Ch06 - Chapter 06 solution for Intermediate Accounting by Donald E. Kieso, Jerry J. PDF

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CHAPTER 6Accounting and the Time Value of MoneyASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)Topics QuestionsBrief Exercises Exercises Problems Present value concepts. 1, 2, 3, 4, 5, 9, 17 Use of tables. 13, 14 8 1 Present and future value problems: a. Unknown future amount. 7, 19 1, 5, 13 2, 3, 4, 7 b....

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CHAPTER 6 Accounting and the Time Value of Money

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Brief Exercises

Exercises

13, 14

8

1

a. Unknown future amount.

7, 19

1, 5, 13

2, 3, 4, 7

b. Unknown payments.

10, 11, 12

6, 12, 15, 17

8, 16, 17

2, 6

4, 9

10, 15

2 2, 7

Topics

Questions

1.

Present value concepts.

1, 2, 3, 4, 5, 9, 17

2.

Use of tables.

3.

Present and future value problems:

c. Unknown number of periods. d. Unknown interest rate.

15, 18

3, 11, 16

9, 10, 11, 14

e. Unknown present value.

8, 19

2, 7, 8, 10, 14

3, 4, 5, 6, 8, 12, 17, 18, 19

Problems

1, 4, 7, 9, 13, 14 3, 5, 8

4.

Value of a series of irregular deposits; changing interest rates.

5.

Valuation of leases, pensions, bonds; choice between projects.

6

6.

Deferred annuity.

16

7.

Expected Cash Flows.

15

7, 12, 13, 14, 15

3, 5, 6, 8, 9, 10, 11, 12, 13, 14, 15

20, 21, 22

13, 14, 15

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Learning Objectives

Questions

Brief Exercises

Exercises

Problems

1, 2

1.

Describe the accounting concepts and fundamental concepts related to the time value of money.

1, 3, 4, 5, 6, 7, 10, 11, 12, 13, 14, 17, 18

2.

Solve future and present value of 1 problems.

2, 7, 8, 10, 11, 12

1, 2, 3, 4, 7, 8

2, 3, 6, 9, 10, 15

1, 2, 3, 5, 7, 9, 10

3.

Solve future value of ordinary and annuity due problems.

8, 9, 10, 11, 13

5, 6, 9, 13

3, 4, 6, 15, 16

2, 7

4.

Solve present value of ordinary and annuity due problems.

12, 14

10, 11, 12, 14, 16, 17

3, 4, 5, 6, 11, 12, 17, 18, 19

1, 2, 3, 4, 5, 7, 8, 9, 10, 13, 14

5.

Solve present value problems related

2, 12, 15, 16, 19

15

7, 8, 13, 14, 20, 21, 22

6, 11, 12, 13, 14, 15

to deferred annuities, bonds, and expected cash flows.

6-2

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE

Item

Description

Level of Difficulty

Time (minutes)

E6-1 E6-2 E6-3 E6-4 E6-5 E6-6 E6-7 E6-8 E6-9 E6-10 E6-11 E6-12 E6-13 E6-14 E6-15 E6-16 E6-17 E6-18 E6-19 E6-20 E6-21 E6-22

Using interest tables. Simple and compound interest computations. Computation of future values and present values. Computation of future values and present values. Computation of present value. Future value and present value problems. Computation of bond prices. Computations for a retirement fund. Unknown rate. Unknown periods and unknown interest rate. Evaluation of purchase options. Analysis of alternatives. Computation of bond liability. Computation of pension liability. Investment decision. Retirement of debt. Computation of amount of rentals. Least costly payoff. Least costly payoff. Expected cash flows. Expected cash flows and present value. Fair value estimate.

Simple Simple Simple Moderate Simple Moderate Moderate Simple Moderate Simple Moderate Simple Moderate Moderate Moderate Simple Simple Simple Simple Simple Moderate Moderate

5–10 5–10 10–15 15–20 10–15 15–20 12–17 10–15 5–10 10–15 10–15 10–15 15–20 15–20 15–20 10–15 10–15 10–15 10–15 5–10 15–20 15–20

P6-1 P6-2 P6-3 P6-4 P6-5 P6-6 P6-7 P6-8 P6-9 P6-10 P6-11 P6-12 P6-13 P6-14 P6-15

Various time value situations. Various time value situations. Analysis of alternatives. Evaluating payment alternatives. Analysis of alternatives. Purchase price of a business. Time value concepts applied to solve business problems. Analysis of alternatives. Analysis of business problems. Analysis of lease vs. purchase. Pension funding. Pension funding. Expected cash flows and present value. Expected cash flows and present value. Fair value estimate.

Moderate Moderate Moderate Moderate Moderate Moderate Complex Moderate Complex Complex Complex Moderate Moderate Moderate Complex

15–20 15–20 20–30 20–30 20–25 25–30 30–35 20–30 30–35 30–35 25–30 20–25 20–25 20–25 20–25

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-3

ANSWERS TO QUESTIONS 1. Money has value because with it one can acquire assets and services and discharge obligations. The holding, borrowing or lending of money can result in costs or earnings. And the longer the time period involved, the greater the costs or the earnings. The cost or earning of money as a function of time is the time value of money. Accountants must have a working knowledge of compound interest, annuities, and present value concepts because of their application to numerous types of business events and transactions which require proper valuation and presentation. These concepts are applied in the following areas: (1) sinking funds, (2) installment contracts, (3) pensions, (4) long-term assets, (5) leases, (6) notes receivable and payable, (7) business combinations, (8) amortization of premiums and discounts, and (9) estimation of fair value. LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

2. Some situations in which present value measures are used in accounting include: (a) Notes receivable and payable—these involve single sums (the face amounts) and may involve annuities, if there are periodic interest payments. (b) Leases—involve measurement of assets and obligations, which are based on the present value of annuities (lease payments) and single sums (if there are residual values and/or bargain purchase options to be paid at the conclusion of the lease). (c) Pensions and other deferred compensation arrangements—involve discounted future annuity payments that are estimated to be paid to employees upon retirement. (d) Bond pricing—the price of bonds payable is comprised of the present value of the principal or face value of the bond plus the present value of the annuity of interest payments. (e) Long-term assets—evaluating various long-term investments or assessing whether an asset is impaired requires determining the present value of the estimated cash flows associated with an investment or long-term asset (may be single sums and/or an annuity). LO: 1, 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

3. Interest is the payment for the use of money. It may represent a cost or earnings depending upon whether the money is being borrowed or loaned. The earning or incurring of interest is a function of the time, as well as the amount of money, and the risk involved (risk may be reflected in the interest rate). Simple interest is computed on the amount of the principal only, while compound interest is computed on the amount of the principal plus any accumulated interest. Compound interest involves interest on interest while simple interest does not. LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

4. The interest rate generally has three components: (a) Pure rate of interest—This would be the amount a lender would charge if there were no possibilities of default and no expectation of inflation. (b) Expected inflation rate of interest—Lenders recognize that in an inflationary economy, they are being paid back with less valuable (future) dollars. As a result, they increase their interest rate to compensate for this loss in purchasing power. When inflationary expectations are high, interest rates are high. (c) Credit risk rate of interest—The U.S. government has little or no credit risk (i.e., risk of nonpayment) when it issues bonds. A business enterprise, however, depending upon its financial stability, profitability, etc. can have a low or a high credit risk. Accountants must have knowledge about these components because these components are essential in identifying an appropriate interest rate for a given company or investor at any given moment. LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

6-4

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

Questions Chapter 6 (Continued) 5. (a) (b) (c) (d)

Present value of an ordinary annuity at 8% for 10 periods (Table 6-4). Future value of 1 at 8% for 10 periods (Table 6-1). Present value of 1 at 8% for 10 periods (Table 6-2). Future value of an ordinary annuity at 8% for 10 periods (Table 6-3).

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

6. He should choose quarterly compounding, because the balance in the account on which interest will be earned will be increased more frequently, thereby resulting in more interest earned on the investment. This is shown in the following calculation: Semiannual compounding, assuming the amount is invested for 2 years: n=4 $1,500 X 1.16986 = $1,755 i=4 Quarterly compounding, assuming the amount is invested for 2 years: n=8 $1,500 X 1.17166 = $1,757 i=2 Thus, with quarterly compounding, Jose could earn $3 more. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

7. $26,898 = $20,000 X 1.34489 (future value of 1 at 21/2% for 12 periods). LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

8. $44,671 = $80,000 X .55839 (present value of 1 at 6% for 10 periods). LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

9. An annuity involves (1) periodic payments or receipts, called rents, (2) of the same amount, (3) spread over equal intervals, (4) with interest compounded once each interval. Rents occur at the end of the intervals for ordinary annuities while the rents occur at the beginning of each of the intervals for annuities due. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

10. Amount paid each year = $40,000 (present value of an ordinary annuity at 12% for 4 years). 3.03735 Amount paid each year = $13,169.37. LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

11. Amount deposited each year = $200,000 4.64100

(future value of an ordinary annuity at 10% for 4 years).

Amount deposited each year = $43,094.16. LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

12. Amount deposited each year = $200,000 [future value of an annuity due at 10% for 4 years 5.10510 (4.64100 X 1.10)]. Amount deposited each year = $39,176.51. LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-5

Questions Chapter 6 (Continued) 13. The process for converting the future value of an annuity due using the future value of an ordinary annuity interest table is to multiply the corresponding future value of the ordinary annuity by one plus the interest rate. For example, the factor for the future value of an annuity due for 4 years at 12% is equal to the factor for the future value of an ordinary annuity times 1.12. LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

14. The basis for converting the present value of an ordinary annuity table to the present value of an annuity due table involves multiplying the present value of an ordinary annuity factor by one plus the interest rate. LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

15. Present value = present value of an ordinary annuity of $25,000 for 20 periods at? percent. $245,000

= present value of an ordinary annuity of $25,000 for 20 periods at? percent.

Present value of an ordinary annuity for 20 periods at? percent =

$245,000 = 9.8. $25,000

The factor 9.8 is closest to 9.81815 in the 8% column (Table 6-4). LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

16.

4.96764 Present value of ordinary annuity at 12% for eight periods. (2.40183) Present value of ordinary annuity at 12% for three periods. 2.56581 Present value of ordinary annuity at 12% for eight periods, deferred three periods. The present value of the five rents is computed as follows: 2.56581 X $20,000 = $51,316..

LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

17. (a) (b) (c) (d)

Present value of an annuity due. Present value of 1. Future value of an annuity due. Future value of 1.

LO: 2, 3, 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

18. $27,600 = PV of an ordinary annuity of $6,900 for five periods at? percent. $27,600 = PV of an ordinary annuity for five periods at? percent. $6,900 4.0 = PV of an ordinary annuity for five periods at? 4.0 = approximately 8%. LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

19. The IRS argues that the future reserves should be discounted to present value. The result would be smaller reserves and therefore less of a charge to income. As a result, income would be higher and income taxes may therefore be higher as well. LO: 5, Bloom: AN, Difficulty: Simple, Time: 3-5, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

6-6

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 8% annual interest i = 8% PV = $15,000

FV = ?

0

1

2

3

n=3 FV = $15,000 (FVF3, 8%) FV = $15,000 (1.25971) FV = $18,896 8% annual interest, compounded semiannually i = 4% PV = $15,000

0

FV = ?

1

2

3

4

5

6

n=6 FV = $15,000 (FVF6, 4%) FV = $15,000 (1.26532) FV = $18,980 LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-7

BRIEF EXERCISE 6-2 12% annual interest

i = 12% PV = ?

FV = $25,000

0

1

2 n=4

3

4

PV = $25,000 (PVF4, 12%) PV = $25,000 (.63552) PV = $15,888

12% annual interest, compounded quarterly i = 3% PV = ?

0

FV = $25,000

1

2

14

15

16

n = 16 PV = $25,000 (PVF16, 3%) PV = $25,000 (.62317) PV = $15,579 LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

6-8

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

BRIEF EXERCISE 6-3 i=? PV = $30,000

0

1

FV = $150,000

2

19

20

21

n = 21 FV = PV (FVF21, i)

PV = FV (PVF21, i) OR

$150,000 = $30,000 (FVF21, i)

$30,000 = $150,000 (PVF21, i)

FVF21, i = 5.0000

PVF21, i = .20000

i = 8%

i = 8%

LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

BRIEF EXERCISE 6-4 i = 5% PV = $10,000

FV = $17,100

0

? n=?

FV = PV (FVFn, 5%)

PV = FV (PVFn, 5%) OR

$17,100 = $10,000 (FVFn, 5%) FVFn, 5% = 1.71000 n = 11 years

$10,000 = $17,100 (PVFn, 5%) PVFn, 5% = .58480 n = 11 years

LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-9

BRIEF EXERCISE 6-5 First payment today (Annuity Due) i = 6% R=

FV – AD =

$8,000 $8,000 $8,000

0

1

$8,000 $8,000

2

18

?

19

20

n = 20 FV – AD = $8,000 (FVF – OA20, 6%) 1.06 FV – AD = $8,000 (36.78559) 1.06 FV – AD = $311,942

First payment at year-end (Ordinary Annuity) i = 6% FV – OA = ? $8,000 $8,000 $8,000

$8,000 $8,000

0

1

2

18

19

20

n = 20 FV – OA = $8,000 (FVF – OA20, 6%) FV – OA = $8,000 (36.78559) FV – OA = $294,285 LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

6-10

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

BRIEF EXERCISE 6-6 i = 5% R=?

0

1

?

?

2

?

8

FV – OA = $250,000

9

10

n = 10 $250,000 = R (FVF – OA10, 5%) $250,000 = R (12.57789) $250,000 12.57789

=R

R = $19,876 LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

BRIEF EXERCISE 6-7 8% annual interest i = 8% PV = ?

0

FV = $300,000

1

2

3

4

5

n=5 PV = $300,000 (PVF5, 8%) PV = $300,000 (.68058) PV = $204,174 LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

Copyright © 2016 John Wiley & Sons, Kieso, Inc. Intermediate Accounting, 16/e, Solutions Manual (For Instructor Use Only)

6-11

BRIEF EXERCISE 6-8 With quarterly compounding, there wil...