and nonprofit organizations for over 30 years.
Dr. Shim has over 50 college and professional books to his credit, including Barron’s Dictionary of Accounting Terms, Budgeting Basics and Beyond, 2011-2012 Corporate Controller’s Handbook of Financial Management, US Master Finance Guide 2012-2013, Project Management, Dictionary of Business Terms, The Complete CPA Reference (formerly The Vest-Pocket CPA), CFO Fundamentals (formerly The Vest-Pocket CFO), and the best-selling Vest-Pocket MBA.
Thirty-one of his publications have been translated into foreign languages such as Chinese, Spanish, Russian, Polish, Croatian, Italian, Japanese, and Korean. Professor Shim’s books have been published by CCH, Barron’s, John Wiley Indonesia, McGraw- Hill, Prentice-Hall, Penguins Portfolio, Thomson Reuters, Global Publishing, American Management Association (Amacom), and the American Institute of CPAs (AICPA).
Dr. Shim has also published numerous articles in professional and academic journals. He was the recipient of the Financial Management Association International’s 1982 Credit Research Foundation Award for his article on cash flow forecasting and financial modeling.
Dr. Shim has been frequently quoted by such media as the Los Angeles Times, Orange County Register, Business Start-ups, Personal Finance, and Money Radio. He also provides business content for CPE e-learning providers and for m-learning providers such as iPhone, iPad, iPod Touch, Blackberry, Android, and Window phones.
He has over 90 online NASBA-compliant CPE courses to his credit.
CHAPTER 1
Time value of money and its applications
A dollar now is worth more than a dollar to be received later. This statement sums up an important principle: money has a time value. The truth of this principle is not that inflation might make the dollar received at a later time worth less in buying power. The reason is that you could invest the dollar now and have more than a dollar at the specified later date.
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, and (8) amortization of premiums and discounts.
Time value of money is also a critical consideration in financial and investment decisions. For example, compound interest calculations are needed to determine future sums of money resulting from an investment. Discounting, or the calculation of present value, which is inversely related to compounding, is used to evaluate the future cash flow associated with capital budgeting projects. There are plenty of applications of time value of money in accounting and finance. The purpose of this book to present the tools and techniques that will help you measure the present value of future cash inflows and outflows.
Accounting Applications
Financial reporting uses different measurements in different situations—historical cost for equipment, net realizable value for inventories, or fair value for investments. The FASB increasingly is requiring the use of fair values in the measurement of assets and liabilities. According to the FASB’s recent guidance on fair value measurements (ASC 820-10-05, FAS-57, Fair Value Measurements), the most useful fair value measures are based on market prices in active markets. Within the fair value hierarchy these are referred to as Level 1. Level 1 fair value measures are the most reliable because they are based on quoted prices, such as a closing stock price in the financial dailies and online finance sites.
However, for many assets and liabilities, market-based fair value information is not readily available. In these cases, fair value can be estimated based on the expected future cash flows related to the asset or liability. Such fair value estimates are generally considered Level 3 (least reliable) in the fair value hierarchy because they are based on unobservable inputs, such as a company’s own data or assumptions related to the expected future cash flows associated with the asset or liability. As discussed in the fair value guidance, present value techniques are used to convert expected cash flows into present values, which represent an estimate of fair value. This issue is covered in depth in Chapter 2.
Because of the increased use of present values in this and other contexts, it is important to understand present value techniques. The timing of the returns on an investment has an important effect on the worth of the investment (asset). Similarly, the timing of debt repayment has an important effect on the value of the debt commitment (liability).
GAAP addresses present value as a measurement basis for a broad array of transactions, such as accounts and notes receivable and payable, leases, pensions and other postretirement benefits, and long-term asset impairments. More are listed below.
Fair Value Measurements
ASC 820-10-05, FAS157 (Fair Value Measurements) states that a fair value measurement reflects current market participant assumptions about future inflows
