Unit 5 - Time Value of Money Flashcards
A company issues a five-year zero-interest-bearing note for a new lathe it purchased for $25,000. The market rate of interest at the time the note was issued is 4%. Assuming an annual interest rate of 4% for five years is appropriate, the present value of the principal is $25,000 × 0.82193 =$20,548. Assuming an annual interest rate of 5% for 4 years is appropriate, the present value of the principal is $25,000 × 0.82270 = $20,568.
What amount should be recorded for the cost of the lathe?
The lathe is recorded at its present value of $20,548. No calculation is required.
Accounting Rule: A An asset acquired in exchange for a noninterest-bearing note is valued at the present value of the note.
Equipment is exchanged for a noninterest-bearing note. Payment of $20,000 on the note is to be made in one year. The market rate for notes of similar risk is 5%. Assuming an annual interest rate of 5% is appropriate, the present value of the principal is $20,000 × 0.95238 = $19,048. Assuming that a semiannual interest rate of 2.5% is appropriate, the present value of the
principal is ($20,000/2) × 1.92742 = $19,274.
What amount should be recorded for the purchase of this equipment?
The equipment is recorded at its present value of $19,048. No calculation is required.
Accounting Rule: An asset acquired in exchange for a noninterest-bearing note is valued at the present value of the note.
Company A sells land to Company B for $100,000. Company A takes a note from Company B that is due in two years. Assuming an annual interest rate of 5% is appropriate, the implied annual interest is $100,000 × 0.05 = $5,000, and the present value of the note is $100,000 × 0.90703 = $90,703.
What amount should Company A record for the sale?
The note is recorded at its present value of $90,703. No calculation is required.
Accounting Rule: A note received in exchange for property is valued at its present value.
Company A sells a parcel of land to Company B in exchange for a note receivable. The terms of the note require Company B to make a single payment of $600,000 in two years. Using a 10% interest rate, the implied annual interest is $600,000 × 0.10 = $60,000, and the present value of the note is $600,000 × 0.82645 = $495,870.
What amount must Company A consider as proceeds from the sale of the land in order to calculate gross profit or gain/loss on the sale, and be in accordance with generally accepted accounting principles (GAAP)?
The note is recorded at its present value of $495,870. No calculation is required.
Accounting Rule: A note received in exchange for property is valued at its present value
A company performs services for a customer in exchange for a noninterest-bearing note. The customer agrees to make a payment of $100,000 in three years. Using a 5% interest rate, the implied annual interest is $100,000 × 0.05 = $5,000, and the present value of the note is $100,000 × 0.86384 = $86,384.
What amount should the company record as service revenue from this transaction to be in accordance with generally accepted accounting principles (GAAP)?
The note is recorded at its present value of $86,384. No calculation is required.
Accounting Rule: A note received in exchange for service is valued at its present value
A customer signs a noninterest-bearing note, promising to pay the company $11,664 in two years. The payment amount is based on an annual interest rate of 8%, which the company believes is appropriate, resulting in the present value of the note of $11,664 × 0.85734 = $10,000.
Which amount should the company record as sales revenue from this transaction to be in accordance with generally accepted accounting principles (GAAP)?
The note is recorded at its present value of $10,000. No calculation is required.
Accounting Rule: A note received in exchange for goods is valued at its present value.
A company requires $8,000 cash in a savings account earning 2% interest at the end of the year. Assuming an annual interest rate of 2% is appropriate, the implied annual interest is $8,000 × 0.02 = $160, and the present value of the savings is $8,000 × 0.98039 = $7,843.
What amount should be deposited into the savings account at the beginning of the year?
The present value of $8,000 at the beginning of the year is $7,843. No calculation is required.
This is a single-sum problem that requires determining the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate.
Accounting Rule: Present value is the amount that must be invested now to produce a known future value. It is always a smaller amount than the given future value.
A company collects $1,500 of rent from a tenant at the end of the year. The company invests the rent money in an investment earning 4% interest per year. Assuming a 4% annual interest rate is appropriate, the implied annual interest is $1,500 × 0.04 = $60, and the present value of the rent is $1,500 × 0.96154 = $1,442.
What is the discounted value of this rent at the beginning of Year 1?
Discounting is the process of reducing the face/principal amount to a present value. The present value of $1,500 at the beginning of the year is $1,442. No calculation is required.
This is a single-sum problem that requires determining the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate.
Accounting Rule: Present value is the amount that must be invested now to produce a known future value. It is always a smaller amount than the given future value.
A company expects to incur $1,000,000 in environmental remediation costs in 10 years to restore land at one of the production sites it is currently operating. Using an 8% interest rate, the implied annual interest is $1,000,000 × 0.08 = $80,000, and the present value of the remediation cost is $1,000,000 × 0.46319 = $463,190.
What amount must the company record today as an asset retirement obligation (ARO) to be in accordance with generally accepted accounting principles (GAAP)?
The present value of $1,000,000 at the beginning of the year is $463,190. No calculation is required.
This is a single-sum problem that requires determining the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate.
Accounting Rule: Present value is the amount that must be invested now to produce a known future value. It is always a smaller amount than the given future value.
A person opens a savings account at a bank that earns 5% interest, compounded annually. Four years after depositing a principal sum into the account, the account contains exactly $5,000. Assuming a 5% annual interest rate is appropriate, the implied annual interest is $5,000 × 0.05 = $250, and the present value of the savings is $5,000 × 0.82270 = $4,114.
How much principal did the person deposit?
The present value of $5,000 at the beginning of the year is $4,114. No calculation is required.
This is a single-sum problem that requires determining the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate.
Accounting Rule: Present value is the amount that must be invested now to produce a known future value. It is always a smaller amount than the given future value.
A company needs to have $70,000 in cash at the end of four years. The company can invest the cash now in a money market account that will return 6% interest compounded annually. Using a 6% interest rate, the implied annual interest is $70,000 × 0.06 = $4,200.
The following information is given:
•Assuming an annual interest rate of 4% for 6 years is appropriate, the present value of the deposit is $70,000 × 0.79031 = $55,322.
•Assuming an annual interest rate of 6% for 4 years is appropriate, the present value of the deposit is $70,000 × 0.79209 = $55,446.
•Assuming an annual interest rate of 6% for 6 years is appropriate, the present value of the deposit is $70,000 × 0.70946 = $49,662.
How much does this company need to deposit today?
The present value of $70,000 at the beginning of the year is $55,446. No calculation is required.
This is a single-sum problem that requires determining the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate.
Accounting Rule: Present value is the amount that must be invested now to produce a known future value. It is always a smaller amount than the given future value.
A company will receive payments of $10,000 at the beginning of each year for the next three years under a subscription contract. Assuming an annual interest rate of 6% is appropriate, the present value of an ordinary annuity is 2.67301 × $10,000 = $26,730, and the present value of an annuity due is 2.83339 × $10,000 = $28,334.
Assuming collection is reasonably assured, what amount should the company record for this sale to be in accordance with the generally accepted accounting principles (GAAP)?
Since the payments occur at the start of each year, the annuity due factor is used to determine the value of the sale which is $28,334. No calculation is required.
Accounting Rule: a present value of an annuity due involves a series of equal payments (an annuity) and the payments are received at the beginning of each period.
A company is leasing a machine for ten years. The annual payments of $5,000 are made at the beginning of the year. Assuming an annual interest rate of 5% is appropriate, the present value of 1 is 0.6139 × $5,000 = $3,070, the present value of an ordinary annuity is 7.7217 × $5,000 = $38,609, and the present value of an annuity due is 8.1078 × $5,000 = $40,539.
What value should this company use to record the machine?
Since the payments occur at the beginning of each year, the annuity due factor is used to determine the value of the machine which is $40,539. No calculation is required.
Accounting Rule: a present value of an annuity due involves a series of equal payments (an annuity) and the payments are received at the beginning of each period.
Company A has agreed to pay Company B $100,000 at the beginning of each year for the next three years for rights to a patent. Assuming an annual interest rate of 4% is appropriate, the present value of an ordinary annuity is 2.77509 × $100,000 = $277,509, and the present value of an annuity due is 2.88609 × $100,000 = $288,609.
What is the present obligation that Company A should record to be in accordance with generally accepted accounting principles (GAAP)?
Since the payments occur at the start of each year, the annuity due factor is used to determine the value of the sale which is $288,609. No calculation is required.
Accounting Rule: The present value of an annuity due involves a series of equal payments (an annuity) and the payments are received at the beginning of each period.
A company will receive payments of $10,000 per year for the next three years under a subscription contract. The first payment will be made at the end of the first year of the contract. Assuming an annual interest rate of 5% is appropriate, the present value of an ordinary annuity is 2.72325 × $10,000 = $27,233, and the present value of an annuity due is 2.85941 × $10,000 = $28,594.
What amount must the company record for this sale in accordance with generally accepted accounting principles (GAAP) if collection is reasonably assured?
Since the payments occur at the end of each year, the ordinary annuity factor is used to determine the value of the sale which is $27,233. No calculation is required.
Accounting Rule: The present value of an ordinary annuity involves a series of equal payments (an annuity) and the payments are paid at the end of each period.
A company is putting together a list of transactions that are affected by
the time value of money.
Which transaction should be included in this list?
a. Current notes receivable.
b. Investments in active markets.
c. Long-term leases.
d. Short-term liabilities.
c. Long-term leases.
Accounting Rule: Study and memorize the content in the following table
Which of the following situations does not base an accounting measure on
present values?
a. Pensions.
b. Prepaid insurance.
c. Leases.
d. Sinking funds.
b. Prepaid insurance.
Accounting Rule: Study and memorize the content in the following table
Which category includes present value-based transactions that must be
evaluated based on the time value of money?
a. Equity.
b. Cash.
c. Goodwill.
d. Postretirement benefits.
d. Postretirement benefits.
Accounting Rule: Study and memorize the content in the following table
A company buys another company.
Which present value-based accounting measurement is associated with this transaction?
a. Stock-based compensation.
b. Disclosure.
c. Long-term asset.
d. Business combination.
d. Business combination.
Accounting Rule: Study and memorize the content in the following table
