unrolling of interest

What’s the present value of $1.10 receivable in 1 year’s time if the company’s cost of capital is 10%.

Take $1.10 and multiply by 1 / (1 + interest rate)

So $1.10 x 1 / (1.1) If it’s payable in 2 years’ time, it’s $1.10 x 1 / (1.1)(1.1)

If our company has an obligation to pay $1.10 in one year’s time , it’s as though we were borrowing $1 at an interest rate of 10%.

In our records, we will show an obligation of $1 and then, in the income statement at the end of the year we’ll show 10c finance charges.

The double entry for the 10c is Dr Finance Charges and Cr Obligation.

Now we have $1,10 in the obligation account ready to be settled by a cash payment Dr Obligations Cr Cash

when we have an obligation which is not payable until sometime in the future. In an exam situation, he’ll not likely put the payment date beyond, say, 3 years into the future.

situations include part of purchase consideration when buying a subsid, costs of provisioning for demolition of, eg, power plant in 20 years’ time ( he’ll give you present value and discount rate / cost of capital and all you will need to do is unroll it for the current year