Question

Respond to the following in a minimum of 175 words:

Many of us apply the time value of money in our personal lives; for example, when we invest dollars in a young child’s bank account earmarked for his or her eventual college education. Share an explanation of the time value of money in your own words. What criteria do accountants use to decide whether to use present or future values in accounting statements?

Answer 1

Time value of money is a concept used to determine the worth of money either in future terms or the present worth of a future money. The essential reason of doing time value of money is the fact that the value of money changes with time due to reasons such as inflation, depreciation in value, no storage value and the like. Money is a moving concept and the worth of each dollar is different at various points of time. Also, the concept of time value is used in estimating the compounding or discounting effect for an investment or a liability. For example, an investment promises to yield $1000 each month for the next 2 years. However, the worth of $1000 each month may not remain same as time progresses. In this case the time value of money has to be measured through the concept of present value of the future cash flows i.e. to know the worth of the $1000 future cash flows today. Similar concept is used to determine the future value of an investment that is made today and helps in matching revenues with the future expenses for many business. Accountants determine the use of future or present value concepts based on the timing and the effect that the cash flows will have on the financial statements. For instance if the firm has taken up a lease of a new building, the same will involve outflow of cash in the future but the liability has to be recognized today. The future cash outflows associated with the lease liability are discounted using an appropriate interest rate and the liability is recognized at money's worth today.