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CHAPTER 7
Accounting and the Time Value of Money
Solutions
Questions

Q7-1 Interest is the price paid for the use of money. For example, if you invest $10,000 in a
savings account today and the savings account yields 8% annually, then you will have $10,800
one year from today. The amount earned on the initial investment ($800 in this case) is referred
to as interest.

Q7-2 When interest is compounded, an investor will earn more revenue than if the investment
only pays simple interest. Interest is computed on both the principal and the interest left on
deposit. The earning of interest on the interest from the prior period is referred to as compound
interest. Any interest earned is then immediately included in the computation of the next
period’s interest. The compounding period can be over any time period such as a quarter or a
day. If a financial instrument provides for interest to be computed on both the principal and any
interest earned and left on deposit, the interest is considered to be compound interest.

Q7-3 When interest is compounded more than once per year, we determine the interest rate used
in computations by dividing the annual rate by the number of compounding periods in a year. If
interest is compounded more than once a year, then the effective interest rate, which is the
amount of interest actually earned, will be greater than the stated interest rate.

Q7-4 The present value of an investment is inversely related to both time and the interest rate.
The time value of money means that a "dollar received today is worth more than a dollar
received at some time in the future." If a dollar is received today, it can be invested in some
alternative activity that will provide a return. The longer you have to wait to receive cash and the
greater the interest or discount rate, the lower the present value. The discount rate is the
opportunity cost of capital: the interest lost by waiting to receive cash. So again, the present
value is reduced the longer the individual has to wait for the cash flow to occur and the greater
the individual's discount rate. That is, the PV is inversely related to time, N, and the rate of
interest, I.

Q7-5 An annuity is a series of periodic deposits, rents or receipts of equal amount and equal time
intervals between each cash flow. Cash flows related to an annuity are known as payments
(PMT). In this case the payments are not the same and therefore, this payment stream is not an
annuity. As a result, each of the different cash flows will be discounted individually by using a
present value of an amount of $1 table.

Q7-6 There are several alternative approaches for calculating the future value of an annuity due.
(1) Use an ordinary annuity computation for (N + 1) and then deduct one payment from the

© 2019 Pearson Education, Inc.

7-2 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

result. Setting the period at (N + 1) is necessary to reflect the fact that the first payment is
received immediately and compounds for an additional period. We then have to subtract 1.0000
(one payment) from the future value of an ordinary annuity factor to avoid double counting the
last payment which is not received at the end of the last period. (2) Multiply the ordinary annuity
factor or the FV of the ordinary annuity by (1 + I). The logic in this case is that we make the first
deposit one period sooner and it accumulates interest for one additional period.

Q7-7 An ordinary annuity is an annuity where cash flows occur at the end of the interest period.
An annuity due is an annuity where cash flows occur at the beginning of the interest period. As a
result, there is one less discounting period for an annuity due, and therefore its present value is
higher than an ordinary annuity.

Q7-8 There are several alternative approaches for calculating the present value of an annuity
due. (1) Use an ordinary annuity computation for (N - 1) and then add one payment to the result
(i.e., add +1.0000 to the table discount factor). There is one less discount period for an annuity
due, so we use one less period than an ordinary annuity. We add 1.0000 to the table factor in
order to account for the first payment that is received but is not discounted. (2) Multiply the
ordinary annuity factor or the PV of the ordinary annuity by (1 + I). The logic in this case is that
the annuity due is received one period before the ordinary annuity and the amount of the present
value of the ordinary annuity can be invested for one additional period.

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-3

Brief Exercises

Solution to BE7-1
Interest= Principal x Interest Rate x Time
$10,000 = $100,000 x 5% x 2 years

The investor would earn $5,000 ($10,000/2) per year in interest for a total of $10,000 for the 2
years.

Solution to BE7-2
Period Annual Interest Amount left on Deposit
1 $100,000 x 5% x 1 = $5,000 $100,000 + 5,000 = $105,000
2 $105,000 x 5% x 1 = $5,250 $105,000 + 5,250 = $110,250

When interest is compounded, the total interest on the contract is equal to $10,250 ($5,000 +
$5,250). This is $250 greater than the $10,000 simple interest earned over the same two-year
period.

Solution to BE7-3
The problem is illustrated in the time line below.

COMPOUNDING @ 6%
PV = 500 FV = ?

t=0 t=1
|--------------------------------------------------------------------|

If we used the simple interest formula we have:

Interest= Principal x Rate x Time

$30 = $500 x 6% x 1 year

The ending (future) value of this investment is the sum of the principal plus interest or:

FV = P + I
$530 = $500 + 30

We can restate this problem by employing the time value of money variables:

FV = PV x (1 + I/Y)
= $500 x (1 + .06)
FV = $530

© 2019 Pearson Education, Inc.

7-4 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

Solution to BE7-4
The problem is illustrated in the time line below.

COMPOUNDING @ 6%
PV = $500 FV = ?

t=0 t=3
|---------------------|----------------------|---------------------|

Periods Computations Balance

on
Deposit
1 FV = $500 x (1 + .06)1 = $530.00
2 FV = $500 x (1 + .06) (1 + .06) = $500 x (1.06)2 $561.80
3 FV = $500 x (1 + .06) (1 + .06) (1 + .06) = $500 x (1.06)3 $595.51

Using the FV of $1 Table 7A.1 where N = 3 and I/Y = 6%:

FV = $500 x FACTOR7A.1
= $500 x 1.19102
FV = $595.51

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-5

OR
The keystrokes on a financial calculator provide the future value of $595.51:

500 +/- PV

6 I/Y

3 N

CPT FV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 3 6.00% -500 0
Solve For FV 595.51 =FV(0.06,3,0,-500)

Solution to BE7-5
The problem is illustrated in the time line below.

DISCOUNTING @ 8%
PV = ? FV = 1,500

t=0 t=1
|---------------------------------------------------------------------|

Using the PV of $1 Table 7A.2 where N = 1 and I/Y = 8%:

PV = $1,500 x FACTOR7A.2
= $1,500 x .92593
PV = $1,388.90

OR
The keystrokes on a financial calculator provide the present value of ($1,388.89):

© 2019 Pearson Education, Inc.

7-6 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

1500 FV

8 I/Y

1 N

CPT PV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 1 8.00% 0 1500
Solve For PV (1388.89) =PV(0.08,1,0,1500)

Solution to BE7-6
The problem is illustrated in the time line below.

DISCOUNTING @ 8%
PV = ? FV = 1,500

t=0 t=2
|--------------------------------|------------------------------------|

Using the PV of $1 Table 7A.2 where N = 2 and I/Y = 8%:

PV = $1,500 x FACTOR7A.2
= $1,500 x .85734
PV = $1,286.01

OR
The keystrokes on a financial calculator provide the present value of ($1,286.01):

1500 FV

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-7

8 I/Y

2 N

CPT PV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 2 8.00% 0 1500
Solve For PV -1286.01 =PV(0.08,2,0,1500)

Solution to BE7-7
The problem is illustrated in the time line below.

COMPOUNDING @ 8%
PV =100,000 FV = ?

t=0 t=5
|-----------|----------|-----------|------------|-------------|

Using the FV of $1 Table 7A.1 where N = 5 and I/Y = 8%:

FV = $100,000 x FACTOR7A.1
= $100,000 x 1.46933
FV = $146,933

© 2019 Pearson Education, Inc.

7-8 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

OR
The keystrokes on a financial calculator provide the future value of $146,932.81:

100000 +/- PV

8 I/Y

5 N

CPT FV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 5 8.00% -100000 0
Solve For FV 146,932.81 =FV(0.08,5,0,-100000)

Solution to BE7-8
The problem is illustrated in the time line below.

Semiannual compounding rate @ 4% for 6 periods

PV = 50,000 FV = ?

t=0 t= 6
|--------|---------|---------|---------|---------|---------|

Semiannual compounding requires that we double the number of periods and divide the interest
rate by two. Therefore, N = 3 x 2 = 6 and I/Y = 8%/2 = 4%.

Using the FV of $1 Table 7A.1 where N = 6 and I/Y = 4%:

FV = $50,000 x FACTOR7A.1
= $50,000 x 1.26532
FV = $63,266

OR
The keystrokes on a financial calculator provide the future value of 63,265.95:

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-9

50000 +/- PV

4 I/Y

6 N

CPT FV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 6 4.00% -50000 0
Solve For FV 63,265.95 =FV(0.04,6,0,-50000)

Solution to BE7-9
The problem is illustrated in the time line below.

Quarterly discounting rate @ 3% for 16 periods

PV = ? FV = 80,000

t=0 t = 16
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|--|

Quarterly compounding requires that we multiply the number of periods by four and divide the
rate by four. Therefore, N = 4 x 4 = 16 and I/Y = 12%/4 = 3%.

Using the PV of $1 Table 7A.2 where N = 16 and I/Y = 3%:

PV = $80,000 x FACTOR7A.2
= $80,000 x .62317
PV = $49,853.60

OR
The keystrokes on a financial calculator provide a present value of ($49,853.36):

© 2019 Pearson Education, Inc.

7-10 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

80000 FV

3 I/Y

16 N

CPT PV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 16 3.00% 0 80000
Solve For PV -49,853.36 =PV(0.03,16,0,80000)

Solution for BE7-10.

Using the PV of $1 Table 7A.2 where N = 17 and I/Y is unknown:

PV = FV x FACTOR7A.2
$43,630 = $100,000 x FACTOR7A.2
FACTOR7A.2 = .43630
I/Y = 5%

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-11

OR
The keystrokes on a financial calculator provide the interest rate of 5%:

100000 FV

43630 PV
+/-

17 N

I/Y
CPT

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 17 -43630 0 100000
Solve For I/Y 5.00% =RATE(17,0,-43630,100000)

Solution to BE7-11

Using the PV of $1 Table 7A.2 where N is unknown and I/Y = 6%:

PV = FV x FACTOR7A.2
$352,480 = $500,000 x FACTOR7A.2
FACTOR7A.2 = .70496
n = 6 years

© 2019 Pearson Education, Inc.

7-12 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

OR
The keystrokes on a financial calculator provide N = 6 years:

352480 +/- PV

500000 FV

6 I/Y

CPT N

OR
Using the spreadsheet approach:
N I/Y PV PMT FV Excel Formula*
Given 6.00% -352,480 0 500,000
Solve For NPER 6.00 =NPER(0.06,0,-352480,500000)

* The spreadsheet automatically selects this formula when variables are input.

Solution to BE7-12
The problem is illustrated in the timeline below.

FV=?

5000 5000 5000 5000

t=0 1 2 3 t=4

This is considered an ordinary annuity because the first payment occurs at year-end.
Using FV of an Ordinary Annuity Table 7A.3 where N = 4 and I/Y = 10%:

FVOA = $5,000 x FACTOR7A.3

FVOA = $5,000 x 4.6410
FVOA = $23,205

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-13

OR
The keystrokes on a financial calculator provide the future value of $23,205.

5000 +/- PMT

4 N

10
I/Y

CPT FV

OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula

Given 4 10% 0 -5000

Solve For FV 23,205.00 =FV(0.10,4,-5000)

© 2019 Pearson Education, Inc.

7-14 SOLUTIONS MANUAL FOR INTERMEDIATE ACCOUNTING

Solution to BE7-13

The problem is illustrated in the time line below.

FV=?

20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000

|
|

t=0 1 2 3 4 5 6 7 t=8

This is considered an annuity due because the first payment into the fund occurs at the beginning
of the year.

Using FV of an Annuity Due Table 7A.4 where N = 8 and I/Y = 8%:

FVAD = $20,000 x FACTOR7A.4

FVAD = $20,000 x 11.48756
FVAD = $229,751.20

OR

The keystrokes on a financial calculator provide the future value of $229,751.16:

20000 +/- PMT

8 N

8 I/Y

2nd BGN 2nd SET 2nd QUIT

CPT FV

OR
Using the spreadsheet approach:

© 2019 Pearson Education, Inc.

 CHAPTER 7 ACCOUNTING AND THE TIME VALUE OF MONEY 7-15

N I/Y PV PMT FV Excel Formula

Given 8 8.00% 0 -20000
Solve For FV 229,751.16 =FV(0.08,8,-20000,0,1)

Solution to BE7-14
The problem is illustrated in the time line below.

? ? ? ?

t=0 1 2 3 t=4 FV = 25,000

This is considered an ordinary annuity because you invest at the end of each year.

Using FV of an Ordinary Annuity in Table 7A.3 where I/Y = 8% and N = 4:

$25,000 = PMT x FACTOR7A.3

$25,000 = PMT x 4.50611
$25,000/4.50611 = $5,548.02

OR
The keystrokes on a financial calculator provide the payments amount of ($5,548.02):

25000 FV

4 N

8 I/Y

CPT PMT
OR
Using the spreadsheet approach:

N I/Y PV PMT FV Excel Formula*

Given 4 8.00% 0 25,000
Solve For PMT -5,548.02 =PMT(0.08,4,0,25000)

© 2019 Pearson Education, Inc.

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