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Explain the difference between an ordinary annuity and an annuity due situation

An annuity is a series of equal-sized cash flows occurring over equal intervals of time. An ordinary annuity exists when the cash flows occur at the end of each period. An annuity due exists when the cash flows occur at the beginning of each period.

Explain the difference between simple and compound interest.

Compound interest includes interest not only on the initial investment but also on the accumulated interest in previous periods.

Solve for unknown values in annuity situations involving present value.

In present value problems involving annuities, there are four variables: PVA or PVAD, the annuity amount, the number of compounding periods (n) and the interest rate (i). If you know any three of these, you can determine the fourth.

Briefly describe how the concept of the time value of money is incorporated into the valuation of bonds, long-term leases, installment notes, and pension obligations.

Most accounting applications of the time value of money involve the present values of annuities. The initial valuation of long-term bonds is determined by calculating the present value of the periodic stated interest payments and the present value of the lump=sum payment made at maturity. Certain leases require the lessee to compute the present value of future value payments to value the leased asset and corresponding lease obligation. Similarly, installment notes sometimes require us to calculate the present value of installment payments as the amount at which to record the note. Also, pension plans require the payment of deferred annuities to retirees.

Compute the future value of a single amount

The future value of a single amount is the amount of money that a dollar will grow to at some point in the future. It is computed by multiplying the single amount by (1 + i)^n, where i is the interest rate and n the number of compounding periods. The Future Value of $1 table allows for the calculation of future value for any single amount by providing the factors for various combinations of i and n.

Compute the future value of both an ordinary annuity and an annuity due.

The future value of an ordinary annuity (FVA) is the future value of a series of equal-sized cash flows with the first payment taking place at the end of the first compounding period. The last payment will not earn any interest since it is made at the end of the annuity period. The future value of annuity due (FVAD) is the future value of a series of equal-sized cash flows with the first payment taking place at the beginning of the annuity period (the beginning of the first compounding period).

Compute the present value of a single amount.

The present value of a single amount is the amount of money today that is equivalent to a given amount to be received or paid in the future. It is computed by dividing the future amount by (1 + i) ^n. The Present Value of $1 table simplifies the calculation of the present value of any future amount.

Compute the present value of an ordinary annuity, and a deferred annuity

The present value of an ordinary annuity (PVA) is the present value of a series of equal-sized cash flows with the first payment taking place at the end of the first compounding period. The present value of an annuity due (PVAD) is the present value of a series of equal-sized cash flows with the first payment taking place at the beginning of the annuity period. The present value of a deferred annuity is the present value of a series of equal-sized cash flows with the first payment taking place more than one time period after the date of the agreement.

Solve for either the interest rate or the number of compounding periods when present value and future value of a single amount are known

There are four variables in the process of adjusting single cash flow amounts for the time value of money: Present value (PV), future value (FV), i and n. If we know any three of these, the fourth can be computed easily.

Apply present value techniques in the variation of notes

We value most notes receivable and notes payable at the present value of future cash flows they call for, reflecting an appropriate time value of money.