The Time Value of Money
Financial accounting information is useful because it provides investors, creditors, and other interested parties with measures of solvency and earning power. In developing these measures, the valuation of the transactions in which the company participates and ultimately the valuation of a company's assets and liabilities as well as the company itself are very important. It is essential, therefore, that investors, creditors, managers, auditors, and others understand the concepts of valuation. This is especially true as IFRS, which relies extensively on fair market value, plays a larger role, and U.S. GAAP continues to move toward a fair market value framework (e.g., the fair value option for financial instruments).
The economic value of an asset or liability is its present value. In computing present value, the future cash inflows and outflows associated with an asset or liability are predicted and then adjusted in a way that reflects the time value of money (i.e., a dollar in the future is worth less than a dollar at present). Financial accounting statements rely extensively on the concept of present value. In theory, providing measures of present value is the ultimate goal of financial accounting.
This appendix covers the time value of money and, specifically, the concept of present value. We first point out that money has a price (interest). The price of money gives it a time value; it ensures that money held today has a greater value than ...