ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
TIME VALUE OF MONEY
BY: THOMAS PANZICA
LIBERTY UNIVERSITY
JULY 9TH, 2018
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
I will attempt to explain the concept of the time value of money as it relates to managerial
accounting. The concept of the time value of money plays a vital roll in managerial accounting
within companies. It also plays an important part with financial investors, as they investor $1
today what will it be worth in the future. To simply sum it up when an investor considers a
long-term investment they ask themselves “If I invest $1 today what is my return in the future,
and what will my $1 be worth?” There is a variable of principles at work as money grows in
value over time. The assumption is that the value of money today will be worth more in the
future, given a variable of principles. Some of these principles consist of simple interest and
compound interest. Other key factors that relate to the value of money consist of risk, inflation,
and accessibility of assets. “Present and Future value computations provide quantitative
techniques for determining the value of time in tax and financial decision making and are a great
understanding of the effect of time on profitability.” (Spiceland, 2016) As a company grows they
need financial investors and investments to achieve the assets needed to reach the goals set for
the year. Some considerations are annuities investments which have a formula to calculate
present and future values. This concept is set aside for a company with a long-term plan with
many moving pieces. This way a company can set money aside for the future due to the fact the
product has many steps over time to achieve the goal. Other concepts which may affect the
value of money consist of loan amortization and tax deferral options.
The time value of money concept is a principle that money will gain value over time.
The time value of money definition is summed up as “money saved today is worth more in the
future and money spent today is worth less in the future.” (Spiceland, 2016) Let start by
discussing the future and present value of money. A variety of investment accounts exist in
business each having their own benefits. These accounts basically fall under two categories,
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
taxable accounts (after tax) or tax-deferred accounts (pre-tax). Each of these accounts have their
own advantages and disadvantages. An after-tax account such as a Roth IRA is an account you
contribute money in after tax. Therefore, when you draw money out it was already taxed so it is
tax free. As we look at this in depth with the time value of money and the concept of money
saved today is worth more in future. The easiest way to explain this concept is you invest your
money after it has been taxed at today value. By the definition it will be worth more in the future
and you will not be taxed at the greater value. The tax deferred or pre-tax accounts consist of
401Ks or traditional IRAs, etc., are accounts that take money out prior to being taxed and when
you withdraw in the future you will be taxed at the future value of the money. (Horan, 2008)
One of the advantages to these types of accounts is that you are decreasing you present value
taxable income putting more money in your pocket today placing you in lowest tax bracket as
possible. A disadvantage is in the future when you withdraw from these accounts you will be
taxed at the date you withdraw your money. Therefore, you are being taxed at the greater value
of your money by definition.
As we continue to understand how important the time value of money is to the financial
managers of a company for investment purposes, employee stand points and purchasing. As a
company purchases equipment and assets they need to understand the different types of interest
available. Financial managers need to make the decisions to pay cash for specific items or by
them on loan or credit utilizing simple interest or compound interest. If something is purchased
with cash then the item is own by the company free and clear of any liability. On some
occasions this is a benefit to the company if they get a benefit, such as tax breaks, for owning it.
Other items may be purchased with a loan or on credit where you pay a monthly cost, with the
cost comes interest which is either compounded or simple. Compounded interest is interest
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
based on the value at that point. For example, you buy an item for $10,000 with compound
interest of 5%; your payment will consist of principle (part of the $10000 pay back) and interest
of 5% given a period. Let us assume annual for argument sake, you are paying the loan back in 5
years. Year 1 payment consists of $500 interest and $2000 principle. Year 2 would then consist
of $2000 principle with interest calculated by taking 5% times $8000 and so on until loan is paid
off. Simple interest is basically, paying the same amount every year of $2500 until loan paid off.
(Guide, 2006)
We also need to understand how to calculate the future and present values of investment
options. Let us start with the future value which is given an amount invested today what will the
future value be at a future point in time. (Spiceland, 2016) For example if you set aside $100 in a
bank which has an annual interest of 10% and you want to know what your future value will be
after 2 years. You formula looks like this, FV = $100(1.1)(1.1)=$121. There are specific tables
which calculate time and interest into a value to make the formula user friendly. The future
value of money calculates the value of an investment into the future, the present value of money
will represent the amount of money needed today to achieve a future target value. Once again
these can become very complicate calculation which again is why there is tables to assist in these
calculations.
As you examine the business world you can see across all of sports how they utilize what
is called a deferred compensation plan. This plan has advantages for sports team because all
sports have annual salary caps to give every team the opportunity to be competitive. This plan
was put together by a financial manager to achieve the ultimate goal of being the best in that year
which in turn sells merchandise and tickets. (Tyler, 2017) A great example was in 1999 when the
New York Mets signed Bobby Bonilla to a deferred compensation contract. This contract
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
consisted of 25 annual payments of $1.9 million which totals $47.5 million over time with the
end being in 2032. (Tyler, 2017) The advantage to the Mets at the time is they were given the
opportunity to sign other players to take them to and win the World Series in 2000. However,
now the Mets have this $1.9 million liability for the next 25 years. This is a great example of the
live for today and we will figure it out in the future. All professional sports team owners have
the same financial management style because they all want to be the best for that year. This
becomes a big concern as time goes on and the value of money grows if the team is bringing in
revenue they have to release and trade players to manage what they can afford. You can’t release
that deferred compensation contract. Worse case scenario the owner have to sell the team to a
more financially stable company or individual. Putting this all together on some occasions sports
teams will sign these deferred contracts, if they can afford it, their financial managers will invest
into an annuity an amount of money today to get them the future value needed to make the
annual salary payments. This concept relieves some of the liability of the contract.
Another concept where the time value of money plays a vital role is for retirement plans
for employees. Financial managers utilize the future value of a given sum of money to calculate
the idea of if you place this amount annually you end account value will be at a given point in
time. (Schmidt, 2016) As you near retirement you want to know how much, present value, you
can withdraw from your retirement account given the amount you currently have in the account.
These work hand in hand when an employee wants to seriously plan for retirement. First you
will decide how much you can afford to put into a retirement account. (Horan, 2008) With that
the future value will be calculated at a given point you want to retire. You take that value to
calculate the present value of how much you want to withdraw and how long it will last you.
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
The future value and present value of money plays a vital roll for employees planning for
retirement.
We are seeing changes in business as we get older due to the technology changes and the
value of money changing over time. I remember growing up items costing half of what they cost
today. The value of money has increased dramatically over the years due to cost of living,
inflation and the American dream to make money. Production of products have a greater cost in
turn places a greater price to the consumer. As consumers pay more for items they want higher
salaries in their place of employment. This concept has a great ripple down effect within the
economy. As prices go up some consumers find items cheaper online from other manufacturers
in turn driving companies out of business. It becomes a juggling act for the financial managers
to keep production costs down, produce a quality product and price it right to maximize profits
today. You see a lot of businesses come and go with unknown reasons except financial hardship.
In conclusion, as you can see the time value of money is very key for business on many
levels. Understanding this concept allows companies to invest for the future to meet the needs of
the public. It also allows businesses like sport teams to achieve the ultimate-goal of winning the
championship by building a great team with the annual salary cap. Successful financial
managers are successful due to the fact they understand this concept assisting in planning for the
future. This concept also benefits the employee in planning for retirement so they can put money
away and understand what retirement will look like for them in time.
ACCOUNTING 301 RESEARCH PAPER: TIME VALUE OF MONEY
REFERENCES:
David Spiceland, Mark Nelson, Wayne Thomas, 2016, Financial Planning: Intermediate
Accounting, 9e Time value of money and quantitative analysis, Chapter 20
Stephen M. Horan, Ph. D., CFA, Thomas R. Robinson, PhD, CFA, (2008), After tax
value of annuities, Financial service review
Daniel R Guide Jr, Gilvan C Souza, Luk N Van Wassenhove, Joesph D Blackburn, (2006)
Time value of commercial product returns, Management Science
Carolin E Schmidt, 2016, A journey through time: From Present value to the future value
and back Or: Retirement planning: Comprehensible application of the time value of money
concept.” American journal of business education
David Tyler, (2017), Using time value of money decision tree to calculate an athlete’s
contract offers.” Case studies in sport management, volume 6 case study 6
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