Intermediate Accounting, Ch. 6 by Kieso

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23 terms · Chapter 6 - time value of money

annuity

A series of payments or receipts (called rents) that occur at equal intervals.

annuity due

An annuity in which each rent is payable/receivable at the beginning of the period.

compound interest

Interest that accrues on both the principal and the interest earned in past periods (interest not withdrawn or paid out).

deferred annuity

An annuity in which the rents begin after a specified number of periods.

discounting

The process of reducing the amounts or values of cash flows from the future to the present, making the present value less than the future amount. (p. 271).

effective yield

The rate of interest the bondholders actually earn on a bond (and which takes into account the frequency of compounding). If bonds sell at a discount, the effective yield exceeds the stated rate; if bonds sell at a premium, the effective yield is lower than the stated rate. (p. 269).

effective-interest method

The preferred procedure for computing the amortization of a discount or premium. Under this method, companies compute bond interest expense (revenue) at the beginning of the period by the effective-interest rate) and then subtract bond interest paid (calculated as the face amount of the bonds times the stated interest rate); the result is the amortization amount. (p. 289).

expected cash flow approach

Method of calculating present value that uses a range of cash flows and incorporates the probability of those cash flows to provide as accurate as possible measure of expected future cash flows. (p. 290).

face rate

The annual interest rate stated on a financial instrument. Also called nominal or stated rate. (p. 269).

future value

Value at a later date of a single sum that is invested at compound interest. (p. 270).

future value of an annuity

The accumulated total that results from a series of equal deposits (rents) invested at compound interest. (p. 276).

interest

Payment for the use of someone else's money. It is the excess cash received/repaid over and above the amount lent/borrowed. (p. 265).

nominal rate

The annual interest rate stated on a financial instrument (a note or bond, for example). Also called face or stated rate. (p. 269).

ordinary annuity

An annuity in which each rent is payable/receivable at the end of the period. (p. 276).

present value

The value at an earlier date (usually now) of a given future sum discounted at compound interest. (p. 270).

principal

The amount borrowed or invested. (p. 265).

risk-free rate of return

The pure (real) rate of return plus the expected inflation rate. Typically measured by the return on a low-risk security (such as a 3-month U.S. Treasury bill.) (p. 291).

simple interest

Interest on principal only, regardless of interest that may have accrued in past periods (compounded). (p. 266).

stated rate

The annual interest rate stated on a financial instrument (a note or bond, for example). Also called face or nominal rate. (p. 269).

time value of money

The relationship between time and money. A dollar received today is worth more than a dollar promised at some time in the future, because of the opportunity to invest today's dollar and receive interest on the investment. (p. 264).

When computing the future value of an ordinary annuity, the number of compounding periods __

will always be one less than the number of rents.

What are some topics where the the time value of money is relevant?

(1) notes, (2) leases, (3) pensions and other postretirement benefits, (4) long-term assets, (5) sinking funds, (6) business combinations, (7) disclosures, and (8) installment contracts

What is the difference between simple and compounded interest?

Simple interest is computed on only the principal. Compounded interest is computed on the principal and any interest earned to date.

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