Accounting 301 notes

Chapter 5: Time Value of Money Concepts

• Time Value of Money: Concept that money invested today is worth more in the future due to its potential earning capacity.

Interest

• Simple Interest: Calculated on the initial investment only.

  • Formula: I = Initial investment × Annual interest rate × Period of time

• Compound Interest: Interest calculated on the initial principal and also on the accumulated interest from previous periods.

• Effective Rate: Actual rate at which money grows over a year considering compounding.

Single Future Amount (Lump-sum)

• Future Value (FV): Amount of money that an investment grows into at a specified future date.

  • Formula: FV = I × (1 + i)^n

    • FV = Future Value

    • I = Initial amount

    • i = Interest rate per compounding period

    • n = Number of compounding periods

• Future Value Factor for $1: (1 + i)^n

• Present Value (PV): Current value of a future sum of money or stream of cash flows given a specified rate of return.

  • Formula: PV = FV / (1+i)^n

    • PV = Present Value

    • FV = Future Value

    • i = Interest rate per compounding period

    • n = Number of compounding periods

• Using Financial Calculator (BAII Plus):

  • N: Number of payment periods

  • I/Y: Interest rate per year

  • PV: Present value

  • FV: Future value

• In Accounting: Present Value is used to account for monetary assets like notes receivable and liabilities like notes payable.

Page 2: Series of Future Payments/Receipts (Annuity)

• Annuity: Series of cash payments or receipts of the same amount at regular intervals.

  • Ordinary Annuity: Payments made at the end of each period.

  • Annuity Due: Payments made at the beginning of each period.

• Using Financial Calculator (BAII Plus):

  • PMT: Payment amount for the annuity

  • Switch Payment Types: Use [2nd] [BGN] for annuity due and [2nd] [SET] for ordinary annuity.

• Tables from Textbook: Useful for calculating future and present values of annuities:

  • Future value of ordinary annuity ($1).

  • Future value of annuity due.

  • Present value of ordinary annuity.

  • Present value of annuity due.

• Deferred Annuity: First cash flow occurs more than one period after the agreement starts.

  • Step 1: Calculate PV as of the beginning of the annuity period.

  • Step 2: Reduce that result to present value as of today.

Page 3: Steps to Solve Time Value of Money Problems

1. Determine if it is a single future amount or an annuity.

   • Tip: Draw a time diagram if helpful.

   • If annuity, distinguish between ordinary annuity, annuity due, or deferred annuity.

2. Identify given information.

3. Solve for unknown using the financial calculator or provided tables.

4. Reminder: Clear your calculator after each problem with [2nd] [CLR TVM].

Page 4: In-Class Practice Problems

1. Problem regarding saving for a trip based on interest rate to accumulate sufficient funds.

2. Land purchase agreement with payment structure and calculation of total present cost based on different discount rates.

3. Savings account contribution calculations for future trip based on quarterly deposits and interest.

4. Similar savings account problem with different deposit amount and timing.

Page 5: Company Borrowing Scenarios

1. Company requiring annual installment payments considering specific interest rates.

2. Another borrowing scenario with delayed payments and looking for the loan amount.

3. Complex payment options for equipment purchase with comparative present value calculations.

Page 6: Financing Purchases

1. Appliance purchase with installment plan and calculation of monthly payments based on interest rate and payment structure.

Chapter 7: Cash and Receivables

Cash

• Cash: Comprises currency, checks, and balances in checking accounts.

• Cash Equivalents: Include money market funds, treasury bills, with narrow maturity dates.

• Internal Controls: Strategies to ensure business policy adherence, efficiency, reduction in errors and theft, accuracy in accounting.

  • Sarbanes-Oxley Act: Mandates documentation and assessment of internal controls.

  • COSO: Framework for designing internal controls.

  • Example: Separation of duty in cash receipt processes.

• Restricted Cash: Cash set aside for specific future use and typically classified as noncurrent.

• Compensating Balance: Amount required to be held in a bank account as per creditor stipulations.

Receivables

• Receivables: Future claims to collect cash, other assets, or services.

• Accounts Receivable: Result from credit sales.

  • Normal Terms: Payments due in 30-60 days.

  • Discounts: Trade discounts and sales discounts incentivizing timely payment.

Example of Sale Discounts

• Trade Discounts: Reduced sale amounts for specific groups (e.g., student discounts).

• Sales Discounts: Reductions provided to customers who pay promptly (e.g., 2% off if paid within a specified duration).

Journal Entries for Sales Discounts

• Gross Method: Full amount recorded initially.

• Net Method: Records the expected discounted amount.

Sales Returns

• Goods returned impacting revenue and requiring careful recording in accounts.

Accounting for Allowances and Bad Debts

• Direct Write-off Method: Basic method for uncollectible accounts but not GAAP compliant due to potential misstatements.

• Allowance Method: GAAP compliant; estimates total allowed amount for bad debts.

Journal Entries for Allowance Method

1. Recognition of bad debt expense.

2. Write-offs when uncollectible.

3. Reinstatement if debt deemed collectible post-write-off.

In-Class Practice Problems

1. Year-end adjusting journal entries for anticipanted sales returns.

2. Entry to establish allowance for uncollectible accounts from closing balance of accounts receivable.

3. Calculation problems on bad debts and receivables based on transactions throughout the year.