepts Single Sum Principal Amount of money borrowed or invested Interest Rate cost or return on the money borrowed or lent stated as an annual percentage of the outstanding principal Time Number of year or fraction of years the principal is outstanding Simple interest computed on the principal only Interest P x I x N o P principal o I interest o N number of years Compound Interest computes interest on principal and interest that is earned that has not been paid or withdrawn FVF 1 i n FVF future value factor for n periods at I interest I interest rate N periods Annuities Periodic payments or receipts of the same amount Compounding of interest once each interval Ordinarily Annuity occurs at the end of each period Annuity Due occur at the beginning of each period Bond Amortization Stated rate and stated amount to calculate cash flows Discount on bonds payable to balance the equation Carrying value amount a company owes a bondholder at any given time o Bond Value Discount on bond Carrying Value When the Stated Interest rate is less than market rate Cash Discount on bonds payable Bonds Payable 5000 100000 95000 Valuation of Long Term Bonds Periodic Interest payment Annuity Principal paid at maturity single sum Illustration Alltech Corporation on January 1 2017 issues 100 000 of 5 bonds due in 5 years with interest payable annually at year end The current market rate of interest for bonds of similar risk is 6 What will the buyers pay for this bond issue Stated interest rate only tells you your payments or your cash flows DON T PUT IN CALCULATOR 100 000 bonds at 5 5 000 payments 6 market rate 4 Tables Present value of an Ordinary Annuity Interest payment x factor market rate Present value of ordinary annuity Present Value of present value of a single sum Principal x Factor market value Add the present value of Interest to the present value of principal Present value of bond JOURNAL ENTRY Present value of Interest Present value of Principal Bond current market value 95 787 80 Bond market value x market rate Interest expense 21 061 80 74 726 00 Discount on bonds pays Interest Exp Cash 5000 Debit Credit 5747 747