Cost of investment

This is an F2 / F3 topic!

When we undertake to make a payment in the future, we need to take account of the PRESENT value (ie today’s value) of that future payment

Thus, where an entity has a cost of capital of 10% and has promised to pay $1,000 in 3 years’ time, we need the present value of that $1,000

This we arrive at by multiplying the $1,000 by 1/1.10 (ie 1 + the cost of capital expressed as a percentage) and we do this 3 times (for the three years)

So we arrive at $1,000 * 1/1.10 * 1/1.10 * 1/1.10 and we get to the figure of $751.31 and that figure is the “today” value of $1,000 payable in 3 years’ time

At the end of the first year, that due date for payment is now only 2 years away so we need to unwind that discounted amount by one year

Thus $751.31 * 1.10 = $826.45 and that is the value of the $1,000 with just 2 years to go

The double entry to record that increased obligation is:

Dr Finance costs $75.14
Cr Deferred Obligation $75.14

Another year passes so we’re now only 1 year away from payment and we need to unroll / unwind the discounted amount by another year

Thus $826.45 * 1.10 = $909.09 and the double entry is:

Dr Finance costs $82.64
Cr Deferred Obligation $82.64

You can do the last year! (I hope)

OK?