Appendix C: Accounting and the Time Value of Money Flashcards
What are the two components of interest rates?
Risk free rate
Risk premium rate
What is a credit risk premium?
The amount added to the nominal interest rate to account for the expected inflation over the loan or investment period.
What is the risk-free rate?
The rate of return or cost of borrowing that is adjusted for inflation.
What is a stated rate vs. a market rate?
Stated - a rate that is explicitly stated (fixed) or specified in a financial agreement
Market rate - rate that reflects the current rates in the financial markets; determined by demand and supply
When should the time value of money be used in accounting?
Whenever future cash flows need to be compared to present value OR when those future cash flows need to be adjusted for the passage of time.
How does TVM relate to the definition of assets and liabilities?
Assets - helps so that they will not be overstated
Liabilities - discount future cash outflows to their present values (reflect true costs)
What is an installment loan?
requires the principal and interest to be paid back in equal regular payments (annuity)
What is the discount on the note receivable account?
Contra Asset Account
What is the normal balance of a contra asset account?
Credit
Why is it bad accounting to just record the note receivable account?
The value of the money could be overstated.
Why can’t we recognize the interest revenue at the initial date?
Because time has not passed for interest to be accrued
What is the discount on the note payable account?
Contra Liability Account
What is the normal balance of a contra liability account?
Debit
Why is it bad account to just record the note payable and the equipment at the gross amount?
Could overstate the note payable, fail to recognize interest expense, and it does not comply with GAAP
Why can’t we recognize the interest expense at the initial date?
Because time has not passed for interest to be accrued
