Basic Time Value Concepts Nature of Interest Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction: 1.Principal Amount borrowed or invested. 2.Interest Rate A percentage. 3.Time-The number of years or portion of a year that the principal is outstanding. Chapter 6-6 LO 1 Identify accounting topics where the time value of money is relevant
Chapter 6-6 Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction: 1. Principal - Amount borrowed or invested. 2. Interest Rate - A percentage. 3. Time - The number of years or portion of a year that the principal is outstanding. Nature of Interest
Simple Interest Interest computed on the principal only. ILLUSTRATION: On January 2,2007,Tomalczyk borrows $20,000 for 3 years at a rate of 7%per year.Calculate the annual interest cost. Principal $20,000 FULL YEAR Interest rate Annual interest X 7% $1,400 Federal law requires the disclosure of interest rates on an annual basis in all contracts. Chapter 6-7 LO 2 Distinguish between simple and compound interest
Chapter 6-7 Interest computed on the principal only. ILLUSTRATION: On January 2, 2007, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the annual interest cost. Principal $20,000 Interest rate Annual interest x 7% $ 1,400 Federal law requires the disclosure of interest rates on an annual basis in all contracts
Simple Interest ILLUSTRATION continued: On March 31,2007,Tomalczyk borrows $20,000 for 3 years at a rate of 7%per year.Calculate the interest cost for the year ending December 31,2007. Principal PARTIAL Interest rate $20,000 YEAR Annual interest X 7% Partial year $1,400 Interest for9 months× 9/12 $1,050 Chapter 6-8 LO 2 Distinguish between simple and compound interest
Chapter 6-8 ILLUSTRATION continued: On March 31, 2007, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the interest cost for the year ending December 31, 2007. Principal Interest rate $20,000 Annual interest x 7% Partial year $ 1,400 Interest for 9 months x 9/12 $ 1,050
Compound Interest Computes interest on >the principal and > on interest earned to date (assuming interest is left on deposit). Compound interest is the typical interest computation applied in business situations. Chapter 6-9 LO 2 Distinguish between simple and compound interest
Chapter 6-9 Computes interest on Ø the principal and Ø on interest earned to date (assuming interest is left on deposit). Compound interest is the typical interest computation applied in business situations
Compound Interest ILLUSTRATION: On January 2,2007,Tomalczyk borrows $20,000 for 3 years at a rate of 7%per year.Calculate the total interest cost for all three years,assuming interest is compounded annually. Compound Interest Accumulated Date Calculation Interest Balance Jan.2007 $ 20,000 2007 $20,000X7% $ 1,400 21,400 2008 $21,400X7% 1,498 22,898 2009 $22,898X7% 1,603 24,501 $ 4,501 Chapter 6-10 LO 2 Distinguish between simple and compound interest
Chapter 6-10 ILLUSTRATION: On January 2, 2007, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the total interest cost for all three years, assuming interest is compounded annually. Compound Interest Accumulated Date Calculation Interest Balance Jan. 2007 $ 20,000 2007 $20,000 x 7% $ 1,400 21,400 2008 $21,400 x 7% 1,498 22,898 2009 $22,898 x 7% 1,603 24,501 $ 4,501