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ACCT 301 > Chapter 6 > Flashcards

Chapter 6 Flashcards

1
Q

Time value of money

A

Indicates a relationship between time and money.

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2
Q

The dollar received today is worth more than a dollar promises at some time in the future. Why?

A

Bc the opportunity to invest today’s dollar and receive interest on the investment

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3
Q

Historical cost used for
Net realizeable value used for
Fair value used for

A

Equipment

Inventories

Investments

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4
Q

FASB requires the use of what to measure assets and liabilities?

A

Fair value

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5
Q

The most useful fair value measures are based on what?

A

Market prices in active markets

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6
Q

How can fair value be estimated

A

Based on expected future cash flows related to asset or liability

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7
Q

Notes

A

valuing incurrent receivables and payables that carry no stated interest rate or a lower than market interest rate

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8
Q

Leases

A

Valuing assets and obligations to be capitalized under long term leases and measuring the amount of the lease payments and annual leasehold amortization

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9
Q

Pensions and other post retirement benefits

A

Measuring service cost components of employers post retirement benefits expense and post retirement benefits obligations

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10
Q

Long term assets

A

Evaluating alt long term investments by discounting future cash flows.

Determining the value of assets acquired under deferred payment contracts. Measuring impairments of assets

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11
Q

Stock based compensation

A

Determining fair value of employee services in compensatory stock option plans

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12
Q

Business combinations

A

Determining the value of receivables payables liabilities accruals and commitments acquired or assumed in a purchase

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13
Q

Disclosures

A

Measuring the value of future cash flows from oil and gas reserves for disclosure in supplementary information

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14
Q

Environmental liabilities

A

Determine fair value of future obligations for asset retirements

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15
Q

Interest

A

Payment for use of money

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16
Q

Principal

A

Excess cash received or repaid over and above the amount lent or borrowed (principal).

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17
Q

How do business managers make investing and borrowing decisions ?

A

On th basis of rate interest involved rather than on the actual dollar amount of interest to be received or paid

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18
Q

How is interest rate determined?

A

One important factor is the level of credit risk involved.

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19
Q

The higher the credit risk, the higher

A

The interest rate

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20
Q

What are the variables in interest computation?

A

Principal – the amount borrowed or invested

Interest rate – a % of outstanding principal

Time – the # of years or fractional portion of a year that principle is outstanding

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21
Q

Three relationships apply:

A

Larger principal amount the larger the dollar amount of interest

The higher the interest rate, the larger the dollar amount of interest

The longer the time period, the larger the dollar amount of interest

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22
Q

Simple interest

A

On the amount of principal only.

It is the return on (or growth of) principle for one time period.

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23
Q

Simple interest formula

A

Interest = p x i x n

P = principal
R = rate of interest for a single period
N = # of periods
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24
Q

Compound interest

A

Compute c.i. On principal and any interest earned that has not been paid or withdrawn

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25
Q

Compound interest uses what at the year end to compute interest in succeeding year?

A

Uses the accumulated balance

Principal plus interest to date

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26
Q

Any rational investor would choose _____ over ______ if available

A

Choose compound interest if available over simple interest

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27
Q

Which is the typical interest computation applied in business situations?

A

Compound interest

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28
Q

Simple interest usually applies to only what?

A

Short term investments and debts that involve a time span of one year or less

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29
Q

Future value of 1 table

A

Contains amounts to which 1 will accumulate if deposited now at a specified rate and left for a specified number of periods

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30
Q

Present value of 1 table

A

Contains the amounts that must be deposited now at a specified rate of interest to equal 1 at the end of a specified number of periods

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31
Q

Future value of an ordinary annuity of 1 table

A

Contains the amounts to which periodic rents of 1 will accumulate of the payments (rents) are invested at the end of each period at a specified rate of interest for a specified # of periods

32
Q

Present value of an ordinary annuity of 1 table

A

Contains the amounts that must be deposited now at a specified rate of interest to permit withdrawals of 1 at the end of regular periodic intervals for the specified # of periods

33
Q

Present value of an annuity due of 1 table

A

Contains the amounts that must be deposited now at a specified rate of interest to permit withdrawals of 1 at the beginning of regular periodic intervals for the specified number of periods

34
Q

Interest is generally expressed as?

A

In terms of annual rate

35
Q

But when businesses circumstances dictate a compounding period of less than one year….. a company must what?

A

Concert the annual interest rate to correspond to the length of the period

36
Q

How to convert annual interest rate into compounding period interest rate ?

A

Divides the annual rate by the # of compounding periods per year

37
Q

How to determine # of periods

A

Multiplying # of years involved by the # of compounding periods per year

38
Q

Fundamental variables are

A

Rate of interest – unless otherwise stated, an annual rate that must be adjusted to reflect the length of compounding period if less than a year

of time periods – # of compounding periods ( a period maybe equal to or less than a year)

FV – the value at a future date of a given sum or sums invested assuming compound interest

PV– the value now (present) of a future sum or sums discounted assuming compound interest

39
Q

Single sum problems are classified into one of the following

A
  1. Computing the unknown FV, of a known single sum of money that is invested now for a certain # of periods at a certain interest rate
  2. Computing unknown PV of a known single sum of money in the future that is discounted for a certain # of periods at a certain interest rate
40
Q

Rule for solving a FV

A

Accumulate all cash flows to a future point

In this instance, interest increases the amounts or values over time so that the FV exceeds PV

41
Q

Rule for solving for a PV

A

Discount all cash flows from future to present

In this case discounting reduces amounts of values, PV is less than FUture amount

42
Q

Present value is the amount needed to invest now,

A

To produce a known fv

43
Q

Present value of a single sum

The present value is always smaller than

A

Known FV due to earned and accumulated interest

44
Q

Present value of a single sum

In determining FV ,

A

The company moves forward in time using the process of accumulation

45
Q

Present value of a single sum

In determining PV,

A

It moves backward in time using a process of discounting

46
Q

In many business situations both the FV and PV are known but what could be unknown?

A

Interest rate or the number of periods

47
Q

Annuity by definition requires the following

A
  1. Periodic payments or receipts (called rents) of same amount
  2. Same length interval between such rents
  3. Compounding of interest once each interval
48
Q

Future value of annuity

A

Is the sum of all rents plus the accumulated compound interest on them

49
Q

If the rent occurs at the end of each period

A

It is classified as ordinary annuity

50
Q

If rent occurs at beginning of each period,

A

Annuity is classified as an annuity due

51
Q

What is one way in determine future value of annuity?

A

Compute value to which each of the rents in the series will accumulate and then totals their individual FV

52
Q

Because of ordinary annuity consists of rents deposited at the end of each period, the rents earn no what?

A

No interest during the period in which they are deposited

53
Q

When computing FV of an ordinary annuity , the # of compounding periods will always be

A

One less than the # of rents

54
Q

Preceding analysis of an ordinary annuity assumes that periodic rents occur when?

A

At end of each period

55
Q

Annuity due assumes periodic rents occur

A

At the beginning of each period

This means annuity due will accumulate interest during first period and ordinary annuity rent will NOT

56
Q

How to find future value of annuity due factor?

A

Multiply the FV of an ordinary annuity factor by 1 plus interest rate

57
Q

In determining FV of an annuity there will be one less interest period than if the rents occur

A

At the beginning of the period (annuity due)

58
Q

Present value of an ordinary annuity

A

Present value of series of equal rents to be withdrawn at equal intervals at the end of th period

59
Q

One approach to finding PV of annuity determines

A

PV of each of the rents in series and then totals their individual present values

60
Q

Present value of ordinary annuity,

A

Discounted final rent based on # of rents periods

61
Q

Determining PV of an annuity due

A

There is always one fewer discount period

62
Q

To find PV of an annuity due factor

A

Multiplying PV of an ordinary annuity factor by 1 plus interest rate

(1 + i)

63
Q

What are the other time value of money issues

A
  1. Deferred annuities
  2. Bond problems
  3. PV measurement
64
Q

Deferred annuity

A

Is the annuity in which the rent begin after a specified # of periods

65
Q

A deferred annuity does not begin to produce rents until

A

Two or more periods have expired

66
Q

Why is computing FV of a deferred annuity relatively straightforward?

A

There is no accumulation or investment on which interest may accrue, FV of a deferred annuity is the same as FV of annuity not deferred

That is, COMPUTING FV SIMPLY IGNORES DEFERRED PERIOD

67
Q

Computing PV of deferred annuity must recognize what?

A

The interest that accrues on the original investment during the deferral period

68
Q

To compute PV of deferred annuity

A

We compute PV of an ordinary annuity of 1 as if the rents had occurred for entire period

We then subtract PV of rents that were not received during deferral period

We are left with PV of rents actually received subsequent to the deferral period

69
Q

Long term bond produces 2 cash flows

A
  1. periodic interest payment during the life of bond

2. Principle (FV) paid at maturity

70
Q

Valuation of long term bonds

Period interest payments represent what?

Principal represents

A

Annuity

Single sum problem

71
Q

Effective interest method

A

The preferred procedure for amortization of a discount or premium

72
Q

Under the effective interest method

A
  1. Company issues bond first computes bond interest expense by multiplying the carrying value of bonds at beginning of period by effective interest rate
  2. The company then determines bond discount or premium amortization by comparing bond interest expense with interest to be paid
73
Q

The effect interest method produces what?

A

A periodic interest expense equal to a constant % of carrying value of the bonds

74
Q

Expected cash flow approach

A

It uses range of cash flows and incorporates the probabilities of those cash flows to provide a more relevant measurement of PV

75
Q

3 components of interest

A
  1. Pure rate of interest (2-4%)
  2. Expected inflation rate of interest (0%-?)
  3. Credit risk rate of interest (0-5%)
76
Q

A company should discount those cash flows by

A

Risk free rate of return

77
Q

The rate is defined as

A

Pure rate of return plus the expected inflation rate

ACCT 301 (12 decks)

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