ACCOUNTING AND THE TIME VALUE OF MONEY
Due to the time value of money, a certain sum today is not equal to the same sum at a future point in time. We must consider the compound interest factor for the time between two given dates in order to determine what amount in the future is equivalent to a given sum today or what amount today is equivalent to a given sum in the future. We compound the dollar amount forward in time in the former case and discount the dollar amount from the future to the present time in the latter case. In this chapter we discuss both of these procedures for a single sum and the appropriate procedures for compounding and discounting annuities. Interest tables appear at the end of this chapter.
SUMMARY OF LEARNING OBJECTIVES
- Identify accounting topics where the time value of money is relevant. Some of the applications of present-value-based measurements to accounting topics are: (1) notes, (2) leases, (3) pensions and other postretirement benefits, (4) long-term assets, (5) stock-based compensation (6) business combinations, (7) disclosures, (8) installment contracts, (9) sinking funds, and (10) environmental liabilities.
- Distinguish between simple and compound interest. Interest is a payment for the use of money. It is the excess cash received or repaid over and above the amount lent (invested) or borrowed (principal). Simple interest is interest that is computed on the amount of the principal only. It is the return on (or growth of) the ...