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I have got few questions to be asked. I apologize for asking so lengthy queries.
1) Is it true that in deferred consideration when we calculate the present value by taking the present cashflows and discounting them to the number of years given when the payment will be made?
2) Now the problem is that when we discount the cashflows they are less than the actual amount ($21.840m) which means we need to unwind the deferred cashflows to the final value of $24m to compensate for the money reduced by the time value of money (Is that correct?)
3) Is it true that unwind in this context would mean to compensate (or make up) for the discounted amount ($2.16m) which is the difference between final value ($24m) and present value ($21.840m) which is called the interest?
4) We have total deferred liability of $24m where the payment is to be made within one year so we discount the present cashflows ($24m) with the interest rate of 10% to see how much the discounted liability plus interest do we have to pay in order to pay the total liability of deferred consideration ($24m).
5) We will pay $24m in total but when we take out its present value then it is $21.840 which is to be paid within one year but the amount is not equivalent to the deferred consideration of $24m therefore we need to pay the interest of $2.16m each month so that after the one year we paid the total deferred liability of $24m which we were supposed to pay in the first place but due to time value of the money the vqlue of money diminish over the period of one year?
6) Deferred actually means “accruals” where the liability is paid in future but the time value of money concept force us to calculate the present value of cashflows in advance to see how much interest do we have to pay to reconcile for the difference in total liability?
Are these ALL correct?
1) Yes the consideration is due in the future so we discount that amount back to present value.
2) Yes, the amount recognised as deferred consideration is unwound where we apply the interest to the present value, recognising it as a finance cost.
3) Yes, this is interest and is a recognised as a finance cost.
4) The present value would be calculated as $24m/1.1
5) Initially we DR Investment $21.84m CR Deferred consideration $21.84m. The interest is recorded as DR Finance cost $2.16m DR Deferred consideration $2.16m
6) Effectively we are using the accruals concept to recognise the future consideration to be paid at today’s value as that is when the acquisition is made.
Hope that clears all the points up.
Thanks
I understand your points but could you please correct my points (4 and 5) above what I said was correct or not?
I have few more queries:
1) Future value is used to calculate for investment purpose where the consideration will be received in future to see how much our money will grow over time and earn with simple or compound interest effect being added to the final consideration to be received in future from our investment at present.
2) We calculate Future value by taking the present value of money being invested today and adding the simple or compound interest effect over the period like FV = PV x (1+r)^n
3) The purpose we calculate future value is to see how much our investment will earn in future with the interest effect being added upon our initial investment to make us profitable (i.e. NPV+)?
3) Future value is also known as Final value?
4) Present value is used to calculate for liability purpose where the deferred consideration will be due/paid in future. We used it to see how much we will owe at present time (today) from our liability that will be paid in future.
5) We calculate Present value by discounting the Future cashflows (FV of money) back to the PV (as u said :)) to see how much money will be paid in future after adding on the interest over the period.
6) The problem with calculating PV is that it discounts our future cashflows which means we have less amount unless we add interest by unwinding the deferred consideration to compensate for the difference between Future value and Present value which is the interest caused by time value for money?
7) The purpose of calculating PV is to see how much our future liability will cost at present (today) with the interest effect being added upon our initial liability to make us decision to take up the loan (i.e. NPV+) or not?
8) The purpose of calculating both the FV and PV of a liability or investment is to seperate the costs of principal and interest so we can recognize them separately each year in our financial statements?
Please correct me understanding this. I apologised for taking your time. I hope you don’t mind 🙂
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