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ACCT 301 > Chapter 6 > Flashcards

Chapter 6 Flashcards

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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
Compound interest uses what at the year end to compute interest in succeeding year?
Uses the accumulated balance | Principal plus interest to date
26
Any rational investor would choose _____ over ______ if available
Choose compound interest if available over simple interest
27
Which is the typical interest computation applied in business situations?
Compound interest
28
Simple interest usually applies to only what?
Short term investments and debts that involve a time span of one year or less
29
Future value of 1 table
Contains amounts to which 1 will accumulate if deposited now at a specified rate and left for a specified number of periods
30
Present value of 1 table
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
31
Future value of an ordinary annuity of 1 table
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
Present value of an ordinary annuity of 1 table
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
Present value of an annuity due of 1 table
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
Interest is generally expressed as?
In terms of annual rate
35
But when businesses circumstances dictate a compounding period of less than one year..... a company must what?
Concert the annual interest rate to correspond to the length of the period
36
How to convert annual interest rate into compounding period interest rate ?
Divides the annual rate by the # of compounding periods per year
37
How to determine # of periods
Multiplying # of years involved by the # of compounding periods per year
38
Fundamental variables are
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
Single sum problems are classified into one of the following
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
Rule for solving a FV
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
Rule for solving for a PV
Discount all cash flows from future to present In this case discounting reduces amounts of values, PV is less than FUture amount
42
Present value is the amount needed to invest now,
To produce a known fv
43
Present value of a single sum The present value is always smaller than
Known FV due to earned and accumulated interest
44
Present value of a single sum In determining FV ,
The company moves forward in time using the process of accumulation
45
Present value of a single sum In determining PV,
It moves backward in time using a process of discounting
46
In many business situations both the FV and PV are known but what could be unknown?
Interest rate or the number of periods
47
Annuity by definition requires the following
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
Future value of annuity
Is the sum of all rents plus the accumulated compound interest on them
49
If the rent occurs at the end of each period
It is classified as ordinary annuity
50
If rent occurs at beginning of each period,
Annuity is classified as an annuity due
51
What is one way in determine future value of annuity?
Compute value to which each of the rents in the series will accumulate and then totals their individual FV
52
Because of ordinary annuity consists of rents deposited at the end of each period, the rents earn no what?
No interest during the period in which they are deposited
53
When computing FV of an ordinary annuity , the # of compounding periods will always be
One less than the # of rents
54
Preceding analysis of an ordinary annuity assumes that periodic rents occur when?
At end of each period
55
Annuity due assumes periodic rents occur
At the beginning of each period This means annuity due will accumulate interest during first period and ordinary annuity rent will NOT
56
How to find future value of annuity due factor?
Multiply the FV of an ordinary annuity factor by 1 plus interest rate
57
In determining FV of an annuity there will be one less interest period than if the rents occur
At the beginning of the period (annuity due)
58
Present value of an ordinary annuity
Present value of series of equal rents to be withdrawn at equal intervals at the end of th period
59
One approach to finding PV of annuity determines
PV of each of the rents in series and then totals their individual present values
60
Present value of ordinary annuity,
Discounted final rent based on # of rents periods
61
Determining PV of an annuity due
There is always one fewer discount period
62
To find PV of an annuity due factor
Multiplying PV of an ordinary annuity factor by 1 plus interest rate (1 + i)
63
What are the other time value of money issues
1. Deferred annuities 2. Bond problems 3. PV measurement
64
Deferred annuity
Is the annuity in which the rent begin after a specified # of periods
65
A deferred annuity does not begin to produce rents until
Two or more periods have expired
66
Why is computing FV of a deferred annuity relatively straightforward?
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
Computing PV of deferred annuity must recognize what?
The interest that accrues on the original investment during the deferral period
68
To compute PV of deferred annuity
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
Long term bond produces 2 cash flows
1. periodic interest payment during the life of bond | 2. Principle (FV) paid at maturity
70
Valuation of long term bonds Period interest payments represent what? Principal represents
Annuity Single sum problem
71
Effective interest method
The preferred procedure for amortization of a discount or premium
72
Under the effective interest method
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
The effect interest method produces what?
A periodic interest expense equal to a constant % of carrying value of the bonds
74
Expected cash flow approach
It uses range of cash flows and incorporates the probabilities of those cash flows to provide a more relevant measurement of PV
75
3 components of interest
1. Pure rate of interest (2-4%) 2. Expected inflation rate of interest (0%-?) 3. Credit risk rate of interest (0-5%)
76
A company should discount those cash flows by
Risk free rate of return
77
The rate is defined as
Pure rate of return plus the expected inflation rate

ACCT 301 (12 decks)

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