# Exam 3 Review. FV = PV (1 + i) n. Format. What to Bring/Remember. Time Value of Money. Solving for Other Variables Example. Solving for Other Values

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1 Format Exam 3 Review plaube/acct301/default.htm 15 questions Multiple choice (12) Essay (2) Problem (1) What to Bring/Remember What to bring Calculator I ll bring scrap paper Remember to try to make it legible If I can t tell what you re doing, it s hard to give partial credit. Time Value of Money FV PV Annuities Ordinary Annuity Annuity Due When to use How to interpret tables FV = PV (1 + i) n Future Value Solving for Other Values Present Value Interest Rate Number of Periods There are four variables needed when determining the time value of money. If you know any three of these, the fourth can be determined. Solving for Other Variables Example Suppose a friend wants to borrow \$1,000 today and promises to repay you \$1,092 two years from now. What is the annual interest rate you would be agreeing to? a. 3.5% b. 4.0% c. 4.5% d. 5.0% 1

2 Solving for Other Variables Example Suppose a friend wants to borrow \$1,000 today and promises to repay you \$1,092 two years from now. What is the annual interest rate you would be agreeing to? a. 3.5% b. 4.0% Present Value of \$1 Table \$1,000 = \$1,092? c. 4.5% \$1,000 \$1,092 = d. 5.0% Search the PV of \$1 table in row 2 (n=2) for this value. No Explicit Interest Some notes do not include a stated interest rate. We call these notes noninterest-bearing notes. Even though the agreement states it is a noninterest-bearing note, the note does, in fact, include interest. We impute an appropriate interest rate for a loan of this type to use as the interest rate. Ordinary Annuity Annuity Due An annuity with payments at the end of the period is known as an ordinary annuity. An annuity with payments at the beginning of the period is known as an annuity due. End End Present Value of a Deferred Annuity On January 1, 2003, you are considering an investment that will pay \$12,500 a year for 2 years beginning on December 31, If you require a 12% return on your investments, how much are you willing to pay for this investment? Cost Today? \$12,500 \$12,500 1/1/03 12/31/03 12/31/04 12/31/05 12/31/06 12/31/ Present Value of a Deferred Annuity Payment PV of \$1 i = 12% PV n 1 \$ 12, \$ 8, , ,944 4 \$ 16,841 Cost Today? \$12,500 \$12,500 1/1/03 12/31/03 12/31/04 12/31/05 12/31/06 12/31/

3 Encourages adherence to company policies and procedures Enhances the reliability and accuracy of accounting data Internal Control of Cash Promotes operational efficiency Minimizes errors and theft Restricted Cash and Compensating Balances Restricted Cash Management s intent to use a certain amount of cash for a specific purpose future plant expansion, future payment of debt. Compensating Balance Minimum balance that must be maintained in a company s account as support for funds borrowed from the bank. Cash Discounts Cash Discounts 2/10,n/30 Gross Method Discount Percent Number of Days Discount is Available Otherwise, Net (or All) is Due Credit Period Net Method Sales Returns and Allowances Uncollectible Accounts Receivable Sales Returns Sales Allowance Bad debts result from credit customers who will not pay the amount they owe, regardless of continuing collection efforts. Merchandise returned by a customer to a supplier. A reduction in the cost of defective merchandise. PAST DUE 3

4 Methods to Estimate Bad Debts Income Statement Approach Emphasis on Matching Sales Bad Debts Exp. Income Statement Focus Balance Sheet Approach Emphasis on Realizable Value Accts. Rec. All. for Uncoll. Accts. Balance Sheet Focus Now, let s look at the accounts receivable aging approach! Balance Sheet Approach Aging of Receivables Year-end Accounts Receivable is is broken down into age classifications. Each age grouping has a different likelihood of of being uncollectible. Compute estimated uncollectible amount. Compare estimated uncollectible amount with the balance in in the allowance account. Noninterest-Bearing Notes Actually do bear interest. Interest is deducted (discounted) from the face value of the note. Cash proceeds equal face value of note less discount. Financing With Receivables Secured borrowing or Sale of receivables Method depends on the surrender of control over the receivables transferred. Secured Borrowing Assigning The use of specific receivables for collateral, and the promise that any failure to repay debt will result in proceeds from specific accounts receivable collections being used to repay the debt. Reclassify Accounts Receivable as Accounts Receivable Assigned. 4

5 Secured Borrowing Pledging Receivables in general are pledged as collateral for loans. SUPPLIER (Transferor) 2. Accounts Receivable 3. Accounts Receivable 1. Merchandise RETAILER Pledged Receivable are disclosed in notes to the financial statements. 4. Cash 5. Cash FACTOR (Transferee) A factor is is a financial institution that buys receivables for cash, handles the billing and collection of of the receivables and charges a fee for the service. Treat as a sale if all of these conditions are met: Receivables are isolated from transferor. Transferee has right to pledge or exchange receivables. Transferor does not have control over the receivables. Transferor cannot repurchase receivable before maturity. Transferor cannot require return of specific receivables. Without recourse An ordinary sale of receivables to the factor. Factor assumes all risk of uncollectibility. Control of receivable passes to the factor. Receivables are removed from the books, cash is received and a financing expense or loss is recognized. With recourse Transferor (seller) retains risk of uncollectibility, Must meet the three conditions of determining surrender of control to be recognized as a sale. If the transaction fails to meet the three conditions necessary to be classified as a sale, it it will be treated as a secured borrowing. 5

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