Introduction to Non-current Liabilities
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[{"Name":"Introduction to Non-current Liabilities","TopicPlaylistFirstVideoID":0,"Duration":null,"Videos":[{"Watched":false,"Name":"Review Discounted Value Calculations","Duration":"21m 54s","ChapterTopicVideoID":28796,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":"https://www.proprep.uk/Images/Videos_Thumbnails/28796.jpeg","UploadDate":"2022-04-27T08:06:32.0270000","DurationForVideoObject":"PT21M54S","Description":null,"MetaTitle":"Review Discounted Value Calculations: Video + Workbook | Proprep","MetaDescription":"Non-current Liabilities - Introduction to Non-current Liabilities. Watch the video made by an expert in the field. Download the workbook and maximize your learning.","Canonical":"https://www.proprep.uk/general-modules/all/introduction-to-financial-accounting-and-reporting/non_current-liabilities/introduction-to-non_current-liabilities/vid30303","VideoComments":[],"Subtitles":[{"Start":"00:00.080 ","End":"00:04.365","Text":"Hello and welcome to this series of video presentations"},{"Start":"00:04.365 ","End":"00:08.835","Text":"on non-current liabilities brought to you by Proprep."},{"Start":"00:08.835 ","End":"00:13.320","Text":"The objectives of this series of videos are to one,"},{"Start":"00:13.320 ","End":"00:16.574","Text":"present the accounting for debt instruments,"},{"Start":"00:16.574 ","End":"00:21.385","Text":"which include both bonds and loans and number 2,"},{"Start":"00:21.385 ","End":"00:25.830","Text":"to present the accounting for lease contracts."},{"Start":"00:25.830 ","End":"00:31.485","Text":"In this video, we will review discounted value calculations."},{"Start":"00:31.485 ","End":"00:39.545","Text":"Debt liabilities are usually a value with the concept of a discounted present value."},{"Start":"00:39.545 ","End":"00:44.090","Text":"Now, what does discounted present value mean?"},{"Start":"00:44.090 ","End":"00:52.544","Text":"The concept of a present value refers to what amount"},{"Start":"00:52.544 ","End":"01:00.320","Text":"a particular cash-flow is represented at or what the value of that cash flow is to"},{"Start":"01:00.320 ","End":"01:09.499","Text":"you today compared to the amount which will be received or paid in the future period."},{"Start":"01:09.499 ","End":"01:13.805","Text":"In order to determine that present value,"},{"Start":"01:13.805 ","End":"01:17.615","Text":"we use a concept of a discount,"},{"Start":"01:17.615 ","End":"01:20.700","Text":"or in other words, a discounted present value."},{"Start":"01:20.700 ","End":"01:27.115","Text":"This all relates to the concept of the time value of money."},{"Start":"01:27.115 ","End":"01:29.590","Text":"Money has a time value."},{"Start":"01:29.590 ","End":"01:37.120","Text":"The reason money has a time value is clearly because money or cash that is available"},{"Start":"01:37.120 ","End":"01:40.480","Text":"today could be invested at"},{"Start":"01:40.480 ","End":"01:46.255","Text":"a particular rate to earn a return and therefore have a higher value in the future."},{"Start":"01:46.255 ","End":"01:53.235","Text":"Therefore, a unit of currency today 1 pound or 1 dollar today,"},{"Start":"01:53.235 ","End":"01:58.770","Text":"is not equivalent to 1 pound or 1 dollar in 1 year\u0027s time."},{"Start":"01:58.770 ","End":"02:05.970","Text":"Conversely, 1 pound or 1 dollar which you may receive in 1 year\u0027s time,"},{"Start":"02:05.970 ","End":"02:09.540","Text":"is not worth 1 pound or 1 dollar today."},{"Start":"02:09.540 ","End":"02:12.025","Text":"It\u0027ll be worth less today."},{"Start":"02:12.025 ","End":"02:16.805","Text":"Therefore, way of thinking about that is to ask yourself,"},{"Start":"02:16.805 ","End":"02:22.790","Text":"if you were offered 1 pound or 1 dollar in 1 year\u0027s time,"},{"Start":"02:22.790 ","End":"02:27.289","Text":"what amount would you accept today in place of that?"},{"Start":"02:27.289 ","End":"02:31.235","Text":"Your answer has to be something less than 1 pound."},{"Start":"02:31.235 ","End":"02:35.735","Text":"Which you\u0027d accept today in place of or being"},{"Start":"02:35.735 ","End":"02:41.800","Text":"ambivalent to receiving the 1 pound or 1 dollar in 1 year\u0027s time."},{"Start":"02:41.800 ","End":"02:48.500","Text":"Securely interests accrues on any money invested today and"},{"Start":"02:48.500 ","End":"02:51.110","Text":"that interests accruing is one of"},{"Start":"02:51.110 ","End":"02:55.130","Text":"the fundamental concepts of understanding the time value of money."},{"Start":"02:55.130 ","End":"02:58.880","Text":"Because interests accrues, you will get more in"},{"Start":"02:58.880 ","End":"03:03.275","Text":"the future compared to what is invested today."},{"Start":"03:03.275 ","End":"03:07.790","Text":"Therefore, always the future value is larger,"},{"Start":"03:07.790 ","End":"03:14.455","Text":"and therefore the present value is going to be smaller of the two amounts."},{"Start":"03:14.455 ","End":"03:17.759","Text":"To further explain this concept,"},{"Start":"03:17.759 ","End":"03:23.225","Text":"assume you have 1000 currency units today"},{"Start":"03:23.225 ","End":"03:29.225","Text":"and you can invest it in the savings account which matures in 1 year\u0027s time."},{"Start":"03:29.225 ","End":"03:34.850","Text":"The 1000 you have today is equitably the present value."},{"Start":"03:34.850 ","End":"03:40.970","Text":"We\u0027re looking to say or to compute what amount would be received in 1 year\u0027s time,"},{"Start":"03:40.970 ","End":"03:44.150","Text":"which is effectively the future value."},{"Start":"03:44.150 ","End":"03:49.325","Text":"This will be invested at some kind of interest rate,"},{"Start":"03:49.325 ","End":"03:58.910","Text":"which will determine or refer to as r. The future value can be computed by simply"},{"Start":"03:58.910 ","End":"04:09.570","Text":"taking the amount of currency unit invested multiplied by 1 plus the interest rate."},{"Start":"04:09.640 ","End":"04:15.330","Text":"We\u0027ll look at an example of this in the next slide."},{"Start":"04:15.370 ","End":"04:23.630","Text":"In this example, we\u0027re taking the interest rate to be 2% is in terms of the formula."},{"Start":"04:23.630 ","End":"04:27.980","Text":"The interest rate is the r. The amount of"},{"Start":"04:27.980 ","End":"04:33.095","Text":"time we invest in this amount for is 1 year\u0027s time."},{"Start":"04:33.095 ","End":"04:36.817","Text":"Investing the amount for a period of 1 year"},{"Start":"04:36.817 ","End":"04:41.775","Text":"and the amount be investing is 1000 currency units."},{"Start":"04:41.775 ","End":"04:47.690","Text":"Therefore, taking the formula of the amount"},{"Start":"04:47.690 ","End":"04:53.705","Text":"invested multiplied by 1 plus the interest rate,"},{"Start":"04:53.705 ","End":"04:57.830","Text":"we now have 1000 multiplied"},{"Start":"04:57.830 ","End":"05:08.870","Text":"by 1,02 and that gives us an answer of 1020."},{"Start":"05:08.870 ","End":"05:10.805","Text":"In this particular example,"},{"Start":"05:10.805 ","End":"05:14.900","Text":"the 1000 and investing today is the present value and the"},{"Start":"05:14.900 ","End":"05:21.590","Text":"1020 in 1 year\u0027s time is in fact the future value."},{"Start":"05:21.590 ","End":"05:26.870","Text":"We now continue the example looking now at compounding interest."},{"Start":"05:26.870 ","End":"05:28.610","Text":"In the previous example,"},{"Start":"05:28.610 ","End":"05:31.500","Text":"we invested the 1000 pound for 1 year."},{"Start":"05:31.500 ","End":"05:36.110","Text":"We\u0027re now investing the same amount of 1000."},{"Start":"05:36.110 ","End":"05:38.255","Text":"We invest it now for 2 years,"},{"Start":"05:38.255 ","End":"05:45.330","Text":"not for 1 year and the same 2% is the r or the interest rate."},{"Start":"05:45.470 ","End":"05:47.940","Text":"We\u0027re looking over here,"},{"Start":"05:47.940 ","End":"05:51.365","Text":"at what we\u0027ll receive in 2 years time,"},{"Start":"05:51.365 ","End":"05:53.600","Text":"which in fact is the future value."},{"Start":"05:53.600 ","End":"05:59.305","Text":"Whereas this 1000 invested today is the present value."},{"Start":"05:59.305 ","End":"06:08.420","Text":"Now intuitively, should be able to understand and appreciate that if we take the 1020,"},{"Start":"06:08.420 ","End":"06:12.290","Text":"which was the amount that we had after 1 year,"},{"Start":"06:12.290 ","End":"06:16.775","Text":"multiply by the same 1,02,"},{"Start":"06:16.775 ","End":"06:24.365","Text":"we get the amount of 1040.4 for which the amount you\u0027ll have after the second year."},{"Start":"06:24.365 ","End":"06:29.270","Text":"But let\u0027s look at that in terms of the future value formula."},{"Start":"06:29.270 ","End":"06:37.775","Text":"We know the future value formula is the currency units multiplied by 1 plus r,"},{"Start":"06:37.775 ","End":"06:39.890","Text":"which is the interest rate."},{"Start":"06:39.890 ","End":"06:44.810","Text":"Now, that interest rate is expressed to the power of n,"},{"Start":"06:44.810 ","End":"06:46.295","Text":"which is a number of years."},{"Start":"06:46.295 ","End":"06:50.180","Text":"This 2 is a number of years in this case."},{"Start":"06:50.180 ","End":"06:56.800","Text":"We have over here is the amount of 1000 multiplied"},{"Start":"06:56.800 ","End":"07:03.885","Text":"by 1.02 to the power of 2 number of years,"},{"Start":"07:03.885 ","End":"07:07.960","Text":"which is 1000 multiplied by"},{"Start":"07:07.960 ","End":"07:15.595","Text":"1.0404 and that comes out to a total."},{"Start":"07:15.595 ","End":"07:18.550","Text":"This can be obviously currency units now,"},{"Start":"07:18.550 ","End":"07:25.150","Text":"a total of 1,040.4."},{"Start":"07:25.150 ","End":"07:28.975","Text":"In relation to future value and present value,"},{"Start":"07:28.975 ","End":"07:37.230","Text":"there\u0027s 1040 is the future value and the present value"},{"Start":"07:37.230 ","End":"07:45.920","Text":"today is the 1000 invested at 2% for 2 years."},{"Start":"07:45.920 ","End":"07:49.330","Text":"Having looked at the concept of future value,"},{"Start":"07:49.330 ","End":"07:56.515","Text":"we now swing the discussion around and look at the concept of a present value."},{"Start":"07:56.515 ","End":"07:59.080","Text":"Now keenly, you should appreciate that the future value and"},{"Start":"07:59.080 ","End":"08:03.280","Text":"present value are simply 2 sides of the same coin."},{"Start":"08:03.280 ","End":"08:09.710","Text":"Here we say, suppose you are offered an amount of 1000 pounds."},{"Start":"08:09.710 ","End":"08:13.020","Text":"Your next birthday is in 1 year\u0027s time."},{"Start":"08:13.020 ","End":"08:18.295","Text":"Here, the 1000 pound you being offered for your next birthday in 1 year\u0027s time."},{"Start":"08:18.295 ","End":"08:20.785","Text":"That in fact is the future value."},{"Start":"08:20.785 ","End":"08:28.770","Text":"We now asking, what does the value of that 1000 pounds for you today?"},{"Start":"08:28.770 ","End":"08:31.870","Text":"Which in fact would be the present value."},{"Start":"08:31.870 ","End":"08:36.550","Text":"To put it in different words,"},{"Start":"08:36.550 ","End":"08:42.265","Text":"if you were to be offered that 1000 pounds in 1 year\u0027s time,"},{"Start":"08:42.265 ","End":"08:47.830","Text":"taking into account and considering the time value of money to you,"},{"Start":"08:47.830 ","End":"08:52.720","Text":"which would as we know, we expressed by the r or the interest rate."},{"Start":"08:52.720 ","End":"09:00.640","Text":"What amount would you accept today in place of the 1000 in 1 year\u0027s time?"},{"Start":"09:00.640 ","End":"09:03.165","Text":"That becomes the present value."},{"Start":"09:03.165 ","End":"09:10.430","Text":"The formula for computing the present value is therefore simply the amount invested."},{"Start":"09:10.430 ","End":"09:15.470","Text":"The currency units invested multiplied by 1"},{"Start":"09:15.470 ","End":"09:22.040","Text":"over 1 plus the interest rate to the power of number of years."},{"Start":"09:22.040 ","End":"09:24.230","Text":"That clearly is the same as saying,"},{"Start":"09:24.230 ","End":"09:27.350","Text":"the currency units simply divided by"},{"Start":"09:27.350 ","End":"09:32.435","Text":"1 plus the interest rate to the power of a number of years."},{"Start":"09:32.435 ","End":"09:35.429","Text":"Carrying on with the previous example,"},{"Start":"09:35.429 ","End":"09:39.280","Text":"where you were offered 1000 pounds for your birthday in"},{"Start":"09:39.280 ","End":"09:42.230","Text":"1 year\u0027s time and asking what amount would you"},{"Start":"09:42.230 ","End":"09:45.380","Text":"accept today to be ambivalent between the 2?"},{"Start":"09:45.380 ","End":"09:47.780","Text":"If we\u0027re determining the present value."},{"Start":"09:47.780 ","End":"09:52.925","Text":"We now are looking at a discount rate in the first scenario here of 10%,"},{"Start":"09:52.925 ","End":"09:57.980","Text":"step becomes the r. We now take the present value formula."},{"Start":"09:57.980 ","End":"10:03.215","Text":"In this case, we know that the amount offered in 1 year\u0027s time is 1000."},{"Start":"10:03.215 ","End":"10:05.810","Text":"To determine the present value,"},{"Start":"10:05.810 ","End":"10:12.215","Text":"we multiply that by 1 over 1 plus the interest rate to power number of years."},{"Start":"10:12.215 ","End":"10:20.770","Text":"Therefore, we have 1000 multiplied by 1 over 1 plus.0,"},{"Start":"10:20.770 ","End":"10:26.710","Text":"therefore 1.1 to the power of 1 year."},{"Start":"10:26.710 ","End":"10:33.935","Text":"That becomes 1000 multiplied by 0.909,"},{"Start":"10:33.935 ","End":"10:42.860","Text":"which comes to currency unit approximately 909."},{"Start":"10:42.860 ","End":"10:47.750","Text":"What then we can say is that the present value of 1,000,"},{"Start":"10:47.750 ","End":"10:49.225","Text":"1,000 is the future value,"},{"Start":"10:49.225 ","End":"10:52.030","Text":"the present value of 1,000,"},{"Start":"10:52.030 ","End":"10:55.135","Text":"which will be received in 1 years time,"},{"Start":"10:55.135 ","End":"10:59.365","Text":"the present value of that is 909."},{"Start":"10:59.365 ","End":"11:02.380","Text":"If in fact the discount rate,"},{"Start":"11:02.380 ","End":"11:05.710","Text":"the time value of money is only 5 percent,"},{"Start":"11:05.710 ","End":"11:08.890","Text":"then the answer changes like this."},{"Start":"11:08.890 ","End":"11:10.465","Text":"We have the same story,"},{"Start":"11:10.465 ","End":"11:18.950","Text":"1,000 multiplied by 1 over 1 plus the interest rates, therefore,"},{"Start":"11:20.760 ","End":"11:30.020","Text":"1.05^1, which comes to 1,000 multiplied by 0.952,"},{"Start":"11:31.140 ","End":"11:36.940","Text":"which equals approximately 952."},{"Start":"11:36.940 ","End":"11:40.015","Text":"That therefore is the present value,"},{"Start":"11:40.015 ","End":"11:43.120","Text":"1,000 is your future value,"},{"Start":"11:43.120 ","End":"11:49.015","Text":"what we\u0027re saying now is if your time value of money is measured by a discount rate of"},{"Start":"11:49.015 ","End":"11:54.775","Text":"5 percent and you\u0027re offered 1,000 in 1 year\u0027s time,"},{"Start":"11:54.775 ","End":"12:00.505","Text":"the present value today is in the amount of 952."},{"Start":"12:00.505 ","End":"12:04.735","Text":"You\u0027d be ambivalent, equally happy to receive"},{"Start":"12:04.735 ","End":"12:12.880","Text":"952 today or 1,000 in 1 year\u0027s time."},{"Start":"12:12.880 ","End":"12:14.590","Text":"At the 10 percent,"},{"Start":"12:14.590 ","End":"12:21.565","Text":"you are happy to receive 909 today or the 1,000 in 1 year\u0027s time."},{"Start":"12:21.565 ","End":"12:25.750","Text":"Note therefore there\u0027s this inverse relationship between"},{"Start":"12:25.750 ","End":"12:30.520","Text":"the present value and the discount rate."},{"Start":"12:30.520 ","End":"12:35.650","Text":"Now, we\u0027re going to extend this example and assume you will receive"},{"Start":"12:35.650 ","End":"12:41.755","Text":"your £1,000 now only in 3 years time,"},{"Start":"12:41.755 ","End":"12:43.705","Text":"not in 1 year\u0027s time."},{"Start":"12:43.705 ","End":"12:48.280","Text":"3 becomes the n and we\u0027re going to keep with the same r,"},{"Start":"12:48.280 ","End":"12:52.820","Text":"same discount rate of 10 percent."},{"Start":"12:53.400 ","End":"12:57.460","Text":"Applying the present value formula,"},{"Start":"12:57.460 ","End":"13:01.855","Text":"we get 1,000,"},{"Start":"13:01.855 ","End":"13:03.640","Text":"which is the future value,"},{"Start":"13:03.640 ","End":"13:08.110","Text":"multiplied by 1 over 1,1,"},{"Start":"13:08.110 ","End":"13:14.565","Text":"so 1 plus interest rate to the power of 3,"},{"Start":"13:14.565 ","End":"13:21.690","Text":"which is 1,000, multiplied by 0.751."},{"Start":"13:21.690 ","End":"13:29.725","Text":"Therefore the present value comes out at £751 or currency units."},{"Start":"13:29.725 ","End":"13:33.145","Text":"751 is the present value"},{"Start":"13:33.145 ","End":"13:40.795","Text":"of £1,000 to be received in 3 years time at a discount rate of 10 percent."},{"Start":"13:40.795 ","End":"13:47.508","Text":"The 1,000 in 3 years time is the future value and at a discount rate of 10 percent,"},{"Start":"13:47.508 ","End":"13:52.255","Text":"the amounts of 751 is in fact the present value."},{"Start":"13:52.255 ","End":"13:57.430","Text":"We now turn our discussion to the present value for multiple payments."},{"Start":"13:57.430 ","End":"14:00.549","Text":"To assume a discount rate of 10 percent,"},{"Start":"14:00.549 ","End":"14:04.420","Text":"10 percent is our r, you\u0027re asked the question,"},{"Start":"14:04.420 ","End":"14:13.150","Text":"what would you prefer to receive 1,100 in 3 years time or to receive"},{"Start":"14:13.150 ","End":"14:17.680","Text":"500 in 1 year\u0027s time which you can obviously invest at"},{"Start":"14:17.680 ","End":"14:24.520","Text":"10 percent plus a further 500 in 2 years time,"},{"Start":"14:24.520 ","End":"14:27.445","Text":"which we\u0027ll also invest at 10 percent"},{"Start":"14:27.445 ","End":"14:32.390","Text":"and also consider the compound interests on the first 500."},{"Start":"14:32.670 ","End":"14:37.570","Text":"We can\u0027t compare the cashflows of"},{"Start":"14:37.570 ","End":"14:43.735","Text":"1,100 and 1,000 in total for b because these cashflows,"},{"Start":"14:43.735 ","End":"14:47.710","Text":"these receipts happen at different points in time."},{"Start":"14:47.710 ","End":"14:53.185","Text":"Therefore the only way to compare this is to look at the present values."},{"Start":"14:53.185 ","End":"14:55.540","Text":"Let\u0027s now look at these calculations."},{"Start":"14:55.540 ","End":"15:01.015","Text":"Looking now at the calculations for the present value in these needs two scenarios,"},{"Start":"15:01.015 ","End":"15:03.775","Text":"you will recall in part a,"},{"Start":"15:03.775 ","End":"15:10.150","Text":"the receipt in 3 years time is 1,100."},{"Start":"15:10.150 ","End":"15:16.120","Text":"So 1,100 is in fact the future value and"},{"Start":"15:16.120 ","End":"15:19.720","Text":"the 3 years time is the n. Remember"},{"Start":"15:19.720 ","End":"15:23.665","Text":"here we\u0027re looking firstly at a 10 percent discount rate,"},{"Start":"15:23.665 ","End":"15:31.535","Text":"which is the r. Looking for 10 percent discount rate, in option a,"},{"Start":"15:31.535 ","End":"15:35.605","Text":"we can compute the present value by taking the"},{"Start":"15:35.605 ","End":"15:43.945","Text":"1,100 and multiplying it by the formula of 1 over 1.1,"},{"Start":"15:43.945 ","End":"15:47.080","Text":"the interest rate to the power of 3,"},{"Start":"15:47.080 ","End":"15:48.925","Text":"which is 3 years time,"},{"Start":"15:48.925 ","End":"15:58.270","Text":"which equates to 1,100 multiplied by 0.751."},{"Start":"15:58.270 ","End":"16:02.620","Text":"Therefore the present value comes out at"},{"Start":"16:02.620 ","End":"16:12.820","Text":"approximately 826.1 currency units being the present value."},{"Start":"16:12.820 ","End":"16:15.175","Text":"To put it in different words,"},{"Start":"16:15.175 ","End":"16:20.035","Text":"826.1 is the present value"},{"Start":"16:20.035 ","End":"16:26.695","Text":"of 1,100 to be received in 3 years time."},{"Start":"16:26.695 ","End":"16:36.640","Text":"Looking at option b, we now have 500 in 1 years time and 500 in 2 years time."},{"Start":"16:36.640 ","End":"16:42.325","Text":"You have to take into account the 2 different dates of receipt."},{"Start":"16:42.325 ","End":"16:49.670","Text":"We will start off with 500 multiplied by 1 over again,"},{"Start":"16:51.360 ","End":"16:59.200","Text":"1.1^1 plus the second 500 to be received now in 2 years time,"},{"Start":"16:59.200 ","End":"17:05.050","Text":"so multiplied by 1 over 1.1^2."},{"Start":"17:05.050 ","End":"17:10.600","Text":"This all computes out at 500 multiplied by"},{"Start":"17:10.600 ","End":"17:20.950","Text":"0.909 plus the second 500 multiplied by 0.826."},{"Start":"17:20.950 ","End":"17:25.940","Text":"This comes to 400 currency units,"},{"Start":"17:26.490 ","End":"17:38.425","Text":"454.5, approximately, it\u0027s all rounded and this comes to currency units of 413."},{"Start":"17:38.425 ","End":"17:42.580","Text":"The two together give you a total of"},{"Start":"17:42.580 ","End":"17:49.615","Text":"867.5 as the present value."},{"Start":"17:49.615 ","End":"17:52.060","Text":"Again expressed in different words,"},{"Start":"17:52.060 ","End":"17:59.500","Text":"the 867.5 is the present value of 500 to be"},{"Start":"17:59.500 ","End":"18:07.885","Text":"received in 1 years time and a further 500 to be received in 2 years time."},{"Start":"18:07.885 ","End":"18:11.290","Text":"Then comparing the 2 present values,"},{"Start":"18:11.290 ","End":"18:16.555","Text":"the present value in option a is an amount of 826."},{"Start":"18:16.555 ","End":"18:22.525","Text":"The present value in option b is an amount of 867."},{"Start":"18:22.525 ","End":"18:28.750","Text":"Therefore, it\u0027s clearly preferable to receive a lower total amount,"},{"Start":"18:28.750 ","End":"18:32.590","Text":"to receive 500 plus 500 end of year 1,"},{"Start":"18:32.590 ","End":"18:34.240","Text":"end of year 2,"},{"Start":"18:34.240 ","End":"18:39.700","Text":"as opposed to receiving 1100 at the end of your 3."},{"Start":"18:39.700 ","End":"18:43.180","Text":"That\u0027s because of the time value of money."},{"Start":"18:43.180 ","End":"18:47.590","Text":"Let us now do the calculation again where the interest rate,"},{"Start":"18:47.590 ","End":"18:50.035","Text":"the r drops to 5 percent."},{"Start":"18:50.035 ","End":"18:58.690","Text":"Option a, we\u0027re now looking at a future value of 1,100 as in the previous slide."},{"Start":"18:58.690 ","End":"19:02.830","Text":"Multiply this time by 1 over"},{"Start":"19:02.830 ","End":"19:10.690","Text":"1 plus the interest rate, so 1.05^3."},{"Start":"19:10.690 ","End":"19:18.500","Text":"This computes out at 1,100 multiplied by 0.864,"},{"Start":"19:18.780 ","End":"19:25.370","Text":"which gives us total currency units of 950.4,"},{"Start":"19:26.360 ","End":"19:30.735","Text":"which in fact is the present value."},{"Start":"19:30.735 ","End":"19:36.300","Text":"We therefore say the present value of 1,100,"},{"Start":"19:36.300 ","End":"19:39.825","Text":"the future value in 3 years time,"},{"Start":"19:39.825 ","End":"19:45.090","Text":"it has a present value of 950.4 today."},{"Start":"19:45.090 ","End":"19:47.670","Text":"Looking now at option b,"},{"Start":"19:47.670 ","End":"19:52.640","Text":"where we receive 500 in 1 years time and 500 in 2 years time,"},{"Start":"19:52.640 ","End":"19:55.270","Text":"using the same formula as before,"},{"Start":"19:55.270 ","End":"20:03.190","Text":"we have 500 multiplied by 1 over 1 plus the interest rate,"},{"Start":"20:03.190 ","End":"20:10.390","Text":"so 1.05^1 plus 500"},{"Start":"20:10.390 ","End":"20:17.185","Text":"multiplied by 1 over 1.05^2."},{"Start":"20:17.185 ","End":"20:22.180","Text":"This comes out at 500 multiplied by"},{"Start":"20:22.180 ","End":"20:29.710","Text":"0.952 plus"},{"Start":"20:29.710 ","End":"20:35.330","Text":"500 multiplied by 0.907."},{"Start":"20:37.140 ","End":"20:44.995","Text":"Multiplying these out, we get here currency units of 476,"},{"Start":"20:44.995 ","End":"20:50.170","Text":"and here we get currency units or pounds of"},{"Start":"20:50.170 ","End":"20:57.820","Text":"453.5 is the total present value,"},{"Start":"20:57.820 ","End":"21:02.240","Text":"is the amount of 929.5."},{"Start":"21:02.760 ","End":"21:06.205","Text":"Therefore, what can we say from this?"},{"Start":"21:06.205 ","End":"21:15.580","Text":"The present value of 500 in 1 years time and 500 in 2 years time,"},{"Start":"21:15.580 ","End":"21:20.095","Text":"the present value 929.5."},{"Start":"21:20.095 ","End":"21:21.840","Text":"Note what happens now,"},{"Start":"21:21.840 ","End":"21:26.430","Text":"when the discount rate decreases to 5 percent,"},{"Start":"21:26.430 ","End":"21:28.820","Text":"we note that in option a,"},{"Start":"21:28.820 ","End":"21:33.500","Text":"the present value is 950.4,"},{"Start":"21:33.500 ","End":"21:38.790","Text":"whereas in option b, the present value is 929.5."},{"Start":"21:38.790 ","End":"21:41.675","Text":"Therefore, the lower discount rate,"},{"Start":"21:41.675 ","End":"21:44.850","Text":"option a becomes a preferable option."},{"Start":"21:44.850 ","End":"21:47.295","Text":"This has been caused as we said before about"},{"Start":"21:47.295 ","End":"21:53.970","Text":"the inverse relationship between the discount rate and the present value."}],"ID":30303},{"Watched":false,"Name":"Accounting for Debt Liabilities","Duration":"18m 46s","ChapterTopicVideoID":28797,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.020 ","End":"00:04.365","Text":"Hello and welcome to this series of video presentations"},{"Start":"00:04.365 ","End":"00:08.790","Text":"on non-current liabilities brought to you by Proprep."},{"Start":"00:08.790 ","End":"00:13.935","Text":"In this video, we will look at the accounting for debt liabilities."},{"Start":"00:13.935 ","End":"00:17.830","Text":"To determine the balance on any debt liability,"},{"Start":"00:17.830 ","End":"00:23.410","Text":"in other words, the amount that will appear on the statement of financial position."},{"Start":"00:23.660 ","End":"00:27.435","Text":"This is based on the present value."},{"Start":"00:27.435 ","End":"00:36.175","Text":"We\u0027ve discussed the concept of present value in the previous presentation."},{"Start":"00:36.175 ","End":"00:40.955","Text":"We look at the present value of the remaining future payments."},{"Start":"00:40.955 ","End":"00:43.955","Text":"Other words, the cash flows from"},{"Start":"00:43.955 ","End":"00:49.140","Text":"the current date to the end of the life or the liability."},{"Start":"00:49.420 ","End":"00:52.880","Text":"The amount of the annual interest expense,"},{"Start":"00:52.880 ","End":"00:57.950","Text":"the amount that will go on the income statement will be the opening balance of"},{"Start":"00:57.950 ","End":"01:04.205","Text":"that debt liability multiplied by the effective interest rate."},{"Start":"01:04.205 ","End":"01:07.280","Text":"To take a look at an example of this,"},{"Start":"01:07.280 ","End":"01:12.485","Text":"the entity borrows an amount of 929.71,"},{"Start":"01:12.485 ","End":"01:20.525","Text":"the interest rate is 5 percent and it is borrowed on the 31st of December of the X1 year."},{"Start":"01:20.525 ","End":"01:25.190","Text":"Now, the repayment will be in 2 equal installments."},{"Start":"01:25.190 ","End":"01:28.505","Text":"The amount of each installment will be 500."},{"Start":"01:28.505 ","End":"01:34.435","Text":"The first installment on 31 December of the 20X2 year,"},{"Start":"01:34.435 ","End":"01:37.260","Text":"1 year after borrowing,"},{"Start":"01:37.260 ","End":"01:43.260","Text":"and the second installment on 31 December of the 20X3 year,"},{"Start":"01:43.260 ","End":"01:46.055","Text":"in other words, 2 years after borrowing."},{"Start":"01:46.055 ","End":"01:51.845","Text":"Let\u0027s go all the way to 31 December of 20X2,"},{"Start":"01:51.845 ","End":"01:54.170","Text":"which is 1 year after borrowing,"},{"Start":"01:54.170 ","End":"02:00.650","Text":"and therefore 1 year before 31 December of 20X3."},{"Start":"02:00.650 ","End":"02:06.335","Text":"We\u0027re sitting here now at 31 December 20X2 and we ask,"},{"Start":"02:06.335 ","End":"02:14.345","Text":"what is the balance of the statement of financial position at that date?"},{"Start":"02:14.345 ","End":"02:18.455","Text":"Well, it\u0027s going to be the present value of future payments."},{"Start":"02:18.455 ","End":"02:22.780","Text":"We know the present value formula is equal to"},{"Start":"02:22.780 ","End":"02:27.770","Text":"1 over 1 plus the interest rate to the power of number of years."},{"Start":"02:27.770 ","End":"02:33.180","Text":"In this case, it is 1 over 1,"},{"Start":"02:33.180 ","End":"02:35.340","Text":"and the interest rate is 5 percent,"},{"Start":"02:35.340 ","End":"02:39.965","Text":"therefore 1, 05 to the power of 1."},{"Start":"02:39.965 ","End":"02:46.175","Text":"There\u0027s 1 further payment to be made of 500 at this date,"},{"Start":"02:46.175 ","End":"02:48.650","Text":"at December 20X3,"},{"Start":"02:48.650 ","End":"02:52.770","Text":"so that is the single future payments."},{"Start":"02:53.230 ","End":"02:58.345","Text":"Therefore, 500 multiplied by 1 over 1,"},{"Start":"02:58.345 ","End":"03:04.430","Text":"05 to the power of 1 will give you the present value of the future payments,"},{"Start":"03:04.430 ","End":"03:06.830","Text":"that 1 payment today and"},{"Start":"03:06.830 ","End":"03:11.645","Text":"therefore the amount for the statement of financial position at today\u0027s date,"},{"Start":"03:11.645 ","End":"03:15.550","Text":"today being 31 December of 20X2."},{"Start":"03:15.550 ","End":"03:23.995","Text":"We take 500 and we multiply it by 0,9524,"},{"Start":"03:23.995 ","End":"03:32.420","Text":"we find out the present value comes out therefore at 476.2."},{"Start":"03:32.420 ","End":"03:37.900","Text":"That is the amount that will appear on the statement of financial position for"},{"Start":"03:37.900 ","End":"03:46.805","Text":"this borrowing at 31 December 20X2 being the present value of the future cash flows."},{"Start":"03:46.805 ","End":"03:51.490","Text":"Let us now take a look at this on the accounting equation worksheet."},{"Start":"03:51.490 ","End":"03:58.940","Text":"As always here we have assets equals liabilities plus owner\u0027s equity."},{"Start":"03:59.070 ","End":"04:04.740","Text":"Initial borrowing on 31 December 20X1 increases"},{"Start":"04:04.740 ","End":"04:13.635","Text":"the asset cash by the amount of 929.71 in effect,"},{"Start":"04:13.635 ","End":"04:18.940","Text":"a debit to cash and it increases the liability of the loan, in effect,"},{"Start":"04:18.940 ","End":"04:23.110","Text":"a credit to the loan of the same amount 929.71,"},{"Start":"04:23.110 ","End":"04:26.335","Text":"that\u0027s a credit to the loan account."},{"Start":"04:26.335 ","End":"04:28.120","Text":"The interests expense, remember,"},{"Start":"04:28.120 ","End":"04:34.220","Text":"is 5 percent and therefore we take the 929.71"},{"Start":"04:34.220 ","End":"04:41.495","Text":"multiplied by 5 percent and we get the interest of 46.49."},{"Start":"04:41.495 ","End":"04:44.675","Text":"It\u0027s a debit the income statement, reducing equity,"},{"Start":"04:44.675 ","End":"04:50.130","Text":"46.49, that\u0027s the debit to the income statement to reduce equity."},{"Start":"04:50.130 ","End":"04:53.900","Text":"As you\u0027ve seen in the previous presentation,"},{"Start":"04:53.900 ","End":"04:59.280","Text":"the credit amount goes to the loan account 46.49,"},{"Start":"04:59.980 ","End":"05:03.290","Text":"that\u0027s a credit gain to the loan."},{"Start":"05:03.290 ","End":"05:07.370","Text":"There\u0027s then the first repayment of 500 at"},{"Start":"05:07.370 ","End":"05:11.720","Text":"December X2 and therefore we have to reduce the loan,"},{"Start":"05:11.720 ","End":"05:17.495","Text":"debit the loan by 500 and obviously also reduce cash,"},{"Start":"05:17.495 ","End":"05:21.270","Text":"which is a credit to cash of 500."},{"Start":"05:21.310 ","End":"05:26.720","Text":"End of the period. The amount of the interest expense,"},{"Start":"05:26.720 ","End":"05:28.940","Text":"which is the only expense in this case,"},{"Start":"05:28.940 ","End":"05:33.470","Text":"is transferred to retained earnings and therefore,"},{"Start":"05:33.470 ","End":"05:38.765","Text":"there\u0027s a 46.49 in effect to credit going to income statement"},{"Start":"05:38.765 ","End":"05:45.260","Text":"and a 46.49 reduction in retained earnings."},{"Start":"05:45.260 ","End":"05:50.430","Text":"The balance of 31 December of the 20X2 year shows an amount of"},{"Start":"05:50.430 ","End":"05:57.260","Text":"429.71 in the cash in respect to this particular transaction,"},{"Start":"05:57.260 ","End":"06:02.250","Text":"the loan account balance is now 476.20,"},{"Start":"06:02.690 ","End":"06:07.385","Text":"there\u0027s a 0 in income statement because it has been closed off to"},{"Start":"06:07.385 ","End":"06:15.070","Text":"retained earnings and retained earnings shows a negative 46.49."},{"Start":"06:15.070 ","End":"06:18.540","Text":"We then come to the 20X3 year."},{"Start":"06:18.540 ","End":"06:24.065","Text":"We base the interest for the end of 20X3 on the opening balance in the loan,"},{"Start":"06:24.065 ","End":"06:30.135","Text":"476.20 multiplied by 5 percent."},{"Start":"06:30.135 ","End":"06:33.240","Text":"This comes to 23.80."},{"Start":"06:33.240 ","End":"06:35.405","Text":"Once again reduction equity,"},{"Start":"06:35.405 ","End":"06:40.920","Text":"debit interest expense and an amount of"},{"Start":"06:40.920 ","End":"06:49.165","Text":"23.80 debit interest expense and the credit increases the loan 23.80."},{"Start":"06:49.165 ","End":"06:51.065","Text":"That\u0027s what the credit goes to."},{"Start":"06:51.065 ","End":"06:56.810","Text":"The secondary payment on 31 December of the 20X3 year same interests,"},{"Start":"06:56.810 ","End":"07:02.045","Text":"the first repayment debit the loan of 500,"},{"Start":"07:02.045 ","End":"07:08.250","Text":"and obviously also decrease credit cash for 500."},{"Start":"07:08.920 ","End":"07:15.905","Text":"Closing entry closes off the interest to retain earnings 23.80,"},{"Start":"07:15.905 ","End":"07:19.895","Text":"clearly a credit to the interest expense to reduce it to 0,"},{"Start":"07:19.895 ","End":"07:26.160","Text":"and the debit goes to retained earnings of 23.80."},{"Start":"07:26.350 ","End":"07:32.255","Text":"Look at the balances at the end of December 20X3."},{"Start":"07:32.255 ","End":"07:36.410","Text":"On this transaction, there\u0027s been a negative effect,"},{"Start":"07:36.410 ","End":"07:40.805","Text":"an overdraft effect into cash of 70.29,"},{"Start":"07:40.805 ","End":"07:44.740","Text":"the loan is tallied back to 0 because it\u0027s been fully repaid,"},{"Start":"07:44.740 ","End":"07:50.945","Text":"income statement is cleared out and the effect of this transaction on retained earnings,"},{"Start":"07:50.945 ","End":"07:57.680","Text":"is the sum of the 2 interest amounts, which total 70.29."},{"Start":"07:57.680 ","End":"08:02.460","Text":"When we come to classify the debt liability on the balance sheet,"},{"Start":"08:02.460 ","End":"08:06.070","Text":"the balance at the end of any particularly year needs to be"},{"Start":"08:06.070 ","End":"08:13.120","Text":"a split between current liabilities and non-current liabilities."},{"Start":"08:13.120 ","End":"08:16.030","Text":"What is the amount of the current liability?"},{"Start":"08:16.030 ","End":"08:20.255","Text":"We look at the payment which is due in the next year."},{"Start":"08:20.255 ","End":"08:22.200","Text":"That payment, remember,"},{"Start":"08:22.200 ","End":"08:26.980","Text":"is split between partly a repayment of the capital amount"},{"Start":"08:26.980 ","End":"08:32.545","Text":"of the loan and is partly an interest payments."},{"Start":"08:32.545 ","End":"08:38.425","Text":"We strip out the interest component of that payments."},{"Start":"08:38.425 ","End":"08:44.965","Text":"We get the amount of the capital or principle that will be repaid in the following year."},{"Start":"08:44.965 ","End":"08:47.935","Text":"Then following on from that,"},{"Start":"08:47.935 ","End":"08:50.980","Text":"the non-current liability will simply be"},{"Start":"08:50.980 ","End":"08:55.615","Text":"the total balance outstanding less the current portion,"},{"Start":"08:55.615 ","End":"09:00.485","Text":"which we determined in the previous calculation."},{"Start":"09:00.485 ","End":"09:04.300","Text":"Let us now take a look at the application of"},{"Start":"09:04.300 ","End":"09:07.180","Text":"the non-current and current liability principal"},{"Start":"09:07.180 ","End":"09:10.750","Text":"based on the example we\u0027ve just been working through."},{"Start":"09:10.750 ","End":"09:15.619","Text":"The table here is repeated for ease of reference."},{"Start":"09:15.690 ","End":"09:19.855","Text":"To determine the current and non-current portion,"},{"Start":"09:19.855 ","End":"09:23.770","Text":"we will use this 31 December 20X1 as"},{"Start":"09:23.770 ","End":"09:29.270","Text":"the balance sheet date and try and determine how much of the total liability,"},{"Start":"09:29.270 ","End":"09:31.760","Text":"which is 929.71,"},{"Start":"09:31.760 ","End":"09:35.815","Text":"how much is current and how much is non-current."},{"Start":"09:35.815 ","End":"09:42.860","Text":"Just to re-emphasize, the amount of the total liability is 929.71."},{"Start":"09:42.860 ","End":"09:47.015","Text":"We want to determine for purposes of presenting on the balance sheet,"},{"Start":"09:47.015 ","End":"09:50.870","Text":"how much is the current liability and how much is"},{"Start":"09:50.870 ","End":"09:56.930","Text":"the non-current liability portion of the 929.71."},{"Start":"09:56.930 ","End":"10:00.860","Text":"Well, looking at the current portion first,"},{"Start":"10:00.860 ","End":"10:08.525","Text":"we know the current portion will be the amount of next year\u0027s payment due next year."},{"Start":"10:08.525 ","End":"10:14.975","Text":"We look over here and we see that in December of 20X2 the amount of the payment,"},{"Start":"10:14.975 ","End":"10:16.700","Text":"we can look at either these numbers,"},{"Start":"10:16.700 ","End":"10:20.115","Text":"here\u0027s the payment of 500."},{"Start":"10:20.115 ","End":"10:25.244","Text":"Next year\u0027s payments is 500 but also,"},{"Start":"10:25.244 ","End":"10:34.340","Text":"what we need to appreciate is that there is an interest element of 46.49,"},{"Start":"10:34.340 ","End":"10:38.025","Text":"which is sitting inside that payment."},{"Start":"10:38.025 ","End":"10:39.975","Text":"This 46.49."},{"Start":"10:39.975 ","End":"10:45.754","Text":"We subtract 46.49 and we end up with therefore,"},{"Start":"10:45.754 ","End":"10:53.170","Text":"the current portion of 453.51,"},{"Start":"10:53.170 ","End":"10:57.800","Text":"to note it down here, the current portion is 453.51."},{"Start":"10:58.200 ","End":"11:03.610","Text":"We now come to the non-current portion of the liability."},{"Start":"11:03.610 ","End":"11:07.390","Text":"Now here we know we go back to the total liability,"},{"Start":"11:07.390 ","End":"11:13.420","Text":"which we know is an amount of 929.71,and we"},{"Start":"11:13.420 ","End":"11:20.480","Text":"subtract the current portion that we have just computed, which is 453.51."},{"Start":"11:21.930 ","End":"11:28.670","Text":"That therefore gives us a non-current portion of 476.20,"},{"Start":"11:31.380 ","End":"11:36.460","Text":"which we\u0027ll note down over here as well, 476.20."},{"Start":"11:36.460 ","End":"11:40.420","Text":"Therefore to sum up, the amount of the total liability on"},{"Start":"11:40.420 ","End":"11:45.010","Text":"the balance sheet at 31 December of 21x_1 year,"},{"Start":"11:45.010 ","End":"11:49.990","Text":"will be this totally you see over here of 929.71."},{"Start":"11:49.990 ","End":"11:57.490","Text":"That\u0027ll be broken down on the balance sheet into a non-current portion of 476.20,"},{"Start":"11:57.490 ","End":"12:02.500","Text":"and a current portion of 453.51."},{"Start":"12:02.500 ","End":"12:04.840","Text":"There are many loans, for example,"},{"Start":"12:04.840 ","End":"12:06.370","Text":"mortgage type loans,"},{"Start":"12:06.370 ","End":"12:08.515","Text":"and mortgage loan as the type of loan that"},{"Start":"12:08.515 ","End":"12:11.830","Text":"a person or entity would take out against property."},{"Start":"12:11.830 ","End":"12:17.500","Text":"This involves repayments typically in equal amounts over many years."},{"Start":"12:17.500 ","End":"12:19.450","Text":"The payments can be made quarterly,"},{"Start":"12:19.450 ","End":"12:23.290","Text":"annually, or more commonly on a monthly basis."},{"Start":"12:23.290 ","End":"12:28.090","Text":"There\u0027s a certain formula that we can use which is very useful to"},{"Start":"12:28.090 ","End":"12:34.120","Text":"calculate all the amounts related to this loan that we need for the financial statements."},{"Start":"12:34.120 ","End":"12:36.790","Text":"There are many variations in this formula."},{"Start":"12:36.790 ","End":"12:38.710","Text":"They all may look a bit different,"},{"Start":"12:38.710 ","End":"12:43.660","Text":"but they are essentially just an algebraic rearrangement,"},{"Start":"12:43.660 ","End":"12:46.885","Text":"all the formula are effectively equivalent."},{"Start":"12:46.885 ","End":"12:50.750","Text":"Let\u0027s take a look at this particular formula."},{"Start":"12:51.120 ","End":"12:53.740","Text":"The present value here,"},{"Start":"12:53.740 ","End":"12:56.665","Text":"this is the said to be the amount that is borrowed."},{"Start":"12:56.665 ","End":"13:01.075","Text":"The payments will be the periodic payments,"},{"Start":"13:01.075 ","End":"13:04.870","Text":"the amounts of the payments that is made every month,"},{"Start":"13:04.870 ","End":"13:09.145","Text":"quarter, or once a year, every year."},{"Start":"13:09.145 ","End":"13:14.140","Text":"The n refers to the number of periods,"},{"Start":"13:14.140 ","End":"13:20.485","Text":"example, how many months or years is the loan outstanding for?"},{"Start":"13:20.485 ","End":"13:25.780","Text":"Clearly also, the loan will be borrowed at a particular interest rate,"},{"Start":"13:25.780 ","End":"13:28.805","Text":"so r will be the interest rate."},{"Start":"13:28.805 ","End":"13:31.890","Text":"Let\u0027s now take a look at an example"},{"Start":"13:31.890 ","End":"13:35.730","Text":"to apply the principles learned in the previous slide."},{"Start":"13:35.730 ","End":"13:43.210","Text":"You or the entity borrow an amounts of 913.62,"},{"Start":"13:43.210 ","End":"13:44.965","Text":"that\u0027s the amount of the borrowing."},{"Start":"13:44.965 ","End":"13:49.015","Text":"You borrow this amount on 31.12X_1,"},{"Start":"13:49.015 ","End":"13:52.880","Text":"the last day of the 21X_1 year."},{"Start":"13:52.980 ","End":"14:00.220","Text":"The amount you borrow will be repaid in 24 monthly installments,"},{"Start":"14:00.220 ","End":"14:02.365","Text":"and we take out the loan you see,"},{"Start":"14:02.365 ","End":"14:05.170","Text":"remember on December 31X_1."},{"Start":"14:05.170 ","End":"14:13.465","Text":"Therefore, the first installment happens on 31 January of 20X_2,"},{"Start":"14:13.465 ","End":"14:17.470","Text":"and going forward 24 installments,"},{"Start":"14:17.470 ","End":"14:22.585","Text":"the last installment is on 31 December of 20X_3."},{"Start":"14:22.585 ","End":"14:28.970","Text":"You\u0027re given the annual interest rate of 4.907 percent."},{"Start":"14:29.340 ","End":"14:34.645","Text":"Now that 4.907 percent remember is the annual interest rate."},{"Start":"14:34.645 ","End":"14:38.530","Text":"We\u0027re asked now compute the monthly interest rate,"},{"Start":"14:38.530 ","End":"14:41.410","Text":"which is applicable to this loan."},{"Start":"14:41.410 ","End":"14:47.020","Text":"Then number b, calculate what is the amount of the actual monthly payments."},{"Start":"14:47.020 ","End":"14:49.135","Text":"Now to answer number b,"},{"Start":"14:49.135 ","End":"14:55.030","Text":"we\u0027ll have to use the formula which you saw on the previous slide."},{"Start":"14:55.030 ","End":"15:01.825","Text":"Then in part c, to calculate the balance of the loan after 6 months."},{"Start":"15:01.825 ","End":"15:07.375","Text":"Now remember the total loan is for 24 months,"},{"Start":"15:07.375 ","End":"15:11.365","Text":"and therefore once 6 months has gone past,"},{"Start":"15:11.365 ","End":"15:16.355","Text":"there are 18 months remaining of the loan."},{"Start":"15:16.355 ","End":"15:21.930","Text":"You also know that the balance of the loan of a borrowing will be"},{"Start":"15:21.930 ","End":"15:28.435","Text":"the present value of future payments at discounted at the interest rate."},{"Start":"15:28.435 ","End":"15:31.075","Text":"We\u0027ll have to in part c,"},{"Start":"15:31.075 ","End":"15:33.220","Text":"go back to understanding of"},{"Start":"15:33.220 ","End":"15:38.910","Text":"that present value calculation and effectively look at the present value of"},{"Start":"15:38.910 ","End":"15:43.815","Text":"the 18 payments that\u0027ll be made from"},{"Start":"15:43.815 ","End":"15:49.920","Text":"that 6 month point to the last payment at the end of 24 months."},{"Start":"15:49.920 ","End":"15:55.720","Text":"Now for b and c, it\u0027s possible to do the calculation on an Excel formula,"},{"Start":"15:55.720 ","End":"15:58.930","Text":"but we\u0027ll do the calculation here using"},{"Start":"15:58.930 ","End":"16:03.220","Text":"the formula we\u0027ve learnt about in this series of videos."},{"Start":"16:03.220 ","End":"16:07.105","Text":"Part a requires us to compute the monthly interest rate."},{"Start":"16:07.105 ","End":"16:13.319","Text":"To do this, we know that the annual interest rate is 4,0907 percent."},{"Start":"16:13.319 ","End":"16:22.960","Text":"Therefore, 1.04907^1/12 to take"},{"Start":"16:22.960 ","End":"16:24.970","Text":"to 1 month,"},{"Start":"16:24.970 ","End":"16:27.820","Text":"subtract 1 comes to 0,"},{"Start":"16:27.820 ","End":"16:32.530","Text":"4 percent or 0.004."},{"Start":"16:32.530 ","End":"16:40.120","Text":"This is because if you take 1.004 and take it to the power of 12,"},{"Start":"16:40.120 ","End":"16:47.110","Text":"that will give you 1.0497 as the annual rate."},{"Start":"16:47.110 ","End":"16:50.335","Text":"In part b, to compute monthly payments,"},{"Start":"16:50.335 ","End":"16:55.285","Text":"we revert back to the formula which was discussed on the previous slide,"},{"Start":"16:55.285 ","End":"16:59.544","Text":"and as you know, as long as we know 3 of the 4 variables,"},{"Start":"16:59.544 ","End":"17:01.900","Text":"we can compute the missing variable."},{"Start":"17:01.900 ","End":"17:03.580","Text":"In this particular case,"},{"Start":"17:03.580 ","End":"17:08.275","Text":"we know the present value is 913.62."},{"Start":"17:08.275 ","End":"17:11.530","Text":"We know there are 24 months in the contract."},{"Start":"17:11.530 ","End":"17:16.780","Text":"We know the monthly interest rate is 0.004."},{"Start":"17:16.780 ","End":"17:20.635","Text":"Therefore, by solving for the missing number,"},{"Start":"17:20.635 ","End":"17:22.240","Text":"which is the payment,"},{"Start":"17:22.240 ","End":"17:26.530","Text":"using the equation or by using an Excel spreadsheet,"},{"Start":"17:26.530 ","End":"17:32.905","Text":"we can compute the payment to be equal to the amount of 40 per month."},{"Start":"17:32.905 ","End":"17:38.530","Text":"In part c, you\u0027re asked to compute the balance of the loan after 6 payments."},{"Start":"17:38.530 ","End":"17:43.150","Text":"Remember the contract is for a period of 24 months,"},{"Start":"17:43.150 ","End":"17:45.595","Text":"and after 6 payments have been made,"},{"Start":"17:45.595 ","End":"17:47.155","Text":"6 months of payments,"},{"Start":"17:47.155 ","End":"17:52.675","Text":"there are therefore 18 months of payments left in this particular contract."},{"Start":"17:52.675 ","End":"17:56.725","Text":"Again, it\u0027s a matter of looking at the formula and"},{"Start":"17:56.725 ","End":"18:01.330","Text":"plugging in the numbers we know and solving for the missing amount."},{"Start":"18:01.330 ","End":"18:02.770","Text":"In this case here,"},{"Start":"18:02.770 ","End":"18:06.985","Text":"we are trying to determine the present value because as you remember,"},{"Start":"18:06.985 ","End":"18:14.155","Text":"the amount to record for a debt liability is the present value of future payments."},{"Start":"18:14.155 ","End":"18:20.140","Text":"We know from a previous calculation that the monthly payment is an amount of 40."},{"Start":"18:20.140 ","End":"18:25.930","Text":"We now know that there are 18 remaining payments because 6 months have gone past."},{"Start":"18:25.930 ","End":"18:32.305","Text":"We know that the interest rate is the 0.004,"},{"Start":"18:32.305 ","End":"18:36.460","Text":"and therefore we can solve for the missing figure and solve for"},{"Start":"18:36.460 ","End":"18:40.915","Text":"the present value of 693.35."},{"Start":"18:40.915 ","End":"18:46.910","Text":"That therefore is the present value of the remaining 18 payments."}],"ID":30304},{"Watched":false,"Name":"Bonds Payable","Duration":"40m 36s","ChapterTopicVideoID":28800,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:01.310 ","End":"00:09.495","Text":"In this video, we will examine the accounting for bonds payable. What is a bond?"},{"Start":"00:09.495 ","End":"00:14.595","Text":"A bond is sometimes referred to as a debenture."},{"Start":"00:14.595 ","End":"00:19.410","Text":"A bond or a debenture is a form of debt."},{"Start":"00:19.410 ","End":"00:21.420","Text":"The issuing company,"},{"Start":"00:21.420 ","End":"00:23.334","Text":"which is the borrower,"},{"Start":"00:23.334 ","End":"00:25.860","Text":"effectively owes the bondholder,"},{"Start":"00:25.860 ","End":"00:34.065","Text":"who is the lender, an amount of money referred to as the principal or face value."},{"Start":"00:34.065 ","End":"00:42.945","Text":"This principal or face value is repaid at maturity,"},{"Start":"00:42.945 ","End":"00:45.870","Text":"which is the end of the bond term."},{"Start":"00:45.870 ","End":"00:50.415","Text":"There\u0027s also going to be interest payments,"},{"Start":"00:50.415 ","End":"00:52.905","Text":"referred to as coupon payments,"},{"Start":"00:52.905 ","End":"01:00.780","Text":"that the borrower has to pay to the bondholder over the life of this instrument."},{"Start":"01:00.780 ","End":"01:04.245","Text":"They are generally issued for a fixed term,"},{"Start":"01:04.245 ","End":"01:06.960","Text":"5 years or 10 years."},{"Start":"01:06.960 ","End":"01:14.355","Text":"It is companies that issue bonds to obtain normally large amounts of finance."},{"Start":"01:14.355 ","End":"01:19.530","Text":"Individuals and small businesses do not issue bonds."},{"Start":"01:19.530 ","End":"01:26.070","Text":"They are costly and complex and therefore normally require a financial institution"},{"Start":"01:26.070 ","End":"01:35.160","Text":"to act as an intermediary and also to do all the regulatory work relating to the bond."},{"Start":"01:35.160 ","End":"01:41.790","Text":"Also, as opposed to the company borrowing money from 1 lender,"},{"Start":"01:41.790 ","End":"01:48.915","Text":"the bonds are issued to many bondholders and therefore many investors."},{"Start":"01:48.915 ","End":"01:54.000","Text":"For example, a company wishing to raise, for example,"},{"Start":"01:54.000 ","End":"01:59.114","Text":"£100,000,000 as a loan could"},{"Start":"01:59.114 ","End":"02:05.130","Text":"raise 1,000,000 bonds of £100 each."},{"Start":"02:05.130 ","End":"02:07.290","Text":"In other word,"},{"Start":"02:07.290 ","End":"02:11.325","Text":"there going to be 1,000,000 different bondholders or investors,"},{"Start":"02:11.325 ","End":"02:14.955","Text":"each investing a smaller amount."},{"Start":"02:14.955 ","End":"02:17.025","Text":"Investing, in other words,"},{"Start":"02:17.025 ","End":"02:20.220","Text":"lending a smaller amount to the company."},{"Start":"02:20.220 ","End":"02:23.355","Text":"To understand bond valuation,"},{"Start":"02:23.355 ","End":"02:29.310","Text":"we need to understand the concept of the interest rates and"},{"Start":"02:29.310 ","End":"02:33.420","Text":"specifically the concept of how"},{"Start":"02:33.420 ","End":"02:38.910","Text":"an effective interest rate differs from a stated interest rate."},{"Start":"02:38.910 ","End":"02:42.585","Text":"Now, when a company issues bonds,"},{"Start":"02:42.585 ","End":"02:47.730","Text":"it will offer the bonds at a stated interest rate."},{"Start":"02:47.730 ","End":"02:50.565","Text":"That\u0027s the rate offered by the firm."},{"Start":"02:50.565 ","End":"02:57.840","Text":"For example, a company issues a £100 bond at 10%."},{"Start":"02:57.840 ","End":"03:01.440","Text":"Then we need to look at that stated interest rate in"},{"Start":"03:01.440 ","End":"03:04.875","Text":"relation to the effective interest rate."},{"Start":"03:04.875 ","End":"03:10.050","Text":"The effective interest rate is the rate demanded by the market."},{"Start":"03:10.050 ","End":"03:12.180","Text":"To put this into context,"},{"Start":"03:12.180 ","End":"03:15.315","Text":"relative to the face value of the bond,"},{"Start":"03:15.315 ","End":"03:21.945","Text":"and the face value of the bond is often referred to as the par value of the bond."},{"Start":"03:21.945 ","End":"03:28.035","Text":"The bond price can be issued equal to that par value,"},{"Start":"03:28.035 ","End":"03:30.390","Text":"below the par value, in other words,"},{"Start":"03:30.390 ","End":"03:34.635","Text":"at a discount, or above the par value,"},{"Start":"03:34.635 ","End":"03:37.755","Text":"in other words, at a premium."},{"Start":"03:37.755 ","End":"03:45.929","Text":"Therefore, in what situation would a company issue a bond at par,"},{"Start":"03:45.929 ","End":"03:50.880","Text":"in what situation would the company issue the bond at a discount,"},{"Start":"03:50.880 ","End":"03:56.860","Text":"and in what situation would the company issue the bond at a premium?"},{"Start":"03:59.630 ","End":"04:02.310","Text":"To answer that question,"},{"Start":"04:02.310 ","End":"04:07.125","Text":"let us assume that the stated rate is 10%."},{"Start":"04:07.125 ","End":"04:13.440","Text":"I\u0027ll put in here 10% for all 3 scenarios."},{"Start":"04:13.440 ","End":"04:19.995","Text":"What would cause the company to issue the bonds at par,"},{"Start":"04:19.995 ","End":"04:25.680","Text":"that would happen when the effective rate is also 10%."},{"Start":"04:25.680 ","End":"04:31.875","Text":"Other words, the rate offered by the company, stated rate,10%,"},{"Start":"04:31.875 ","End":"04:33.870","Text":"is equal to the market rate of 10%,"},{"Start":"04:33.870 ","End":"04:41.265","Text":"and therefore the company issues its bonds at par value, at face value."},{"Start":"04:41.265 ","End":"04:47.400","Text":"However, if the stated rate is 10% and the effective rate,"},{"Start":"04:47.400 ","End":"04:51.090","Text":"for example, now is 12%."},{"Start":"04:51.090 ","End":"04:53.400","Text":"What is this saying to us?"},{"Start":"04:53.400 ","End":"04:58.679","Text":"It\u0027s saying the market is demanding a rate of 12%,"},{"Start":"04:58.679 ","End":"05:01.185","Text":"yet the company is only offering 10%."},{"Start":"05:01.185 ","End":"05:04.649","Text":"Therefore, to entice bondholders to invest,"},{"Start":"05:04.649 ","End":"05:09.850","Text":"the company now must issue bonds at a discount to par value."},{"Start":"05:09.850 ","End":"05:13.940","Text":"What this means is if the par value of the bond is,"},{"Start":"05:13.940 ","End":"05:15.905","Text":"for example, 100,"},{"Start":"05:15.905 ","End":"05:20.120","Text":"issuing at a discount would mean issuing the bonds at,"},{"Start":"05:20.120 ","End":"05:23.410","Text":"for example, at 95."},{"Start":"05:23.410 ","End":"05:27.165","Text":"The discount therefore being the amount of 5."},{"Start":"05:27.165 ","End":"05:29.085","Text":"Look at the third scenario."},{"Start":"05:29.085 ","End":"05:31.320","Text":"Again, taking the stated rate to be"},{"Start":"05:31.320 ","End":"05:36.015","Text":"10% but now the stated rate is higher than the effective rate."},{"Start":"05:36.015 ","End":"05:37.980","Text":"To say, for example, here,"},{"Start":"05:37.980 ","End":"05:42.420","Text":"the effective rate is only 8%."},{"Start":"05:42.420 ","End":"05:47.115","Text":"What we\u0027re seeing here is with the stated rate of 10%,"},{"Start":"05:47.115 ","End":"05:50.505","Text":"but the market is only requiring 8%."},{"Start":"05:50.505 ","End":"05:54.855","Text":"The company can now in fact demand a premium."},{"Start":"05:54.855 ","End":"06:00.525","Text":"It can demand an excess amount over par value for its debenture, its bonds."},{"Start":"06:00.525 ","End":"06:04.815","Text":"Again, if the par value of the bonds is 100,"},{"Start":"06:04.815 ","End":"06:08.220","Text":"it can now issue the bonds at a premium."},{"Start":"06:08.220 ","End":"06:11.025","Text":"For example, 105."},{"Start":"06:11.025 ","End":"06:12.975","Text":"The premium amount,"},{"Start":"06:12.975 ","End":"06:19.470","Text":"the excess over the par value of 5 gives us a premium of 105 because of"},{"Start":"06:19.470 ","End":"06:26.280","Text":"the fact that the rate offered is in fact less than the rate the market demands."},{"Start":"06:26.280 ","End":"06:29.505","Text":"We will now start to take a look at some examples,"},{"Start":"06:29.505 ","End":"06:31.845","Text":"looking at bond valuation."},{"Start":"06:31.845 ","End":"06:36.930","Text":"In this question, you are told on 1 January of the 20X1 year,"},{"Start":"06:36.930 ","End":"06:44.940","Text":"this company issues a bond at a face value of 100."},{"Start":"06:44.940 ","End":"06:50.085","Text":"Face value, we can often also refer to as the par value."},{"Start":"06:50.085 ","End":"06:53.625","Text":"The annual coupon is 9%."},{"Start":"06:53.625 ","End":"06:56.775","Text":"By referring to the annual coupon of 9%,"},{"Start":"06:56.775 ","End":"07:00.705","Text":"we\u0027re referring to the stated interest rate."},{"Start":"07:00.705 ","End":"07:05.250","Text":"The stated interest rate is 9%."},{"Start":"07:05.250 ","End":"07:07.830","Text":"This is payable at the end of each year."},{"Start":"07:07.830 ","End":"07:14.250","Text":"We\u0027re told that the principal is repaid on 31 December 20x2."},{"Start":"07:14.250 ","End":"07:22.755","Text":"Therefore, you can see from 1 January X1 to 31 December X2 is in fact a 2-year period."},{"Start":"07:22.755 ","End":"07:29.475","Text":"Now, what is important to notice is that because the bond is issued at face value,"},{"Start":"07:29.475 ","End":"07:31.590","Text":"as I said, par value,"},{"Start":"07:31.590 ","End":"07:35.669","Text":"that means that the required rate of"},{"Start":"07:35.669 ","End":"07:43.710","Text":"return or the rate of return required by investors of this case 9%."},{"Start":"07:43.710 ","End":"07:45.615","Text":"I will say the last sentence again."},{"Start":"07:45.615 ","End":"07:48.210","Text":"As the bond is issued at face value,"},{"Start":"07:48.210 ","End":"07:54.015","Text":"this means prospective investors require rate of return of 9%."},{"Start":"07:54.015 ","End":"07:57.854","Text":"Therefore the effective interest rate is in fact"},{"Start":"07:57.854 ","End":"08:02.100","Text":"equal to the stated or coupon interest rate."},{"Start":"08:02.100 ","End":"08:08.805","Text":"Let us do a present value calculation of the bond at 1 January X1 to illustrate this."},{"Start":"08:08.805 ","End":"08:10.290","Text":"We have 2 years,"},{"Start":"08:10.290 ","End":"08:13.620","Text":"we have year 1 and we have year 2."},{"Start":"08:13.620 ","End":"08:20.295","Text":"Let\u0027s look at the cash flows related to this bond over these 2 years."},{"Start":"08:20.295 ","End":"08:26.355","Text":"In year 1, the cash flow will be an amount of 9."},{"Start":"08:26.355 ","End":"08:35.955","Text":"The 9 cash flow is the 100 face value of the bond multiplied by the 9% interest rate."},{"Start":"08:35.955 ","End":"08:37.950","Text":"In year 2,"},{"Start":"08:37.950 ","End":"08:40.890","Text":"the cash flow will be 109,"},{"Start":"08:40.890 ","End":"08:44.129","Text":"which in fact is the repayment of"},{"Start":"08:44.129 ","End":"08:49.860","Text":"the 100 face value of the bond plus obviously the interest for that last year,"},{"Start":"08:49.860 ","End":"08:53.940","Text":"which will also be 100 at 9%."},{"Start":"08:53.940 ","End":"08:58.815","Text":"Looking at the present value of these cash flows,"},{"Start":"08:58.815 ","End":"09:02.129","Text":"we can compute it for year 1 as being the 9 as"},{"Start":"09:02.129 ","End":"09:06.705","Text":"the cash flow multiplied by the PV formula of 1"},{"Start":"09:06.705 ","End":"09:14.610","Text":"over 1 plus the interest rate, therefore 1.09^1."},{"Start":"09:14.610 ","End":"09:19.215","Text":"For year 2, it\u0027s going to be 109"},{"Start":"09:19.215 ","End":"09:26.280","Text":"multiplied by 1 over 1.09^2."},{"Start":"09:26.280 ","End":"09:34.499","Text":"This comes to 9 multiplied by 0.9174."},{"Start":"09:34.499 ","End":"09:36.345","Text":"For year 2,"},{"Start":"09:36.345 ","End":"09:44.040","Text":"109 multiplied by 0.5316."},{"Start":"09:44.040 ","End":"09:46.290","Text":"The total present value,"},{"Start":"09:46.290 ","End":"09:48.600","Text":"therefore, in year 1,"},{"Start":"09:48.600 ","End":"09:54.000","Text":"is 8.256, and in year 2,"},{"Start":"09:54.000 ","End":"09:58.710","Text":"it will be 91.743."},{"Start":"09:58.710 ","End":"10:02.415","Text":"That totals an amount of 100."},{"Start":"10:02.415 ","End":"10:08.340","Text":"What is this showing to you is that the present value of the cash flows, other words,"},{"Start":"10:08.340 ","End":"10:16.905","Text":"the cash flow of 9 at the end of year 1 discounted to 1 January X1 and the cash flow"},{"Start":"10:16.905 ","End":"10:25.830","Text":"of 109 at the end of year 2 discounted to 1 January X1 amounts to the par value,"},{"Start":"10:25.830 ","End":"10:28.340","Text":"which in fact is 100."},{"Start":"10:28.340 ","End":"10:32.690","Text":"We now turn our attention to the accounting treatment of bonds payable."},{"Start":"10:32.690 ","End":"10:35.395","Text":"Looking firstly at the balance sheet,"},{"Start":"10:35.395 ","End":"10:40.380","Text":"bonds are liability and the amount that will be recognized in"},{"Start":"10:40.380 ","End":"10:47.330","Text":"the balance sheet is the amortized cost of that particular bond liability."},{"Start":"10:47.330 ","End":"10:50.029","Text":"The amortized cost effectively being"},{"Start":"10:50.029 ","End":"10:55.685","Text":"the discounted present value of the remaining payments."},{"Start":"10:55.685 ","End":"10:59.380","Text":"As you saw on the example on the previous slide,"},{"Start":"10:59.380 ","End":"11:03.240","Text":"when the bond was issued at par value for 100,"},{"Start":"11:03.240 ","End":"11:06.825","Text":"at a 9% interest rate,"},{"Start":"11:06.825 ","End":"11:12.105","Text":"when I calculated the present value of the future cash flows,"},{"Start":"11:12.105 ","End":"11:19.950","Text":"which you recall was the £9 at the end of year 1 and the £109 at the end of year 2,"},{"Start":"11:19.950 ","End":"11:28.170","Text":"the present value of those 2 cash flows at the date of issue was in fact the 100."},{"Start":"11:28.170 ","End":"11:33.819","Text":"The balance at the end of a particular period will be"},{"Start":"11:33.819 ","End":"11:36.909","Text":"the balance at the beginning of the period"},{"Start":"11:36.909 ","End":"11:41.289","Text":"plus any interest expense which is recognized in the period."},{"Start":"11:41.289 ","End":"11:47.650","Text":"In other words the accounting entry here will be a debit to the interest as"},{"Start":"11:47.650 ","End":"11:55.884","Text":"the expense account credit to the bond account as liability account less any cash paid,"},{"Start":"11:55.884 ","End":"12:02.200","Text":"and therefore the cash paid will be recognized or journalized as a debit to"},{"Start":"12:02.200 ","End":"12:05.349","Text":"the bond liability reducing the obligation because"},{"Start":"12:05.349 ","End":"12:09.834","Text":"cash is being paid and a credit to cash."},{"Start":"12:09.834 ","End":"12:17.840","Text":"This procedure will be demonstrated to you in the slides coming up after this."},{"Start":"12:18.120 ","End":"12:21.415","Text":"Looking at the income statement,"},{"Start":"12:21.415 ","End":"12:28.374","Text":"we recognize interests based on the effective interest rate not the stated rate."},{"Start":"12:28.374 ","End":"12:31.645","Text":"Again this will be shown in the examples to follow,"},{"Start":"12:31.645 ","End":"12:36.609","Text":"and the computation of the interest expense will be the balance in"},{"Start":"12:36.609 ","End":"12:39.025","Text":"the bond liability at the beginning of the period"},{"Start":"12:39.025 ","End":"12:43.089","Text":"multiplied by that effective interest rate."},{"Start":"12:43.089 ","End":"12:48.295","Text":"We will now start looking at some examples of the accounting for bonds payable."},{"Start":"12:48.295 ","End":"12:53.440","Text":"If you recall an example we started a couple of slides back that"},{"Start":"12:53.440 ","End":"12:58.212","Text":"the bonds in the first example were issued at par,"},{"Start":"12:58.212 ","End":"13:01.989","Text":"and because they\u0027ve issued at par we know that"},{"Start":"13:01.989 ","End":"13:06.520","Text":"the stated rate was equal to the effective rate."},{"Start":"13:06.520 ","End":"13:13.480","Text":"The stated rate was 9 percent and the effective rate is also 9 percent."},{"Start":"13:13.480 ","End":"13:17.829","Text":"Now because the stated rate is equal to the effective rate,"},{"Start":"13:17.829 ","End":"13:20.245","Text":"the amount of the interest expense"},{"Start":"13:20.245 ","End":"13:24.700","Text":"each year is going to equal the amount of the interest payments."},{"Start":"13:24.700 ","End":"13:30.970","Text":"In other words the expense will equal the cash flow in"},{"Start":"13:30.970 ","End":"13:34.510","Text":"the scenario where the bonds are issued at"},{"Start":"13:34.510 ","End":"13:39.475","Text":"par causing the stated rate to equal the effective rate."},{"Start":"13:39.475 ","End":"13:43.494","Text":"Looking at the accounting equation worksheet remember assets"},{"Start":"13:43.494 ","End":"13:48.145","Text":"equals liabilities plus owner\u0027s equity."},{"Start":"13:48.145 ","End":"13:54.583","Text":"At the beginning of Year 1 when the bonds are issued the asset called cash increases;"},{"Start":"13:54.583 ","End":"13:57.280","Text":"that in fact is a debit to the asset cash,"},{"Start":"13:57.280 ","End":"14:01.814","Text":"and the liability bonds payable also increases;"},{"Start":"14:01.814 ","End":"14:05.904","Text":"that in fact is a credit to the liability account bonds payable."},{"Start":"14:05.904 ","End":"14:08.320","Text":"When we come to the end of the first year,"},{"Start":"14:08.320 ","End":"14:10.520","Text":"we have to account for the interest."},{"Start":"14:10.520 ","End":"14:12.990","Text":"Now I\u0027m going to do this in 2 steps."},{"Start":"14:12.990 ","End":"14:18.750","Text":"You recall in the previous slide it said that when we account for the interest on"},{"Start":"14:18.750 ","End":"14:25.549","Text":"the bond what we do is we recognize the interest expense with inequity."},{"Start":"14:25.549 ","End":"14:29.650","Text":"In other words a debit to interest expense,"},{"Start":"14:29.650 ","End":"14:32.740","Text":"so I\u0027m going to put the interest expense."},{"Start":"14:32.740 ","End":"14:37.644","Text":"Remember the interest expense is the effective rate,"},{"Start":"14:37.644 ","End":"14:45.099","Text":"and this case 9 percent on the opening balance in the bond liability account."},{"Start":"14:45.099 ","End":"14:52.315","Text":"Therefore if you compute 9 percent times 100,"},{"Start":"14:52.315 ","End":"14:55.135","Text":"we clearly have an answer of 9."},{"Start":"14:55.135 ","End":"15:01.630","Text":"Therefore we debit the interest expense which reduces equity as the debit goes"},{"Start":"15:01.630 ","End":"15:09.880","Text":"to interest expense and the credit goes to the bonds payable account."},{"Start":"15:09.880 ","End":"15:15.505","Text":"Then the actual cash is paid to the bond holders."},{"Start":"15:15.505 ","End":"15:19.339","Text":"Now here we know that cash flow equals the expense,"},{"Start":"15:19.339 ","End":"15:25.420","Text":"so put them to different color and we now know that the payment is made."},{"Start":"15:25.420 ","End":"15:31.630","Text":"Therefore to make the payment we will reduce the asset cash or the same amount of"},{"Start":"15:31.630 ","End":"15:39.115","Text":"9 a credit to cash and we put a debit to the bonds payable account which is 9."},{"Start":"15:39.115 ","End":"15:41.369","Text":"The effect of this;"},{"Start":"15:41.369 ","End":"15:43.614","Text":"and I\u0027ll put the effect in red,"},{"Start":"15:43.614 ","End":"15:47.605","Text":"is essentially while draw a circle rounded to show the effect."},{"Start":"15:47.605 ","End":"15:53.889","Text":"The effect of this is in fact a increase in expense"},{"Start":"15:53.889 ","End":"16:00.954","Text":"of 9 reduction in equity and a decrease in asset cash."},{"Start":"16:00.954 ","End":"16:07.119","Text":"The movements in the bond account simply increases liability with the amount"},{"Start":"16:07.119 ","End":"16:13.214","Text":"of the interest and decreases liability with the amount of the payment."},{"Start":"16:13.214 ","End":"16:15.734","Text":"You may ask why I\u0027ve done this in 2 steps."},{"Start":"16:15.734 ","End":"16:20.710","Text":"What is the purpose of it if the net effect of this account is in fact 0."},{"Start":"16:20.710 ","End":"16:26.522","Text":"We will see in later examples when the bonds are issued at a discount or a premium."},{"Start":"16:26.522 ","End":"16:31.030","Text":"The amount the cash flow will be different to the expense and you\u0027ll need"},{"Start":"16:31.030 ","End":"16:36.205","Text":"this to understand the impact of the interest and cash payments."},{"Start":"16:36.205 ","End":"16:40.299","Text":"We then come to end of the year and we know there\u0027s always a transfer"},{"Start":"16:40.299 ","End":"16:44.410","Text":"of any income and expenses to retained profit,"},{"Start":"16:44.410 ","End":"16:49.074","Text":"so we\u0027ll transfer the non out of retained earnings out of the income statement"},{"Start":"16:49.074 ","End":"16:55.390","Text":"which is a credit and a debit into retained earnings."},{"Start":"16:55.390 ","End":"17:02.410","Text":"The balances looking at these transactions alone shows a cash balance of 91,"},{"Start":"17:02.410 ","End":"17:07.809","Text":"the balance in the bond liability of 100 at the income statement being closed off"},{"Start":"17:07.809 ","End":"17:13.810","Text":"to 0 and the retained profits is in fact a negative 9."},{"Start":"17:13.810 ","End":"17:18.444","Text":"It\u0027s been a non impact retained profit of these transactions."},{"Start":"17:18.444 ","End":"17:22.839","Text":"When we come into Year 2 clearly the closing balance is from the end of"},{"Start":"17:22.839 ","End":"17:25.059","Text":"the previous year are carried"},{"Start":"17:25.059 ","End":"17:27.834","Text":"forward as the opening balances for the beginning of the current year."},{"Start":"17:27.834 ","End":"17:30.980","Text":"The same balances appear over here."},{"Start":"17:31.200 ","End":"17:36.010","Text":"Retained profit; a negative 9,"},{"Start":"17:36.010 ","End":"17:39.520","Text":"and we account for the interest expense in the same way."},{"Start":"17:39.520 ","End":"17:43.285","Text":"Interest expense as I said is based on the effective rate"},{"Start":"17:43.285 ","End":"17:47.590","Text":"multiplied by the opening balance in the bond liability account."},{"Start":"17:47.590 ","End":"17:53.650","Text":"It\u0027s the same as the first year and it will be the same when the bonds are issued at par."},{"Start":"17:53.650 ","End":"17:55.569","Text":"It\u0027s not percent of 100."},{"Start":"17:55.569 ","End":"17:57.894","Text":"Again I\u0027ll do the 2 entries."},{"Start":"17:57.894 ","End":"18:00.985","Text":"We debit the interest expense,"},{"Start":"18:00.985 ","End":"18:05.140","Text":"expense is reduced by 9 debit interest expense and"},{"Start":"18:05.140 ","End":"18:09.340","Text":"a 9 credit into the bonds payable account."},{"Start":"18:09.340 ","End":"18:11.681","Text":"We then pay the interests,"},{"Start":"18:11.681 ","End":"18:20.530","Text":"so a debit of 9 to the bonds payable account and a credit of 9 to bank cash or bank."},{"Start":"18:20.530 ","End":"18:23.919","Text":"Net effect as before; net effect,"},{"Start":"18:23.919 ","End":"18:30.891","Text":"is the debit of 9 to the interest expense and the credits of 9 to the asset account;"},{"Start":"18:30.891 ","End":"18:33.620","Text":"the cash account, which is an asset."},{"Start":"18:33.690 ","End":"18:39.159","Text":"Also at the end of the second year we have to repay the principal,"},{"Start":"18:39.159 ","End":"18:46.240","Text":"so we have to therefore debit the bond liability with the full 100 to repay the amount of"},{"Start":"18:46.240 ","End":"18:54.444","Text":"the liability and we clearly also credit cash to effect the payment."},{"Start":"18:54.444 ","End":"19:00.690","Text":"The transfer to retain profit is the non interest expense from the current year,"},{"Start":"19:00.690 ","End":"19:04.630","Text":"so we move that out of the profit account a credit to"},{"Start":"19:04.630 ","End":"19:08.964","Text":"profit and a debit to retained earnings."},{"Start":"19:08.964 ","End":"19:14.124","Text":"The closing balance again looking at the effect of these transactions only"},{"Start":"19:14.124 ","End":"19:20.455","Text":"shows a closing balance of non-negative 18 in cash and there\u0027s no bond liability."},{"Start":"19:20.455 ","End":"19:26.319","Text":"We\u0027ve closed off the interest expense and over the 2 years there\u0027s clearly been in"},{"Start":"19:26.319 ","End":"19:29.349","Text":"an 18 impact retained profit which is"},{"Start":"19:29.349 ","End":"19:34.345","Text":"the interest expense of 9 for Year 1 and for Year 2."},{"Start":"19:34.345 ","End":"19:40.075","Text":"We now look at an example where the bonds are issued at a discount."},{"Start":"19:40.075 ","End":"19:43.213","Text":"Here we\u0027re going to take the market rate"},{"Start":"19:43.213 ","End":"19:47.919","Text":"which remember is the effective rate to be 12 percent."},{"Start":"19:47.919 ","End":"19:51.467","Text":"That\u0027s the rate demanded by the market,"},{"Start":"19:51.467 ","End":"19:55.779","Text":"is 100 currency units face value of the bond and"},{"Start":"19:55.779 ","End":"20:02.170","Text":"the bond pays 9 percent as the coupon or the stated rate."},{"Start":"20:02.170 ","End":"20:05.785","Text":"Coupon is the stated rate,"},{"Start":"20:05.785 ","End":"20:09.264","Text":"the actual rate in the bond whereas the market requires"},{"Start":"20:09.264 ","End":"20:15.569","Text":"a higher rate at 12 percent and maturity is 2 years."},{"Start":"20:15.569 ","End":"20:19.865","Text":"Give me the start with the cash flow implications."},{"Start":"20:19.865 ","End":"20:28.689","Text":"Looking at the cash flow and looking at Year 1 and then looking at Year 2,"},{"Start":"20:28.689 ","End":"20:34.374","Text":"in Year 1 the interests that will be paid we\u0027ll be"},{"Start":"20:34.374 ","End":"20:40.150","Text":"9 percent on the face value of"},{"Start":"20:40.150 ","End":"20:46.795","Text":"100 because remember the interest is paid based on the stated rate not the actual rate."},{"Start":"20:46.795 ","End":"20:51.930","Text":"The cash flow comes from the stated rate."},{"Start":"20:51.930 ","End":"20:55.919","Text":"Therefore in Year 1 there will be a non interest paid which is in fact"},{"Start":"20:55.919 ","End":"21:06.759","Text":"the bond face value at the 9 percent stated rate and Year 2 the cash flow will be 109."},{"Start":"21:06.759 ","End":"21:10.420","Text":"Similar to the previous example where there will be the repayment of"},{"Start":"21:10.420 ","End":"21:15.966","Text":"the face value plus the interest for the second year,"},{"Start":"21:15.966 ","End":"21:19.720","Text":"but looking now at the present value calculation and the present value of"},{"Start":"21:19.720 ","End":"21:26.250","Text":"this non pounds or non currency units which has its cash flow at the end of Year 1;"},{"Start":"21:26.250 ","End":"21:28.860","Text":"which is paid at the end of Year 1."},{"Start":"21:28.860 ","End":"21:32.759","Text":"The present value today at 12 percent and multiply by 1"},{"Start":"21:32.759 ","End":"21:39.430","Text":"over 1 plus the interest rate, therefore 1.12^1."},{"Start":"21:39.870 ","End":"21:45.579","Text":"For the second year it\u0027s going to be clearly the 109"},{"Start":"21:45.579 ","End":"21:51.910","Text":"multiplied by 1 over 1.12^2."},{"Start":"21:52.440 ","End":"21:54.985","Text":"We do the computation,"},{"Start":"21:54.985 ","End":"22:01.858","Text":"it comes out at 9 multiplied by 0.8928."},{"Start":"22:01.858 ","End":"22:05.185","Text":"For the second year,"},{"Start":"22:05.185 ","End":"22:10.239","Text":"it comes out at 109 multiplied by"},{"Start":"22:10.239 ","End":"22:20.185","Text":"0.7972 because it gives a total of 8.0352."},{"Start":"22:20.185 ","End":"22:22.734","Text":"The second year, the present value,"},{"Start":"22:22.734 ","End":"22:28.044","Text":"the total is 86.8948."},{"Start":"22:28.044 ","End":"22:37.165","Text":"Add those 2 together and we get a total of 94.93. What does this mean?"},{"Start":"22:37.165 ","End":"22:42.324","Text":"94.93 is the present value of"},{"Start":"22:42.324 ","End":"22:48.399","Text":"a cash flow of 9 in 1 year\u0027s time,"},{"Start":"22:48.399 ","End":"22:51.430","Text":"discounted at 12 percent."},{"Start":"22:51.430 ","End":"23:01.010","Text":"The cash flow of 109 in 2 years time also discounted at 12 percent."},{"Start":"23:03.450 ","End":"23:12.579","Text":"Therefore, the amount of cash the firm will receive will be this 94.93."},{"Start":"23:12.579 ","End":"23:18.695","Text":"That\u0027ll be the cash received on the issue of the bonds."},{"Start":"23:18.695 ","End":"23:23.459","Text":"They may ask, and I have to think about why is the cash received of"},{"Start":"23:23.459 ","End":"23:31.259","Text":"94 different from the face value,"},{"Start":"23:31.259 ","End":"23:33.200","Text":"is lower than lower than the face value?"},{"Start":"23:33.200 ","End":"23:40.303","Text":"The reason why the bonds are issued in this case at a discount of 5.07,"},{"Start":"23:40.303 ","End":"23:43.540","Text":"lower cash received compared to face value,"},{"Start":"23:43.540 ","End":"23:48.879","Text":"is because the rate offered is 9 percent,"},{"Start":"23:48.879 ","End":"23:52.450","Text":"whereas the market demands 12 percent."},{"Start":"23:52.450 ","End":"23:58.075","Text":"We will now apply the numbers to the accounting equation worksheet."},{"Start":"23:58.075 ","End":"24:00.325","Text":"Here you see the worksheet,"},{"Start":"24:00.325 ","End":"24:07.220","Text":"assets equals liabilities plus owner\u0027s equity."},{"Start":"24:07.770 ","End":"24:10.750","Text":"The first of January X1,"},{"Start":"24:10.750 ","End":"24:14.394","Text":"the caches raised for the issue of the bond."},{"Start":"24:14.394 ","End":"24:20.169","Text":"As we\u0027ve just seen, the amount of cash raised is 94.93."},{"Start":"24:20.220 ","End":"24:22.690","Text":"They have an increase in cash,"},{"Start":"24:22.690 ","End":"24:27.370","Text":"94.93, the debit to the asset cash,"},{"Start":"24:27.370 ","End":"24:36.649","Text":"and 94.93 credit to the liability account, bonds payable."},{"Start":"24:37.920 ","End":"24:40.720","Text":"Then at the end of year 1,"},{"Start":"24:40.720 ","End":"24:45.249","Text":"the company has to make its first interest payment."},{"Start":"24:45.249 ","End":"24:50.860","Text":"Remember here, because the effective rate and the actual rate differ,"},{"Start":"24:50.860 ","End":"24:55.459","Text":"there\u0027ll be a different interests expense compared to the cash-flow."},{"Start":"24:55.470 ","End":"24:58.659","Text":"I\u0027ll write at the bottom here to remind us,"},{"Start":"24:58.659 ","End":"25:07.519","Text":"the stated rate or the actual rate of interest is equal to 9 percent."},{"Start":"25:07.680 ","End":"25:10.854","Text":"Whereas the effective rate,"},{"Start":"25:10.854 ","End":"25:14.245","Text":"remember, is equal to 12 percent."},{"Start":"25:14.245 ","End":"25:17.200","Text":"Because the stated rate equal to 9 percent,"},{"Start":"25:17.200 ","End":"25:22.840","Text":"we can calculate the cash flow relation to interest payments at"},{"Start":"25:22.840 ","End":"25:31.300","Text":"the face value or the par value of 100 multiplied by 9 percent is equal to 9."},{"Start":"25:31.300 ","End":"25:33.805","Text":"For the interests expense for the first year,"},{"Start":"25:33.805 ","End":"25:38.590","Text":"you recall we based it on the outstanding balance at the beginning of the year,"},{"Start":"25:38.590 ","End":"25:43.104","Text":"which is the discounted present value of future cash flows."},{"Start":"25:43.104 ","End":"25:51.790","Text":"Therefore, we\u0027ll take the 94.93 and multiply that by 12 percent."},{"Start":"25:51.790 ","End":"25:56.380","Text":"That gives the amount of interests of 11.39."},{"Start":"25:56.380 ","End":"26:03.860","Text":"11.39 reduces equity with a debit to interest expense."},{"Start":"26:06.720 ","End":"26:14.515","Text":"The credit of 11.39 goes to the bond liability account."},{"Start":"26:14.515 ","End":"26:17.185","Text":"In the same as in the previous example,"},{"Start":"26:17.185 ","End":"26:19.975","Text":"the cash is then paid for the interest."},{"Start":"26:19.975 ","End":"26:22.329","Text":"We know that actual cash flow,"},{"Start":"26:22.329 ","End":"26:28.539","Text":"there\u0027s an amount of 9 based on the nominal value and the stated interest rate."},{"Start":"26:28.539 ","End":"26:36.910","Text":"Therefore, we will debit or reduce the bond liability by 9 with a debit,"},{"Start":"26:36.910 ","End":"26:44.665","Text":"and the credit really goes to bank that will cash to reduce the cash by 9 as well."},{"Start":"26:44.665 ","End":"26:46.539","Text":"Looking at this together,"},{"Start":"26:46.539 ","End":"26:49.929","Text":"what are you seeing as the cumulative entry?"},{"Start":"26:49.929 ","End":"26:54.414","Text":"You\u0027re seeing there\u0027s a debit interest expense of 11.39,"},{"Start":"26:54.414 ","End":"26:57.295","Text":"a credit to cash of 9."},{"Start":"26:57.295 ","End":"27:05.020","Text":"The net effect of these 2 entries over here is in fact a credit to"},{"Start":"27:05.020 ","End":"27:14.455","Text":"the bond liability account of 2.39 credit as the net effect."},{"Start":"27:14.455 ","End":"27:19.554","Text":"The bond liability account has gone up by the amount of the effect of interest,"},{"Start":"27:19.554 ","End":"27:24.310","Text":"and it\u0027s come down by the amount of the cash payments."},{"Start":"27:24.310 ","End":"27:28.374","Text":"We could then enter the balances at the end of the first year."},{"Start":"27:28.374 ","End":"27:30.460","Text":"The cash balance."},{"Start":"27:30.460 ","End":"27:35.859","Text":"Again, looking at this transaction only as 84.93."},{"Start":"27:35.859 ","End":"27:40.010","Text":"The bond payable is now 97.32."},{"Start":"27:41.490 ","End":"27:50.450","Text":"The effect on retained earnings is the interest cost, the negative 11.39."},{"Start":"27:53.220 ","End":"28:00.939","Text":"We can now move into the second year and let\u0027s calculate the interest expense first."},{"Start":"28:00.939 ","End":"28:06.999","Text":"Now remember the interest expense is based on the opening balance of the bond liability."},{"Start":"28:06.999 ","End":"28:12.550","Text":"In other words, the present value of future cash-flows at the effective interest rate."},{"Start":"28:12.550 ","End":"28:16.270","Text":"We take the 97.32 and multiply it by"},{"Start":"28:16.270 ","End":"28:20.514","Text":"12 percent to get the actual interest expense for the period."},{"Start":"28:20.514 ","End":"28:31.130","Text":"This amount comes to 11.68 as the debit going to interest expense."},{"Start":"28:31.830 ","End":"28:35.780","Text":"Now again, the cash flow doesn\u0027t change."},{"Start":"28:38.370 ","End":"28:41.140","Text":"In fact, before I get to the cash flow,"},{"Start":"28:41.140 ","End":"28:48.714","Text":"let\u0027s enter the 11.68 into the credit of the bond liability account."},{"Start":"28:48.714 ","End":"28:50.980","Text":"The cash flow doesn\u0027t change."},{"Start":"28:50.980 ","End":"28:53.320","Text":"The cash flow remains this 9."},{"Start":"28:53.320 ","End":"28:58.720","Text":"In other words, the face value multiplied by the stated rate."},{"Start":"28:58.720 ","End":"29:01.090","Text":"As in the first year,"},{"Start":"29:01.090 ","End":"29:04.374","Text":"there\u0027s a reduction in the bond liability account,"},{"Start":"29:04.374 ","End":"29:07.690","Text":"a debit to the bond account of 9,"},{"Start":"29:07.690 ","End":"29:12.865","Text":"and a credit to the bank account of 9 as well."},{"Start":"29:12.865 ","End":"29:16.780","Text":"As with a first-year as well, combining the entries,"},{"Start":"29:16.780 ","End":"29:22.359","Text":"the net effect of this is a debit to interest expense of 11.68,"},{"Start":"29:22.359 ","End":"29:28.240","Text":"a credit to the asset cash of the amount of 9,"},{"Start":"29:28.240 ","End":"29:38.515","Text":"and a net credit to the bond liability account of 2.68 net credit."},{"Start":"29:38.515 ","End":"29:41.019","Text":"We then come to the final settlement,"},{"Start":"29:41.019 ","End":"29:44.034","Text":"the repayment of the amount owing to the bond holders,"},{"Start":"29:44.034 ","End":"29:46.810","Text":"which will clearly be a debit going to"},{"Start":"29:46.810 ","End":"29:54.175","Text":"the liability account of 100 and a credit going into the asset of cash account of 100."},{"Start":"29:54.175 ","End":"29:58.044","Text":"Which means the balance at the end of the period,"},{"Start":"29:58.044 ","End":"30:04.030","Text":"the net effect on cash has been 27.07 overdraft."},{"Start":"30:04.030 ","End":"30:06.835","Text":"There\u0027s no liability balance."},{"Start":"30:06.835 ","End":"30:15.340","Text":"That same 27.07 has been the net effect of the two interests expense amounts,"},{"Start":"30:15.340 ","End":"30:19.585","Text":"the effect to retained earnings of this bond issue."},{"Start":"30:19.585 ","End":"30:25.689","Text":"This next example looks at the scenario where bonds are issued at a premium."},{"Start":"30:25.689 ","End":"30:33.340","Text":"In this case, the market rate or the effective rate is now 9 percent."},{"Start":"30:33.340 ","End":"30:37.404","Text":"With the same 100 face value of the bond,"},{"Start":"30:37.404 ","End":"30:42.700","Text":"the bond is now paying 12 percent coupons."},{"Start":"30:42.700 ","End":"30:46.720","Text":"The 12 percent is in fact the stated rate."},{"Start":"30:46.720 ","End":"30:52.420","Text":"Remember that the cash flow is based on the stated rate."},{"Start":"30:52.420 ","End":"30:55.779","Text":"Maturity, as in the previous example,"},{"Start":"30:55.779 ","End":"30:58.315","Text":"is in 2 years time."},{"Start":"30:58.315 ","End":"31:00.550","Text":"If you look at the numbers carefully,"},{"Start":"31:00.550 ","End":"31:09.010","Text":"what you are in fact seeing is that the effective rate is now 9 percent,"},{"Start":"31:09.010 ","End":"31:12.820","Text":"whereas it was 12 percent in the previous example."},{"Start":"31:12.820 ","End":"31:16.570","Text":"The actual rate is now 12 percent,"},{"Start":"31:16.570 ","End":"31:18.489","Text":"whereas it was 9 percent in"},{"Start":"31:18.489 ","End":"31:22.510","Text":"the previous example where the bonds were issued at a discount."},{"Start":"31:22.510 ","End":"31:25.419","Text":"Here what you\u0027re seeing is that"},{"Start":"31:25.419 ","End":"31:31.360","Text":"the stated rate is in fact higher than the effective rate."},{"Start":"31:31.360 ","End":"31:37.255","Text":"Because of that, the company will be able to issue bonds at a premium."},{"Start":"31:37.255 ","End":"31:39.249","Text":"Because it\u0027s paying more"},{"Start":"31:39.249 ","End":"31:48.895","Text":"the 12 percent compared to the market rate or the effective rate of 9 percent."},{"Start":"31:48.895 ","End":"31:52.930","Text":"Let\u0027s look at the cash flow and the present value calculation,"},{"Start":"31:52.930 ","End":"31:58.855","Text":"and you will see the numbers will come out and demonstrate this point."},{"Start":"31:58.855 ","End":"32:02.724","Text":"Looking at the cash flow as a starting point for the 2 years,"},{"Start":"32:02.724 ","End":"32:06.520","Text":"Year 1 and then also for Year 2."},{"Start":"32:06.520 ","End":"32:13.750","Text":"Remember that the interest paid is based on the coupon rate."},{"Start":"32:13.750 ","End":"32:16.270","Text":"The cash flow is based on the coupon rate,"},{"Start":"32:16.270 ","End":"32:20.170","Text":"and therefore the cash flow will be in amounts of 12,"},{"Start":"32:20.170 ","End":"32:23.980","Text":"which will be the par value or stated value of the bond,"},{"Start":"32:23.980 ","End":"32:30.865","Text":"which is 100 multiplied by the stated rate of 12 percent."},{"Start":"32:30.865 ","End":"32:32.545","Text":"In year 2,"},{"Start":"32:32.545 ","End":"32:35.199","Text":"the cash flow will be 112,"},{"Start":"32:35.199 ","End":"32:37.090","Text":"which will be the repayment of"},{"Start":"32:37.090 ","End":"32:44.365","Text":"the 100 face value plus the same 12 interest for the second year."},{"Start":"32:44.365 ","End":"32:47.710","Text":"Looking at a present value calculation,"},{"Start":"32:47.710 ","End":"32:53.799","Text":"the present value of those 12 to be received in 1 year\u0027s time will be 12 multiplied"},{"Start":"32:53.799 ","End":"33:01.775","Text":"by 1 over 1 point the interest rate, so 1.09^1."},{"Start":"33:01.775 ","End":"33:08.680","Text":"The second year, the present value of 112 to be received at the end of year 2,"},{"Start":"33:08.680 ","End":"33:15.655","Text":"112 multiplied by 1 plus the interest rate so 1.09^2."},{"Start":"33:15.655 ","End":"33:19.765","Text":"If you do the computation,"},{"Start":"33:19.765 ","End":"33:25.923","Text":"this comes out to 12 multiplied by 0.9174."},{"Start":"33:25.923 ","End":"33:28.374","Text":"For the 2nd year,"},{"Start":"33:28.374 ","End":"33:34.550","Text":"it\u0027s 112 multiplied by 0.8417."},{"Start":"33:36.240 ","End":"33:41.799","Text":"This gives you 11.008 as"},{"Start":"33:41.799 ","End":"33:46.554","Text":"the present value of the cash flow"},{"Start":"33:46.554 ","End":"33:53.329","Text":"of 12 in 1 year\u0027s time."},{"Start":"33:54.420 ","End":"33:59.409","Text":"The Year 2 calculation comes out at"},{"Start":"33:59.409 ","End":"34:05.650","Text":"94.270 and that,"},{"Start":"34:05.650 ","End":"34:14.275","Text":"therefore, is the present value of 112 to be received in 2 years\u0027 time."},{"Start":"34:14.275 ","End":"34:24.650","Text":"These numbers together give us a present value of the future cash flows of 105.28."},{"Start":"34:25.770 ","End":"34:32.319","Text":"So 105.28 is the present value of 12 to be received in"},{"Start":"34:32.319 ","End":"34:40.623","Text":"1 year\u0027s time at 9 percent plus 112 to be received in 2 years\u0027 time,"},{"Start":"34:40.623 ","End":"34:43.285","Text":"clearly also the same 9 percent."},{"Start":"34:43.285 ","End":"34:52.240","Text":"You will see that the present value of 105.28 is greater than the 100 pound face value."},{"Start":"34:52.240 ","End":"34:56.425","Text":"This is because the stated rate of"},{"Start":"34:56.425 ","End":"35:03.130","Text":"12 percent is in fact higher than the effective rate of 9 percent,"},{"Start":"35:03.130 ","End":"35:06.279","Text":"meaning that the company could issue the bonds at"},{"Start":"35:06.279 ","End":"35:09.625","Text":"an amount higher than face value at a premium."},{"Start":"35:09.625 ","End":"35:13.390","Text":"The premium here has the amount of 5.28."},{"Start":"35:13.390 ","End":"35:16.435","Text":"Finally, we can look at the accounting equation worksheet"},{"Start":"35:16.435 ","End":"35:20.575","Text":"for this example with the bonds issued at a premium."},{"Start":"35:20.575 ","End":"35:25.690","Text":"Again, assets equal liabilities plus"},{"Start":"35:25.690 ","End":"35:33.130","Text":"owner\u0027s equity and upon the issue of the bonds on 1 January of X1,"},{"Start":"35:33.130 ","End":"35:34.854","Text":"there is an increase in cash."},{"Start":"35:34.854 ","End":"35:38.605","Text":"Remember the cash received this time is 105.28,"},{"Start":"35:38.605 ","End":"35:43.810","Text":"that\u0027s the debit going to cash and the credit gains the bond liability,"},{"Start":"35:43.810 ","End":"35:47.170","Text":"it\u0027s the same amount of 105.28;"},{"Start":"35:47.170 ","End":"35:50.454","Text":"the credit going to the bond liability account."},{"Start":"35:50.454 ","End":"35:54.129","Text":"Let\u0027s also take a look now at the calculation of"},{"Start":"35:54.129 ","End":"35:58.089","Text":"the actual cash interest that will be paid."},{"Start":"35:58.089 ","End":"36:02.259","Text":"As before, the interest payment is based on"},{"Start":"36:02.259 ","End":"36:09.534","Text":"the par value or face value and the stated or actual interest rate."},{"Start":"36:09.534 ","End":"36:14.544","Text":"The interest payment will be the amount of 100"},{"Start":"36:14.544 ","End":"36:20.979","Text":"multiplied by the stated or coupon rate of 12 percent is equal to the amount of 12."},{"Start":"36:20.979 ","End":"36:25.779","Text":"But clearly, the interest expense will be a different number."},{"Start":"36:25.779 ","End":"36:30.249","Text":"The actual interest expense is going to be computed based on"},{"Start":"36:30.249 ","End":"36:35.185","Text":"the opening balance and the bonds payable, 105.28,"},{"Start":"36:35.185 ","End":"36:41.215","Text":"which as you know is the present value of the future cash flows at the beginning of,"},{"Start":"36:41.215 ","End":"36:43.195","Text":"in this case, January X1,"},{"Start":"36:43.195 ","End":"36:48.039","Text":"so 105.28 multiplied by"},{"Start":"36:48.039 ","End":"36:58.614","Text":"the effective rate of 9 percent gives an interest cost of 9.47."},{"Start":"36:58.614 ","End":"37:03.843","Text":"Therefore, a debit to interest expense of 9.47,"},{"Start":"37:03.843 ","End":"37:10.795","Text":"deduct from equity debit to interest expense 9.47,"},{"Start":"37:10.795 ","End":"37:18.309","Text":"and also a credit to the bond payable liability account of 9.47,"},{"Start":"37:18.309 ","End":"37:20.364","Text":"for the amount of the interest."},{"Start":"37:20.364 ","End":"37:24.669","Text":"As before, we now need to actually pay the interest"},{"Start":"37:24.669 ","End":"37:29.829","Text":"and we therefore debit the bond liability with the interest amount of 12,"},{"Start":"37:29.829 ","End":"37:35.304","Text":"debit bond liability and we credit cash for the amount of 12."},{"Start":"37:35.304 ","End":"37:40.615","Text":"Again, to summarize the entry or you could in fact do this as 1 entry,"},{"Start":"37:40.615 ","End":"37:45.115","Text":"as a debit to the interest expense of 9.47,"},{"Start":"37:45.115 ","End":"37:51.309","Text":"a credit to cash of 12 and the net effect over"},{"Start":"37:51.309 ","End":"37:59.539","Text":"here is you\u0027ll see a net debit of 2.53."},{"Start":"37:59.760 ","End":"38:08.319","Text":"It\u0027s a 2.53 net debit this time going to the bond liability account."},{"Start":"38:08.319 ","End":"38:10.704","Text":"End of the 1st year."},{"Start":"38:10.704 ","End":"38:16.649","Text":"The cash balance for these transactions is 93.28,"},{"Start":"38:16.649 ","End":"38:23.275","Text":"the bond liability is 102.75,"},{"Start":"38:23.275 ","End":"38:25.779","Text":"and the effect and retained earnings is clearly"},{"Start":"38:25.779 ","End":"38:29.510","Text":"the amount of interest expense, the 9.47."},{"Start":"38:30.270 ","End":"38:32.424","Text":"We come to the 2nd year;"},{"Start":"38:32.424 ","End":"38:34.224","Text":"the end of December X2,"},{"Start":"38:34.224 ","End":"38:37.014","Text":"the interest payment remains the same of 12."},{"Start":"38:37.014 ","End":"38:42.370","Text":"We can now compute the interest expense for the 2nd year."},{"Start":"38:42.370 ","End":"38:47.425","Text":"Remember it\u0027s based on the opening balance of the bond payable,"},{"Start":"38:47.425 ","End":"38:53.634","Text":"which will be the present value of the cash flow at the end of the life of the bond,"},{"Start":"38:53.634 ","End":"39:01.419","Text":"the 112 discounted back for 1 year to this date of December of X1."},{"Start":"39:01.419 ","End":"39:06.519","Text":"We\u0027re going to do the calculation and we compute the interest based on"},{"Start":"39:06.519 ","End":"39:14.590","Text":"102.75 multiplied by 9 percent."},{"Start":"39:14.590 ","End":"39:17.994","Text":"That gives us an amount of 9.25,"},{"Start":"39:17.994 ","End":"39:19.749","Text":"debit to interest expense,"},{"Start":"39:19.749 ","End":"39:27.580","Text":"reduce equity debit to interest expense 9.25 and the credit,"},{"Start":"39:27.580 ","End":"39:32.635","Text":"as before goes to the bond liability account, 9.25 credit."},{"Start":"39:32.635 ","End":"39:34.780","Text":"We then pay the interest,"},{"Start":"39:34.780 ","End":"39:37.675","Text":"the actual amount of cash we need to pay is 12."},{"Start":"39:37.675 ","End":"39:45.280","Text":"We debit the bond liability of 12 and we credit cash for 12."},{"Start":"39:45.280 ","End":"39:48.332","Text":"Again, summarize it together,"},{"Start":"39:48.332 ","End":"39:53.289","Text":"or as 1 entry is a debit interest expense of 9.25."},{"Start":"39:53.289 ","End":"39:56.244","Text":"There is a credit to cash of 12."},{"Start":"39:56.244 ","End":"39:58.690","Text":"Look at these 2 entries combined,"},{"Start":"39:58.690 ","End":"40:06.415","Text":"there is clearly an amount of 2.75 as a net debit to the cash account."},{"Start":"40:06.415 ","End":"40:09.325","Text":"Also the end of the 2nd year,"},{"Start":"40:09.325 ","End":"40:11.170","Text":"you have to pay off the bond,"},{"Start":"40:11.170 ","End":"40:18.730","Text":"so we put a debit to the bond account of 100 and a credit to cash of 100."},{"Start":"40:18.730 ","End":"40:25.089","Text":"The net effect on cash of these transactions is clearly overdraft of"},{"Start":"40:25.089 ","End":"40:28.630","Text":"23.07 which equates to"},{"Start":"40:28.630 ","End":"40:35.990","Text":"the net effect on retained earnings of the 2 amounts interests expense of 23.07."}],"ID":30305},{"Watched":false,"Name":"Repurchase of Debt","Duration":"13m 33s","ChapterTopicVideoID":28798,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:04.890","Text":"In this video, we will look at the repurchase of debt."},{"Start":"00:04.890 ","End":"00:08.260","Text":"In order to discuss the repurchase of debt,"},{"Start":"00:08.260 ","End":"00:12.375","Text":"we will use the example of a zero-coupon bond."},{"Start":"00:12.375 ","End":"00:15.210","Text":"Now we\u0027ll work with zero-coupon bond first and then"},{"Start":"00:15.210 ","End":"00:18.465","Text":"look at the repurchase of debt afterwards."},{"Start":"00:18.465 ","End":"00:23.760","Text":"A zero-coupon bond is one that does not pay any interest,"},{"Start":"00:23.760 ","End":"00:26.850","Text":"hence, the word zero-coupon bond."},{"Start":"00:26.850 ","End":"00:31.710","Text":"It only pays a nominal amount at maturity,"},{"Start":"00:31.710 ","End":"00:34.580","Text":"in other words, at the end of life of the bond."},{"Start":"00:34.580 ","End":"00:40.045","Text":"In this example, we\u0027re going to take a bond with a face value of 1,000."},{"Start":"00:40.045 ","End":"00:46.265","Text":"That, therefore, is the nominal value and a maturity in 3 years\u0027 time."},{"Start":"00:46.265 ","End":"00:50.870","Text":"This bond, you told, is issued on 31 December 20X0,"},{"Start":"00:50.870 ","End":"00:56.780","Text":"and the issue price is currency unit 751.31."},{"Start":"00:56.780 ","End":"01:01.850","Text":"So what we have here will be a cash inflow to the entity of"},{"Start":"01:01.850 ","End":"01:11.055","Text":"751.31 on 31 December 20X0 and a cash outflow in 3 years\u0027 time of 1,000,"},{"Start":"01:11.055 ","End":"01:15.030","Text":"when the bond is repaid to the bondholders on maturity."},{"Start":"01:15.030 ","End":"01:17.820","Text":"So even though it is a zero-interest bond,"},{"Start":"01:17.820 ","End":"01:24.225","Text":"the fact that bondholders will pay 751.31 today,"},{"Start":"01:24.225 ","End":"01:27.410","Text":"and today in this case is 31 December 20X0,"},{"Start":"01:27.410 ","End":"01:32.720","Text":"but will receive the full 1,000 on maturity means that there is,"},{"Start":"01:32.720 ","End":"01:37.630","Text":"in fact, an effective interest rate inherent in this bond."},{"Start":"01:37.630 ","End":"01:43.295","Text":"Number 1 is asking us to compute what is its effective interest rate."},{"Start":"01:43.295 ","End":"01:45.475","Text":"Then in 2 and 3,"},{"Start":"01:45.475 ","End":"01:49.310","Text":"we will look at the interest expense that is recognized in the income statement for"},{"Start":"01:49.310 ","End":"01:54.590","Text":"each year and also the ending balance of the bond on the balance sheet date."},{"Start":"01:54.590 ","End":"01:57.480","Text":"Firstly, the effective interest rate."},{"Start":"01:57.480 ","End":"02:00.290","Text":"Remember the effective interest rate is"},{"Start":"02:00.290 ","End":"02:05.540","Text":"that discount rate that makes us indifferent to having the amount of"},{"Start":"02:05.540 ","End":"02:12.530","Text":"751.31 today and what makes us"},{"Start":"02:12.530 ","End":"02:20.945","Text":"indifferent to having that 751.31 today and having 1,000 in 3 years\u0027 time."},{"Start":"02:20.945 ","End":"02:24.095","Text":"That effective interest rate, the r,"},{"Start":"02:24.095 ","End":"02:26.030","Text":"is what we\u0027re trying to compute,"},{"Start":"02:26.030 ","End":"02:30.080","Text":"the effective interest rate."},{"Start":"02:30.080 ","End":"02:38.740","Text":"So the formula we can write out is 751.31 is equal to"},{"Start":"02:38.740 ","End":"02:47.390","Text":"1,000 over 1 plus r"},{"Start":"02:47.390 ","End":"02:50.680","Text":"to the power of the number of years,"},{"Start":"02:50.680 ","End":"02:52.935","Text":"and we are trying, in this case, 3,"},{"Start":"02:52.935 ","End":"03:00.120","Text":"and we\u0027re trying to compute the missing figure for r. Let us now solve this equation."},{"Start":"03:00.120 ","End":"03:04.410","Text":"So we are borrowing this amount of 751.31,"},{"Start":"03:04.600 ","End":"03:10.745","Text":"and we\u0027re going to accrue interest on an annual basis over 3 years."},{"Start":"03:10.745 ","End":"03:13.700","Text":"So we need to compound it over 3 years."},{"Start":"03:13.700 ","End":"03:23.625","Text":"Therefore, 751.31 multiplied by 1 plus r to the power of 3 is equal to 1,000."},{"Start":"03:23.625 ","End":"03:26.585","Text":"That is simply rearranging the equation."},{"Start":"03:26.585 ","End":"03:34.320","Text":"We can now move the 751.31 or divide both sides by 751.31."},{"Start":"03:34.610 ","End":"03:40.980","Text":"This gives us 1 plus r^3"},{"Start":"03:40.980 ","End":"03:47.770","Text":"equal to 1,000 divided by 751.31."},{"Start":"03:49.550 ","End":"03:58.570","Text":"So we know therefore that 1 plus r^3 is equal to 1.331."},{"Start":"03:59.570 ","End":"04:05.410","Text":"In other words, 1 plus r is equal to"},{"Start":"04:05.410 ","End":"04:12.365","Text":"1.331 to the power of the third root."},{"Start":"04:12.365 ","End":"04:15.270","Text":"Therefore, with further simplification,"},{"Start":"04:15.270 ","End":"04:23.060","Text":"it means that r is equal to 1.1 minus 1,"},{"Start":"04:23.060 ","End":"04:25.795","Text":"which is equal to 0.1,"},{"Start":"04:25.795 ","End":"04:29.185","Text":"which is equal to 10 percent."},{"Start":"04:29.185 ","End":"04:35.605","Text":"Having computed the effective interest rate at 10 percent,"},{"Start":"04:35.605 ","End":"04:42.250","Text":"we can now go on to prepare a worksheet which will determine and show"},{"Start":"04:42.250 ","End":"04:45.160","Text":"the amount of the interest expense and the balance in"},{"Start":"04:45.160 ","End":"04:49.500","Text":"the bond payable for each of the 3 years."},{"Start":"04:49.500 ","End":"04:57.680","Text":"Again, always remember, assets equals liabilities plus owner\u0027s equity."},{"Start":"04:57.680 ","End":"04:59.875","Text":"At the date of borrowing the cash,"},{"Start":"04:59.875 ","End":"05:03.165","Text":"in other words, issuing the bond, in this case,"},{"Start":"05:03.165 ","End":"05:06.270","Text":"31 December of 2020,"},{"Start":"05:06.270 ","End":"05:12.758","Text":"we know the amount of 751.31 is received by the entity."},{"Start":"05:12.758 ","End":"05:15.185","Text":"That in effect is the debited cash,"},{"Start":"05:15.185 ","End":"05:17.030","Text":"and the amount of the liability,"},{"Start":"05:17.030 ","End":"05:18.470","Text":"the bonds payable,"},{"Start":"05:18.470 ","End":"05:21.825","Text":"is also obviously 751.31,"},{"Start":"05:21.825 ","End":"05:23.985","Text":"a credit to bonds payable."},{"Start":"05:23.985 ","End":"05:26.290","Text":"We come to the end of the first year,"},{"Start":"05:26.290 ","End":"05:28.445","Text":"and as you have learned previously,"},{"Start":"05:28.445 ","End":"05:30.653","Text":"we now account for the interest."},{"Start":"05:30.653 ","End":"05:33.005","Text":"In this case, it is 10 percent,"},{"Start":"05:33.005 ","End":"05:41.945","Text":"and we know 75.13 will be the amount of the interest which is added to the bond,"},{"Start":"05:41.945 ","End":"05:49.820","Text":"and 75.13 is the amount of interest expense recorded in profit and loss and,"},{"Start":"05:49.820 ","End":"05:51.735","Text":"ultimately, in retained earnings."},{"Start":"05:51.735 ","End":"05:54.555","Text":"This, therefore, is the debit interest expense,"},{"Start":"05:54.555 ","End":"05:58.335","Text":"and this, therefore, is the credit to the bond payable."},{"Start":"05:58.335 ","End":"06:01.335","Text":"At the end of December 2021,"},{"Start":"06:01.335 ","End":"06:08.270","Text":"the balance of the bond payable is now in the amount of 826.44,"},{"Start":"06:08.270 ","End":"06:16.880","Text":"and the effect of this transaction is clearly a debit into retained earnings of 75.13."},{"Start":"06:16.880 ","End":"06:22.245","Text":"We then come to the yearend of 31 December of 2022,"},{"Start":"06:22.245 ","End":"06:24.435","Text":"and again, we compute the 10 percent."},{"Start":"06:24.435 ","End":"06:27.035","Text":"Remember, the 10 percent interest is now"},{"Start":"06:27.035 ","End":"06:30.140","Text":"based on the balance at the beginning of the year,"},{"Start":"06:30.140 ","End":"06:34.040","Text":"so it\u0027s based on this balance that we have 826.44."},{"Start":"06:34.040 ","End":"06:40.170","Text":"So 10 percent will be 82.64, 82.64,"},{"Start":"06:40.170 ","End":"06:47.100","Text":"a debit to interest expense and 82.64,"},{"Start":"06:47.100 ","End":"06:49.940","Text":"a credit to the bond payable,"},{"Start":"06:49.940 ","End":"06:52.105","Text":"as in the previous year."},{"Start":"06:52.105 ","End":"06:55.550","Text":"The balance on the bond liability, now you\u0027ll see,"},{"Start":"06:55.550 ","End":"06:58.830","Text":"increases again to 909.08,"},{"Start":"06:59.080 ","End":"07:07.270","Text":"and the cumulative effect in retained earnings of these 2 interest amounts is 157.77."},{"Start":"07:07.960 ","End":"07:11.000","Text":"Same pattern again, for the third year,"},{"Start":"07:11.000 ","End":"07:14.349","Text":"we compute the interest based on the opening balance."},{"Start":"07:14.349 ","End":"07:18.630","Text":"Therefore, 10 percent of 909.08"},{"Start":"07:18.880 ","End":"07:25.715","Text":"is rounded up to be equal to 90.92,"},{"Start":"07:25.715 ","End":"07:28.190","Text":"that\u0027s the debit interest expense,"},{"Start":"07:28.190 ","End":"07:33.400","Text":"and 90.92, that\u0027s a credit to the bond liability."},{"Start":"07:33.400 ","End":"07:35.475","Text":"Now at that point in time,"},{"Start":"07:35.475 ","End":"07:39.995","Text":"the balance in the bond liability account will be equal to 1,000."},{"Start":"07:39.995 ","End":"07:44.510","Text":"So we are able to settle the amount aimed to bondholders,"},{"Start":"07:44.510 ","End":"07:49.720","Text":"which will clearly be a debit to the bond liability account of 1,000."},{"Start":"07:49.720 ","End":"07:53.855","Text":"This brings the balance to 0 because the bonds are now being repaid,"},{"Start":"07:53.855 ","End":"07:59.310","Text":"and the credit really goes to cash of 1,000 as well."},{"Start":"07:59.560 ","End":"08:09.390","Text":"You see the net effect of these series of transactions on cash as an outflow of 248.69,"},{"Start":"08:09.880 ","End":"08:16.815","Text":"which indeed is equal to the amount of the interest costs over the 3 years."},{"Start":"08:16.815 ","End":"08:21.715","Text":"Turning now to the specific issue of the repurchase of debt,"},{"Start":"08:21.715 ","End":"08:24.910","Text":"companies can retire the debt earlier by,"},{"Start":"08:24.910 ","End":"08:28.870","Text":"in fact, buying it back from the debt holders."},{"Start":"08:28.870 ","End":"08:33.574","Text":"Now the price which will be paid is determined by market conditions,"},{"Start":"08:33.574 ","End":"08:38.750","Text":"in other words, looking at the prevailing market interest rate."},{"Start":"08:38.750 ","End":"08:44.490","Text":"As an example, refer to the zero-coupon bond from the previous slides."},{"Start":"08:44.490 ","End":"08:48.690","Text":"Assume that on 31 December 2022, in the words,"},{"Start":"08:48.690 ","End":"08:55.545","Text":"after 2 years, the market interest rate falls to 9 percent."},{"Start":"08:55.545 ","End":"08:57.805","Text":"Remember in this particular example,"},{"Start":"08:57.805 ","End":"09:02.760","Text":"the effective interest rate was equal to 10 percent."},{"Start":"09:02.760 ","End":"09:07.745","Text":"Now, if the bond is repurchased on this date of 31 December 2022,"},{"Start":"09:07.745 ","End":"09:10.625","Text":"what entries should be passed?"},{"Start":"09:10.625 ","End":"09:16.670","Text":"To determine how much will be paid to the bondholders on this particular repurchase,"},{"Start":"09:16.670 ","End":"09:21.620","Text":"we need to determine the value of the bond at the repurchase date,"},{"Start":"09:21.620 ","End":"09:26.600","Text":"which we know is 31 December of the 2022 year."},{"Start":"09:26.600 ","End":"09:36.220","Text":"This is exactly 1 year prior to the planned redemption date of 31 December 2023,"},{"Start":"09:36.220 ","End":"09:37.910","Text":"over at 1 year to go."},{"Start":"09:37.910 ","End":"09:40.975","Text":"What you should know about bonding valuations"},{"Start":"09:40.975 ","End":"09:44.210","Text":"is that we need to determine the present value of"},{"Start":"09:44.210 ","End":"09:50.340","Text":"this bond based on the future cash flows,"},{"Start":"09:50.340 ","End":"09:52.080","Text":"in this case, for 1 year."},{"Start":"09:52.080 ","End":"09:58.205","Text":"So 1,000 is the amount that will be repaid in 1 year\u0027s time,"},{"Start":"09:58.205 ","End":"10:02.450","Text":"and we need to bring that back to our present value,"},{"Start":"10:02.450 ","End":"10:08.960","Text":"so multiply it by 1 over 1 plus the interest rate to the power number of years."},{"Start":"10:08.960 ","End":"10:10.970","Text":"In this particular case, we have,"},{"Start":"10:10.970 ","End":"10:16.545","Text":"therefore 1,000 multiplied by 1 over,"},{"Start":"10:16.545 ","End":"10:25.195","Text":"note we now use the new interest rate of 1.09 percent, so 1,09,"},{"Start":"10:25.195 ","End":"10:28.140","Text":"to the power of 1 year\u0027s time,"},{"Start":"10:28.140 ","End":"10:35.645","Text":"and this comes to an amount of 0,9174."},{"Start":"10:35.645 ","End":"10:39.605","Text":"Therefore 1,000 multiplied by"},{"Start":"10:39.605 ","End":"10:46.875","Text":"0,9174 is equal to the present value, 917.43."},{"Start":"10:46.875 ","End":"10:50.150","Text":"917.43 is, therefore,"},{"Start":"10:50.150 ","End":"10:58.370","Text":"the present value of 1,000 in 1 year\u0027s time at the current interest rate of 9 percent."},{"Start":"10:58.380 ","End":"11:05.170","Text":"Therefore, in order to process this on the accounting equation worksheet,"},{"Start":"11:05.170 ","End":"11:13.820","Text":"let\u0027s again put in assets equals liabilities plus equity."},{"Start":"11:13.820 ","End":"11:18.440","Text":"Now, the balance in the cash account at the end"},{"Start":"11:18.440 ","End":"11:22.394","Text":"of December 2022 from the previous slides, you will see,"},{"Start":"11:22.394 ","End":"11:31.630","Text":"is 751.31, and the balance in the bond payable was 909.08."},{"Start":"11:33.470 ","End":"11:44.640","Text":"We\u0027ve said now that the amount we will repay to the bondholders is 917.43."},{"Start":"11:45.010 ","End":"11:49.430","Text":"But clearly the balance in the bond payable account of"},{"Start":"11:49.430 ","End":"11:55.290","Text":"909.08 can only be reduced by the 909.08."},{"Start":"11:55.640 ","End":"12:03.950","Text":"Now 917.43 is clearly going to be a credit to cash to reduce the cash account,"},{"Start":"12:03.950 ","End":"12:10.160","Text":"and the 909.08 here will clearly be a debit to the bond liability account."},{"Start":"12:10.160 ","End":"12:16.490","Text":"The difference between the cash paid of 917.43 and the amount of"},{"Start":"12:16.490 ","End":"12:23.420","Text":"the bond liability of 909.08 represents a expense,"},{"Start":"12:23.420 ","End":"12:25.670","Text":"a loss, because we are paying more back to"},{"Start":"12:25.670 ","End":"12:29.515","Text":"the bondholders than the amount of the bond payable,"},{"Start":"12:29.515 ","End":"12:32.945","Text":"and that is the amount of 8.35,"},{"Start":"12:32.945 ","End":"12:37.790","Text":"which in effect is clearly a debit to the income statement."},{"Start":"12:37.790 ","End":"12:42.800","Text":"That will obviously get transferred at the end of the year to retain profit."},{"Start":"12:42.800 ","End":"12:46.685","Text":"8.35 would be a credit to profit and loss,"},{"Start":"12:46.685 ","End":"12:52.280","Text":"and 8.35 would be a debit to retained profit."},{"Start":"12:52.280 ","End":"12:54.770","Text":"After this transaction is keyed in,"},{"Start":"12:54.770 ","End":"12:57.950","Text":"now the balance in the bond payable account and"},{"Start":"12:57.950 ","End":"13:06.650","Text":"the net effect on the asset cash will be 166.12,"},{"Start":"13:06.650 ","End":"13:11.015","Text":"which is also the net effect on the retained profit account."},{"Start":"13:11.015 ","End":"13:13.340","Text":"I see I hadn\u0027t put in the opening balance yet."},{"Start":"13:13.340 ","End":"13:20.980","Text":"Let\u0027s pop in the opening balance or the balance at December 2022 of 157.77,"},{"Start":"13:20.980 ","End":"13:24.116","Text":"adding the loss and repurchase,"},{"Start":"13:24.116 ","End":"13:27.980","Text":"and the total retained profit effect is 166.12,"},{"Start":"13:27.980 ","End":"13:33.420","Text":"clearly balancing the effect on the cash account."}],"ID":30306},{"Watched":false,"Name":"Leases","Duration":"21m 46s","ChapterTopicVideoID":28799,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.170 ","End":"00:02.970","Text":"Hello. Welcome to this series of"},{"Start":"00:02.970 ","End":"00:08.804","Text":"video presentations on non-current liabilities brought to you by Proprep."},{"Start":"00:08.804 ","End":"00:14.625","Text":"In this video, we will examine the accounting for leases."},{"Start":"00:14.625 ","End":"00:17.925","Text":"In understanding the accounting for leases,"},{"Start":"00:17.925 ","End":"00:22.500","Text":"it is important to appreciate that there are 2 parties to the lease agreement,"},{"Start":"00:22.500 ","End":"00:24.990","Text":"the 1 party is the lessor,"},{"Start":"00:24.990 ","End":"00:27.615","Text":"and the other party is the lessee."},{"Start":"00:27.615 ","End":"00:29.730","Text":"In understanding this arrangement,"},{"Start":"00:29.730 ","End":"00:35.005","Text":"note that the lessor remains the owner of the underlying asset,"},{"Start":"00:35.005 ","End":"00:39.500","Text":"but the lessor grants the lessee the use and,"},{"Start":"00:39.500 ","End":"00:43.605","Text":"therefore, the economic benefits that are derived from the asset."},{"Start":"00:43.605 ","End":"00:46.190","Text":"To really emphasize this point, remember,"},{"Start":"00:46.190 ","End":"00:49.685","Text":"the lessor owns the underlying asset,"},{"Start":"00:49.685 ","End":"00:54.305","Text":"and the lessee uses that underlying asset."},{"Start":"00:54.305 ","End":"00:57.290","Text":"In exchange for using the asset,"},{"Start":"00:57.290 ","End":"01:02.629","Text":"the lessee will make a series of payments to the lessor."},{"Start":"01:02.629 ","End":"01:06.700","Text":"There are effectively 2 types of leases,"},{"Start":"01:06.700 ","End":"01:11.090","Text":"a short-term lease and a long-term lease."},{"Start":"01:11.090 ","End":"01:18.490","Text":"A short-term lease is typically one where the lease period is less than 12 months,"},{"Start":"01:18.490 ","End":"01:23.660","Text":"and the accounting for short-term leases is relatively straightforward,"},{"Start":"01:23.660 ","End":"01:26.260","Text":"and the amount of the lease payments, in other words,"},{"Start":"01:26.260 ","End":"01:29.665","Text":"the rent, is expensed immediately."},{"Start":"01:29.665 ","End":"01:37.630","Text":"In other words, the lessee will process an entry debiting a lease payment,"},{"Start":"01:37.630 ","End":"01:40.240","Text":"importantly, an expense account,"},{"Start":"01:40.240 ","End":"01:45.025","Text":"and crediting cash or bank upon payment."},{"Start":"01:45.025 ","End":"01:47.935","Text":"However, looking at the long-term lease,"},{"Start":"01:47.935 ","End":"01:50.530","Text":"this is treated as a purchase."},{"Start":"01:50.530 ","End":"01:54.940","Text":"But remember it\u0027s not a purchase because ownership remains with"},{"Start":"01:54.940 ","End":"02:01.340","Text":"the lessor but is treated like a purchase funded by a loan."},{"Start":"02:01.340 ","End":"02:07.070","Text":"Now, in order to make the accounting entries work at inception,"},{"Start":"02:07.070 ","End":"02:11.405","Text":"the lessee creates a specific type of asset."},{"Start":"02:11.405 ","End":"02:13.040","Text":"That asset is called,"},{"Start":"02:13.040 ","End":"02:18.040","Text":"importantly, a right-of-use asset."},{"Start":"02:18.040 ","End":"02:22.280","Text":"The right-of-use asset,"},{"Start":"02:22.280 ","End":"02:27.225","Text":"that\u0027ll be the debit that will go onto the balance sheet of the lessee,"},{"Start":"02:27.225 ","End":"02:29.570","Text":"is balanced out by"},{"Start":"02:29.570 ","End":"02:33.440","Text":"a corresponding lease liability"},{"Start":"02:33.440 ","End":"02:38.820","Text":"that will go as the credit on the balance sheet of the lessee."},{"Start":"02:40.420 ","End":"02:44.820","Text":"From an accounting perspective at inception,"},{"Start":"02:44.820 ","End":"02:48.030","Text":"and in most circumstances,"},{"Start":"02:48.030 ","End":"02:50.655","Text":"and also simplifying the accounting,"},{"Start":"02:50.655 ","End":"02:54.860","Text":"the amount recorded as the asset will equal"},{"Start":"02:54.860 ","End":"02:59.650","Text":"the amount recorded as a liability to make the entry balance."},{"Start":"02:59.650 ","End":"03:03.590","Text":"Going back to your knowledge of loans,"},{"Start":"03:03.590 ","End":"03:09.770","Text":"that amount is in fact equal to the present value of those future lease payments."},{"Start":"03:09.770 ","End":"03:14.375","Text":"To determine the present value of the future lease payments,"},{"Start":"03:14.375 ","End":"03:16.505","Text":"we will use what\u0027s referred to as"},{"Start":"03:16.505 ","End":"03:23.135","Text":"a implied or implicit discount rate if the asset value is known or,"},{"Start":"03:23.135 ","End":"03:24.590","Text":"if it is not known,"},{"Start":"03:24.590 ","End":"03:29.750","Text":"by reference what is known as by the lessee\u0027s incremental borrowing rate."},{"Start":"03:29.750 ","End":"03:33.440","Text":"The lessee\u0027s incremental borrowing rate is"},{"Start":"03:33.440 ","End":"03:37.055","Text":"the rate the lessee would have to pay to borrow"},{"Start":"03:37.055 ","End":"03:40.790","Text":"an amount similar to the amount being borrowed to"},{"Start":"03:40.790 ","End":"03:45.665","Text":"fund a similar asset in a similar economic environment."},{"Start":"03:45.665 ","End":"03:51.080","Text":"Note that here the weighted average cost of capital is not appropriate because"},{"Start":"03:51.080 ","End":"03:55.850","Text":"the weighted average cost of capital incorporates equity funding and is,"},{"Start":"03:55.850 ","End":"04:00.800","Text":"in fact, not representative of the rate paid on borrowings."},{"Start":"04:00.800 ","End":"04:07.390","Text":"Once the lessee has recognized this right-of-use asset on this balance sheet,"},{"Start":"04:07.390 ","End":"04:10.995","Text":"as an asset, it needs to then be depreciated."},{"Start":"04:10.995 ","End":"04:17.990","Text":"It will be depreciated either over the useful life of the underlying asset if, in fact,"},{"Start":"04:17.990 ","End":"04:23.570","Text":"the lessee will use the asset for or until the end of its useful life,"},{"Start":"04:23.570 ","End":"04:27.020","Text":"or over the lease agreement if, in fact,"},{"Start":"04:27.020 ","End":"04:33.285","Text":"the lessee will use the asset for less than the useful life of that underlying item,"},{"Start":"04:33.285 ","End":"04:39.795","Text":"and that item will then be returned to the lessee at the end of the lease agreement."},{"Start":"04:39.795 ","End":"04:43.855","Text":"The liability is accounted for like"},{"Start":"04:43.855 ","End":"04:48.939","Text":"any other debt instrument as we\u0027ve explained in previous videos."},{"Start":"04:48.939 ","End":"04:51.400","Text":"Looking at an example now,"},{"Start":"04:51.400 ","End":"04:55.870","Text":"here we are told on the 1st of January of 20X1,"},{"Start":"04:55.870 ","End":"05:01.180","Text":"this company enters into a contract to lease an item,"},{"Start":"05:01.180 ","End":"05:06.259","Text":"and the lease term is a period of 4 years."},{"Start":"05:06.870 ","End":"05:12.294","Text":"It\u0027s noncancelable, and the payments are required,"},{"Start":"05:12.294 ","End":"05:17.230","Text":"an amount of 21,150.90,"},{"Start":"05:17.230 ","End":"05:20.945","Text":"note, at the end of each year."},{"Start":"05:20.945 ","End":"05:24.680","Text":"So these items here are the lease payments."},{"Start":"05:24.680 ","End":"05:32.425","Text":"Now, you\u0027re told the fair value of the equipment at inception date is 75,000."},{"Start":"05:32.425 ","End":"05:35.960","Text":"Now we know that the fair value is also equal to"},{"Start":"05:35.960 ","End":"05:39.650","Text":"the present value of those future lease payments,"},{"Start":"05:39.650 ","End":"05:45.015","Text":"which will be important in the equation which will follow this."},{"Start":"05:45.015 ","End":"05:49.940","Text":"The estimated economic life of the equipment is also 4 years,"},{"Start":"05:49.940 ","End":"05:54.120","Text":"which in this case is the same as the lease term."},{"Start":"05:54.520 ","End":"05:59.990","Text":"Therefore, how do we determine this implied interest rate which,"},{"Start":"05:59.990 ","End":"06:03.710","Text":"in fact, comes out to an amount of 5 percent?"},{"Start":"06:03.710 ","End":"06:09.860","Text":"We use over here the same formula you\u0027ve seen in previous videos relating to"},{"Start":"06:09.860 ","End":"06:17.705","Text":"determining the implicit interest rate and other items relating to long-term loans."},{"Start":"06:17.705 ","End":"06:23.795","Text":"See here we know the present value of future lease payments is 75,000."},{"Start":"06:23.795 ","End":"06:27.890","Text":"That\u0027s equal to the fair value of the equipment at inception."},{"Start":"06:27.890 ","End":"06:35.640","Text":"We are told that there is a payment made at the end of each year of 21,150.90."},{"Start":"06:37.250 ","End":"06:45.695","Text":"What we\u0027re trying to solve for is solve for the amount of the interest rate which is r,"},{"Start":"06:45.695 ","End":"06:50.278","Text":"and I have mentioned we also know that the period,"},{"Start":"06:50.278 ","End":"06:51.875","Text":"the n, is equal to,"},{"Start":"06:51.875 ","End":"06:54.370","Text":"in fact, 4 years."},{"Start":"06:54.370 ","End":"06:58.010","Text":"Solving that equation, you\u0027ll find the r,"},{"Start":"06:58.010 ","End":"07:00.590","Text":"it comes out to 5 percent."},{"Start":"07:00.590 ","End":"07:05.090","Text":"That, therefore, is the interest rate implicit in the lease."},{"Start":"07:05.090 ","End":"07:09.650","Text":"The rates that causes the present value of the future payments of"},{"Start":"07:09.650 ","End":"07:15.185","Text":"21590 to equal today\u0027s value of 75,000."},{"Start":"07:15.185 ","End":"07:19.250","Text":"Let us look a bit more closely now at the accounting entries"},{"Start":"07:19.250 ","End":"07:23.940","Text":"and the numbers for those entries to account for this particular lease."},{"Start":"07:23.980 ","End":"07:26.660","Text":"As we have said previously,"},{"Start":"07:26.660 ","End":"07:30.740","Text":"the right-of-use asset needs to be depreciated."},{"Start":"07:30.740 ","End":"07:36.635","Text":"We know the amount of that right-of-use asset created as an asset is 75,000,"},{"Start":"07:36.635 ","End":"07:43.880","Text":"which is the same as the present value that is divided by the useful life of 4 years,"},{"Start":"07:43.880 ","End":"07:49.990","Text":"and the amount of the depreciation comes to 18750 per year."},{"Start":"07:49.990 ","End":"07:55.835","Text":"That will be recorded via an accounting entry which will be a debit to"},{"Start":"07:55.835 ","End":"08:02.855","Text":"a depreciation expense account and a credit to the accumulated depreciation,"},{"Start":"08:02.855 ","End":"08:05.580","Text":"the contra asset account."},{"Start":"08:06.100 ","End":"08:10.505","Text":"Accounting for the interest expense and lease liability,"},{"Start":"08:10.505 ","End":"08:14.495","Text":"this is similar in a way to other liability calculations."},{"Start":"08:14.495 ","End":"08:20.925","Text":"We start off with the lease liability at the beginning of the year of 75,000."},{"Start":"08:20.925 ","End":"08:23.510","Text":"Maybe to understand that,"},{"Start":"08:23.510 ","End":"08:26.195","Text":"let\u0027s just take a step back and appreciate"},{"Start":"08:26.195 ","End":"08:29.570","Text":"that this lease liability at the beginning of the year is"},{"Start":"08:29.570 ","End":"08:38.690","Text":"the credit side of an entry where the debit side went to the actual asset itself."},{"Start":"08:38.690 ","End":"08:42.350","Text":"So there is our initial accounting entry,"},{"Start":"08:42.350 ","End":"08:44.150","Text":"the debit to the asset,"},{"Start":"08:44.150 ","End":"08:47.389","Text":"and the credit to the lease liability."},{"Start":"08:47.389 ","End":"08:50.779","Text":"Now, in computing the interest expense,"},{"Start":"08:50.779 ","End":"08:56.495","Text":"we take the effective interest rate which we know here to be 5 percent,"},{"Start":"08:56.495 ","End":"09:00.680","Text":"and we apply it to the amount of liability at the beginning of the year."},{"Start":"09:00.680 ","End":"09:06.125","Text":"This, therefore, comes to an amount of 3,750."},{"Start":"09:06.125 ","End":"09:11.960","Text":"That, therefore, is 5 percent of 75,000."},{"Start":"09:11.960 ","End":"09:14.540","Text":"The amount of the payment we know,"},{"Start":"09:14.540 ","End":"09:22.850","Text":"we are told that that payment comes to 21,150.90."},{"Start":"09:22.850 ","End":"09:25.445","Text":"Now the accounting entries, again,"},{"Start":"09:25.445 ","End":"09:32.970","Text":"are similar to the entries we saw for the other types of long-term liabilities."},{"Start":"09:39.940 ","End":"09:43.190","Text":"As you have previously learned,"},{"Start":"09:43.190 ","End":"09:47.960","Text":"we need to determine both the non-current and current portions"},{"Start":"09:47.960 ","End":"09:53.850","Text":"of the lease for disclosure on the balance sheet."},{"Start":"09:56.740 ","End":"10:00.710","Text":"We will look at this as, at the end of year"},{"Start":"10:00.710 ","End":"10:05.570","Text":"1 in our table which I\u0027ve reproduced from the previous slide,"},{"Start":"10:05.570 ","End":"10:07.246","Text":"just typed up this time,"},{"Start":"10:07.246 ","End":"10:14.950","Text":"you will see the balance at the end of year 1 was this 57599.10 as a liability."},{"Start":"10:14.950 ","End":"10:20.750","Text":"So we can write down over here that 57599, in fact,"},{"Start":"10:20.750 ","End":"10:27.115","Text":"is the total amount of the lease liability at the end of that first year."},{"Start":"10:27.115 ","End":"10:30.410","Text":"Let\u0027s see how we can determine what\u0027s going to be"},{"Start":"10:30.410 ","End":"10:35.735","Text":"the current portion and what\u0027s going to be the non-current portion."},{"Start":"10:35.735 ","End":"10:37.804","Text":"We know the current portion,"},{"Start":"10:37.804 ","End":"10:39.245","Text":"looking at the table,"},{"Start":"10:39.245 ","End":"10:41.690","Text":"is the amount due in the next year,"},{"Start":"10:41.690 ","End":"10:44.160","Text":"and the amount due the next year,"},{"Start":"10:45.340 ","End":"10:48.680","Text":"21150.90, the amount given next year."},{"Start":"10:48.680 ","End":"10:58.845","Text":"But, that amount of 21150.90 has got a financing cost embedded inside it."},{"Start":"10:58.845 ","End":"11:04.065","Text":"Therefore, in other words, the 21150.90 includes the financing element."},{"Start":"11:04.065 ","End":"11:09.135","Text":"Therefore we need to subtract that 2880,"},{"Start":"11:09.135 ","End":"11:11.255","Text":"and that gives us, therefore,"},{"Start":"11:11.255 ","End":"11:18.480","Text":"the amount of the current liability of 18270.90."},{"Start":"11:18.480 ","End":"11:20.680","Text":"The non-current liability, therefore,"},{"Start":"11:20.680 ","End":"11:27.935","Text":"is the total liability of 57599 less the current portion,"},{"Start":"11:27.935 ","End":"11:32.710","Text":"less 18270.90, and therefore"},{"Start":"11:32.710 ","End":"11:40.586","Text":"the non-current liability is a total of 39328.10."},{"Start":"11:40.586 ","End":"11:44.415","Text":"Then looking back to the table,"},{"Start":"11:44.415 ","End":"11:50.237","Text":"you will see the balance we get at the end of Year 2 is 39328.20."},{"Start":"11:50.237 ","End":"11:56.655","Text":"That\u0027s just simply a rounding error of the 0.1 or the 0.2 over there."},{"Start":"11:56.655 ","End":"12:04.485","Text":"A further issue we need to talk about in relation to leases is that of a purchase option."},{"Start":"12:04.485 ","End":"12:10.590","Text":"Now, some long-term lease contracts allow the lessee to obtain ownership of"},{"Start":"12:10.590 ","End":"12:14.220","Text":"the underlying asset upon payment for"},{"Start":"12:14.220 ","End":"12:18.839","Text":"a relatively small amount at the end of the contract."},{"Start":"12:18.839 ","End":"12:25.360","Text":"This amount is often referred to as a bargain purchase option."},{"Start":"12:29.120 ","End":"12:34.530","Text":"Now, if the value of the leased asset at"},{"Start":"12:34.530 ","End":"12:37.500","Text":"the end of the lease term is expected to be bigger"},{"Start":"12:37.500 ","End":"12:41.039","Text":"than the amount of that bargain purchase option,"},{"Start":"12:41.039 ","End":"12:46.270","Text":"it is clearly likely that the lessee will exercise or take up this option."},{"Start":"12:46.270 ","End":"12:50.734","Text":"Therefore, when the lessee does exercise the option,"},{"Start":"12:50.734 ","End":"12:56.680","Text":"that will involve a further payment to be made from the lessee to the lessor,"},{"Start":"12:56.680 ","End":"13:00.540","Text":"and therefore, those payments must be taken into account in"},{"Start":"13:00.540 ","End":"13:09.040","Text":"any present value calculation."},{"Start":"13:09.230 ","End":"13:13.350","Text":"Let us now take a look at an example of"},{"Start":"13:13.350 ","End":"13:17.910","Text":"a lease contract where there is a bargain purchase option."},{"Start":"13:17.910 ","End":"13:20.925","Text":"You are told in this example that,"},{"Start":"13:20.925 ","End":"13:24.075","Text":"on the 1st of January of the 20X1 year,"},{"Start":"13:24.075 ","End":"13:26.924","Text":"this company entered into a lease contract,"},{"Start":"13:26.924 ","End":"13:31.270","Text":"and the lease term is a period of 4 years."},{"Start":"13:32.870 ","End":"13:36.015","Text":"The agreement is noncancelable,"},{"Start":"13:36.015 ","End":"13:41.280","Text":"and it requires equal payments at the end of each year,"},{"Start":"13:41.280 ","End":"13:48.105","Text":"and the amount of the payments are 21150.90."},{"Start":"13:48.105 ","End":"13:50.385","Text":"In addition to that,"},{"Start":"13:50.385 ","End":"13:54.465","Text":"there\u0027s this bargain purchase option of 500,"},{"Start":"13:54.465 ","End":"13:59.230","Text":"which would come about at the end of the lease term."},{"Start":"14:00.260 ","End":"14:03.479","Text":"You\u0027re told the fair value of the equipment,"},{"Start":"14:03.479 ","End":"14:05.445","Text":"and this will be at inception,"},{"Start":"14:05.445 ","End":"14:10.845","Text":"so this will be at 1 January 20X1 is 75,000."},{"Start":"14:10.845 ","End":"14:14.070","Text":"Note now, the economic life is 6 years,"},{"Start":"14:14.070 ","End":"14:19.665","Text":"which in fact you will see is different to the lease term of 4 years."},{"Start":"14:19.665 ","End":"14:23.835","Text":"We will consider the implications of that in a moment."},{"Start":"14:23.835 ","End":"14:30.690","Text":"But firstly, we need to look at the relevant applicable interest rate."},{"Start":"14:30.690 ","End":"14:33.645","Text":"Now we\u0027ve seen this formula before,"},{"Start":"14:33.645 ","End":"14:39.780","Text":"and what we need to do is to plug in the numbers that we know to,"},{"Start":"14:39.780 ","End":"14:44.685","Text":"in this case, determine the amount of that effective interest rate."},{"Start":"14:44.685 ","End":"14:47.190","Text":"The missing variable, in this case,"},{"Start":"14:47.190 ","End":"14:51.990","Text":"is going to be in effect the R, the interest rate."},{"Start":"14:51.990 ","End":"14:56.910","Text":"We know the fair value of the equipment is 75,000 which,"},{"Start":"14:56.910 ","End":"14:58.650","Text":"barring other considerations,"},{"Start":"14:58.650 ","End":"15:02.865","Text":"equals the present value of future cash flows."},{"Start":"15:02.865 ","End":"15:06.150","Text":"The annual payment,"},{"Start":"15:06.150 ","End":"15:10.755","Text":"in other words, the payment to be made at the end of each of the 4 years,"},{"Start":"15:10.755 ","End":"15:14.250","Text":"is this 21150.90,"},{"Start":"15:14.250 ","End":"15:20.010","Text":"and we know that the lease term is for a period of 4 years."},{"Start":"15:20.010 ","End":"15:24.360","Text":"Solving the equation or using an Excel spreadsheet,"},{"Start":"15:24.360 ","End":"15:33.220","Text":"you come to the answer that the applicable interest rate is 5.2351 percent."},{"Start":"15:35.840 ","End":"15:40.665","Text":"Moving on to the accounting entries and the accounting numbers,"},{"Start":"15:40.665 ","End":"15:44.805","Text":"note now when we compute the depreciation expense,"},{"Start":"15:44.805 ","End":"15:50.340","Text":"we will take the fair value of the asset of 75,000,"},{"Start":"15:50.340 ","End":"15:57.150","Text":"and the question is, what is the number of years over which we\u0027ll depreciate this asset?"},{"Start":"15:57.150 ","End":"16:00.600","Text":"How many years? In this case,"},{"Start":"16:00.600 ","End":"16:03.000","Text":"it could potentially be 4 years,"},{"Start":"16:03.000 ","End":"16:05.115","Text":"which is the lease term,"},{"Start":"16:05.115 ","End":"16:07.650","Text":"or it could be 6 years which,"},{"Start":"16:07.650 ","End":"16:10.720","Text":"in fact, is the useful life of the asset."},{"Start":"16:12.410 ","End":"16:17.640","Text":"Now, if there was no purchase option,"},{"Start":"16:17.640 ","End":"16:25.635","Text":"we would use the 4 year lease term to depreciate the right-of-use asset."},{"Start":"16:25.635 ","End":"16:30.300","Text":"But because now there is a bargain purchase option and,"},{"Start":"16:30.300 ","End":"16:34.575","Text":"therefore, the lessee is more than likely to take it up,"},{"Start":"16:34.575 ","End":"16:42.480","Text":"we now need to depreciate this right-of-use asset over its useful life,"},{"Start":"16:42.480 ","End":"16:44.640","Text":"which will be longer than the lease term,"},{"Start":"16:44.640 ","End":"16:51.150","Text":"because the lessee will practically keep the asset for a further 2 years."},{"Start":"16:51.150 ","End":"16:58.680","Text":"Therefore, we will take the 75,000 and divide it by 6 years,"},{"Start":"16:58.680 ","End":"17:06.760","Text":"and therefore we will have 12-and-a-half thousand depreciation expense each year."},{"Start":"17:06.760 ","End":"17:12.740","Text":"Moving on to the interest expense and the lease liability,"},{"Start":"17:12.740 ","End":"17:18.465","Text":"the balance at the beginning of the first year is the 75,000,"},{"Start":"17:18.465 ","End":"17:21.165","Text":"present value of future lease payments,"},{"Start":"17:21.165 ","End":"17:28.890","Text":"the interest expense computed at the end of the year will be the 5.235 percent."},{"Start":"17:28.890 ","End":"17:32.370","Text":"Remember the interest rate, this is the R,"},{"Start":"17:32.370 ","End":"17:41.230","Text":"multiplied by 75,000 comes up with a number of 3,926.30."},{"Start":"17:42.680 ","End":"17:51.450","Text":"Remember, the interest expense is recorded as a credit to the lease liability account,"},{"Start":"17:51.450 ","End":"17:57.430","Text":"and clearly the debit goes to the interest expense."},{"Start":"17:57.680 ","End":"18:06.510","Text":"The payment is an amount of 21150.90,"},{"Start":"18:06.510 ","End":"18:12.300","Text":"which we know goes as a debit to the lease liability."},{"Start":"18:12.300 ","End":"18:13.845","Text":"Remember, I\u0027ll put it in here,"},{"Start":"18:13.845 ","End":"18:18.060","Text":"the credit will go to cash or to bank."},{"Start":"18:18.060 ","End":"18:21.090","Text":"Therefore, the balance in the lease liability at"},{"Start":"18:21.090 ","End":"18:29.295","Text":"the end of the period amounts to 57775.40."},{"Start":"18:29.295 ","End":"18:37.980","Text":"That balance, therefore, becomes the balance at the beginning of next period, 57775.40."},{"Start":"18:37.980 ","End":"18:43.950","Text":"Again, we compute the interest for the second year at the same 5.235 percent,"},{"Start":"18:43.950 ","End":"18:50.275","Text":"which amounts to 3024.50."},{"Start":"18:50.275 ","End":"18:52.845","Text":"That\u0027s the credit to the liability account."},{"Start":"18:52.845 ","End":"18:58.695","Text":"The debit is the amount of the cash payment, 21150.90,"},{"Start":"18:58.695 ","End":"19:06.105","Text":"and the end of year balance is 39649.00."},{"Start":"19:06.105 ","End":"19:07.980","Text":"That is, as you should know by now,"},{"Start":"19:07.980 ","End":"19:16.140","Text":"becomes the opening balance, 39649.00."},{"Start":"19:16.140 ","End":"19:26.041","Text":"Interest expense on that opening balance at the end of the third year comes to 2,075.60,"},{"Start":"19:26.041 ","End":"19:29.475","Text":"again, account for the lease payment,"},{"Start":"19:29.475 ","End":"19:32.910","Text":"21150.90,"},{"Start":"19:32.910 ","End":"19:39.750","Text":"and the closing balance is 20573.70."},{"Start":"19:39.750 ","End":"19:42.450","Text":"The last year, that\u0027s obviously"},{"Start":"19:42.450 ","End":"19:50.190","Text":"the opening balance, 20573.70."},{"Start":"19:50.190 ","End":"19:58.455","Text":"5.235 percent of that is 1,007.20."},{"Start":"19:58.455 ","End":"20:03.990","Text":"The payment is the same, obviously 21150.90,"},{"Start":"20:03.990 ","End":"20:09.990","Text":"and the balance must come down to 0 if it\u0027s slightly off from 0, 1, or 2,"},{"Start":"20:09.990 ","End":"20:12.300","Text":"or 3 pounds, or euros,"},{"Start":"20:12.300 ","End":"20:16.590","Text":"or currency units, that\u0027s simply due to rounding and nothing to worry about."},{"Start":"20:16.590 ","End":"20:19.410","Text":"I explained in detail the computation of"},{"Start":"20:19.410 ","End":"20:23.275","Text":"the non-current and current portion in the previous example,"},{"Start":"20:23.275 ","End":"20:26.385","Text":"so we\u0027ll just go over this briefly now."},{"Start":"20:26.385 ","End":"20:30.225","Text":"At the end of Year 1, so over here,"},{"Start":"20:30.225 ","End":"20:32.775","Text":"at the end of the first year,"},{"Start":"20:32.775 ","End":"20:37.635","Text":"what is the amount of the non-current and current portion of the lease liability?"},{"Start":"20:37.635 ","End":"20:41.118","Text":"Remember, you always start with the current portion."},{"Start":"20:41.118 ","End":"20:45.780","Text":"How do we compute this 18126.40?"},{"Start":"20:45.780 ","End":"20:48.420","Text":"We\u0027ll be looking at the payment due in the next year,"},{"Start":"20:48.420 ","End":"20:52.725","Text":"which we know is 21150.90,"},{"Start":"20:52.725 ","End":"20:57.510","Text":"and from that, we subtract the interest elements."},{"Start":"20:57.510 ","End":"20:59.100","Text":"Remember, the interest element in"},{"Start":"20:59.100 ","End":"21:03.420","Text":"that second payment will be the interest applicable for the second year."},{"Start":"21:03.420 ","End":"21:08.445","Text":"So we subtract 3024.50,"},{"Start":"21:08.445 ","End":"21:09.840","Text":"and that does equal,"},{"Start":"21:09.840 ","End":"21:15.540","Text":"in fact, the 18126.40."},{"Start":"21:15.540 ","End":"21:19.125","Text":"Now, this amount of the non-current liability,"},{"Start":"21:19.125 ","End":"21:22.530","Text":"remember again, it will be the total liability at the end of the first year,"},{"Start":"21:22.530 ","End":"21:28.755","Text":"this 57775.40,"},{"Start":"21:28.755 ","End":"21:34.177","Text":"less what we\u0027ve just computed as the current portion,"},{"Start":"21:34.177 ","End":"21:39.810","Text":"so therefore, less 18,126.40 will give"},{"Start":"21:39.810 ","End":"21:47.230","Text":"us the amount we see as the non-current liability, the 39,649.00."}],"ID":30307},{"Watched":false,"Name":"Exercise 1","Duration":"4m 23s","ChapterTopicVideoID":29402,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.050 ","End":"00:06.465","Text":"Hello. Welcome to an exercise in non-current liabilities brought to you by Proprep."},{"Start":"00:06.465 ","End":"00:12.240","Text":"Here we have a basic exercise on future values."},{"Start":"00:12.240 ","End":"00:16.050","Text":"Determine the future value of 100 currency units"},{"Start":"00:16.050 ","End":"00:20.160","Text":"invested today and to be received in 1 year\u0027s time,"},{"Start":"00:20.160 ","End":"00:21.255","Text":"or 2 years\u0027 time,"},{"Start":"00:21.255 ","End":"00:22.575","Text":"or 5 years\u0027 time."},{"Start":"00:22.575 ","End":"00:24.420","Text":"In each of these 3 scenarios,"},{"Start":"00:24.420 ","End":"00:26.370","Text":"we\u0027re going to assume the amount is invested at"},{"Start":"00:26.370 ","End":"00:30.094","Text":"an annual interest rate of 6%, compounded."},{"Start":"00:30.094 ","End":"00:32.985","Text":"We\u0027re going to round to 2 decimal points."},{"Start":"00:32.985 ","End":"00:38.495","Text":"The formula to calculate the future value after 1 year is very simple."},{"Start":"00:38.495 ","End":"00:40.464","Text":"100 is the investment amount,"},{"Start":"00:40.464 ","End":"00:46.760","Text":"multiply that by 1.06 to the power of 1,"},{"Start":"00:46.760 ","End":"00:51.710","Text":"with 1 as the number of years that we\u0027ve invested it for."},{"Start":"00:51.710 ","End":"00:56.090","Text":"So that\u0027s 106. Another way of showing this obviously"},{"Start":"00:56.090 ","End":"01:01.115","Text":"is 100 being the investment amount plus the interest,"},{"Start":"01:01.115 ","End":"01:04.974","Text":"which is 100 multiplied by 0.06,"},{"Start":"01:04.974 ","End":"01:08.245","Text":"and that then gives you 106."},{"Start":"01:08.245 ","End":"01:13.010","Text":"Let\u0027s do Part b. This was an investment for 2 years."},{"Start":"01:13.010 ","End":"01:14.330","Text":"So you take the 100,"},{"Start":"01:14.330 ","End":"01:15.995","Text":"being the investment amount,"},{"Start":"01:15.995 ","End":"01:19.430","Text":"multiply it by 1.06,"},{"Start":"01:19.430 ","End":"01:26.045","Text":"and remember it\u0027s 1.06 and not just 0.6 because we are compounding,"},{"Start":"01:26.045 ","End":"01:31.150","Text":"then it\u0027s to the power of 2 to indicate that it\u0027s for 2 years."},{"Start":"01:31.150 ","End":"01:34.025","Text":"The answer is 112.36."},{"Start":"01:34.025 ","End":"01:36.425","Text":"We could also show it this way."},{"Start":"01:36.425 ","End":"01:39.316","Text":"Let\u0027s work out the interest for the first year."},{"Start":"01:39.316 ","End":"01:41.911","Text":"100 multiplied by 0.06,"},{"Start":"01:41.911 ","End":"01:45.035","Text":"so that gives us interest for the first year of 6."},{"Start":"01:45.035 ","End":"01:48.890","Text":"The second year\u0027s interest calculation would be 100,"},{"Start":"01:48.890 ","End":"01:51.410","Text":"being their first initial investment amount,"},{"Start":"01:51.410 ","End":"01:55.584","Text":"plus the interest that was earned in year 1."},{"Start":"01:55.584 ","End":"01:57.710","Text":"So that\u0027s 106,"},{"Start":"01:57.710 ","End":"02:01.475","Text":"that we\u0027ve got effectively invested for the second year,"},{"Start":"02:01.475 ","End":"02:09.440","Text":"multiplied by 0.06, giving us the interest for the second year, which is 6.36."},{"Start":"02:09.440 ","End":"02:12.680","Text":"You add those 2 interest amounts together,"},{"Start":"02:12.680 ","End":"02:14.510","Text":"6 for the first year,"},{"Start":"02:14.510 ","End":"02:17.120","Text":"6.36 for the second year,"},{"Start":"02:17.120 ","End":"02:21.695","Text":"and that means we\u0027ve earned interest over 2 years of 12.36."},{"Start":"02:21.695 ","End":"02:25.850","Text":"Then don\u0027t forget, add the investment of 100,"},{"Start":"02:25.850 ","End":"02:29.530","Text":"and you get your total of 112.36."},{"Start":"02:29.530 ","End":"02:33.710","Text":"So that\u0027s another way of showing the calculation."},{"Start":"02:33.710 ","End":"02:38.210","Text":"Just remember, we\u0027re multiplying the 100,"},{"Start":"02:38.210 ","End":"02:39.860","Text":"or the investment, should I say,"},{"Start":"02:39.860 ","End":"02:43.060","Text":"compounded in the second year by 0.06."},{"Start":"02:43.060 ","End":"02:45.760","Text":"You can see we\u0027re doing that twice,"},{"Start":"02:45.760 ","End":"02:47.110","Text":"year 1 and year 2."},{"Start":"02:47.110 ","End":"02:48.710","Text":"That\u0027s why, in that formula,"},{"Start":"02:48.710 ","End":"02:50.635","Text":"we have it to the power of 2."},{"Start":"02:50.635 ","End":"02:54.080","Text":"Also, just remember we are compounding,"},{"Start":"02:54.080 ","End":"02:56.330","Text":"so we\u0027re adding that initial investment of 100,"},{"Start":"02:56.330 ","End":"02:59.090","Text":"and then indeed the interest for the first year,"},{"Start":"02:59.090 ","End":"03:03.770","Text":"we add that into the formula for the second year."},{"Start":"03:03.770 ","End":"03:08.900","Text":"That is why, in the shorter formula that you see on your screen,"},{"Start":"03:08.900 ","End":"03:14.010","Text":"we multiply it by 1.06."},{"Start":"03:14.010 ","End":"03:18.590","Text":"That 1 in the 1.06 is because we\u0027re compounding."},{"Start":"03:18.590 ","End":"03:24.215","Text":"Yet another way to show that same calculation is using a table."},{"Start":"03:24.215 ","End":"03:27.530","Text":"We start a new one with an opening investment of 0."},{"Start":"03:27.530 ","End":"03:30.445","Text":"We then invest 100."},{"Start":"03:30.445 ","End":"03:33.635","Text":"So we\u0027ve now got a revised investment of 100."},{"Start":"03:33.635 ","End":"03:38.165","Text":"We calculate the interest at 6% on that 100 and that gives us 6."},{"Start":"03:38.165 ","End":"03:41.285","Text":"So at the end of year 1, we now have 106."},{"Start":"03:41.285 ","End":"03:45.280","Text":"The closing balance then becomes our opening balance in year 2."},{"Start":"03:45.280 ","End":"03:50.545","Text":"We don\u0027t add anything further in this example."},{"Start":"03:50.545 ","End":"03:54.385","Text":"Our revised investment is 106."},{"Start":"03:54.385 ","End":"04:00.125","Text":"That 106 invested at 6% for the year gives us 6.36 interest,"},{"Start":"04:00.125 ","End":"04:01.420","Text":"which we simply add,"},{"Start":"04:01.420 ","End":"04:05.739","Text":"and we\u0027ve now got 112.36 at the end of the second year."},{"Start":"04:05.739 ","End":"04:09.215","Text":"So that\u0027s a third way to show the calculation."},{"Start":"04:09.215 ","End":"04:12.860","Text":"Part c, this is an investment for 5 years,"},{"Start":"04:12.860 ","End":"04:19.802","Text":"so it\u0027s 100 multiplied by 1.06 to the power of 5,"},{"Start":"04:19.802 ","End":"04:24.210","Text":"and that gives us 133.82."}],"ID":31012},{"Watched":false,"Name":"Exercise 2","Duration":"8m 25s","ChapterTopicVideoID":29403,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:02.850","Text":"Hello and welcome to another exercise on"},{"Start":"00:02.850 ","End":"00:06.030","Text":"non-current liabilities brought to you by Proprep."},{"Start":"00:06.030 ","End":"00:08.940","Text":"This exercise involves future values."},{"Start":"00:08.940 ","End":"00:11.580","Text":"It is now the 1st of January 20X1,"},{"Start":"00:11.580 ","End":"00:15.855","Text":"and you start a saving plan whereby on each 1st of January,"},{"Start":"00:15.855 ","End":"00:22.705","Text":"you invest 50 currency units until and including the 1st of January, 20X4."},{"Start":"00:22.705 ","End":"00:26.910","Text":"That means we\u0027re going to be putting 50 currency units in 4 times."},{"Start":"00:26.910 ","End":"00:28.575","Text":"Once in the 20X1,"},{"Start":"00:28.575 ","End":"00:31.950","Text":"and 20X2, and 20X3, and 20X4."},{"Start":"00:31.950 ","End":"00:35.245","Text":"The bank offers 2 percent interest rate."},{"Start":"00:35.245 ","End":"00:38.645","Text":"If you wish to withdraw your savings on the 1st of January,"},{"Start":"00:38.645 ","End":"00:42.740","Text":"20X5, how much should you expect to have at that time?"},{"Start":"00:42.740 ","End":"00:48.155","Text":"Now between the 1st of the 1st 20X1 and the 1st of the 1st 20X5,"},{"Start":"00:48.155 ","End":"00:51.180","Text":"we have 4 years."},{"Start":"00:51.180 ","End":"00:55.940","Text":"Let\u0027s look at the solution to this future value exercise."},{"Start":"00:55.940 ","End":"00:58.220","Text":"We could use a table."},{"Start":"00:58.220 ","End":"01:01.685","Text":"We start with the opening investment,"},{"Start":"01:01.685 ","End":"01:06.440","Text":"and then add on anything that we might invest on the 1st of January,"},{"Start":"01:06.440 ","End":"01:08.780","Text":"and then we have a revised opening balance,"},{"Start":"01:08.780 ","End":"01:10.625","Text":"or revised investment,"},{"Start":"01:10.625 ","End":"01:13.490","Text":"to which we add interests of, in this case,"},{"Start":"01:13.490 ","End":"01:18.145","Text":"2 percent giving us the closing investment and that then becomes the opening balance."},{"Start":"01:18.145 ","End":"01:20.375","Text":"Let\u0027s see, this is Year 1."},{"Start":"01:20.375 ","End":"01:22.640","Text":"We start with nothing to begin with,"},{"Start":"01:22.640 ","End":"01:24.710","Text":"and then on the very first day,"},{"Start":"01:24.710 ","End":"01:27.805","Text":"the 1st of January of Year 1, we put in 50."},{"Start":"01:27.805 ","End":"01:30.275","Text":"We now have a revised investment,"},{"Start":"01:30.275 ","End":"01:32.275","Text":"not 0 but 50."},{"Start":"01:32.275 ","End":"01:34.290","Text":"We add the interest,"},{"Start":"01:34.290 ","End":"01:38.160","Text":"50 times 2 percent is 1 currency unit."},{"Start":"01:38.160 ","End":"01:42.904","Text":"Our closing investment is the 2 combined, which is 51."},{"Start":"01:42.904 ","End":"01:46.130","Text":"That closing balance becomes our opening balance."},{"Start":"01:46.130 ","End":"01:48.620","Text":"Now on the 1st of January,"},{"Start":"01:48.620 ","End":"01:50.885","Text":"we add to it another 50,"},{"Start":"01:50.885 ","End":"01:56.260","Text":"which gives us now a revised investment on the 1st of January of Year 2 of 101."},{"Start":"01:56.260 ","End":"02:01.350","Text":"We multiply that by 2 percent to get 2.02 currency units,"},{"Start":"02:01.350 ","End":"02:05.870","Text":"so our closing investment is now 103.02."},{"Start":"02:05.870 ","End":"02:07.775","Text":"That becomes the opening balance."},{"Start":"02:07.775 ","End":"02:11.915","Text":"We add another 50, gives us a revised investment."},{"Start":"02:11.915 ","End":"02:17.450","Text":"We multiply it by the 2 percent interest to get 3.06 currency units."},{"Start":"02:17.450 ","End":"02:19.285","Text":"We have a closing investment of 156,"},{"Start":"02:19.285 ","End":"02:21.335","Text":"that becomes our opening balance."},{"Start":"02:21.335 ","End":"02:24.238","Text":"Add another 50, gives us 206.08,"},{"Start":"02:24.238 ","End":"02:30.465","Text":"2 percent on top of that is 4.12,"},{"Start":"02:30.465 ","End":"02:34.500","Text":"and our total closing investment is 210.2."},{"Start":"02:34.500 ","End":"02:38.315","Text":"This is 1 way of working out that future amount."},{"Start":"02:38.315 ","End":"02:41.340","Text":"Your answer being 210.2."},{"Start":"02:42.010 ","End":"02:45.889","Text":"Another way of looking at it is that 50,"},{"Start":"02:45.889 ","End":"02:47.975","Text":"the very first 50 in our table,"},{"Start":"02:47.975 ","End":"02:52.295","Text":"was invested for 4 years because it was invested on the 1st of January 20X1."},{"Start":"02:52.295 ","End":"02:55.760","Text":"The second 50, invested at beginning of Year 2,"},{"Start":"02:55.760 ","End":"02:57.665","Text":"was invested for 3 years,"},{"Start":"02:57.665 ","End":"02:59.945","Text":"earning interests for Year 2, 3 and 4."},{"Start":"02:59.945 ","End":"03:04.190","Text":"The third 50, invest at the beginning of year 3,"},{"Start":"03:04.190 ","End":"03:06.900","Text":"was invested for 2 years, Year 3 and Year 4."},{"Start":"03:06.900 ","End":"03:11.970","Text":"Then the last 50 was only invested for 1 year, the 4th year."},{"Start":"03:12.430 ","End":"03:16.390","Text":"The 50 that was invested for 4 years,"},{"Start":"03:16.390 ","End":"03:20.390","Text":"we could work out what that future amount is individually,"},{"Start":"03:20.390 ","End":"03:22.430","Text":"just that individual 50,"},{"Start":"03:22.430 ","End":"03:26.245","Text":"by multiplying it by 1.02,"},{"Start":"03:26.245 ","End":"03:28.160","Text":"2 being the interest rate,"},{"Start":"03:28.160 ","End":"03:32.030","Text":"to the power of 4 because it\u0027s been invested for 4 years,"},{"Start":"03:32.030 ","End":"03:35.420","Text":"compounding at that 2 percent."},{"Start":"03:35.420 ","End":"03:39.440","Text":"The amount invest for 3 years we could work out"},{"Start":"03:39.440 ","End":"03:45.184","Text":"the future value of that individual 50 after the 3 years investment."},{"Start":"03:45.184 ","End":"03:51.205","Text":"We do that by multiplying 50 by 1.02^3."},{"Start":"03:51.205 ","End":"03:56.585","Text":"Then the individual 50 was invested for 2 years,"},{"Start":"03:56.585 ","End":"04:03.750","Text":"we work out the future value that 50 miles by 1.02^2 years."},{"Start":"04:03.830 ","End":"04:07.020","Text":"Then the final 50,"},{"Start":"04:07.020 ","End":"04:11.300","Text":"50 times 1.02 simply or to the power of 1 if you"},{"Start":"04:11.300 ","End":"04:16.175","Text":"want to be pedantic to indicate that it was an investment for 1 year."},{"Start":"04:16.175 ","End":"04:20.044","Text":"That can be written across the page as 50,"},{"Start":"04:20.044 ","End":"04:24.795","Text":"multiply 1.02^4, plus 50 multiplied by 1.02^3,"},{"Start":"04:24.795 ","End":"04:29.018","Text":"plus 50 multiply by 1.02^2,"},{"Start":"04:29.018 ","End":"04:32.465","Text":"plus 50 multiplied by 1.02^1,"},{"Start":"04:32.465 ","End":"04:36.800","Text":"and that gives us 210.2."},{"Start":"04:36.800 ","End":"04:40.685","Text":"That is another way of calculating the same figure,"},{"Start":"04:40.685 ","End":"04:45.500","Text":"the future amount to the 50 invested each year for 4 years,"},{"Start":"04:45.500 ","End":"04:47.975","Text":"so in other words, an annuity."},{"Start":"04:47.975 ","End":"04:51.905","Text":"Now, yet another way of calculating it,"},{"Start":"04:51.905 ","End":"04:58.760","Text":"is using this fairly complex looking formula not difficult to use though."},{"Start":"04:58.760 ","End":"05:04.895","Text":"This is a future value calculation for an annuity."},{"Start":"05:04.895 ","End":"05:07.940","Text":"The payment is 50."},{"Start":"05:07.940 ","End":"05:11.390","Text":"The n is the number of periods,"},{"Start":"05:11.390 ","End":"05:13.655","Text":"and in that case it\u0027s 4,"},{"Start":"05:13.655 ","End":"05:19.340","Text":"the r represents the interest rate, and I forgot."},{"Start":"05:19.340 ","End":"05:23.075","Text":"Let\u0027s see. We\u0027ve got the payment which is 50."},{"Start":"05:23.075 ","End":"05:26.880","Text":"We multiply it by the 1 plus the rate,"},{"Start":"05:26.880 ","End":"05:32.640","Text":"so I\u0027ve highlighted the parts of the formula dealing with the rate."},{"Start":"05:32.840 ","End":"05:36.780","Text":"Apologies for the formula jumping."},{"Start":"05:36.780 ","End":"05:41.790","Text":"The first part, 1 plus r is the 1.02,"},{"Start":"05:41.790 ","End":"05:46.180","Text":"and then the second 1 plus r,"},{"Start":"05:46.180 ","End":"05:50.457","Text":"you can see is in the second bracket of 1.02."},{"Start":"05:50.457 ","End":"05:55.299","Text":"Then the third reference to r is actually not in the numerator,"},{"Start":"05:55.299 ","End":"05:56.770","Text":"but in the denominator,"},{"Start":"05:56.770 ","End":"06:00.540","Text":"and then we don\u0027t add 1 plus r,"},{"Start":"06:00.540 ","End":"06:06.240","Text":"it\u0027s simply divided by r, so that\u0027s 0.02."},{"Start":"06:06.240 ","End":"06:08.800","Text":"A third way we could calculate"},{"Start":"06:08.800 ","End":"06:15.095","Text":"the very same future value is this rather complex looking formula."},{"Start":"06:15.095 ","End":"06:18.520","Text":"This formula is used when you have an annuity and you\u0027re"},{"Start":"06:18.520 ","End":"06:21.985","Text":"trying to work out that future value of the annuity."},{"Start":"06:21.985 ","End":"06:26.680","Text":"The variables that we have in the formula involves the payment,"},{"Start":"06:26.680 ","End":"06:30.195","Text":"which in this case is 50, n,"},{"Start":"06:30.195 ","End":"06:32.550","Text":"which is the number of periods,"},{"Start":"06:32.550 ","End":"06:36.140","Text":"and in this exercise is 4,"},{"Start":"06:36.140 ","End":"06:40.235","Text":"4 years, and then r which represents the interest rate,"},{"Start":"06:40.235 ","End":"06:42.620","Text":"which in this case is 2 percent."},{"Start":"06:42.620 ","End":"06:47.705","Text":"Let\u0027s try it. In place of payment, we pop in the 50."},{"Start":"06:47.705 ","End":"06:52.735","Text":"Then the first part of the numerator is 1 plus r,"},{"Start":"06:52.735 ","End":"07:03.050","Text":"so that\u0027s 1 plus the interest rate of 0.02 or 2 percent, so that\u0027s 1.02."},{"Start":"07:03.050 ","End":"07:09.410","Text":"We have a square bracket followed by 1 plus r again,"},{"Start":"07:09.410 ","End":"07:12.010","Text":"so it\u0027s multiplied by 1.02 again."},{"Start":"07:12.010 ","End":"07:18.200","Text":"That second 1.02 needs to be to the power of n,"},{"Start":"07:18.200 ","End":"07:21.640","Text":"which is 4, 4 years in this case."},{"Start":"07:21.640 ","End":"07:25.980","Text":"Then the third part where the r is referenced is in"},{"Start":"07:25.980 ","End":"07:32.246","Text":"the denominator so notice that the denominator is 0.02."},{"Start":"07:32.246 ","End":"07:34.980","Text":"It\u0027s not 1.02,"},{"Start":"07:34.980 ","End":"07:39.235","Text":"it\u0027s just the rate, 0.02."},{"Start":"07:39.235 ","End":"07:41.675","Text":"Then back to the numerator."},{"Start":"07:41.675 ","End":"07:49.065","Text":"Don\u0027t forget, we\u0027re going to subtract 1 from the 1.02^4."},{"Start":"07:49.065 ","End":"07:55.205","Text":"Notice that is 1 section in those red square brackets."},{"Start":"07:55.205 ","End":"08:01.910","Text":"If you take the part in the square brackets, 1.02^4 minus 1."},{"Start":"08:01.910 ","End":"08:03.800","Text":"Find the answer to that."},{"Start":"08:03.800 ","End":"08:07.179","Text":"Multiply that by 1.02,"},{"Start":"08:07.179 ","End":"08:14.990","Text":"find the answer to that entire numerator now and divide that then by 0.02,"},{"Start":"08:14.990 ","End":"08:21.680","Text":"that answer, multiplied by 50 will give you 210.2."},{"Start":"08:21.680 ","End":"08:25.920","Text":"All right, so there are 3 different ways to calculate the same thing."}],"ID":31013},{"Watched":false,"Name":"Exercise 4","Duration":"9m 28s","ChapterTopicVideoID":29404,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.030 ","End":"00:04.855","Text":"This exercise deals with the calculation of a discounted value,"},{"Start":"00:04.855 ","End":"00:06.820","Text":"otherwise known as the present value."},{"Start":"00:06.820 ","End":"00:10.690","Text":"In this exercise, we were asked to determine the present value of"},{"Start":"00:10.690 ","End":"00:15.055","Text":"100 currency units if it is to be received in 1 year\u0027s time,"},{"Start":"00:15.055 ","End":"00:21.385","Text":"and then again do it again assuming it\u0027s to be received in 2 years time or 5 years time."},{"Start":"00:21.385 ","End":"00:26.240","Text":"We will use a 6 percent interest rate compounded."},{"Start":"00:27.530 ","End":"00:32.665","Text":"Let\u0027s calculate the present values of the 100 currency units received after 1 year,"},{"Start":"00:32.665 ","End":"00:34.870","Text":"after 2 years, and after 5 years."},{"Start":"00:34.870 ","End":"00:39.250","Text":"Part a said, what is the present value if we are"},{"Start":"00:39.250 ","End":"00:43.850","Text":"to receive 100 currency units in a year from now?"},{"Start":"00:43.850 ","End":"00:48.410","Text":"It\u0027s obviously not worth as much had we been receiving it today."},{"Start":"00:48.410 ","End":"00:50.390","Text":"It\u0027s going to be less than a 100."},{"Start":"00:50.390 ","End":"00:55.340","Text":"Now, the way you work it out is you divide it by 1 plus whatever the rate"},{"Start":"00:55.340 ","End":"01:00.530","Text":"is to the power of the number of periods that you have to wait until the end."},{"Start":"01:00.530 ","End":"01:09.080","Text":"The longer you have to wait the less valuable this sum of money is to you."},{"Start":"01:09.080 ","End":"01:10.095","Text":"In Part a,"},{"Start":"01:10.095 ","End":"01:16.160","Text":"it\u0027s simply 100 divided by 1.06 because it\u0027s to the power of 1 year only,"},{"Start":"01:16.160 ","End":"01:19.185","Text":"because we are waiting for 1 year only."},{"Start":"01:19.185 ","End":"01:22.080","Text":"The present value is 94.34,"},{"Start":"01:22.080 ","End":"01:24.910","Text":"so it\u0027s less than 100."},{"Start":"01:25.540 ","End":"01:31.220","Text":"Another way of working it out is to multiply the 100 by a present value factor."},{"Start":"01:31.220 ","End":"01:37.550","Text":"Dividing by 1.06, you\u0027re going to be multiplying by present value factor."},{"Start":"01:37.550 ","End":"01:40.550","Text":"How do you work out the present value factor if you don\u0027t"},{"Start":"01:40.550 ","End":"01:44.015","Text":"have a present value factor table available to you?"},{"Start":"01:44.015 ","End":"01:47.345","Text":"The present value factor for an amount received"},{"Start":"01:47.345 ","End":"01:53.020","Text":"today using 6 percent or any percent is going to be 1."},{"Start":"01:53.020 ","End":"01:57.560","Text":"The future value equals the present value if you receive it today."},{"Start":"01:57.560 ","End":"01:59.180","Text":"Makes logical sense."},{"Start":"01:59.180 ","End":"02:02.510","Text":"Now, what about a present value factor for an amount received"},{"Start":"02:02.510 ","End":"02:06.340","Text":"after 1 year using 6 percent as your interest rate?"},{"Start":"02:06.340 ","End":"02:08.555","Text":"You take the previous year\u0027s,"},{"Start":"02:08.555 ","End":"02:13.605","Text":"present value factor and you divide it by 1 plus the rate,"},{"Start":"02:13.605 ","End":"02:16.695","Text":"in this case it would be 1.06."},{"Start":"02:16.695 ","End":"02:20.165","Text":"The previous year\u0027s present value factor for"},{"Start":"02:20.165 ","End":"02:27.215","Text":"the present value factor calculation after 1 year is the present value factor for today."},{"Start":"02:27.215 ","End":"02:30.860","Text":"The numerator rather is 1,"},{"Start":"02:30.860 ","End":"02:35.020","Text":"so that 1 is going to be divided by the 1 plus r,"},{"Start":"02:35.020 ","End":"02:42.675","Text":"in this case it\u0027s 6 percent and therefore it\u0027s 1 plus 0.06."},{"Start":"02:42.675 ","End":"02:46.320","Text":"We\u0027re going to divide that 1 by 1.06."},{"Start":"02:46.320 ","End":"02:50.439","Text":"It\u0027s 1, previous year present value factor,"},{"Start":"02:50.439 ","End":"02:58.515","Text":"divide by 1.06 and that gives us the factor, which is 0.943396."},{"Start":"02:58.515 ","End":"03:05.060","Text":"You\u0027ll get a more accurate results depending on how many decimal points you include."},{"Start":"03:05.060 ","End":"03:08.915","Text":"Thus in this case, we were dealing with 100 currency units,"},{"Start":"03:08.915 ","End":"03:14.850","Text":"and we multiply it by the present value factor for 6 percent received after 1 year,"},{"Start":"03:14.850 ","End":"03:16.730","Text":"and so you multiply it by that factor,"},{"Start":"03:16.730 ","End":"03:20.150","Text":"0.943396 and obviously you get the same answer as we"},{"Start":"03:20.150 ","End":"03:24.815","Text":"had have we done it the initial way, it\u0027s 94.34."},{"Start":"03:24.815 ","End":"03:27.230","Text":"Now looking at b. Here,"},{"Start":"03:27.230 ","End":"03:31.580","Text":"the 100 currency units is going to be received by us 2 years from now."},{"Start":"03:31.580 ","End":"03:35.045","Text":"Logically that would mean it\u0027s worth less to"},{"Start":"03:35.045 ","End":"03:39.140","Text":"us than had it been received 1 year from now or today."},{"Start":"03:39.140 ","End":"03:41.420","Text":"The way you calculate it is simply the 100,"},{"Start":"03:41.420 ","End":"03:44.990","Text":"the currency units, divide by 1.06,"},{"Start":"03:44.990 ","End":"03:47.360","Text":"in other words 1 plus whatever the rate is,"},{"Start":"03:47.360 ","End":"03:52.415","Text":"and that denominator 1.06 is to the power of,"},{"Start":"03:52.415 ","End":"03:55.970","Text":"in this case 2 because there are 2 years we have to wait."},{"Start":"03:55.970 ","End":"03:58.550","Text":"In this case the answer is 89."},{"Start":"03:58.550 ","End":"04:03.490","Text":"We can also calculate this by multiplying by the relevant present value factor."},{"Start":"04:03.490 ","End":"04:08.990","Text":"Now, what is the present value factor for an amount received after 2 years at 6 percent."},{"Start":"04:08.990 ","End":"04:16.330","Text":"Now remember, the present value factor for an amount received now is always equal to 1."},{"Start":"04:16.330 ","End":"04:19.880","Text":"Then if you wanted to work out the present value factor after 1 year,"},{"Start":"04:19.880 ","End":"04:26.198","Text":"you would then take 1 being the previous year\u0027s present value factor,"},{"Start":"04:26.198 ","End":"04:31.355","Text":"1 divided by 1.06 because we are using 6 percent."},{"Start":"04:31.355 ","End":"04:36.170","Text":"That gives us 0.943396 as we\u0027d worked at in Part a."},{"Start":"04:36.170 ","End":"04:40.820","Text":"Then to work out the present value factor after Year 2,"},{"Start":"04:40.820 ","End":"04:45.650","Text":"you\u0027re taking that present value factor that we worked out for after"},{"Start":"04:45.650 ","End":"04:51.245","Text":"Year 1 and we\u0027re dividing that by 1.06,"},{"Start":"04:51.245 ","End":"04:56.720","Text":"because we are working with a 6 percent and that gives us 0.889996."},{"Start":"04:56.720 ","End":"05:01.910","Text":"Therefore, the present value calculated using the factor like this is"},{"Start":"05:01.910 ","End":"05:09.140","Text":"simply currency units 100 multiplied by that present value factor 0.889996,"},{"Start":"05:09.140 ","End":"05:12.425","Text":"giving us 89 rounded."},{"Start":"05:12.425 ","End":"05:16.490","Text":"Just for interest, what would be the present value factor after 3 years?"},{"Start":"05:16.490 ","End":"05:18.680","Text":"Let\u0027s say if you\u0027ve got the hang of this."},{"Start":"05:18.680 ","End":"05:23.818","Text":"After Year 3, what are we going to use as our numerator?"},{"Start":"05:23.818 ","End":"05:30.380","Text":"Is 0.889996, well done and that is the previous year\u0027s present value factor and"},{"Start":"05:30.380 ","End":"05:37.685","Text":"we divide by 1.06, giving us 0.839619."},{"Start":"05:37.685 ","End":"05:40.860","Text":"Now, let\u0027s do Part c. Here,"},{"Start":"05:40.860 ","End":"05:42.480","Text":"it\u0027s after 5 years."},{"Start":"05:42.480 ","End":"05:44.880","Text":"You can see the solution is very simple,"},{"Start":"05:44.880 ","End":"05:51.270","Text":"simply 100 divided by 1.06^5, giving us 74.73."},{"Start":"05:51.270 ","End":"05:53.625","Text":"Using the factor approach,"},{"Start":"05:53.625 ","End":"05:58.068","Text":"remember the present value factor for an amount received at 6 percent,"},{"Start":"05:58.068 ","End":"06:02.210","Text":"at any percent, if it\u0027s now the factor is 1."},{"Start":"06:02.210 ","End":"06:04.835","Text":"After Year 1, it\u0027ll be that factor 1,"},{"Start":"06:04.835 ","End":"06:09.215","Text":"that was the previous factor, divide by 1.06, giving us 0.943396."},{"Start":"06:09.215 ","End":"06:11.880","Text":"After Year 2, it\u0027s 0.943396."},{"Start":"06:12.230 ","End":"06:17.150","Text":"After Year 2, it\u0027s 0.943396 divide by 1.06,"},{"Start":"06:17.150 ","End":"06:19.865","Text":"giving us that 0.889996."},{"Start":"06:19.865 ","End":"06:25.725","Text":"After Year 3, it\u0027s 0.889996 divided by 1.06 rather,"},{"Start":"06:25.725 ","End":"06:28.575","Text":"and that gives us 0.839619."},{"Start":"06:28.575 ","End":"06:35.700","Text":"After Year 4, we take the 0.839619 divide that by 1.06, gives us 0.792094."},{"Start":"06:35.700 ","End":"06:41.040","Text":"After Year 5, it\u0027s 0.792094 divided by 1.06,"},{"Start":"06:41.040 ","End":"06:45.435","Text":"it gives us 0.747258."},{"Start":"06:45.435 ","End":"06:49.445","Text":"The present value factor calculation can be simplified."},{"Start":"06:49.445 ","End":"06:53.900","Text":"It\u0027s 1 divide by 1 plus r to the power of"},{"Start":"06:53.900 ","End":"06:58.760","Text":"n. Instead of calculating each one of those as we\u0027ve just done on the right,"},{"Start":"06:58.760 ","End":"07:03.775","Text":"you could simply say 1 divide by 1.06^5,"},{"Start":"07:03.775 ","End":"07:06.215","Text":"and you will have your present value factor."},{"Start":"07:06.215 ","End":"07:08.630","Text":"Irrespective of how you work out the present value factor,"},{"Start":"07:08.630 ","End":"07:10.490","Text":"the long way or the short way,"},{"Start":"07:10.490 ","End":"07:16.190","Text":"it\u0027s 100 multiplied by 0.747258,"},{"Start":"07:16.190 ","End":"07:19.820","Text":"and that\u0027s our present value, 74.73."},{"Start":"07:19.820 ","End":"07:22.475","Text":"If you look at those figures,"},{"Start":"07:22.475 ","End":"07:25.750","Text":"if you receive 100 currency units now,"},{"Start":"07:25.750 ","End":"07:32.450","Text":"it\u0027s worth 100 currency units as it\u0027s worth 100 currency units as a present value."},{"Start":"07:32.450 ","End":"07:35.705","Text":"Then each year that it\u0027s delayed,"},{"Start":"07:35.705 ","End":"07:41.680","Text":"that amount of money that you can receive becomes worth less and less to us."},{"Start":"07:41.680 ","End":"07:46.270","Text":"Just for interest, let\u0027s check that our answers are correct."},{"Start":"07:46.270 ","End":"07:49.160","Text":"Hopefully, this will help cement your understanding and"},{"Start":"07:49.160 ","End":"07:52.220","Text":"also if you\u0027re still battling with it hopefully cement."},{"Start":"07:52.220 ","End":"07:53.630","Text":"Just for interest,"},{"Start":"07:53.630 ","End":"07:56.930","Text":"let\u0027s check to make sure our answers are correct."},{"Start":"07:56.930 ","End":"07:59.225","Text":"In this process hopefully,"},{"Start":"07:59.225 ","End":"08:01.520","Text":"it will cement your full understanding."},{"Start":"08:01.520 ","End":"08:06.070","Text":"If you\u0027re battling, it will cement your understanding of what we have done,"},{"Start":"08:06.070 ","End":"08:08.120","Text":"what are present value or"},{"Start":"08:08.120 ","End":"08:11.900","Text":"the relationship between the present value and the future value."},{"Start":"08:11.900 ","End":"08:15.160","Text":"Using a little table might be very useful."},{"Start":"08:15.160 ","End":"08:17.960","Text":"We\u0027ve got an opening balance of 94.34,"},{"Start":"08:17.960 ","End":"08:19.180","Text":"so that\u0027s our present value."},{"Start":"08:19.180 ","End":"08:21.980","Text":"That\u0027s why we\u0027re starting with the present value as our opening balance."},{"Start":"08:21.980 ","End":"08:23.750","Text":"It\u0027s now. We worked it out."},{"Start":"08:23.750 ","End":"08:29.960","Text":"We said 100 received at the end of Year 1 is worth 94.34 now."},{"Start":"08:29.960 ","End":"08:33.500","Text":"In other words, if we had 94.34 in currency units,"},{"Start":"08:33.500 ","End":"08:38.860","Text":"we could invest it at 6 percent and it will be worth 100 a year from now."},{"Start":"08:38.860 ","End":"08:42.800","Text":"94.34 multiplied by 6 percent gives us interest of"},{"Start":"08:42.800 ","End":"08:47.810","Text":"5.66 and if you add those 2 figures together, you get 100."},{"Start":"08:47.810 ","End":"08:51.035","Text":"You can see our opening balance is the present value,"},{"Start":"08:51.035 ","End":"08:53.390","Text":"our closing balance is the future value."},{"Start":"08:53.390 ","End":"08:56.000","Text":"In this question, we have been given"},{"Start":"08:56.000 ","End":"08:59.780","Text":"the future value and asked to work backwards to the present value."},{"Start":"08:59.780 ","End":"09:03.320","Text":"Let\u0027s check Part b for interest."},{"Start":"09:03.320 ","End":"09:04.925","Text":"Here\u0027s our table."},{"Start":"09:04.925 ","End":"09:08.105","Text":"Let\u0027s put in the opening balance being the 89,"},{"Start":"09:08.105 ","End":"09:09.410","Text":"that\u0027s the present value."},{"Start":"09:09.410 ","End":"09:14.660","Text":"We say that if we had 100 received at the end of Year 2, the present value is 89."},{"Start":"09:14.660 ","End":"09:18.815","Text":"We\u0027re just going to check if we have 89 currency units,"},{"Start":"09:18.815 ","End":"09:22.460","Text":"and we could invest it today at"},{"Start":"09:22.460 ","End":"09:29.290","Text":"6 percent interest in 2 years time will it indeed grow to 100? Let\u0027s see."}],"ID":31014},{"Watched":false,"Name":"Exercise 5","Duration":"7m 18s","ChapterTopicVideoID":29405,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:02.850","Text":"This exercise deals with present values,"},{"Start":"00:02.850 ","End":"00:06.360","Text":"but this time a present value of an annuity."},{"Start":"00:06.360 ","End":"00:09.030","Text":"It is now the first of January 20X1,"},{"Start":"00:09.030 ","End":"00:12.315","Text":"and we wish to borrow money to renovate the house."},{"Start":"00:12.315 ","End":"00:17.430","Text":"We can afford 10 annual payments of a 1,000 currency units paid at each year end,"},{"Start":"00:17.430 ","End":"00:22.440","Text":"the 31st, December and the bank is offering a loan at 2 percent interest."},{"Start":"00:22.440 ","End":"00:27.435","Text":"Required. How much can we afford to borrow rounded to the nearest whole number?"},{"Start":"00:27.435 ","End":"00:30.075","Text":"Now if we\u0027re going to use present value factors,"},{"Start":"00:30.075 ","End":"00:35.640","Text":"I always recommend using at least 6 decimal points to maintain accuracy."},{"Start":"00:35.640 ","End":"00:37.215","Text":"What is an annuity?"},{"Start":"00:37.215 ","End":"00:41.445","Text":"An annuity involves equal payments over a number of periods."},{"Start":"00:41.445 ","End":"00:44.510","Text":"Payments are generally denoted by PMT,"},{"Start":"00:44.510 ","End":"00:46.625","Text":"and the number of periods simply by"},{"Start":"00:46.625 ","End":"00:50.720","Text":"n. There are a number of ways to calculate the present value of an annuity."},{"Start":"00:50.720 ","End":"00:53.510","Text":"The first method is to use present value factors where we"},{"Start":"00:53.510 ","End":"00:56.960","Text":"calculate the present value of each one of those 10 payments,"},{"Start":"00:56.960 ","End":"01:00.050","Text":"and then we add each one of those 10 present values"},{"Start":"01:00.050 ","End":"01:04.070","Text":"together to get the present value of the 10-year annuity."},{"Start":"01:04.070 ","End":"01:08.060","Text":"Or we could, using present value factors again,"},{"Start":"01:08.060 ","End":"01:11.425","Text":"calculate the present value of the total annuity,"},{"Start":"01:11.425 ","End":"01:15.590","Text":"slightly shorter and the third method we\u0027re going to cover"},{"Start":"01:15.590 ","End":"01:20.480","Text":"here is using the present value formula to calculate the present value of the annuity."},{"Start":"01:20.480 ","End":"01:22.525","Text":"This is actually quite a lot shorter,"},{"Start":"01:22.525 ","End":"01:25.400","Text":"but it looks more complex, but it isn\u0027t really."},{"Start":"01:25.400 ","End":"01:28.195","Text":"Let\u0027s have a look. This is the formula."},{"Start":"01:28.195 ","End":"01:33.145","Text":"It looks complex, but we\u0027ll go through it and you\u0027ll see it isn\u0027t really."},{"Start":"01:33.145 ","End":"01:39.875","Text":"Let\u0027s look at the solution to the exercise involving the present value of an annuity."},{"Start":"01:39.875 ","End":"01:41.765","Text":"What is an annuity?"},{"Start":"01:41.765 ","End":"01:49.405","Text":"Well, it\u0027s simply where we have equal payments over a number of periods or years."},{"Start":"01:49.405 ","End":"01:54.710","Text":"Now, there are a number of ways to calculate the present value of an annuity."},{"Start":"01:54.710 ","End":"01:58.279","Text":"One way we\u0027ll do is by using"},{"Start":"01:58.279 ","End":"02:02.870","Text":"the present value factors for each year in which a payment is made,"},{"Start":"02:02.870 ","End":"02:07.070","Text":"and we\u0027ll use those individual present value factors"},{"Start":"02:07.070 ","End":"02:11.284","Text":"to then calculate the present value of each of the 10 payments."},{"Start":"02:11.284 ","End":"02:14.150","Text":"Then we add all of these 10 present values"},{"Start":"02:14.150 ","End":"02:17.824","Text":"together to get the present value of the annuity."},{"Start":"02:17.824 ","End":"02:21.740","Text":"Then the second method we\u0027ll use is by calculating"},{"Start":"02:21.740 ","End":"02:27.485","Text":"the present value factor for a 10-year annuity at 2 percent,"},{"Start":"02:27.485 ","End":"02:29.840","Text":"and then we\u0027ll calculate the present value of"},{"Start":"02:29.840 ","End":"02:33.545","Text":"the total annuity using that annuity factor."},{"Start":"02:33.545 ","End":"02:43.468","Text":"Then the third and final method we\u0027ll use is by using the present value formula"},{"Start":"02:43.468 ","End":"02:45.920","Text":"which if you can remember it might be"},{"Start":"02:45.920 ","End":"02:54.920","Text":"an easier and quicker way to get to the answer."},{"Start":"02:54.920 ","End":"03:00.325","Text":"The present value formula that you\u0027ll need to remember is this one."},{"Start":"03:00.325 ","End":"03:04.345","Text":"Let\u0027s use the present value factors first."},{"Start":"03:04.345 ","End":"03:07.865","Text":"The first method is to calculate the present value factor for"},{"Start":"03:07.865 ","End":"03:11.930","Text":"a single amount received or paid at the specific rate,"},{"Start":"03:11.930 ","End":"03:13.700","Text":"and in this case, 2 percent."},{"Start":"03:13.700 ","End":"03:18.910","Text":"The present value factor for an amount received or paid now is always 1."},{"Start":"03:18.910 ","End":"03:23.120","Text":"Because obviously the present value and the future value will be the same."},{"Start":"03:23.120 ","End":"03:26.120","Text":"The present value factor after year 1"},{"Start":"03:26.120 ","End":"03:29.150","Text":"would be calculated by taking the previous year\u0027s factor,"},{"Start":"03:29.150 ","End":"03:32.495","Text":"which was 1, and dividing it by 1.02,"},{"Start":"03:32.495 ","End":"03:36.865","Text":"and we get 0.980392."},{"Start":"03:36.865 ","End":"03:39.440","Text":"The more decimal places you use,"},{"Start":"03:39.440 ","End":"03:41.450","Text":"the more accurate your answer will be."},{"Start":"03:41.450 ","End":"03:44.065","Text":"Then the present value factor after year 2,"},{"Start":"03:44.065 ","End":"03:46.940","Text":"you take the prior present value factor,"},{"Start":"03:46.940 ","End":"03:53.330","Text":"which was 0.980392, and we divide that by 1.02 and so on."},{"Start":"03:53.330 ","End":"03:56.550","Text":"After year 3, after year 4,"},{"Start":"03:56.550 ","End":"03:59.220","Text":"after year 5, after year 6,"},{"Start":"03:59.220 ","End":"04:02.035","Text":"7, 8, 9, 10."},{"Start":"04:02.035 ","End":"04:04.100","Text":"Then using method a,"},{"Start":"04:04.100 ","End":"04:07.010","Text":"we will take each one of those present value factors for"},{"Start":"04:07.010 ","End":"04:10.535","Text":"single payments and multiply it by that payment."},{"Start":"04:10.535 ","End":"04:12.650","Text":"We\u0027ve got 10 payments of a 1,000,"},{"Start":"04:12.650 ","End":"04:15.230","Text":"so we multiply the 1,000 by"},{"Start":"04:15.230 ","End":"04:20.245","Text":"the relevant present value factor based on which year the payment occurred in,"},{"Start":"04:20.245 ","End":"04:24.620","Text":"and we get the present value of each one of those payments."},{"Start":"04:24.620 ","End":"04:29.210","Text":"We then add up all of those individual present values,"},{"Start":"04:29.210 ","End":"04:31.460","Text":"and we get 8,983,"},{"Start":"04:31.460 ","End":"04:36.425","Text":"which is the total present value of the 10-year annuity"},{"Start":"04:36.425 ","End":"04:43.915","Text":"involving 1,000 currency unit payments each year and using an interest rate of 2 percent."},{"Start":"04:43.915 ","End":"04:46.810","Text":"Right now, what about method b?"},{"Start":"04:46.810 ","End":"04:49.479","Text":"Well, method b still involves calculating"},{"Start":"04:49.479 ","End":"04:55.104","Text":"the present value factor for a payment or receipt after each one of those years."},{"Start":"04:55.104 ","End":"05:00.340","Text":"But then instead of multiplying it by a 1,000 each time,"},{"Start":"05:00.340 ","End":"05:04.374","Text":"in other words, instead of using those factors and multiplying it by the payments,"},{"Start":"05:04.374 ","End":"05:08.619","Text":"what you do is you add all of those factors together,"},{"Start":"05:08.619 ","End":"05:11.500","Text":"and you get a present value factor instead of"},{"Start":"05:11.500 ","End":"05:14.440","Text":"a present value factor for a single payment."},{"Start":"05:14.440 ","End":"05:18.250","Text":"What we have there at the bottom of 8.98258,"},{"Start":"05:18.250 ","End":"05:22.525","Text":"that\u0027s the present value factor for a 10-year annuity."},{"Start":"05:22.525 ","End":"05:28.250","Text":"In other words, 10 payments of a 1,000 each using an interest rate of 2 percent."},{"Start":"05:28.250 ","End":"05:33.185","Text":"It\u0027s the present value factor for the 10-year annuity."},{"Start":"05:33.185 ","End":"05:37.130","Text":"Once we have that present value factor for an annuity,"},{"Start":"05:37.130 ","End":"05:41.120","Text":"all we have to do is multiply it by the annuity amount,"},{"Start":"05:41.120 ","End":"05:42.185","Text":"which is a 1,000,"},{"Start":"05:42.185 ","End":"05:44.430","Text":"in other words, the annual amount."},{"Start":"05:44.430 ","End":"05:50.000","Text":"We take a 1,000, the annual amount that gets paid and we multiply it by the factor that"},{"Start":"05:50.000 ","End":"05:57.300","Text":"reflects a 10-year annuity at 2 percent and we get the same answer, 8983."},{"Start":"05:57.300 ","End":"06:00.515","Text":"This one is slightly shorter than method a."},{"Start":"06:00.515 ","End":"06:02.735","Text":"Then we have the third method,"},{"Start":"06:02.735 ","End":"06:06.187","Text":"which maybe is a bit quicker."},{"Start":"06:06.187 ","End":"06:08.275","Text":"That\u0027s the formula method."},{"Start":"06:08.275 ","End":"06:12.290","Text":"What do we have here? There are 3 variables in this formula."},{"Start":"06:12.290 ","End":"06:14.390","Text":"One is the payment, well,"},{"Start":"06:14.390 ","End":"06:16.790","Text":"the payment every year is a 1,000."},{"Start":"06:16.790 ","End":"06:21.270","Text":"The next variable is the n, which is 10."},{"Start":"06:21.270 ","End":"06:23.629","Text":"In other words, it\u0027s a 10-year annuity."},{"Start":"06:23.629 ","End":"06:28.150","Text":"Then we have r, which is the 2 percent rate."},{"Start":"06:28.150 ","End":"06:30.675","Text":"Let\u0027s pop that into the formula."},{"Start":"06:30.675 ","End":"06:32.790","Text":"The payment is a 1,000."},{"Start":"06:32.790 ","End":"06:37.815","Text":"We multiply that by now let us look at the highlighted bits."},{"Start":"06:37.815 ","End":"06:40.830","Text":"It\u0027s 1.02, in other words,"},{"Start":"06:40.830 ","End":"06:47.220","Text":"is 1 plus the rate of 2 percent or 0.02^10,"},{"Start":"06:47.220 ","End":"06:49.665","Text":"because we\u0027ve got a 10-year annuity,"},{"Start":"06:49.665 ","End":"06:53.389","Text":"and notice we\u0027ve got that on the numerator and the denominator."},{"Start":"06:53.389 ","End":"06:56.270","Text":"In other words, it\u0027s above the line and below the line."},{"Start":"06:56.270 ","End":"06:59.405","Text":"Then the next thing we do is above the line, the numerator,"},{"Start":"06:59.405 ","End":"07:02.630","Text":"we subtract 1 and the denominator,"},{"Start":"07:02.630 ","End":"07:06.870","Text":"we multiply by the rate which is 0.02,"},{"Start":"07:06.920 ","End":"07:09.005","Text":"and if you solve that,"},{"Start":"07:09.005 ","End":"07:13.190","Text":"you get 8982.59 or in other words,"},{"Start":"07:13.190 ","End":"07:18.600","Text":"8983, if we\u0027re going to round to the nearest whole number."}],"ID":31015},{"Watched":false,"Name":"Exercise 6","Duration":"14m 18s","ChapterTopicVideoID":29406,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:04.155","Text":"This exercise deals with how to account for the repayment of a loan."},{"Start":"00:04.155 ","End":"00:10.875","Text":"It\u0027s now 31st December 20X0 and Plush borrows 100,000 currency units."},{"Start":"00:10.875 ","End":"00:14.550","Text":"The terms of the loan are that we\u0027re going to be repaying"},{"Start":"00:14.550 ","End":"00:18.975","Text":"10 equal payments starting on 31st December 20X1."},{"Start":"00:18.975 ","End":"00:22.155","Text":"In other words, 1 year after we borrowed 100,000,"},{"Start":"00:22.155 ","End":"00:25.270","Text":"and we\u0027re going to be charged 4 percent interest."},{"Start":"00:25.270 ","End":"00:27.905","Text":"Now, what are we required to do?"},{"Start":"00:27.905 ","End":"00:31.520","Text":"We\u0027re going to assume the financial year is 31st December."},{"Start":"00:31.520 ","End":"00:36.500","Text":"Then we\u0027re asked to calculate what is the annual payment amount,"},{"Start":"00:36.500 ","End":"00:38.599","Text":"so how much do we pay each year."},{"Start":"00:38.599 ","End":"00:44.150","Text":"Then what will be the outstanding balance of the loan on 31st December 20X3?"},{"Start":"00:44.150 ","End":"00:46.907","Text":"That\u0027s 3 years after we\u0027ve borrowed the"},{"Start":"00:46.907 ","End":"00:50.240","Text":"100,000 and they specify after the third payment,"},{"Start":"00:50.240 ","End":"00:55.415","Text":"because remember the payment happens on the 31st December 20X3."},{"Start":"00:55.415 ","End":"00:59.870","Text":"Then see how much of the amount calculated in b, in other words,"},{"Start":"00:59.870 ","End":"01:03.695","Text":"what the outstanding balance of the loan is on 31st December 20X3."},{"Start":"01:03.695 ","End":"01:09.400","Text":"How much of that balance should be classified as a current liability on that date?"},{"Start":"01:09.400 ","End":"01:19.175","Text":"Then finally, d, how much interest expense should Plush recognize in 20X4, not 20X3?"},{"Start":"01:19.175 ","End":"01:25.505","Text":"Let\u0027s look at the solution to the exercise on how to account for the repayment of a loan."},{"Start":"01:25.505 ","End":"01:27.515","Text":"Let\u0027s start with part a,"},{"Start":"01:27.515 ","End":"01:31.465","Text":"which was we had to calculate the annual payment amount."},{"Start":"01:31.465 ","End":"01:34.785","Text":"We\u0027re being asked for the annuity amount."},{"Start":"01:34.785 ","End":"01:36.405","Text":"Let\u0027s use the formula."},{"Start":"01:36.405 ","End":"01:39.115","Text":"That\u0027s the formula that we\u0027re going to use."},{"Start":"01:39.115 ","End":"01:42.565","Text":"The payment is the annuity amount,"},{"Start":"01:42.565 ","End":"01:44.290","Text":"PMT is the annuity amount,"},{"Start":"01:44.290 ","End":"01:46.630","Text":"and that\u0027s what we\u0027re being asked to calculate."},{"Start":"01:46.630 ","End":"01:49.435","Text":"The present value, well, we know that."},{"Start":"01:49.435 ","End":"01:52.660","Text":"That\u0027s the amount that we receive at the very beginning,"},{"Start":"01:52.660 ","End":"01:55.555","Text":"ie, is the present value, 100,000."},{"Start":"01:55.555 ","End":"02:00.020","Text":"N is the number of periods we\u0027re going to take to repay it,"},{"Start":"02:00.020 ","End":"02:03.210","Text":"and r is the interest rate."},{"Start":"02:03.210 ","End":"02:06.465","Text":"Let\u0027s put this information into the formula."},{"Start":"02:06.465 ","End":"02:09.445","Text":"We start with the present value, which is 100,000."},{"Start":"02:09.445 ","End":"02:13.707","Text":"We put that in on the left-hand side of the equals sign, 100,000."},{"Start":"02:13.707 ","End":"02:15.290","Text":"Then the payment, well,"},{"Start":"02:15.290 ","End":"02:18.830","Text":"we can\u0027t put a figure in for that because that\u0027s what we\u0027re looking for."},{"Start":"02:18.830 ","End":"02:25.700","Text":"Then because the interest rate is 4 percent and the number of periods is 10 years,"},{"Start":"02:25.700 ","End":"02:28.250","Text":"we multiply by 1.04."},{"Start":"02:28.250 ","End":"02:30.284","Text":"In other words, 1 plus 4 percent, in brackets,"},{"Start":"02:30.284 ","End":"02:33.680","Text":"to the power of 10 minus 1."},{"Start":"02:33.680 ","End":"02:43.135","Text":"Then the denominator is 1.04^10 and the denominator instead of subtracting 1,"},{"Start":"02:43.135 ","End":"02:46.640","Text":"we multiply it by the rate, 0.04."},{"Start":"02:48.530 ","End":"02:56.510","Text":"You can see that the numerator and denominator both have this 1.04^10."},{"Start":"02:56.510 ","End":"02:58.990","Text":"Let\u0027s calculate what that is."},{"Start":"02:58.990 ","End":"03:06.690","Text":"If we solve for that, it\u0027s 1.480244."},{"Start":"03:06.690 ","End":"03:08.300","Text":"Let\u0027s deal with the numerator."},{"Start":"03:08.300 ","End":"03:13.550","Text":"In other words, above the line, 1.480244 minus 1."},{"Start":"03:13.550 ","End":"03:18.185","Text":"What does that give us? Well, that\u0027s obviously 0.480244."},{"Start":"03:18.185 ","End":"03:20.845","Text":"Then let\u0027s look at the denominator."},{"Start":"03:20.845 ","End":"03:31.650","Text":"So this is 1.480244 multiplied by the rate of 0.04 and we get 0.05921."},{"Start":"03:32.630 ","End":"03:37.070","Text":"We are trying to get to that payment amount."},{"Start":"03:37.070 ","End":"03:41.070","Text":"We need to get that payment amount on its own."},{"Start":"03:41.360 ","End":"03:48.605","Text":"What we do is to get rid of that denominator of 0.05921,"},{"Start":"03:48.605 ","End":"03:52.415","Text":"we\u0027re going to multiply by 0.05921,"},{"Start":"03:52.415 ","End":"03:54.270","Text":"and the two will cancel out."},{"Start":"03:54.270 ","End":"03:58.730","Text":"Then to get rid, of the numerator of 0.480244,"},{"Start":"03:58.730 ","End":"04:02.840","Text":"we\u0027re going to divide by 0.480244 and that will get rid of that."},{"Start":"04:02.840 ","End":"04:05.390","Text":"Then remember, whatever you do to the right-hand side of"},{"Start":"04:05.390 ","End":"04:09.455","Text":"the equation you have to do to the left. Let\u0027s see what I mean."},{"Start":"04:09.455 ","End":"04:16.280","Text":"We\u0027re going to multiply it by the 0.05921 divide by 0.480244."},{"Start":"04:16.280 ","End":"04:19.670","Text":"The 0.05 cancels out,"},{"Start":"04:19.670 ","End":"04:23.180","Text":"the 0.48 cancels out."},{"Start":"04:23.180 ","End":"04:24.230","Text":"Then as I say,"},{"Start":"04:24.230 ","End":"04:26.390","Text":"whatever you do to the right-hand side of the equation,"},{"Start":"04:26.390 ","End":"04:28.685","Text":"you\u0027ve got to do to the left-hand side of the equation,"},{"Start":"04:28.685 ","End":"04:31.590","Text":"otherwise, you\u0027ve actually changed the equation."},{"Start":"04:31.840 ","End":"04:38.615","Text":"By multiplying both sides by this 0.05 divide by 0.48,"},{"Start":"04:38.615 ","End":"04:41.430","Text":"you\u0027ve actually not changed anything."},{"Start":"04:43.040 ","End":"04:46.040","Text":"You can see by what we\u0027ve done here,"},{"Start":"04:46.040 ","End":"04:47.390","Text":"we\u0027ve managed to get rid of"},{"Start":"04:47.390 ","End":"04:51.980","Text":"those pesky numerator and denominator on the right-hand side,"},{"Start":"04:51.980 ","End":"04:54.340","Text":"so now the payment is left on its own,"},{"Start":"04:54.340 ","End":"04:58.880","Text":"and we\u0027ve moved it across to the left-hand side of the equation,"},{"Start":"04:58.880 ","End":"05:02.535","Text":"and you see the amounts have inverted."},{"Start":"05:02.535 ","End":"05:04.460","Text":"Whereas on the right-hand side of the equation,"},{"Start":"05:04.460 ","End":"05:08.345","Text":"you are multiplying by 0.48 and dividing by 0.05."},{"Start":"05:08.345 ","End":"05:12.605","Text":"If you take it across to the other side of the equation, it inverts."},{"Start":"05:12.605 ","End":"05:18.020","Text":"In other words, now the 0.05 is on top and the 0.48 is underneath the line."},{"Start":"05:18.020 ","End":"05:24.380","Text":"So you simply solve for that and you get the payment is 12,329.09."},{"Start":"05:24.380 ","End":"05:26.105","Text":"Now, if you have the time,"},{"Start":"05:26.105 ","End":"05:28.430","Text":"it\u0027s best to check that the figure that you\u0027ve"},{"Start":"05:28.430 ","End":"05:32.030","Text":"calculated is actually correct because you\u0027ve got A, B, C,"},{"Start":"05:32.030 ","End":"05:33.230","Text":"and D to this question,"},{"Start":"05:33.230 ","End":"05:34.985","Text":"and if you get A wrong,"},{"Start":"05:34.985 ","End":"05:38.420","Text":"it will have implications on the rest of your answer."},{"Start":"05:38.420 ","End":"05:41.390","Text":"Let\u0027s have a quick look. To check that"},{"Start":"05:41.390 ","End":"05:44.609","Text":"the payment that we\u0027ve just calculated is correct,"},{"Start":"05:44.609 ","End":"05:46.100","Text":"what we\u0027re trying to do here in"},{"Start":"05:46.100 ","End":"05:49.010","Text":"this table is to make sure that if we start with the balance of"},{"Start":"05:49.010 ","End":"05:54.065","Text":"100,000 and repay that amount of 12,329,"},{"Start":"05:54.065 ","End":"05:56.270","Text":"we will get to closing balance of 0."},{"Start":"05:56.270 ","End":"05:58.885","Text":"So let\u0027s see, does it actually work?"},{"Start":"05:58.885 ","End":"06:01.070","Text":"So we add the interest for the year,"},{"Start":"06:01.070 ","End":"06:02.810","Text":"which is 4 percent of 100,000,"},{"Start":"06:02.810 ","End":"06:04.475","Text":"which is obviously 4,000."},{"Start":"06:04.475 ","End":"06:06.800","Text":"Put in the repayment that we\u0027ve just calculated,"},{"Start":"06:06.800 ","End":"06:10.340","Text":"12,329, and calculate the closing balance."},{"Start":"06:10.340 ","End":"06:14.085","Text":"So opening balance plus interest minus the repayment."},{"Start":"06:14.085 ","End":"06:16.145","Text":"That gives us 91,671."},{"Start":"06:16.145 ","End":"06:18.860","Text":"That becomes the opening balance in year 2."},{"Start":"06:18.860 ","End":"06:23.780","Text":"Now we multiply 91,671 by 4 percent to get the interest for year 2."},{"Start":"06:23.780 ","End":"06:28.850","Text":"We subtract the 12,329 and we get the closing balance of 83,009."},{"Start":"06:28.850 ","End":"06:31.845","Text":"Then we repeat this for years 3,"},{"Start":"06:31.845 ","End":"06:34.845","Text":"4, 5, 6,"},{"Start":"06:34.845 ","End":"06:36.375","Text":"7, 8,"},{"Start":"06:36.375 ","End":"06:38.140","Text":"9, and 10."},{"Start":"06:38.140 ","End":"06:43.085","Text":"You\u0027ll see here that I get to a closing balance of 1. It should be 0."},{"Start":"06:43.085 ","End":"06:46.200","Text":"It\u0027s simply a rounding error."},{"Start":"06:51.810 ","End":"06:56.515","Text":"Now let\u0027s look at b. What will be the outstanding balance of the loan"},{"Start":"06:56.515 ","End":"07:00.565","Text":"on 31st December 20X3 after the third payment?"},{"Start":"07:00.565 ","End":"07:04.735","Text":"So essentially, what we\u0027re being asked for is what is the present value."},{"Start":"07:04.735 ","End":"07:11.170","Text":"But pretending that we are presently at the 31st of December 20X3."},{"Start":"07:11.170 ","End":"07:13.840","Text":"If we\u0027ve drawn up that table that we used a moment"},{"Start":"07:13.840 ","End":"07:16.300","Text":"ago to double-check our answer in part A,"},{"Start":"07:16.300 ","End":"07:18.400","Text":"we can pick out the answer very easily."},{"Start":"07:18.400 ","End":"07:20.860","Text":"If you have a look here, we\u0027ve got a table showing"},{"Start":"07:20.860 ","End":"07:23.500","Text":"the closing balances in each of the years."},{"Start":"07:23.500 ","End":"07:28.090","Text":"We\u0027re looking for the closing balance of the loan at the end of year 3."},{"Start":"07:28.090 ","End":"07:30.220","Text":"There it is, that\u0027s the line."},{"Start":"07:30.220 ","End":"07:32.725","Text":"Which of those figures is the one we\u0027re looking for?"},{"Start":"07:32.725 ","End":"07:34.750","Text":"It\u0027s the 74,000."},{"Start":"07:34.750 ","End":"07:38.470","Text":"We can also see it as the present value of the future payments."},{"Start":"07:38.470 ","End":"07:40.600","Text":"In other words, pretending we\u0027re at the end of year 3,"},{"Start":"07:40.600 ","End":"07:43.135","Text":"we\u0027ve 7 payments to go."},{"Start":"07:43.135 ","End":"07:46.515","Text":"In other words, ignore years 1, 2,"},{"Start":"07:46.515 ","End":"07:52.065","Text":"and 3, except for the last closing balance for year 3, 74,000."},{"Start":"07:52.065 ","End":"07:56.390","Text":"We\u0027re looking at it as if we\u0027re the first day of year 4, if you like."},{"Start":"07:56.390 ","End":"07:58.765","Text":"How much do we have to pay?"},{"Start":"07:58.765 ","End":"08:05.545","Text":"In this case, now got an annuity of 7 years with repayments of 12,329,"},{"Start":"08:05.545 ","End":"08:07.705","Text":"and interest rate of 4 percent,"},{"Start":"08:07.705 ","End":"08:09.745","Text":"and we can work to the present value,"},{"Start":"08:09.745 ","End":"08:11.665","Text":"which would be 74,000."},{"Start":"08:11.665 ","End":"08:16.690","Text":"So 74,000 is the present value as at the end of Year 3,"},{"Start":"08:16.690 ","End":"08:23.125","Text":"7 future repayments of 12,329 each at an interest rate of 4 percent."},{"Start":"08:23.125 ","End":"08:25.240","Text":"Now if you haven\u0027t drawn up that table,"},{"Start":"08:25.240 ","End":"08:27.925","Text":"which is time-consuming,"},{"Start":"08:27.925 ","End":"08:30.799","Text":"you might want to use the formula."},{"Start":"08:31.440 ","End":"08:34.540","Text":"There is the formula."},{"Start":"08:34.540 ","End":"08:39.740","Text":"Remember, the amounts are going to differ because we are now at a different date."},{"Start":"08:41.730 ","End":"08:44.170","Text":"We\u0027re looking for the present value."},{"Start":"08:44.170 ","End":"08:45.475","Text":"We don\u0027t have that amount."},{"Start":"08:45.475 ","End":"08:46.810","Text":"That\u0027s what we\u0027re looking for."},{"Start":"08:46.810 ","End":"08:48.279","Text":"You put in the payment,"},{"Start":"08:48.279 ","End":"08:51.355","Text":"this case now we know what it is, it\u0027s 12,329."},{"Start":"08:51.355 ","End":"08:53.950","Text":"Then we\u0027re going to put in the number of periods,"},{"Start":"08:53.950 ","End":"08:56.920","Text":"that\u0027s 7, so it\u0027s to the power of 7."},{"Start":"08:56.920 ","End":"09:00.565","Text":"The interest rates remains the same at 4 percent."},{"Start":"09:00.565 ","End":"09:03.865","Text":"If we solve for that,"},{"Start":"09:03.865 ","End":"09:08.125","Text":"we\u0027ve got the numerator 1.04 to the power of 7,"},{"Start":"09:08.125 ","End":"09:10.570","Text":"and the denominator is also got that same figure,"},{"Start":"09:10.570 ","End":"09:12.595","Text":"1.04 to the power of 7."},{"Start":"09:12.595 ","End":"09:16.870","Text":"If we work that out, it\u0027s 1.315932,"},{"Start":"09:16.870 ","End":"09:18.550","Text":"and the more decimal points you have,"},{"Start":"09:18.550 ","End":"09:21.055","Text":"obviously the more accurate your answer will be."},{"Start":"09:21.055 ","End":"09:23.290","Text":"Now we can solve for the numerator."},{"Start":"09:23.290 ","End":"09:29.950","Text":"In other words, the formula above the line 12,329 multiplied by the difference"},{"Start":"09:29.950 ","End":"09:38.000","Text":"between 1.315932 minus 1, multiplied by 0.315932."},{"Start":"09:39.930 ","End":"09:43.930","Text":"Then we\u0027re going to divide by 1.315932,"},{"Start":"09:43.930 ","End":"09:49.900","Text":"multiply by 0.04, which is actually 0.052637."},{"Start":"09:49.900 ","End":"09:55.360","Text":"We get to the present value is the numerator works out to 3,895,"},{"Start":"09:55.360 ","End":"09:58.330","Text":"and the denominator, the 0.05 odd,"},{"Start":"09:58.330 ","End":"10:01.510","Text":"and you divide those two, you get 74,000."},{"Start":"10:01.510 ","End":"10:04.660","Text":"That is the present value at 31st December X3."},{"Start":"10:04.660 ","End":"10:08.980","Text":"Now let\u0027s look at c. How much of the amount calculated in"},{"Start":"10:08.980 ","End":"10:14.230","Text":"b should be classified as a current liability on 31st, December, X3?"},{"Start":"10:14.230 ","End":"10:17.200","Text":"We\u0027re being asked what portion of that present value at"},{"Start":"10:17.200 ","End":"10:24.130","Text":"31st December 20X3 will have been repaid by the 31st of December 20X4?"},{"Start":"10:24.130 ","End":"10:30.425","Text":"Because a current liability is a liability that will be repaid within 1 year of the date."},{"Start":"10:30.425 ","End":"10:32.845","Text":"The date that we\u0027re looking at is 20X3."},{"Start":"10:32.845 ","End":"10:35.380","Text":"How much will it been repaid within a year?"},{"Start":"10:35.380 ","End":"10:39.295","Text":"How much will have been repaid by 31st, December 20X4?"},{"Start":"10:39.295 ","End":"10:41.050","Text":"If we\u0027ve drawn up the table,"},{"Start":"10:41.050 ","End":"10:43.630","Text":"we can pick out the answer again very easily."},{"Start":"10:43.630 ","End":"10:46.645","Text":"There we had it. At the end of year 3,"},{"Start":"10:46.645 ","End":"10:49.495","Text":"we have a closing balance of 74,000."},{"Start":"10:49.495 ","End":"10:55.210","Text":"We\u0027ll still be owing 64,631 a year later,"},{"Start":"10:55.210 ","End":"10:58.390","Text":"at the end of 20X4."},{"Start":"10:58.390 ","End":"11:01.690","Text":"Thus, that means we will have paid off the difference."},{"Start":"11:01.690 ","End":"11:06.160","Text":"If you take 74,000 and you subtract 64,631,"},{"Start":"11:06.160 ","End":"11:09.685","Text":"you get to an amount that\u0027s disappeared or missing,"},{"Start":"11:09.685 ","End":"11:15.220","Text":"repaid 9,369 during the next year."},{"Start":"11:15.220 ","End":"11:23.740","Text":"We will have paid off 9,369 of the principal\u0027s sum during the next year, 20X4."},{"Start":"11:23.740 ","End":"11:26.274","Text":"That is the current portion."},{"Start":"11:26.274 ","End":"11:31.165","Text":"Remember, we are already paying 12,329 in year 4,"},{"Start":"11:31.165 ","End":"11:35.545","Text":"but not all of that repays the principal sum."},{"Start":"11:35.545 ","End":"11:40.300","Text":"Some of you may be wondering why the current portion is not 12,329 because,"},{"Start":"11:40.300 ","End":"11:41.830","Text":"as you can see from the table,"},{"Start":"11:41.830 ","End":"11:45.010","Text":"we\u0027re going to be paying 12,329 in year 4."},{"Start":"11:45.010 ","End":"11:49.210","Text":"What you must remember is that what the liability represents is"},{"Start":"11:49.210 ","End":"11:53.920","Text":"the remaining portion of the principal sum that still remains outstanding."},{"Start":"11:53.920 ","End":"11:56.875","Text":"That 1,329 that is repaid in year 4,"},{"Start":"11:56.875 ","End":"11:59.695","Text":"also includes interest, which is expensed."},{"Start":"11:59.695 ","End":"12:01.840","Text":"It\u0027s not included in the liability."},{"Start":"12:01.840 ","End":"12:04.180","Text":"That\u0027s the difference between the 12,329,"},{"Start":"12:04.180 ","End":"12:05.545","Text":"and the 2,960,"},{"Start":"12:05.545 ","End":"12:09.310","Text":"that gives us that amount of 9,369,"},{"Start":"12:09.310 ","End":"12:13.525","Text":"which is the current portion of liability at the end of X3."},{"Start":"12:13.525 ","End":"12:17.710","Text":"To recap, the total liability will be 74,000 at 31st,"},{"Start":"12:17.710 ","End":"12:22.585","Text":"December 20X3, of which 9,369 is the current portion."},{"Start":"12:22.585 ","End":"12:24.745","Text":"But what if we\u0027ve not drawn up the table?"},{"Start":"12:24.745 ","End":"12:27.640","Text":"Well, we\u0027ll just simply use the same formula as usual."},{"Start":"12:27.640 ","End":"12:31.000","Text":"This time we\u0027re going to calculate the present value at the end of year 4."},{"Start":"12:31.000 ","End":"12:33.040","Text":"The payment is still 12,329,"},{"Start":"12:33.040 ","End":"12:34.690","Text":"so pop that into the formula."},{"Start":"12:34.690 ","End":"12:37.300","Text":"The present value, that\u0027s what we\u0027re looking for."},{"Start":"12:37.300 ","End":"12:39.370","Text":"We\u0027re looking for the present value at 31st,"},{"Start":"12:39.370 ","End":"12:42.610","Text":"December 20X4, that\u0027s the unknown amount."},{"Start":"12:42.610 ","End":"12:46.660","Text":"Given that we\u0027re now pretending it\u0027s the 31st, December 20X4,"},{"Start":"12:46.660 ","End":"12:51.085","Text":"n is then going to be 6 years because they will be 6 repayments lift."},{"Start":"12:51.085 ","End":"12:54.114","Text":"R is the interest rate of 4 percent."},{"Start":"12:54.114 ","End":"12:57.415","Text":"We\u0027ve pumped all of that into the formula."},{"Start":"12:57.415 ","End":"13:00.745","Text":"Now what we have to do is solve it."},{"Start":"13:00.745 ","End":"13:05.500","Text":"The present value, 31st December X3 was 74,000,"},{"Start":"13:05.500 ","End":"13:10.135","Text":"but the present value at 31st December X4 is 64,630."},{"Start":"13:10.135 ","End":"13:17.230","Text":"The 74,000 being the balance at 31st December X3 minus the 64,630 being the balance at"},{"Start":"13:17.230 ","End":"13:24.370","Text":"31st December X4 is the 9,369 of the loan capital that will be repaid off during 20X4."},{"Start":"13:24.370 ","End":"13:29.515","Text":"The answer to part C is 9,369, the current portion."},{"Start":"13:29.515 ","End":"13:32.080","Text":"Now let\u0027s look at d. In d,"},{"Start":"13:32.080 ","End":"13:34.885","Text":"we\u0027re asked for the interest expense in 20X4."},{"Start":"13:34.885 ","End":"13:38.260","Text":"To calculate this, we take the present value of the liability at"},{"Start":"13:38.260 ","End":"13:40.960","Text":"the end of 20X3 or the opening balance at"},{"Start":"13:40.960 ","End":"13:44.035","Text":"the beginning of 20X4 and multiply it by the interest rate."},{"Start":"13:44.035 ","End":"13:47.170","Text":"What is the present value of the liability at end of 20X3?"},{"Start":"13:47.170 ","End":"13:50.635","Text":"In other words, what is the total liability at the end of 20X3?"},{"Start":"13:50.635 ","End":"13:52.615","Text":"It\u0027s 74,000."},{"Start":"13:52.615 ","End":"13:54.115","Text":"What\u0027s the interest rate?"},{"Start":"13:54.115 ","End":"13:55.420","Text":"That\u0027s 4 percent."},{"Start":"13:55.420 ","End":"14:01.000","Text":"If we take the present value at the end of 20X3 is 74,000 multiplied by 4 percent,"},{"Start":"14:01.000 ","End":"14:02.845","Text":"we get 2,960,"},{"Start":"14:02.845 ","End":"14:05.560","Text":"and that\u0027s the interest expense in 20X4."},{"Start":"14:05.560 ","End":"14:10.220","Text":"We could also pick up this interest in 20X4 using the table."},{"Start":"14:10.220 ","End":"14:13.220","Text":"There it is. In the fourth row,"},{"Start":"14:13.220 ","End":"14:17.580","Text":"74,000 interest is 2,960."}],"ID":31016},{"Watched":false,"Name":"Exercise 7","Duration":"7m 34s","ChapterTopicVideoID":29407,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:06.220","Text":"Hello and welcome to an exercise on non-current liabilities brought to you by Proprep."},{"Start":"00:06.220 ","End":"00:12.060","Text":"This is an exercise involving accounting for repayment of a loan."},{"Start":"00:12.060 ","End":"00:15.090","Text":"Imagine, it is now 31st,"},{"Start":"00:15.090 ","End":"00:20.485","Text":"December 20X0 and Vanish borrows CU 100,000."},{"Start":"00:20.485 ","End":"00:30.560","Text":"The terms of this loan are that there\u0027ll be 20 equal payments of CU 5,818.21."},{"Start":"00:30.560 ","End":"00:34.820","Text":"These are going to be paid on the 30th of June and 31st of December,"},{"Start":"00:34.820 ","End":"00:37.715","Text":"so every 6 months."},{"Start":"00:37.715 ","End":"00:40.280","Text":"The interest rate is 3 percent."},{"Start":"00:40.280 ","End":"00:42.995","Text":"Note that this is an annual rate."},{"Start":"00:42.995 ","End":"00:46.895","Text":"Assume the financial year is 31st December,"},{"Start":"00:46.895 ","End":"00:52.915","Text":"what will be the outstanding balance of the loan on 31 December, 20X1?"},{"Start":"00:52.915 ","End":"00:57.620","Text":"B, how much of the amount calculated in a should be classified"},{"Start":"00:57.620 ","End":"01:02.605","Text":"as a current liability on 31st December 20X1?"},{"Start":"01:02.605 ","End":"01:11.040","Text":"C, how much interest expense should Vanish recognize in 20X1?"},{"Start":"01:11.040 ","End":"01:14.060","Text":"Let\u0027s do the solution to the exercise"},{"Start":"01:14.060 ","End":"01:17.480","Text":"involving the accounting for a repayment of the loan."},{"Start":"01:17.480 ","End":"01:21.700","Text":"In this example, we\u0027re going to first need to calculate the semi-annual interest rate,"},{"Start":"01:21.700 ","End":"01:24.485","Text":"and that is because we were given an annual interest rate,"},{"Start":"01:24.485 ","End":"01:28.975","Text":"but the repayments happen more frequently during the year."},{"Start":"01:28.975 ","End":"01:30.760","Text":"We start with 1,"},{"Start":"01:30.760 ","End":"01:34.520","Text":"we add the annual rate and we take it to the power of n,"},{"Start":"01:34.520 ","End":"01:40.145","Text":"where n is the portion of the year at which point a repayment occurs,"},{"Start":"01:40.145 ","End":"01:41.800","Text":"and then we subtract 1."},{"Start":"01:41.800 ","End":"01:43.670","Text":"Let\u0027s see how this works."},{"Start":"01:43.670 ","End":"01:47.990","Text":"We\u0027ve got an annual rate of 3 percent or 0.03."},{"Start":"01:47.990 ","End":"01:51.810","Text":"We\u0027ve taken 1 plus the 0.03, we make this to the power of 5,"},{"Start":"01:53.750 ","End":"01:58.190","Text":"and that is because halfway through the year we make a payment,"},{"Start":"01:58.190 ","End":"02:02.515","Text":"so every half a year we make a payment, minus 1."},{"Start":"02:02.515 ","End":"02:09.390","Text":"That gives us 0.014889."},{"Start":"02:09.390 ","End":"02:14.740","Text":"That is our interest rate, 1.4889 percent."},{"Start":"02:14.740 ","End":"02:16.880","Text":"Now let\u0027s drive to loan schedule."},{"Start":"02:16.880 ","End":"02:18.980","Text":"This will just be an extract because"},{"Start":"02:18.980 ","End":"02:21.500","Text":"the complete loan schedule will have 20 lines"},{"Start":"02:21.500 ","End":"02:24.470","Text":"and we don\u0027t need as many as that to answer the question."},{"Start":"02:24.470 ","End":"02:29.065","Text":"We\u0027re going to do a loan schedule to 31st of December X2."},{"Start":"02:29.065 ","End":"02:32.555","Text":"We start with the opening balance of 100,000,"},{"Start":"02:32.555 ","End":"02:36.260","Text":"interests at 1.4889 percent,"},{"Start":"02:36.260 ","End":"02:41.395","Text":"multiplied by that 100,000 gives us 1,488.92,"},{"Start":"02:41.395 ","End":"02:50.495","Text":"5,818.21, and that gives us a closing balance, 95,670.71."},{"Start":"02:50.495 ","End":"02:54.710","Text":"That is the closing balance halfway through the year though, 30th of June."},{"Start":"02:54.710 ","End":"02:57.560","Text":"That then becomes the opening balance for the next period,"},{"Start":"02:57.560 ","End":"03:00.340","Text":"which will end on the 31st of December."},{"Start":"03:00.340 ","End":"03:04.425","Text":"In other words, the first of July, 20X1."},{"Start":"03:04.425 ","End":"03:08.825","Text":"We then multiply that by the interest rate of 1.4889 percent,"},{"Start":"03:08.825 ","End":"03:11.525","Text":"and that gives us 1,424.46."},{"Start":"03:11.525 ","End":"03:15.185","Text":"We subtract the payment of 5,818.21,"},{"Start":"03:15.185 ","End":"03:18.185","Text":"and that gives us a closing balance of"},{"Start":"03:18.185 ","End":"03:25.339","Text":"91,276.95 at the end of the year 31st, December X1."},{"Start":"03:25.339 ","End":"03:29.705","Text":"In turn, that becomes the opening balance in \u0027X2, 1st of January,"},{"Start":"03:29.705 ","End":"03:37.195","Text":"20X2, or the opening balance for the period that will end 30th of June \u0027X2."},{"Start":"03:37.195 ","End":"03:42.955","Text":"We multiply the 91,276.95 by the interest rate of 1.4889,"},{"Start":"03:42.955 ","End":"03:44.405","Text":"we subtract the payment,"},{"Start":"03:44.405 ","End":"03:47.930","Text":"we get the closing balance for that 6 monthly period,"},{"Start":"03:47.930 ","End":"03:54.805","Text":"becomes the opening balance on the 1st of July, 20X2, 86,817.78."},{"Start":"03:54.805 ","End":"04:00.035","Text":"We add interests at 1.4889 percent, subtract the payment,"},{"Start":"04:00.035 ","End":"04:06.020","Text":"and we get to the closing balance at 31st December \u0027X2 of 82,292.21,"},{"Start":"04:06.020 ","End":"04:08.095","Text":"which is the end of the second year."},{"Start":"04:08.095 ","End":"04:11.220","Text":"In part a, what were we asked?"},{"Start":"04:11.220 ","End":"04:17.755","Text":"A said, what will be the outstanding balance of the loan on 31, December 20X1?"},{"Start":"04:17.755 ","End":"04:21.395","Text":"Well, looking at that schedule that we drafted a moment ago,"},{"Start":"04:21.395 ","End":"04:28.330","Text":"the closing balance at 31st December \u0027X1 is 91,276.95."},{"Start":"04:28.330 ","End":"04:30.045","Text":"Just for interest,"},{"Start":"04:30.045 ","End":"04:32.685","Text":"if you are going to be using the formula,"},{"Start":"04:32.685 ","End":"04:37.610","Text":"this 91,276.95 could also have been calculated as"},{"Start":"04:37.610 ","End":"04:43.240","Text":"the present value of the remaining 18 payments of 5,818.21,"},{"Start":"04:43.240 ","End":"04:44.765","Text":"and the interest rate, obviously,"},{"Start":"04:44.765 ","End":"04:48.545","Text":"you use is 1.4889 percent."},{"Start":"04:48.545 ","End":"04:50.815","Text":"We ask ourselves first and foremost,"},{"Start":"04:50.815 ","End":"04:55.500","Text":"what will be the outstanding balance of the loan of 31 December 20X2?"},{"Start":"04:55.500 ","End":"05:00.429","Text":"Now, the reason that we look to calculating the outstanding balance at 31 December 20X2,"},{"Start":"05:00.429 ","End":"05:03.550","Text":"when we\u0027re being asked what is the current liability balance of"},{"Start":"05:03.550 ","End":"05:05.770","Text":"31 December 20X1 is because"},{"Start":"05:05.770 ","End":"05:09.865","Text":"a current liability is a liability that will be repaid within a year."},{"Start":"05:09.865 ","End":"05:14.780","Text":"If we compare the outstanding balance of the loan at 31 December 20X1,"},{"Start":"05:14.780 ","End":"05:16.450","Text":"with the outstanding balance of the loan at"},{"Start":"05:16.450 ","End":"05:21.830","Text":"31 December 20X2 we\u0027ll be able to work out how much gets paid within the next year,"},{"Start":"05:21.830 ","End":"05:25.035","Text":"20X2, and that\u0027s the current portion."},{"Start":"05:25.035 ","End":"05:29.530","Text":"Let\u0027s have a look. What will be the outstanding balance of the loan 31 December 20X2?"},{"Start":"05:29.530 ","End":"05:30.730","Text":"You can see it on the schedule,"},{"Start":"05:30.730 ","End":"05:33.220","Text":"it\u0027s 82,292.21."},{"Start":"05:33.220 ","End":"05:34.610","Text":"That\u0027s our answer."},{"Start":"05:34.610 ","End":"05:36.920","Text":"Then we ask ourselves what will be the outstanding balance"},{"Start":"05:36.920 ","End":"05:39.185","Text":"of the loan at 31 December 20X1?"},{"Start":"05:39.185 ","End":"05:42.185","Text":"Well, we worked that out in part a but let\u0027s have a look again."},{"Start":"05:42.185 ","End":"05:46.345","Text":"The answer is 91,276.95."},{"Start":"05:46.345 ","End":"05:48.675","Text":"You can see that a year later,"},{"Start":"05:48.675 ","End":"05:52.490","Text":"20X2, it\u0027s dropped a few thousand."},{"Start":"05:52.490 ","End":"05:53.795","Text":"How much has it dropped by?"},{"Start":"05:53.795 ","End":"05:58.025","Text":"Well, how much of the 20X balance will be repaid in 20X2?"},{"Start":"05:58.025 ","End":"05:59.165","Text":"Being the current portion,"},{"Start":"05:59.165 ","End":"06:04.238","Text":"it\u0027s the difference between the 91,276.95,"},{"Start":"06:04.238 ","End":"06:06.585","Text":"and the 82,292.21,"},{"Start":"06:06.585 ","End":"06:11.370","Text":"the difference there is 8,984.74."},{"Start":"06:11.370 ","End":"06:17.770","Text":"The 82,292.21 reflects the amount that will still be owed 1 year late."},{"Start":"06:17.770 ","End":"06:22.010","Text":"The 82,292.21 at 31 December X2"},{"Start":"06:22.010 ","End":"06:25.625","Text":"is the amount that is still owed 1 year later from the date we\u0027re actually working with,"},{"Start":"06:25.625 ","End":"06:27.695","Text":"which is 31 December 20X1."},{"Start":"06:27.695 ","End":"06:32.095","Text":"That 82,292.21 is the long-term portion."},{"Start":"06:32.095 ","End":"06:34.350","Text":"The difference between those 2 figures,"},{"Start":"06:34.350 ","End":"06:39.390","Text":"the 91,276.95 and 82,292.21,"},{"Start":"06:39.390 ","End":"06:43.575","Text":"the 8984.74, that\u0027s the current portion."},{"Start":"06:43.575 ","End":"06:48.250","Text":"The total liability at 31 December 20X1 is 91,276.95,"},{"Start":"06:53.540 ","End":"06:58.835","Text":"of which 82,292.21 will be reflected as"},{"Start":"06:58.835 ","End":"07:06.755","Text":"a non-current or long-term liability and the 8984.74 is the current liability."},{"Start":"07:06.755 ","End":"07:12.640","Text":"Then part c, how much interest expense should Vanish recognize in 20X1?"},{"Start":"07:12.640 ","End":"07:18.185","Text":"We look at that same table and because we\u0027re repaying twice a year,"},{"Start":"07:18.185 ","End":"07:19.369","Text":"you must be careful."},{"Start":"07:19.369 ","End":"07:26.910","Text":"We need to pick up 2 interest payments is 1,488.92 and 1,424.46."},{"Start":"07:26.910 ","End":"07:30.980","Text":"The total interest expense will be the total of those 2,"},{"Start":"07:30.980 ","End":"07:35.290","Text":"which gives us 2,913.38."}],"ID":31017},{"Watched":false,"Name":"Exercise 8","Duration":"9m 59s","ChapterTopicVideoID":29408,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:02.205","Text":"This exercise deals with"},{"Start":"00:02.205 ","End":"00:08.834","Text":"a zero-coupon bond which is a bond that appears to incur no interest."},{"Start":"00:08.834 ","End":"00:14.505","Text":"On 31, December X1 Poogy issues a zero-coupon bond"},{"Start":"00:14.505 ","End":"00:20.340","Text":"with face value of 80,000 which will be due on 31, December XX."},{"Start":"00:20.340 ","End":"00:25.965","Text":"In other words, Poogy will have to repay it on 31st December XX."},{"Start":"00:25.965 ","End":"00:30.585","Text":"The market prices the bond at 5 percent."},{"Start":"00:30.585 ","End":"00:34.590","Text":"Required, assume the financial year end is 31,"},{"Start":"00:34.590 ","End":"00:36.510","Text":"December; a,"},{"Start":"00:36.510 ","End":"00:41.160","Text":"calculate the amount Poogy borrows on 31, December 20X1,"},{"Start":"00:41.160 ","End":"00:46.940","Text":"b, calculate the interest expense Poogy needs to recognize in the year ending 31,"},{"Start":"00:46.940 ","End":"00:50.510","Text":"December 20X4, and c,"},{"Start":"00:50.510 ","End":"00:57.330","Text":"determine the net amount of cash Poogy will repay bond investors over the 5 year period."},{"Start":"00:57.590 ","End":"01:03.530","Text":"Bearing in mind that we\u0027re dealing with a zero-coupon bond it means that we\u0027re not"},{"Start":"01:03.530 ","End":"01:09.315","Text":"actually paying any interest during the 5-year period,"},{"Start":"01:09.315 ","End":"01:11.265","Text":"but at the end of the 5-year period,"},{"Start":"01:11.265 ","End":"01:15.480","Text":"we will be repaying the 80,000 currency units."},{"Start":"01:15.480 ","End":"01:20.195","Text":"The amount that we\u0027re going to record as having been borrowed is"},{"Start":"01:20.195 ","End":"01:26.480","Text":"the present value of that future repayment of 80,000 and that\u0027s all."},{"Start":"01:26.480 ","End":"01:29.900","Text":"There are no payments of interest between"},{"Start":"01:29.900 ","End":"01:34.090","Text":"now and the date of repayment of that 80,000 at the end of 5 years."},{"Start":"01:34.090 ","End":"01:38.435","Text":"To calculate this using the present value factors you simply multiply the"},{"Start":"01:38.435 ","End":"01:44.040","Text":"80,000 by the relevant present value factor which we then have to calculate."},{"Start":"01:44.040 ","End":"01:48.920","Text":"How do you calculate the present value factor of an amount that is received or paid?"},{"Start":"01:48.920 ","End":"01:54.730","Text":"In this case, it\u0027s an amount paid discounted at the market rate of 5 percent."},{"Start":"01:54.730 ","End":"01:57.450","Text":"Well, we start with now."},{"Start":"01:57.450 ","End":"02:00.620","Text":"If you receive or pay something right now"},{"Start":"02:00.620 ","End":"02:04.715","Text":"the present value and the future value are the same so the factor is always 1."},{"Start":"02:04.715 ","End":"02:06.950","Text":"What about after 1 year?"},{"Start":"02:06.950 ","End":"02:10.540","Text":"Well then we take now\u0027s factor, which is 1,"},{"Start":"02:10.540 ","End":"02:16.055","Text":"and you divide by 1.05 and you get 0.952381."},{"Start":"02:16.055 ","End":"02:20.870","Text":"What about for a payment were to happen at the end of year 2?"},{"Start":"02:20.870 ","End":"02:24.470","Text":"Well, you would take last year\u0027s present value factor of"},{"Start":"02:24.470 ","End":"02:33.630","Text":"0.952381 from after year 1 and you divide it by 1.05 again."},{"Start":"02:33.630 ","End":"02:38.175","Text":"This time you get a smaller factor 0.907029."},{"Start":"02:38.175 ","End":"02:43.340","Text":"It\u0027s a smaller factor because it indicates that the value has gone down."},{"Start":"02:43.460 ","End":"02:47.760","Text":"After year 3 take the 0.907029,"},{"Start":"02:47.760 ","End":"02:50.685","Text":"which was last year\u0027s present value factor,"},{"Start":"02:50.685 ","End":"02:57.525","Text":"you divide by 1.05 and you get 0.863838, and so on."},{"Start":"02:57.525 ","End":"03:03.945","Text":"You do that for year 4 and year 5 and it\u0027s after year 5 that we\u0027re making the payment."},{"Start":"03:03.945 ","End":"03:12.390","Text":"This is the present value factor we\u0027re looking for, 0.783526."},{"Start":"03:12.390 ","End":"03:14.630","Text":"The present value factor calculation that we\u0027ve just"},{"Start":"03:14.630 ","End":"03:17.360","Text":"performed there could actually be simplified as follows."},{"Start":"03:17.360 ","End":"03:23.480","Text":"1 divide by 1 plus whatever the rate is to the power of n,"},{"Start":"03:23.480 ","End":"03:29.395","Text":"where n is the number of years until the payment is actually going to occur."},{"Start":"03:29.395 ","End":"03:37.325","Text":"In this question, it\u0027s 1/1.05 where that 5 refers to the market rate of 5 percent,"},{"Start":"03:37.325 ","End":"03:41.520","Text":"close brackets to the power of 5, where 5,"},{"Start":"03:41.520 ","End":"03:43.880","Text":"in this case, refers to the number of years"},{"Start":"03:43.880 ","End":"03:46.595","Text":"between now and when that payment is going to occur."},{"Start":"03:46.595 ","End":"03:49.655","Text":"You see it\u0027s a lot shorter calculation."},{"Start":"03:49.655 ","End":"03:51.970","Text":"But you can do it either way."},{"Start":"03:51.970 ","End":"03:54.980","Text":"Now that we\u0027ve got a present value factor you can"},{"Start":"03:54.980 ","End":"03:57.560","Text":"calculate the present value, it\u0027s quite simple."},{"Start":"03:57.560 ","End":"04:00.080","Text":"It\u0027s the 80,000 the actual cash outflow"},{"Start":"04:00.080 ","End":"04:03.200","Text":"that\u0027s going to occur and you multiply it by the factor"},{"Start":"04:03.200 ","End":"04:11.375","Text":"0.783526 and our answer then is 62,682.09 currents units."},{"Start":"04:11.375 ","End":"04:13.520","Text":"Now there is another way that we could have actually"},{"Start":"04:13.520 ","End":"04:16.820","Text":"calculated this instead of in 2 steps where you"},{"Start":"04:16.820 ","End":"04:22.910","Text":"first calculate the present value factor and then multiply the cash flow by the factor."},{"Start":"04:22.910 ","End":"04:25.235","Text":"You could do it all in 1 as follows."},{"Start":"04:25.235 ","End":"04:28.710","Text":"This is the present value of a single cash flow."},{"Start":"04:28.710 ","End":"04:32.015","Text":"You take the cash flow and you divide it by"},{"Start":"04:32.015 ","End":"04:35.690","Text":"1 plus whatever the rate is to the power of n,"},{"Start":"04:35.690 ","End":"04:38.900","Text":"being the number of periods until that cash flow occurs."},{"Start":"04:38.900 ","End":"04:45.530","Text":"In this case would have been 80,000/(1.05)^5,"},{"Start":"04:45.530 ","End":"04:49.370","Text":"giving us the same answer, 62,682.09."},{"Start":"04:49.370 ","End":"04:51.490","Text":"It\u0027s a lot quicker that way."},{"Start":"04:51.490 ","End":"04:53.850","Text":"Now we\u0027re going to do part b."},{"Start":"04:53.850 ","End":"04:56.720","Text":"What is the interest expense Poogy needs to recognize in"},{"Start":"04:56.720 ","End":"05:00.080","Text":"the year ending 31 December 20X4?"},{"Start":"05:00.080 ","End":"05:03.155","Text":"Just a quick reminder of the details given in the question."},{"Start":"05:03.155 ","End":"05:06.905","Text":"On 31 December 20X1 Poogy issued"},{"Start":"05:06.905 ","End":"05:12.500","Text":"the zero-coupon bond with a face value of 80,000 and it\u0027s due on the 31,"},{"Start":"05:12.500 ","End":"05:15.140","Text":"December XX or 5 years later,"},{"Start":"05:15.140 ","End":"05:17.720","Text":"and the market prices the bond at 5 percent."},{"Start":"05:17.720 ","End":"05:24.575","Text":"Although we\u0027re not paying interest the market sees it as being a 5 percent bond."},{"Start":"05:24.575 ","End":"05:26.840","Text":"It\u0027s a 5 year bond,"},{"Start":"05:26.840 ","End":"05:30.915","Text":"and we\u0027re being asked for the interests in the 3rd year."},{"Start":"05:30.915 ","End":"05:32.670","Text":"20X1 to 20X4,"},{"Start":"05:32.670 ","End":"05:40.215","Text":"there\u0027s a gap of 3 years so they\u0027re looking for that 3rd year ending 31, December 20X4."},{"Start":"05:40.215 ","End":"05:43.400","Text":"In b, the interest expense in 20X4 is"},{"Start":"05:43.400 ","End":"05:46.520","Text":"obviously the product of the opening balance in 20X4."},{"Start":"05:46.520 ","End":"05:48.950","Text":"In other words, the amount we still owe at the beginning"},{"Start":"05:48.950 ","End":"05:51.830","Text":"of 20X4 multiplied by 5 percent."},{"Start":"05:51.830 ","End":"05:56.810","Text":"This opening balance in 20X4 is also the closing balance on 31,"},{"Start":"05:56.810 ","End":"05:59.780","Text":"December 20X3, the day before."},{"Start":"05:59.780 ","End":"06:03.920","Text":"Now, bearing in mind that the bond is repayable on 31,"},{"Start":"06:03.920 ","End":"06:09.320","Text":"December 20X6 we can see then that there are 3 years remaining."},{"Start":"06:09.320 ","End":"06:12.260","Text":"At 31st, December 20X3 there are 3 years"},{"Start":"06:12.260 ","End":"06:16.775","Text":"left before the repayment of the 80,000 has to take place."},{"Start":"06:16.775 ","End":"06:19.130","Text":"The ending balance on 31,"},{"Start":"06:19.130 ","End":"06:22.910","Text":"December 20X3 is the present value of the 80,000"},{"Start":"06:22.910 ","End":"06:29.635","Text":"repayment discounted at 5 percent over the remaining 3 years."},{"Start":"06:29.635 ","End":"06:32.650","Text":"The ending balance on 31, December 20X3,"},{"Start":"06:32.650 ","End":"06:34.640","Text":"which is the same thing as the opening balance on"},{"Start":"06:34.640 ","End":"06:38.640","Text":"the 1st of the 1st 20X4 is 80,000/1.05,"},{"Start":"06:39.460 ","End":"06:43.695","Text":"where 5 is the market rate, to the power of 3,"},{"Start":"06:43.695 ","End":"06:48.365","Text":"which is because there are 3 years remaining before the actual cash flow takes place."},{"Start":"06:48.365 ","End":"06:55.035","Text":"That gives us a present value of 69,107.01 currency units."},{"Start":"06:55.035 ","End":"06:57.570","Text":"That is the opening balance on the 1st of the 1st,"},{"Start":"06:57.570 ","End":"07:04.040","Text":"20X4 and thus the interest expense in 20X4 is simply 69,107.01"},{"Start":"07:04.040 ","End":"07:11.820","Text":"multiplied by 5 percent giving us interest of 3,455.35."},{"Start":"07:11.820 ","End":"07:17.670","Text":"We could pick this up from the table if you prefer to using the table. Let\u0027s take a look."},{"Start":"07:17.670 ","End":"07:21.120","Text":"If you draw up a table you start with the opening balance which was"},{"Start":"07:21.120 ","End":"07:25.800","Text":"62,682.09 which was calculated in part a."},{"Start":"07:25.800 ","End":"07:27.630","Text":"The interest at 5 percent is simply the"},{"Start":"07:27.630 ","End":"07:34.140","Text":"62,682.09 multiplied by the 5 percent giving us 3,134.10."},{"Start":"07:34.140 ","End":"07:37.310","Text":"Now, remember this is a zero-coupon bond which means we\u0027re"},{"Start":"07:37.310 ","End":"07:40.160","Text":"actually not paying interest even though we"},{"Start":"07:40.160 ","End":"07:42.920","Text":"are going to be recording an interest expense we\u0027re not"},{"Start":"07:42.920 ","End":"07:46.145","Text":"actually paying any interest across on this bond."},{"Start":"07:46.145 ","End":"07:49.730","Text":"The repayment is currently 0 so the closing balance is simply"},{"Start":"07:49.730 ","End":"07:53.405","Text":"those 2 added together 65,816.20."},{"Start":"07:53.405 ","End":"07:55.850","Text":"That becomes the opening balance in year 2."},{"Start":"07:55.850 ","End":"07:57.325","Text":"We do the same thing again."},{"Start":"07:57.325 ","End":"08:02.115","Text":"Multiply by 5 percent to give us the interest 3,290.81."},{"Start":"08:02.115 ","End":"08:05.930","Text":"Still, no repayments so the balance at the end of that period of"},{"Start":"08:05.930 ","End":"08:09.745","Text":"the 2nd year is 69,107.01."},{"Start":"08:09.745 ","End":"08:13.310","Text":"That becomes the opening balance in year 3 or the 3rd year of"},{"Start":"08:13.310 ","End":"08:17.370","Text":"the bond which is the 1st of the 1st 20X4."},{"Start":"08:17.370 ","End":"08:20.085","Text":"We multiply that by 5 percent and there we have it"},{"Start":"08:20.085 ","End":"08:26.130","Text":"3,455.35 and that\u0027s the answer to part b using the table."},{"Start":"08:26.130 ","End":"08:31.230","Text":"Just for interest, the closing balance would then be 72,562.36 which becomes"},{"Start":"08:31.230 ","End":"08:36.510","Text":"the opening balance in the next year the 4th year of the bond giving 3,628.12."},{"Start":"08:36.510 ","End":"08:42.490","Text":"We add those 2 together they gives us the closing balance at 76,190.48."},{"Start":"08:42.490 ","End":"08:44.316","Text":"Becomes our opening balance,"},{"Start":"08:44.316 ","End":"08:51.465","Text":"multiply by 5 percent gives us 3,809.52 and at that point,"},{"Start":"08:51.465 ","End":"08:53.295","Text":"we repay the bond."},{"Start":"08:53.295 ","End":"08:58.225","Text":"We\u0027ve got minus 80,000 there giving us a closing balance of nothing."},{"Start":"08:58.225 ","End":"09:00.265","Text":"Now part c,"},{"Start":"09:00.265 ","End":"09:03.650","Text":"determine the net amount of cash Poogy will"},{"Start":"09:03.650 ","End":"09:07.525","Text":"be repaying its bond investors over the 5-year period."},{"Start":"09:07.525 ","End":"09:10.740","Text":"Let us recap. 31st, December 20X1,"},{"Start":"09:10.740 ","End":"09:15.190","Text":"Poogy issued the zero-coupon bond with a face value of 80,000."},{"Start":"09:15.190 ","End":"09:18.660","Text":"It\u0027s due on 31, December 20X6,"},{"Start":"09:18.660 ","End":"09:19.875","Text":"5 years later,"},{"Start":"09:19.875 ","End":"09:22.935","Text":"and the market price the bond at 5 percent."},{"Start":"09:22.935 ","End":"09:27.180","Text":"Part c, being the net impact on Poogy\u0027s cash for the 5-year period using a table."},{"Start":"09:27.180 ","End":"09:31.870","Text":"Let\u0027s take a look. What we worked out was the inflow."},{"Start":"09:31.870 ","End":"09:34.930","Text":"In other words, the cash that we actually received when we sold"},{"Start":"09:34.930 ","End":"09:39.685","Text":"these bonds was 62,682.09,"},{"Start":"09:39.685 ","End":"09:45.525","Text":"and that was calculated in part a and then the outflow which was given to us was 80,000."},{"Start":"09:45.525 ","End":"09:48.295","Text":"We can tell the difference between those 2,"},{"Start":"09:48.295 ","End":"09:52.580","Text":"the outflow less inflow is our net outflow."},{"Start":"09:52.580 ","End":"09:55.070","Text":"In other words, that\u0027s the net impact on our cash."},{"Start":"09:55.070 ","End":"09:58.830","Text":"That was 17,317.9."}],"ID":31018},{"Watched":false,"Name":"Exercise 9","Duration":"11m 16s","ChapterTopicVideoID":29409,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:03.795","Text":"This exercise deals with the bond issued at a discount."},{"Start":"00:03.795 ","End":"00:06.500","Text":"On 31 December, 20X1,"},{"Start":"00:06.500 ","End":"00:09.915","Text":"Gallop issued a bond with the following details."},{"Start":"00:09.915 ","End":"00:12.495","Text":"It had a 3 percent coupon."},{"Start":"00:12.495 ","End":"00:15.285","Text":"The coupon is payable on 31 December,"},{"Start":"00:15.285 ","End":"00:17.319","Text":"starting in 20X2,"},{"Start":"00:17.319 ","End":"00:21.375","Text":"so the first coupon will be on the 31st, December, 20X2."},{"Start":"00:21.375 ","End":"00:24.975","Text":"Its face value is 100,000 currency units,"},{"Start":"00:24.975 ","End":"00:30.375","Text":"and the redemption of the bond is due on 31 December, 20X6."},{"Start":"00:30.375 ","End":"00:34.650","Text":"The market prices the bond at 5 percent."},{"Start":"00:34.650 ","End":"00:40.304","Text":"Note that although we\u0027re going to be paying a coupon rate of only 3 percent,"},{"Start":"00:40.304 ","End":"00:45.395","Text":"the market considers that the interest is higher at 5 percent."},{"Start":"00:45.395 ","End":"00:50.765","Text":"It is because, of this discrepancy that the bond is effectively issued at a discount."},{"Start":"00:50.765 ","End":"00:54.545","Text":"Required; assume the financial year-end is December 31."},{"Start":"00:54.545 ","End":"01:00.465","Text":"A, calculate the amount that Gallop borrowers on 31 December, 20X1."},{"Start":"01:00.465 ","End":"01:04.430","Text":"B, what is the interest expense that Gallop needs to"},{"Start":"01:04.430 ","End":"01:09.450","Text":"recognize in the year ending 31 December, 20X4?"},{"Start":"01:09.450 ","End":"01:13.235","Text":"That\u0027s 3 years after the bond was issued."},{"Start":"01:13.235 ","End":"01:17.090","Text":"C, determine the net amount of cash that Gallop"},{"Start":"01:17.090 ","End":"01:21.035","Text":"will pay the bond investors over the 5-year period."},{"Start":"01:21.035 ","End":"01:25.228","Text":"Let\u0027s do the solution to the exercise in the bond issued at a discount,"},{"Start":"01:25.228 ","End":"01:27.890","Text":"and let\u0027s start with part A which is,"},{"Start":"01:27.890 ","End":"01:32.900","Text":"calculate the amount Gallop borrows on the 31 December, 20X1."},{"Start":"01:32.900 ","End":"01:36.230","Text":"Well, the amount borrowed on the 31st December,"},{"Start":"01:36.230 ","End":"01:42.300","Text":"20X1 is going to be the total of 2 months relating to the outflows."},{"Start":"01:42.300 ","End":"01:44.630","Text":"The first amount that we\u0027re going to calculate is"},{"Start":"01:44.630 ","End":"01:48.014","Text":"the present value of that 100,000 redemption,"},{"Start":"01:48.014 ","End":"01:50.930","Text":"that\u0027s going to happen at the end of the fifth year."},{"Start":"01:50.930 ","End":"01:56.240","Text":"Then we\u0027re going to add to that the present value of the 5 coupon payments,"},{"Start":"01:56.240 ","End":"01:58.685","Text":"in other words, the annuity."},{"Start":"01:58.685 ","End":"02:03.605","Text":"We have 100,000 face value for this bond,"},{"Start":"02:03.605 ","End":"02:05.850","Text":"and the coupon rate is 3 percent."},{"Start":"02:05.850 ","End":"02:09.245","Text":"Therefore the coupon payments will be 100,000 face value"},{"Start":"02:09.245 ","End":"02:13.465","Text":"times by the coupon rate of 3 percent, which is 3,000."},{"Start":"02:13.465 ","End":"02:19.140","Text":"There will be 15,000 paid in terms of coupon payments in total."},{"Start":"02:19.420 ","End":"02:23.390","Text":"Calculating the present value of the future cash outflows."},{"Start":"02:23.390 ","End":"02:29.050","Text":"We\u0027ve got the single outflow of the 100,000 that happens at the end of the fifth year,"},{"Start":"02:29.050 ","End":"02:30.695","Text":"so after 5 years."},{"Start":"02:30.695 ","End":"02:34.280","Text":"Now notice that we are using not the coupon rate,"},{"Start":"02:34.280 ","End":"02:37.325","Text":"but we must always use the market rate."},{"Start":"02:37.325 ","End":"02:43.885","Text":"The market has identified 5 percent as an appropriate rate for this particular bond."},{"Start":"02:43.885 ","End":"02:50.210","Text":"We take the 100,000 as the cash outflows in the numerator and we divide it by,"},{"Start":"02:50.210 ","End":"02:51.755","Text":"and this is the denominator,"},{"Start":"02:51.755 ","End":"02:55.520","Text":"1 plus whatever the market rate is."},{"Start":"02:55.520 ","End":"02:59.585","Text":"It\u0027s 1.05 because the market rate is 5 percent."},{"Start":"02:59.585 ","End":"03:02.240","Text":"Then we take that to the power of 5,"},{"Start":"03:02.240 ","End":"03:06.920","Text":"and the power of 5 relates to the number of years"},{"Start":"03:06.920 ","End":"03:12.115","Text":"or periods before which we will have to repay this sum of money."},{"Start":"03:12.115 ","End":"03:18.830","Text":"That works out to 78,352.62 currency units."},{"Start":"03:18.830 ","End":"03:24.005","Text":"Then we have the present value of the annuity being those coupon payments,"},{"Start":"03:24.005 ","End":"03:25.380","Text":"the total 15,000,"},{"Start":"03:25.380 ","End":"03:26.870","Text":"but we don\u0027t work with 15,000."},{"Start":"03:26.870 ","End":"03:29.240","Text":"We know we\u0027re going to have to pay 15,000 in total,"},{"Start":"03:29.240 ","End":"03:33.875","Text":"but it\u0027s 3,000 per year for 5 years."},{"Start":"03:33.875 ","End":"03:37.300","Text":"Again, we always use the market rate."},{"Start":"03:37.300 ","End":"03:39.365","Text":"Here\u0027s the formula that we use."},{"Start":"03:39.365 ","End":"03:40.760","Text":"Remember the 3 variables;"},{"Start":"03:40.760 ","End":"03:41.929","Text":"you\u0027ve got the payment,"},{"Start":"03:41.929 ","End":"03:44.705","Text":"PMT, that\u0027s going to be 3,000."},{"Start":"03:44.705 ","End":"03:47.930","Text":"The n refers to how many of these payments are going to happen,"},{"Start":"03:47.930 ","End":"03:50.555","Text":"and r refers to the market rate."},{"Start":"03:50.555 ","End":"03:54.965","Text":"Let\u0027s populate this formula with the information that we have."},{"Start":"03:54.965 ","End":"03:58.165","Text":"The payment is 3,000."},{"Start":"03:58.165 ","End":"04:03.050","Text":"Then the 1 plus r that you see on the numerator,"},{"Start":"04:03.050 ","End":"04:09.035","Text":"and 1 plus r that is in the denominator is both 1 plus 0.05,"},{"Start":"04:09.035 ","End":"04:12.044","Text":"the numerator and the denominator,"},{"Start":"04:12.044 ","End":"04:18.780","Text":"that 1 plus 0.05 is to the power of 5 because there are 5 payments."},{"Start":"04:18.780 ","End":"04:21.530","Text":"Then remember the numerator,"},{"Start":"04:21.530 ","End":"04:24.770","Text":"you then subtract 1, but the denominator,"},{"Start":"04:24.770 ","End":"04:31.470","Text":"you multiply by 0.05 being the market rate."},{"Start":"04:31.470 ","End":"04:36.245","Text":"If you solve that, it\u0027s 12,988.43."},{"Start":"04:36.245 ","End":"04:40.870","Text":"What we were asked is how much was borrowed on the 31 December, 20X1."},{"Start":"04:40.870 ","End":"04:44.905","Text":"Obviously, it\u0027s the total of those 2 present values."},{"Start":"04:44.905 ","End":"04:46.575","Text":"Our total present value,"},{"Start":"04:46.575 ","End":"04:53.895","Text":"or the amount that we would have actually received in cash is 91,341.05."},{"Start":"04:53.895 ","End":"04:58.100","Text":"Let\u0027s look at part B. What is the interest expense that Gallop needs"},{"Start":"04:58.100 ","End":"05:02.480","Text":"to recognize in the year ending 31 December, 20X4?"},{"Start":"05:02.480 ","End":"05:06.811","Text":"Bearing in mind that the bond was issued on the 31st, December, 20X1,"},{"Start":"05:06.811 ","End":"05:09.110","Text":"this means it\u0027s in the third year,"},{"Start":"05:09.110 ","End":"05:12.690","Text":"so we\u0027re looking for the interest in the third year."},{"Start":"05:13.420 ","End":"05:18.620","Text":"Well, if you try to work out the interest in the third year or 20X4,"},{"Start":"05:18.620 ","End":"05:21.915","Text":"what you need to do is work out what the opening balance is for that year,"},{"Start":"05:21.915 ","End":"05:25.530","Text":"and multiply it by the market interest rate."},{"Start":"05:26.200 ","End":"05:29.555","Text":"We take the opening balance in 20X4,"},{"Start":"05:29.555 ","End":"05:31.820","Text":"and multiply by 5 percent."},{"Start":"05:31.820 ","End":"05:36.020","Text":"Remember that the opening balance in 20X4 is obviously the ending or"},{"Start":"05:36.020 ","End":"05:40.250","Text":"closing balance on the 31st of December, 20X3."},{"Start":"05:40.250 ","End":"05:46.520","Text":"Then bear in mind that the redemption is going to occur on the 31st of December, 20X6."},{"Start":"05:46.520 ","End":"05:48.964","Text":"It means then that the 31st, December,"},{"Start":"05:48.964 ","End":"05:51.739","Text":"20X3 is 3 years before redemption."},{"Start":"05:51.739 ","End":"05:55.400","Text":"As if you\u0027re standing on that timeline and you\u0027re standing on the 31st of December,"},{"Start":"05:55.400 ","End":"05:58.655","Text":"20X3 and you\u0027re looking forward into the future to see what"},{"Start":"05:58.655 ","End":"06:02.090","Text":"cash outflows are going to occur between now and then."},{"Start":"06:02.090 ","End":"06:03.950","Text":"This ending balance on 31st December,"},{"Start":"06:03.950 ","End":"06:09.195","Text":"20X3 is as the present value of all the cash flows over the remaining 3 years."},{"Start":"06:09.195 ","End":"06:11.690","Text":"Now we didn\u0027t have any inflows of the remaining 3 years,"},{"Start":"06:11.690 ","End":"06:14.070","Text":"we just have outflows."},{"Start":"06:14.210 ","End":"06:17.735","Text":"What we have, there are 2 different kinds."},{"Start":"06:17.735 ","End":"06:19.819","Text":"Again, the single outflow,"},{"Start":"06:19.819 ","End":"06:21.260","Text":"and then the annuity outflow,"},{"Start":"06:21.260 ","End":"06:23.060","Text":"just like as in part A."},{"Start":"06:23.060 ","End":"06:26.570","Text":"The present value of the single cash outflow being"},{"Start":"06:26.570 ","End":"06:30.005","Text":"the 100,000 redemption that\u0027s going to happen now after 3 years."},{"Start":"06:30.005 ","End":"06:31.535","Text":"Notice that when we did part A,"},{"Start":"06:31.535 ","End":"06:32.690","Text":"we said after 5 years,"},{"Start":"06:32.690 ","End":"06:36.410","Text":"and that is because we are standing at a different point on that timeline."},{"Start":"06:36.410 ","End":"06:40.280","Text":"We\u0027re standing at the beginning of the bonds."},{"Start":"06:40.280 ","End":"06:44.240","Text":"In other words, when we initially issued the bond."},{"Start":"06:44.240 ","End":"06:48.500","Text":"We\u0027re trying to work out how much we received on 31st, December, 20X1."},{"Start":"06:48.500 ","End":"06:51.870","Text":"Now, we\u0027re 2 years down the line."},{"Start":"06:51.870 ","End":"06:55.510","Text":"Now we\u0027re looking only 3 years away."},{"Start":"06:55.510 ","End":"06:59.134","Text":"Then we\u0027re going to calculate the present value of the annuity."},{"Start":"06:59.134 ","End":"07:02.330","Text":"But again, whereas in part A,"},{"Start":"07:02.330 ","End":"07:04.550","Text":"we did annuity for 5 years,"},{"Start":"07:04.550 ","End":"07:06.898","Text":"and that was because we were still at the beginning of the bond,"},{"Start":"07:06.898 ","End":"07:09.170","Text":"here we\u0027re going to look at the present value of the annuity"},{"Start":"07:09.170 ","End":"07:11.660","Text":"for 3 years because we\u0027re 2 years into the bond,"},{"Start":"07:11.660 ","End":"07:13.630","Text":"so there are only 3 years left."},{"Start":"07:13.630 ","End":"07:16.265","Text":"Let\u0027s look at the single cash outflow."},{"Start":"07:16.265 ","End":"07:18.485","Text":"It\u0027s 100,000. That\u0027s outflow."},{"Start":"07:18.485 ","End":"07:24.740","Text":"We divide it by 1.05 being the market rate at 21,"},{"Start":"07:24.740 ","End":"07:26.240","Text":"and to the power of 3."},{"Start":"07:26.240 ","End":"07:28.490","Text":"So that denominators to the power 3,"},{"Start":"07:28.490 ","End":"07:32.015","Text":"and that gives you 86,383.76."},{"Start":"07:32.015 ","End":"07:35.965","Text":"Then lets look at the present value of the annuity for the 3 years."},{"Start":"07:35.965 ","End":"07:39.355","Text":"Here\u0027s this rather complex looking formula again."},{"Start":"07:39.355 ","End":"07:44.185","Text":"We simply populate it with the relevant information compared to part A, if you will."},{"Start":"07:44.185 ","End":"07:46.045","Text":"But the payment is 3,000,"},{"Start":"07:46.045 ","End":"07:47.995","Text":"that\u0027s the same as in part A."},{"Start":"07:47.995 ","End":"07:52.660","Text":"Then both the numerator and the denominator is 1 plus"},{"Start":"07:52.660 ","End":"07:58.830","Text":"0.05 to the power of 3 because already 3 years left."},{"Start":"07:58.830 ","End":"08:00.730","Text":"Then remember the numerator,"},{"Start":"08:00.730 ","End":"08:04.180","Text":"you subtract 1 from that, and the denominator,"},{"Start":"08:04.180 ","End":"08:07.750","Text":"you multiply it by 0.05 being the market rate,"},{"Start":"08:07.750 ","End":"08:11.335","Text":"and then you get the 8,169.74."},{"Start":"08:11.335 ","End":"08:14.705","Text":"Remember that the closing balance on 31st, December,"},{"Start":"08:14.705 ","End":"08:19.270","Text":"20X3 is the total of these 2 present values."},{"Start":"08:19.270 ","End":"08:25.220","Text":"The present value of the single cash flow is 86,383.76, and then the other,"},{"Start":"08:25.220 ","End":"08:28.295","Text":"the present value of the annuity is 8,169.74,"},{"Start":"08:28.295 ","End":"08:32.275","Text":"giving you a total of 94,553.5."},{"Start":"08:32.275 ","End":"08:35.570","Text":"Remember, part B wasn\u0027t asking for the closing balance,"},{"Start":"08:35.570 ","End":"08:37.940","Text":"was asking us for the interest in 20X4."},{"Start":"08:37.940 ","End":"08:42.980","Text":"The interest in 20X4 is 94,553.5 being the closing balance at 31st,"},{"Start":"08:42.980 ","End":"08:45.230","Text":"December, 20X3 with the first of January,"},{"Start":"08:45.230 ","End":"08:48.200","Text":"20X4, multiplied by 5 percent."},{"Start":"08:48.200 ","End":"08:51.020","Text":"Remember market rate, not coupon rate,"},{"Start":"08:51.020 ","End":"08:54.245","Text":"and that gives you 477.68."},{"Start":"08:54.245 ","End":"08:55.700","Text":"Now let\u0027s look at part C,"},{"Start":"08:55.700 ","End":"08:57.680","Text":"determine the net amount of cash that Gallop will"},{"Start":"08:57.680 ","End":"09:00.770","Text":"pay bond investors over the 5-year period."},{"Start":"09:00.770 ","End":"09:07.240","Text":"The answer here is going to be the net cash impact is an outflow of 23,659."},{"Start":"09:07.240 ","End":"09:10.955","Text":"Remember when you do provide an answer such as this, always remember,"},{"Start":"09:10.955 ","End":"09:12.260","Text":"you\u0027re not just giving the amount,"},{"Start":"09:12.260 ","End":"09:15.970","Text":"you\u0027ve got to indicate whether it\u0027s an inflow and outflow."},{"Start":"09:15.970 ","End":"09:18.100","Text":"This is calculated as follows."},{"Start":"09:18.100 ","End":"09:20.675","Text":"We\u0027ve got the total amount repaid, the outflow,"},{"Start":"09:20.675 ","End":"09:22.385","Text":"to the bond investors,"},{"Start":"09:22.385 ","End":"09:24.580","Text":"is the principle that we\u0027re repaying."},{"Start":"09:24.580 ","End":"09:27.360","Text":"We\u0027re going to give them 100,000 in cash."},{"Start":"09:27.360 ","End":"09:30.560","Text":"Now remember we\u0027re not worried about the present value."},{"Start":"09:30.560 ","End":"09:32.797","Text":"We just, how much cash are we going to give?"},{"Start":"09:32.797 ","End":"09:38.025","Text":"It\u0027s the principal amount of 100,000 plus those 5 payments of 3,000."},{"Start":"09:38.025 ","End":"09:40.710","Text":"So 5 times 3,000 is 15,000."},{"Start":"09:40.710 ","End":"09:44.015","Text":"It gives us a 115,000 cash outflow."},{"Start":"09:44.015 ","End":"09:48.275","Text":"Now, you\u0027ve got to put that against the total amount that you borrowed."},{"Start":"09:48.275 ","End":"09:50.420","Text":"Now the amount when you issue a bond,"},{"Start":"09:50.420 ","End":"09:52.003","Text":"you\u0027re actually borrowing money,"},{"Start":"09:52.003 ","End":"09:54.110","Text":"and you\u0027re going to receive that money."},{"Start":"09:54.110 ","End":"09:55.310","Text":"The total amount borrowed,"},{"Start":"09:55.310 ","End":"09:59.225","Text":"the inflow is 91,341.05,"},{"Start":"09:59.225 ","End":"10:01.220","Text":"which we worked out in part A."},{"Start":"10:01.220 ","End":"10:04.325","Text":"We take the outflow of a 115,000,"},{"Start":"10:04.325 ","End":"10:08.435","Text":"subtract the inflow of 91,341.05,"},{"Start":"10:08.435 ","End":"10:13.565","Text":"and we get that net outflow of 23,658.95."},{"Start":"10:13.565 ","End":"10:15.080","Text":"Notice that that net outflow of"},{"Start":"10:15.080 ","End":"10:20.780","Text":"23,658.95 is actually going to be recognized as interest over the 5 years."},{"Start":"10:20.780 ","End":"10:23.000","Text":"You can see that quite clearly on the table."},{"Start":"10:23.000 ","End":"10:25.610","Text":"For those of you who are interested in looking at the table,"},{"Start":"10:25.610 ","End":"10:27.890","Text":"even answering it using a table,"},{"Start":"10:27.890 ","End":"10:29.805","Text":"here is the table."},{"Start":"10:29.805 ","End":"10:35.720","Text":"We\u0027ve got 91,341 as our opening balance that was worked out in part A."},{"Start":"10:35.720 ","End":"10:38.345","Text":"Then we get the outflows of 115,000."},{"Start":"10:38.345 ","End":"10:44.125","Text":"That\u0027s the 5 payments of 3,000 plus the 100,000 redemption."},{"Start":"10:44.125 ","End":"10:48.210","Text":"The outflow is 115,000 less the inflow of 91,341,"},{"Start":"10:48.210 ","End":"10:50.790","Text":"gives us a net outflow of 23,659,"},{"Start":"10:50.790 ","End":"10:53.490","Text":"which is the answer to part C. Then just for interest,"},{"Start":"10:53.490 ","End":"10:56.720","Text":"there\u0027s also the interest expense of 20X4,"},{"Start":"10:56.720 ","End":"10:58.610","Text":"which was asked for part B."},{"Start":"10:58.610 ","End":"11:01.550","Text":"You can see that figure there 4,728."},{"Start":"11:01.550 ","End":"11:05.210","Text":"We could have used the table approach to work on part B and part C,"},{"Start":"11:05.210 ","End":"11:10.460","Text":"but you\u0027d have to have been able to work out part A using present value factors,"},{"Start":"11:10.460 ","End":"11:17.070","Text":"or using the formula that we used in this set of slides. I hope this helped."}],"ID":31019},{"Watched":false,"Name":"Exercise 10","Duration":"14m 32s","ChapterTopicVideoID":29397,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:05.820","Text":"Hello and welcome to an exercise on non-current liabilities brought to you by Proprep."},{"Start":"00:05.820 ","End":"00:09.510","Text":"This exercise deals with a bond issued at a premium."},{"Start":"00:09.510 ","End":"00:12.120","Text":"On 31st December 20X1,"},{"Start":"00:12.120 ","End":"00:17.325","Text":"Pulp issues a bond with the following details: it\u0027s a 5 percent coupon,"},{"Start":"00:17.325 ","End":"00:21.515","Text":"payable on 31 December, starting from 20X2."},{"Start":"00:21.515 ","End":"00:23.730","Text":"In other words, the very first coupon payment would"},{"Start":"00:23.730 ","End":"00:28.125","Text":"happen a year after the bond was issued, which is normal."},{"Start":"00:28.125 ","End":"00:32.565","Text":"Then we have a face value of 100,000,"},{"Start":"00:32.565 ","End":"00:37.910","Text":"and a due date, which means the redemption date of 31 December X6."},{"Start":"00:37.910 ","End":"00:41.755","Text":"In other words, it\u0027s going to be repaid 5 years from now."},{"Start":"00:41.755 ","End":"00:45.320","Text":"The market prices the bond at 3 percent Another way"},{"Start":"00:45.320 ","End":"00:48.920","Text":"of saying that is that the market rate is 3 percent."},{"Start":"00:48.920 ","End":"00:55.125","Text":"Required. Assume the financial year-end is 31st December: a,"},{"Start":"00:55.125 ","End":"00:59.730","Text":"calculate the amount borrowed by Pulp on 31 December 20X1,"},{"Start":"00:59.730 ","End":"01:03.050","Text":"and what is the interest expense Pulp needs to"},{"Start":"01:03.050 ","End":"01:08.170","Text":"recognize in the year ending 31 December 20X4?"},{"Start":"01:08.170 ","End":"01:10.955","Text":"That is 3 years after the bond was issued."},{"Start":"01:10.955 ","End":"01:13.640","Text":"We don\u0027t calculate interest in the first year,"},{"Start":"01:13.640 ","End":"01:15.980","Text":"we\u0027re calculating the interest somewhere"},{"Start":"01:15.980 ","End":"01:21.050","Text":"in-between its issue date and its redemption date."},{"Start":"01:21.520 ","End":"01:26.525","Text":"Then remember, when you\u0027re calculating the interest expense,"},{"Start":"01:26.525 ","End":"01:30.890","Text":"you\u0027re going to have to consider both the 5 percent coupon,"},{"Start":"01:30.890 ","End":"01:33.460","Text":"and the market rate of 3 percent."},{"Start":"01:33.460 ","End":"01:37.070","Text":"Then c, determine the net amount of cash that"},{"Start":"01:37.070 ","End":"01:41.670","Text":"Pulp will pay the bond investors over the 5-year period."},{"Start":"01:41.680 ","End":"01:48.055","Text":"Let\u0027s look at the solution to the exercise about the bond that was issued at a premium."},{"Start":"01:48.055 ","End":"01:51.180","Text":"Let\u0027s start with part a, the required said,"},{"Start":"01:51.180 ","End":"01:56.685","Text":"calculate the amount borrowed by Pulp on 31 December 20X1."},{"Start":"01:56.685 ","End":"02:02.825","Text":"The amount borrowed on 31st December 20X1 is going to be the total of 2 amounts."},{"Start":"02:02.825 ","End":"02:06.110","Text":"It\u0027s the present value of the actual amount that\u0027s going to be"},{"Start":"02:06.110 ","End":"02:10.040","Text":"redeemed so that payment that\u0027s going to happen after 5 years,"},{"Start":"02:10.040 ","End":"02:12.820","Text":"it\u0027s a single amount of 100,000,"},{"Start":"02:12.820 ","End":"02:16.670","Text":"plus the present value of the coupon payments."},{"Start":"02:16.670 ","End":"02:17.770","Text":"Now, the coupon payments,"},{"Start":"02:17.770 ","End":"02:21.025","Text":"remember we were given a coupon rate of 5 percent,"},{"Start":"02:21.025 ","End":"02:25.635","Text":"that gets multiplied by the face value, which was 100,000."},{"Start":"02:25.635 ","End":"02:30.860","Text":"The coupon payments are based on the coupon rate of 5 percent,"},{"Start":"02:30.860 ","End":"02:35.885","Text":"so the coupon payment is 5,000 per annum for those 5 years."},{"Start":"02:35.885 ","End":"02:39.770","Text":"That\u0027s an annuity. The market rate of 3 percent is"},{"Start":"02:39.770 ","End":"02:43.835","Text":"used purely to do the discounting to those 2 present values."},{"Start":"02:43.835 ","End":"02:46.353","Text":"The present value of the future cash outflows."},{"Start":"02:46.353 ","End":"02:49.655","Text":"Let\u0027s start with that redemption payment of 100,000."},{"Start":"02:49.655 ","End":"02:52.533","Text":"The present value of 100,000,"},{"Start":"02:52.533 ","End":"02:57.385","Text":"1 single payment, which will be paid after 5 years,"},{"Start":"02:57.385 ","End":"03:07.880","Text":"discounted at the market rate of 3 percent is calculated as 100,000 divide by 1.03,"},{"Start":"03:07.880 ","End":"03:11.150","Text":"being the market rate, to the power of 5,"},{"Start":"03:11.150 ","End":"03:15.985","Text":"being the number of years after which that payment will actually take place."},{"Start":"03:15.985 ","End":"03:21.300","Text":"You solve for that, and you get 86,260.88."},{"Start":"03:21.300 ","End":"03:26.320","Text":"Now let\u0027s look at the second aspect to the present value calculation,"},{"Start":"03:26.320 ","End":"03:28.190","Text":"and that is our annuity."},{"Start":"03:28.190 ","End":"03:32.930","Text":"We\u0027ve got here coupon payments of 5,000 per annum for"},{"Start":"03:32.930 ","End":"03:38.315","Text":"5 years discounted at the market rate of 3 percent."},{"Start":"03:38.315 ","End":"03:43.180","Text":"Here we have the fairly complex-looking formula yet again,"},{"Start":"03:43.180 ","End":"03:46.425","Text":"and let\u0027s just populate that."},{"Start":"03:46.425 ","End":"03:49.640","Text":"The payment, how much is the annuity payments?"},{"Start":"03:49.640 ","End":"03:52.505","Text":"In other words, how much is paid every single year?"},{"Start":"03:52.505 ","End":"03:54.995","Text":"That\u0027s 5,000 every year."},{"Start":"03:54.995 ","End":"03:59.625","Text":"Then let\u0027s look at the numerator."},{"Start":"03:59.625 ","End":"04:05.420","Text":"It\u0027s 1 plus the market rate, 0.03."},{"Start":"04:05.420 ","End":"04:10.940","Text":"Put that in brackets to the power of how long does this annuity continue for?"},{"Start":"04:10.940 ","End":"04:13.520","Text":"5 years, so it\u0027s to the power of 5,"},{"Start":"04:13.520 ","End":"04:18.260","Text":"and then remember the numerator is minus 1."},{"Start":"04:18.260 ","End":"04:21.410","Text":"Aspects of the denominator are similar to the numerator."},{"Start":"04:21.410 ","End":"04:25.970","Text":"You can see there we\u0027ve got 1 plus 0.03,"},{"Start":"04:25.970 ","End":"04:28.730","Text":"the market rate again in brackets,"},{"Start":"04:28.730 ","End":"04:30.335","Text":"to the power of 5,"},{"Start":"04:30.335 ","End":"04:35.150","Text":"being the number of periods that the annuity continues for,"},{"Start":"04:35.150 ","End":"04:39.170","Text":"and whereas the numerator above the line,"},{"Start":"04:39.170 ","End":"04:40.795","Text":"we then subtract it by 1,"},{"Start":"04:40.795 ","End":"04:45.185","Text":"the denominator we multiply by the market rate."},{"Start":"04:45.185 ","End":"04:50.855","Text":"We solve for that and we get 22,898.54."},{"Start":"04:50.855 ","End":"04:54.590","Text":"We then add those 2 present values together to give us"},{"Start":"04:54.590 ","End":"04:58.785","Text":"the present value of the entire outflows,"},{"Start":"04:58.785 ","End":"05:02.270","Text":"and that\u0027s the amount borrowed on the 31 December 20X1."},{"Start":"05:02.270 ","End":"05:05.435","Text":"In other words, that is literally what we received in cash"},{"Start":"05:05.435 ","End":"05:13.120","Text":"on the 31st December 20X1, 109,159.41."},{"Start":"05:13.120 ","End":"05:18.380","Text":"Now let\u0027s look at part b. What is the interest expense Pulp"},{"Start":"05:18.380 ","End":"05:23.755","Text":"needs to recognize in the year ending on 31 December 20X4?"},{"Start":"05:23.755 ","End":"05:27.540","Text":"Bearing in mind, it was issued on 31 December 20X1,"},{"Start":"05:27.540 ","End":"05:29.940","Text":"that is a gap of 3 years."},{"Start":"05:29.940 ","End":"05:32.915","Text":"We\u0027re looking at the third year of the bond."},{"Start":"05:32.915 ","End":"05:38.930","Text":"The interest expense in 20X4 is calculated as follows: it is"},{"Start":"05:38.930 ","End":"05:45.875","Text":"the product of the opening balance in 20X4 multiplied by 3 percent."},{"Start":"05:45.875 ","End":"05:48.350","Text":"I want you just to think for a moment."},{"Start":"05:48.350 ","End":"05:52.700","Text":"Although we are working in the third year of the bond"},{"Start":"05:52.700 ","End":"05:57.655","Text":"because it was issued the end of 20X1,"},{"Start":"05:57.655 ","End":"06:00.180","Text":"so we\u0027re in 20X4 now,"},{"Start":"06:00.180 ","End":"06:01.820","Text":"it\u0027s 3 years down the track."},{"Start":"06:01.820 ","End":"06:09.390","Text":"Remember what we\u0027re doing here is we\u0027re looking at the opening balance in 20X4,"},{"Start":"06:09.390 ","End":"06:13.245","Text":"so after 2 years of having been issued."},{"Start":"06:13.245 ","End":"06:15.840","Text":"Issued the end of 20X1,"},{"Start":"06:15.840 ","End":"06:20.555","Text":"so we will have recognized the interest expense for 20X2 and we will have"},{"Start":"06:20.555 ","End":"06:26.365","Text":"recognized interest for 20X3 as well the second year."},{"Start":"06:26.365 ","End":"06:30.950","Text":"Another way of putting this opening balance in 20X4"},{"Start":"06:30.950 ","End":"06:36.595","Text":"is describing it as the ending balance on 31 December 20X3."},{"Start":"06:36.595 ","End":"06:42.094","Text":"The ending balance on 31st December 20X3 is 3 years before redemption."},{"Start":"06:42.094 ","End":"06:44.570","Text":"It\u0027s 2 years after the issue,"},{"Start":"06:44.570 ","End":"06:46.220","Text":"3 years before redemption."},{"Start":"06:46.220 ","End":"06:48.830","Text":"Remember, when are we going to redeem this bond?"},{"Start":"06:48.830 ","End":"06:53.630","Text":"We\u0027re going to redeem the bond on 31st December 20X6."},{"Start":"06:53.630 ","End":"06:56.728","Text":"There\u0027s 3 years left."},{"Start":"06:56.728 ","End":"06:58.205","Text":"That\u0027s the most important thing."},{"Start":"06:58.205 ","End":"07:00.440","Text":"Not so much how many years have gone by,"},{"Start":"07:00.440 ","End":"07:02.000","Text":"but how many years are left,"},{"Start":"07:02.000 ","End":"07:05.665","Text":"because that\u0027s going to feed directly into our present value calculation."},{"Start":"07:05.665 ","End":"07:11.690","Text":"In other words, this ending balance on 31st December 20X3 is going to be calculated"},{"Start":"07:11.690 ","End":"07:14.690","Text":"as being the present value of the cash flows that are going to"},{"Start":"07:14.690 ","End":"07:18.160","Text":"be payable over the remaining 3 years."},{"Start":"07:18.160 ","End":"07:20.690","Text":"Now, remember that those future cash outflows"},{"Start":"07:20.690 ","End":"07:22.730","Text":"of the remaining 3 years are 2 different kinds."},{"Start":"07:22.730 ","End":"07:25.175","Text":"We\u0027ve got the single outflow at the end,"},{"Start":"07:25.175 ","End":"07:28.150","Text":"which will happen on the 31st December 20X6."},{"Start":"07:28.150 ","End":"07:32.715","Text":"I know we\u0027ve got the remaining payments in terms of that annuity."},{"Start":"07:32.715 ","End":"07:35.580","Text":"All right, let\u0027s deal with that 100,000 that\u0027s going to be paid,"},{"Start":"07:35.580 ","End":"07:38.525","Text":"that single amount that\u0027s going to be paid after 3 years."},{"Start":"07:38.525 ","End":"07:41.930","Text":"Present value of 100,000 after 3 years,"},{"Start":"07:41.930 ","End":"07:46.950","Text":"discounted at the market rate of 3% is simply 100,000 divide"},{"Start":"07:46.950 ","End":"07:52.885","Text":"by 1.03 where the 0.03 is the market rate."},{"Start":"07:52.885 ","End":"07:57.245","Text":"That is to the power of 3 with the letter"},{"Start":"07:57.245 ","End":"08:03.065","Text":"3 refers to how many years is going to be before we actually make this payment."},{"Start":"08:03.065 ","End":"08:07.425","Text":"You can see if you compare part a with part b."},{"Start":"08:07.425 ","End":"08:11.970","Text":"Part a\u0027s calculation here is almost identical except it was to the power of 5."},{"Start":"08:11.970 ","End":"08:16.560","Text":"Because in part a, we were looking at remaining annuity of 5 years."},{"Start":"08:16.560 ","End":"08:20.860","Text":"Whereas in part b, we\u0027re looking at a remaining annuity of only 3 years."},{"Start":"08:20.860 ","End":"08:23.685","Text":"Otherwise, the formula looks the same."},{"Start":"08:23.685 ","End":"08:29.660","Text":"If we solve for that, we get 91,514.17."},{"Start":"08:29.660 ","End":"08:32.520","Text":"Then we work on the annuity,"},{"Start":"08:32.520 ","End":"08:36.260","Text":"the present value of the annuity for the remaining 3 years."},{"Start":"08:36.260 ","End":"08:38.855","Text":"Just like part a again,"},{"Start":"08:38.855 ","End":"08:41.255","Text":"we\u0027re dealing with 5,000 a year."},{"Start":"08:41.255 ","End":"08:43.210","Text":"But the difference is we\u0027re now looking at, instead of,"},{"Start":"08:43.210 ","End":"08:45.245","Text":"an annuity for 5 years."},{"Start":"08:45.245 ","End":"08:47.135","Text":"We\u0027re looking at the annuity for 3 years."},{"Start":"08:47.135 ","End":"08:50.675","Text":"Of course, we\u0027re still using the market rate of 3% that never changes."},{"Start":"08:50.675 ","End":"08:55.585","Text":"Put down your formula and then let\u0027s populate the formula."},{"Start":"08:55.585 ","End":"08:58.205","Text":"All right, so first of all, let\u0027s put in the payment."},{"Start":"08:58.205 ","End":"09:01.955","Text":"The payment is 5,000 a year so pop that into the formula."},{"Start":"09:01.955 ","End":"09:06.370","Text":"Then in terms of putting in the market rate,"},{"Start":"09:06.370 ","End":"09:10.800","Text":"you can see it populating on the numerator and the denominator."},{"Start":"09:10.800 ","End":"09:11.855","Text":"Looking at the numerator,"},{"Start":"09:11.855 ","End":"09:16.985","Text":"we\u0027ve got 1 plus whatever the market rate is that\u0027s 1 plus 0.03."},{"Start":"09:16.985 ","End":"09:18.335","Text":"Then on the denominator,"},{"Start":"09:18.335 ","End":"09:19.685","Text":"in other words, below the line,"},{"Start":"09:19.685 ","End":"09:25.350","Text":"we\u0027ve got the 1 plus the market rate 0.03,"},{"Start":"09:25.350 ","End":"09:33.265","Text":"close brackets and obviously to the power of n. We multiply that product by 0.03."},{"Start":"09:33.265 ","End":"09:36.675","Text":"The important bit here is that we\u0027ve only got 3 years left."},{"Start":"09:36.675 ","End":"09:42.739","Text":"Both the numerator and the denominator where we have the 1.03 to the power of,"},{"Start":"09:42.739 ","End":"09:46.670","Text":"you\u0027ll see that if you compare part b with part a,"},{"Start":"09:46.670 ","End":"09:48.780","Text":"is to the power of 3 years,"},{"Start":"09:48.780 ","End":"09:53.085","Text":"not 5 as it was in part a,"},{"Start":"09:53.085 ","End":"09:55.710","Text":"and we simply solve that."},{"Start":"09:55.710 ","End":"10:01.475","Text":"That means that the present value of the annuity if you\u0027re looking at it after the end of"},{"Start":"10:01.475 ","End":"10:06.920","Text":"the second year with only 3 years left that present value at the end of the second year."},{"Start":"10:06.920 ","End":"10:15.725","Text":"In other words, at the end of 31 December 20X3 is 14,143.06."},{"Start":"10:15.725 ","End":"10:19.120","Text":"These 2 separate present value calculations now need to be added"},{"Start":"10:19.120 ","End":"10:24.300","Text":"together to give you the closing balance at 31 December X3,"},{"Start":"10:24.300 ","End":"10:29.450","Text":"and that totals 105,657.2."},{"Start":"10:29.450 ","End":"10:32.344","Text":"Now we can calculate the interest expense."},{"Start":"10:32.344 ","End":"10:39.050","Text":"The interest expense in 20X4 is that closing balance at the end of 20X3 105,657."},{"Start":"10:39.050 ","End":"10:46.110","Text":"In other words, it\u0027s the opening balance in 20X4 multiplied by the market rate of 3%."},{"Start":"10:46.110 ","End":"10:51.665","Text":"That gives us 3,170 and that\u0027s the answer to b,"},{"Start":"10:51.665 ","End":"10:56.075","Text":"coupon payment is actually 5,000 but the interest expense that is"},{"Start":"10:56.075 ","End":"11:01.765","Text":"recognized is 3,170 in 20X4."},{"Start":"11:01.765 ","End":"11:05.860","Text":"Now let\u0027s look at part c. Determine the net amount"},{"Start":"11:05.860 ","End":"11:10.220","Text":"of cash that Pulp will pay the bond investors over the 5 year period."},{"Start":"11:10.220 ","End":"11:13.980","Text":"How do we calculate this outflow of 15,841,"},{"Start":"11:13.980 ","End":"11:17.170","Text":"the total amount repaid to our bond investors?"},{"Start":"11:17.170 ","End":"11:19.530","Text":"In other words how much are we actually going to physically"},{"Start":"11:19.530 ","End":"11:22.450","Text":"give back to our bond investors?"},{"Start":"11:22.450 ","End":"11:23.790","Text":"In other words, the lenders,"},{"Start":"11:23.790 ","End":"11:25.565","Text":"people actually lend us money."},{"Start":"11:25.565 ","End":"11:29.860","Text":"How much do we give them in return for that favor?"},{"Start":"11:29.860 ","End":"11:34.410","Text":"We\u0027ve got to give back the principal of 100,000. That\u0027s what we agreed."},{"Start":"11:34.410 ","End":"11:38.365","Text":"That set face value that\u0027s going to be repaid at 31st, December 20X6."},{"Start":"11:38.365 ","End":"11:41.015","Text":"We give them back that in cash."},{"Start":"11:41.015 ","End":"11:45.185","Text":"Plus we\u0027re going to make 5 payments of 5,000 each."},{"Start":"11:45.185 ","End":"11:48.800","Text":"That\u0027s another 25,000 in cash."},{"Start":"11:48.800 ","End":"11:56.610","Text":"Our outflows says Pulp our outflows are 125,000 over the 5 years."},{"Start":"11:56.610 ","End":"11:59.374","Text":"But what do we receive from these investors?"},{"Start":"11:59.374 ","End":"12:01.885","Text":"In other words, how much did they lend us in cash?"},{"Start":"12:01.885 ","End":"12:09.740","Text":"In part a, we calculated that we\u0027d borrowed 109,159 and there was an inflow."},{"Start":"12:09.740 ","End":"12:14.800","Text":"In other words, if we compare the 125,000 with"},{"Start":"12:14.800 ","End":"12:20.850","Text":"109,000 the 125,000 was an outflow to 109,159 is an inflow."},{"Start":"12:20.850 ","End":"12:24.250","Text":"We get a net outflow of 15,841."},{"Start":"12:24.250 ","End":"12:31.095","Text":"Notice also that 15,841 is the total interest expense over the 5 years."},{"Start":"12:31.095 ","End":"12:34.130","Text":"Now that becomes clear if you look at the table."},{"Start":"12:34.130 ","End":"12:36.335","Text":"We haven\u0027t actually drawn up the table yet,"},{"Start":"12:36.335 ","End":"12:37.910","Text":"so let\u0027s have a look at it right now."},{"Start":"12:37.910 ","End":"12:41.765","Text":"If we were to draw up the table instead of using formula and whatnot."},{"Start":"12:41.765 ","End":"12:43.925","Text":"There we have the inflow,"},{"Start":"12:43.925 ","End":"12:47.635","Text":"the amount that we actually receive in cash at the beginning,"},{"Start":"12:47.635 ","End":"12:51.015","Text":"which was on the 31st of December 20X1,"},{"Start":"12:51.015 ","End":"12:53.495","Text":"and that was calculated in part a."},{"Start":"12:53.495 ","End":"12:55.120","Text":"That\u0027s our opening balance."},{"Start":"12:55.120 ","End":"12:58.990","Text":"You add the interest of 3% giving you 3,275."},{"Start":"12:58.990 ","End":"13:03.880","Text":"It\u0027s calculated as 109,159 multiplied by 3%."},{"Start":"13:03.880 ","End":"13:06.970","Text":"Then you have a column for the repayments and our coupon payment"},{"Start":"13:06.970 ","End":"13:10.680","Text":"the actual cash outflow is 5,000 if you subtract"},{"Start":"13:10.680 ","End":"13:20.410","Text":"that 109,159 plus the 3275 minus the 5,000 gives us a closing balance of 107,434,"},{"Start":"13:20.410 ","End":"13:25.280","Text":"which becomes the opening balance in the second year of the bond and so on."},{"Start":"13:25.280 ","End":"13:30.890","Text":"But now you can see the outflow at the end."},{"Start":"13:30.890 ","End":"13:32.795","Text":"If you look at your repayment column,"},{"Start":"13:32.795 ","End":"13:35.250","Text":"you\u0027ve got the 5 payments of 5,000."},{"Start":"13:35.250 ","End":"13:37.305","Text":"There\u0027s 5 coupon payments."},{"Start":"13:37.305 ","End":"13:41.584","Text":"Plus you have the redemption of the principal sum of 100,000"},{"Start":"13:41.584 ","End":"13:46.210","Text":"so your total cash outflow is 125,000."},{"Start":"13:46.210 ","End":"13:49.019","Text":"The outflow lists the inflow,"},{"Start":"13:49.019 ","End":"13:54.270","Text":"gives us a net outflow of 15,841 and that was the answer we were looking for."},{"Start":"13:54.270 ","End":"13:56.810","Text":"But just remember, as I say,"},{"Start":"13:56.810 ","End":"14:01.170","Text":"what is interesting is that the difference that net outflow of 15,841,"},{"Start":"14:01.170 ","End":"14:03.565","Text":"the excess that we\u0027re having to pay."},{"Start":"14:03.565 ","End":"14:06.740","Text":"That\u0027s our effective interest,"},{"Start":"14:06.740 ","End":"14:10.745","Text":"and that\u0027s what we recognize over those 5 years using"},{"Start":"14:10.745 ","End":"14:16.400","Text":"the effective interest rate method and measured using the market rate,"},{"Start":"14:16.400 ","End":"14:18.265","Text":"not the coupon rate."},{"Start":"14:18.265 ","End":"14:21.309","Text":"All right, and then if you wanted to view the table,"},{"Start":"14:21.309 ","End":"14:24.235","Text":"you could have used the table for part b."},{"Start":"14:24.235 ","End":"14:27.110","Text":"You can see the interest expense for 20X4."},{"Start":"14:27.110 ","End":"14:28.200","Text":"If you go back to part b,"},{"Start":"14:28.200 ","End":"14:32.020","Text":"that\u0027s what we\u0027d calculated it\u0027s 3,170."}],"ID":31020},{"Watched":false,"Name":"Exercise 11","Duration":"13m 34s","ChapterTopicVideoID":29398,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:06.750","Text":"Hello and welcome to an exercise on non-current liabilities brought to you by Proprep."},{"Start":"00:06.750 ","End":"00:12.195","Text":"This exercise deals with the repurchase of a bond that was issued at a discount."},{"Start":"00:12.195 ","End":"00:15.030","Text":"On 31 December 20X1,"},{"Start":"00:15.030 ","End":"00:18.179","Text":"Jobs issues a bond with the following details."},{"Start":"00:18.179 ","End":"00:22.485","Text":"It\u0027s a 3 percent coupon which is payable on the 31st December,"},{"Start":"00:22.485 ","End":"00:27.105","Text":"starting from 31st December 20X2."},{"Start":"00:27.105 ","End":"00:35.160","Text":"It has a face value of 100,000 and there is a due date of 31 December \u0027X6 in other words,"},{"Start":"00:35.160 ","End":"00:37.455","Text":"that\u0027s when it\u0027s due to be redeemed."},{"Start":"00:37.455 ","End":"00:40.790","Text":"The market prices the bond at 6 percent."},{"Start":"00:40.790 ","End":"00:43.850","Text":"Notice that this is higher than the coupon rate."},{"Start":"00:43.850 ","End":"00:47.285","Text":"Notice this is 3 years, 20X4,"},{"Start":"00:47.285 ","End":"00:52.650","Text":"20X5, and 20X6 before it was due to be redeemed."},{"Start":"00:53.170 ","End":"00:58.415","Text":"At that time, the market prices the bond at 4 percent,"},{"Start":"00:58.415 ","End":"01:02.545","Text":"so the market fee of the bond has changed."},{"Start":"01:02.545 ","End":"01:07.455","Text":"Required: Assume the financial year-end is 31 December,"},{"Start":"01:07.455 ","End":"01:12.705","Text":"a, calculate the amount Jobs borrows on 31 December 20X1."},{"Start":"01:12.705 ","End":"01:16.010","Text":"B, what is the interest expense Jobs needs to"},{"Start":"01:16.010 ","End":"01:20.290","Text":"recognize in the year ending 31 December 20X3?"},{"Start":"01:20.290 ","End":"01:23.950","Text":"C, determine the total amount of cash Jobs"},{"Start":"01:23.950 ","End":"01:27.985","Text":"spends on repurchasing the bond on the 1st of January 20X4."},{"Start":"01:27.985 ","End":"01:33.820","Text":"D, determine the gain or loss it would recognize on the repurchase of the bond."},{"Start":"01:33.820 ","End":"01:37.105","Text":"Let\u0027s try the solution to the exercise."},{"Start":"01:37.105 ","End":"01:43.585","Text":"A requires that we calculate the amount Jobs borrows on 31 December 20X1."},{"Start":"01:43.585 ","End":"01:49.165","Text":"Well, the amount borrowed on that date is a total of 2 amounts."},{"Start":"01:49.165 ","End":"01:52.690","Text":"What we\u0027ll do is we\u0027ll calculate the present value of"},{"Start":"01:52.690 ","End":"01:56.650","Text":"the redemption payment of 100,000 after 5 years."},{"Start":"01:56.650 ","End":"02:01.795","Text":"It\u0027s a single cash flow that\u0027s going to occur at the end of the 5 years"},{"Start":"02:01.795 ","End":"02:08.700","Text":"plus the present value of the 5 coupon payments of 3,000 currency units each."},{"Start":"02:08.700 ","End":"02:14.120","Text":"What we have here are two different art flows."},{"Start":"02:14.120 ","End":"02:18.949","Text":"The 1 is the single amount and the other is the annuity."},{"Start":"02:18.949 ","End":"02:22.600","Text":"The single amount is the redemption at the end of the 5 years,"},{"Start":"02:22.600 ","End":"02:26.495","Text":"the annuity is the coupon payments of,"},{"Start":"02:26.495 ","End":"02:28.730","Text":"in this case, 3,000 per annum."},{"Start":"02:28.730 ","End":"02:31.700","Text":"Remember, the coupon payment is calculated by taking"},{"Start":"02:31.700 ","End":"02:36.635","Text":"the face value multiplied by the coupon rate."},{"Start":"02:36.635 ","End":"02:39.575","Text":"Let\u0027s calculate these present values."},{"Start":"02:39.575 ","End":"02:41.630","Text":"The present value of the single amount of"},{"Start":"02:41.630 ","End":"02:46.645","Text":"the redemption payment of 100,000 at the end of the 5th year,"},{"Start":"02:46.645 ","End":"02:50.390","Text":"remember when we calculate that present value,"},{"Start":"02:50.390 ","End":"02:53.090","Text":"we\u0027re discounting it using the market rate,"},{"Start":"02:53.090 ","End":"02:55.440","Text":"which was 6 percent."},{"Start":"02:56.090 ","End":"03:01.385","Text":"The present value of a single payment is simply the actual payment,"},{"Start":"03:01.385 ","End":"03:03.485","Text":"the cash outflow, in this case,"},{"Start":"03:03.485 ","End":"03:08.520","Text":"divide by 1 point in whatever the market rate is,"},{"Start":"03:08.520 ","End":"03:12.405","Text":"and in this case it was 6 percent, that\u0027s 1.06."},{"Start":"03:12.405 ","End":"03:15.530","Text":"That 1.06 is to the power of"},{"Start":"03:15.530 ","End":"03:19.385","Text":"however many years we\u0027re going to have to wait before that cash flow occurs."},{"Start":"03:19.385 ","End":"03:23.375","Text":"In this case, is to the power of 5 because there\u0027s a 5-year delay."},{"Start":"03:23.375 ","End":"03:28.625","Text":"That comes to 74,725.82."},{"Start":"03:28.625 ","End":"03:31.565","Text":"Then we calculate the present value of annuity."},{"Start":"03:31.565 ","End":"03:33.170","Text":"Now, in this calculation,"},{"Start":"03:33.170 ","End":"03:34.729","Text":"there are going to be 3 variables."},{"Start":"03:34.729 ","End":"03:37.490","Text":"It\u0027s the actual annual amount that gets paid,"},{"Start":"03:37.490 ","End":"03:39.080","Text":"which is 3,000 per year."},{"Start":"03:39.080 ","End":"03:45.580","Text":"Remember, it\u0027s the face value of 100,000 multiplied by the coupon rate of 3 percent."},{"Start":"03:45.580 ","End":"03:49.790","Text":"Next variable is the number of years that this payment is going to take place."},{"Start":"03:49.790 ","End":"03:51.335","Text":"Then finally, of course,"},{"Start":"03:51.335 ","End":"03:52.945","Text":"it\u0027s the market rate."},{"Start":"03:52.945 ","End":"03:54.515","Text":"There\u0027s the formula."},{"Start":"03:54.515 ","End":"03:58.475","Text":"It\u0027s the payment multiplied by and on the numerator,"},{"Start":"03:58.475 ","End":"04:00.860","Text":"it is 1 plus r,"},{"Start":"04:00.860 ","End":"04:04.830","Text":"the market rate to the power of n minus 1."},{"Start":"04:04.830 ","End":"04:09.410","Text":"Then your denominator is the 1 plus r^n being"},{"Start":"04:09.410 ","End":"04:14.555","Text":"the number of periods multiplied by r again."},{"Start":"04:14.555 ","End":"04:17.050","Text":"Let\u0027s populate this formula."},{"Start":"04:17.050 ","End":"04:26.685","Text":"The payment is 3,000 then we multiply it by 1 plus the 6 percent or 1.06^5."},{"Start":"04:26.685 ","End":"04:30.965","Text":"The number of periods that this payment is going to take place."},{"Start":"04:30.965 ","End":"04:32.900","Text":"Subtract the 1."},{"Start":"04:32.900 ","End":"04:36.640","Text":"Notice the brackets, so it\u0027s the 1.06^5,"},{"Start":"04:37.310 ","End":"04:40.410","Text":"you calculate that first."},{"Start":"04:40.410 ","End":"04:42.670","Text":"Then you subtract the 1,"},{"Start":"04:42.670 ","End":"04:44.255","Text":"and then whatever that gives you,"},{"Start":"04:44.255 ","End":"04:46.460","Text":"you multiply that by 3,000."},{"Start":"04:46.460 ","End":"04:48.735","Text":"Let\u0027s look at the denominator."},{"Start":"04:48.735 ","End":"04:51.330","Text":"It\u0027s 1 plus whatever the market rate is."},{"Start":"04:51.330 ","End":"04:55.560","Text":"It\u0027s 1 plus 6 percent or 1.06."},{"Start":"04:55.560 ","End":"05:01.455","Text":"We take that 1.06^5 being the number of periods,"},{"Start":"05:01.455 ","End":"05:07.200","Text":"and then we multiply that total by 0.06,"},{"Start":"05:07.200 ","End":"05:08.550","Text":"the market rate again."},{"Start":"05:08.550 ","End":"05:14.250","Text":"If you solve for that, you get 12,637.09."},{"Start":"05:14.250 ","End":"05:22.655","Text":"Remember to add the two present values together and we get 87,362.91."},{"Start":"05:22.655 ","End":"05:28.250","Text":"That total present value of 87,362.91 is in fact"},{"Start":"05:28.250 ","End":"05:33.410","Text":"the exact amount of cash we would have received on the 31st, December 20X1."},{"Start":"05:33.410 ","End":"05:37.250","Text":"Now let\u0027s look at b. What is the interest expense Jobs needs to"},{"Start":"05:37.250 ","End":"05:41.435","Text":"recognize in the year ended the 31st, December 20X3?"},{"Start":"05:41.435 ","End":"05:43.775","Text":"This is the end of the second year."},{"Start":"05:43.775 ","End":"05:46.420","Text":"Well, the interest expense in 20X3."},{"Start":"05:46.420 ","End":"05:50.270","Text":"This is going to be calculated by taking the opening balance in 20X3."},{"Start":"05:50.270 ","End":"05:52.340","Text":"So the amount that we owe at the beginning of"},{"Start":"05:52.340 ","End":"05:56.210","Text":"23 and multiplying it by the 6 percent market rate."},{"Start":"05:56.210 ","End":"06:00.710","Text":"Now we\u0027ll just bear in mind that the opening balance in 20X3 is the same thing as saying"},{"Start":"06:00.710 ","End":"06:05.440","Text":"the ending balance the day before 31st December 20X2."},{"Start":"06:05.440 ","End":"06:08.570","Text":"Then compare that 31 December 20X2 with"},{"Start":"06:08.570 ","End":"06:12.530","Text":"the due date of 31 December 20X6 and you can calculate very easily,"},{"Start":"06:12.530 ","End":"06:15.925","Text":"that\u0027s 4 years before redemption."},{"Start":"06:15.925 ","End":"06:19.040","Text":"What we\u0027re needing to do is to work out what"},{"Start":"06:19.040 ","End":"06:22.790","Text":"the present value is of those future cash flows of"},{"Start":"06:22.790 ","End":"06:25.850","Text":"the remaining 4 years but because then we have the closing balance"},{"Start":"06:25.850 ","End":"06:29.770","Text":"of the liability on that day, 31 December 20X2."},{"Start":"06:29.770 ","End":"06:32.570","Text":"Let\u0027s look at the present value of those future cash outflows."},{"Start":"06:32.570 ","End":"06:34.400","Text":"Remember that there are two kinds,"},{"Start":"06:34.400 ","End":"06:37.984","Text":"is that single outflow that\u0027s going to happen when we redeem the bond,"},{"Start":"06:37.984 ","End":"06:44.085","Text":"and then there\u0027s the annuity which relates to the coupon payments."},{"Start":"06:44.085 ","End":"06:48.680","Text":"Let\u0027s calculate that present value of that single amount to start with."},{"Start":"06:48.680 ","End":"06:56.225","Text":"We know we\u0027re going to be paying 100,000 to our investors on 31, December 20X6."},{"Start":"06:56.225 ","End":"07:00.920","Text":"Now bearing in mind, we\u0027re now looking at this on the 31st, December 20X2,"},{"Start":"07:00.920 ","End":"07:03.475","Text":"that means that there are 4 years"},{"Start":"07:03.475 ","End":"07:06.790","Text":"that we\u0027re going to have to wait before making that payment."},{"Start":"07:06.790 ","End":"07:13.105","Text":"Whereas in part a, we calculated the present value of the 100,000 after 5 years."},{"Start":"07:13.105 ","End":"07:17.020","Text":"Now we\u0027re calculating the present value of 100,000 after 4 years because"},{"Start":"07:17.020 ","End":"07:20.860","Text":"we\u0027ve moved along that timeline if you like,"},{"Start":"07:20.860 ","End":"07:22.830","Text":"you\u0027ve moved along it by a year,"},{"Start":"07:22.830 ","End":"07:24.090","Text":"so now we\u0027re pretending, all right,"},{"Start":"07:24.090 ","End":"07:27.340","Text":"let\u0027s pretend we\u0027re now at the 31st, December 20X2,"},{"Start":"07:27.340 ","End":"07:30.500","Text":"how many years remain at that point?"},{"Start":"07:30.500 ","End":"07:31.950","Text":"We take the cash flow,"},{"Start":"07:31.950 ","End":"07:34.665","Text":"we divide it by 1 plus whatever the market rate is."},{"Start":"07:34.665 ","End":"07:42.315","Text":"It\u0027s 1.06 and that 1.06^4 not to the power of 5 anymore."},{"Start":"07:42.315 ","End":"07:50.250","Text":"That means that the present value of that future cash flow is 79,209.37."},{"Start":"07:50.250 ","End":"07:54.730","Text":"Now let\u0027s calculate the present value of that annuity over the remaining 4 years."},{"Start":"07:54.730 ","End":"07:57.720","Text":"There\u0027s 3,000 a year based on the coupon rate,"},{"Start":"07:57.720 ","End":"08:01.700","Text":"there are 4 years left if we\u0027re looking at it from the 31st, December 20X2,"},{"Start":"08:01.700 ","End":"08:04.490","Text":"and the market rate is still 6 percent."},{"Start":"08:04.490 ","End":"08:07.180","Text":"Let\u0027s populate that formula."},{"Start":"08:07.180 ","End":"08:10.125","Text":"We put in the payment of 3,000,"},{"Start":"08:10.125 ","End":"08:13.234","Text":"then looking at the remaining formula,"},{"Start":"08:13.234 ","End":"08:18.170","Text":"let\u0027s just pop in the unknown r. The r is 6 percent."},{"Start":"08:18.170 ","End":"08:19.250","Text":"Wherever you see an r,"},{"Start":"08:19.250 ","End":"08:22.090","Text":"you just put in the 0.06."},{"Start":"08:22.090 ","End":"08:24.485","Text":"Then wherever you see an n,"},{"Start":"08:24.485 ","End":"08:33.290","Text":"you put in the 4 for the 4 years and you solve, and that\u0027s 10,395.32."},{"Start":"08:33.290 ","End":"08:35.990","Text":"Don\u0027t forget, you need to add those two present values"},{"Start":"08:35.990 ","End":"08:38.780","Text":"together to give you the total closing balance"},{"Start":"08:38.780 ","End":"08:44.460","Text":"on your liability at 31 December, 20X2."},{"Start":"08:44.460 ","End":"08:47.240","Text":"Remember, you need to add those two present values"},{"Start":"08:47.240 ","End":"08:49.910","Text":"together to get the total present value,"},{"Start":"08:49.910 ","End":"08:54.395","Text":"which is the liability balance at that 31 December,"},{"Start":"08:54.395 ","End":"08:59.580","Text":"20X2, which is the same thing as 1st of January 20X3 remember."},{"Start":"08:59.580 ","End":"09:01.790","Text":"Now that wasn\u0027t the final answer to part b."},{"Start":"09:01.790 ","End":"09:04.550","Text":"Remember, what we\u0027re trying to achieve here was actually"},{"Start":"09:04.550 ","End":"09:07.985","Text":"simply to calculate the interest expense for 20X3."},{"Start":"09:07.985 ","End":"09:13.250","Text":"Once we have the closing balance at 31 December 20X2 or the beginning of 20X3,"},{"Start":"09:13.250 ","End":"09:17.535","Text":"89,604.68, we simply multiply that"},{"Start":"09:17.535 ","End":"09:22.535","Text":"by the 6 percent market rate to give us the interest expense."},{"Start":"09:22.535 ","End":"09:30.125","Text":"The interest expense, your answer to the part b is 5,376.28."},{"Start":"09:30.125 ","End":"09:32.510","Text":"Now let\u0027s look at part c,"},{"Start":"09:32.510 ","End":"09:35.510","Text":"determine the total amount of cash that Jobs spends on"},{"Start":"09:35.510 ","End":"09:39.805","Text":"repurchasing the bond on the 1st of the 1st, 20X4."},{"Start":"09:39.805 ","End":"09:44.945","Text":"The important information given to us was the date of the repurchase,"},{"Start":"09:44.945 ","End":"09:46.580","Text":"there was 1st the 1st, 20X4."},{"Start":"09:46.580 ","End":"09:49.850","Text":"Remember that is before the due date."},{"Start":"09:49.850 ","End":"09:56.535","Text":"The due date was 31 December, 20X6."},{"Start":"09:56.535 ","End":"10:01.670","Text":"That\u0027s 3 years early and remember when we worked out the market rate,"},{"Start":"10:01.670 ","End":"10:04.240","Text":"it was 6 percent originally,"},{"Start":"10:04.240 ","End":"10:08.210","Text":"but it\u0027s now 4 percent on the 1st of 1st, 20X4."},{"Start":"10:08.210 ","End":"10:12.380","Text":"The total amount repaid to our bond investors, in other words,"},{"Start":"10:12.380 ","End":"10:14.615","Text":"the people who have lent us the money,"},{"Start":"10:14.615 ","End":"10:17.630","Text":"when we repurchase it, in other words,"},{"Start":"10:17.630 ","End":"10:23.300","Text":"we\u0027re buying it back earlier than we were supposed to redeem it,"},{"Start":"10:23.300 ","End":"10:28.520","Text":"is the discounted value of all the remaining payments on that date of repurchase."},{"Start":"10:28.520 ","End":"10:30.755","Text":"But using the latest market rate,"},{"Start":"10:30.755 ","End":"10:33.120","Text":"which is now 4 percent."},{"Start":"10:33.440 ","End":"10:38.010","Text":"Remember, the due date was 31 December 20X6,"},{"Start":"10:38.010 ","End":"10:40.120","Text":"so we\u0027re 3 years early."},{"Start":"10:40.120 ","End":"10:42.140","Text":"When you do the calculation,"},{"Start":"10:42.140 ","End":"10:45.040","Text":"remember we\u0027re going to use the 4 percent now,"},{"Start":"10:45.040 ","End":"10:49.190","Text":"not the original market rate of 6 percent."},{"Start":"10:49.730 ","End":"10:54.580","Text":"Remember again, what we have here are two different types of cash flows."},{"Start":"10:54.580 ","End":"10:56.935","Text":"There are going to be two different calculation types."},{"Start":"10:56.935 ","End":"10:59.850","Text":"The 1 is the single outflow of 100,000."},{"Start":"10:59.850 ","End":"11:02.800","Text":"We have to do that present value calculation on its own."},{"Start":"11:02.800 ","End":"11:07.720","Text":"Then we have the coupon payments of 3,000 per annum, that\u0027s an annuity."},{"Start":"11:07.720 ","End":"11:10.795","Text":"We have a different present value calculation for that."},{"Start":"11:10.795 ","End":"11:20.195","Text":"Remember, it\u0027s 3 years away and we\u0027re using the market rate of 4 percent,"},{"Start":"11:20.195 ","End":"11:22.570","Text":"not the original 6 percent."},{"Start":"11:22.570 ","End":"11:25.609","Text":"The present value of future cash outflows."},{"Start":"11:25.609 ","End":"11:27.845","Text":"Let\u0027s do the single outflow first."},{"Start":"11:27.845 ","End":"11:32.900","Text":"That\u0027s the 100,000 that\u0027s due to be paid after 3 years."},{"Start":"11:32.900 ","End":"11:36.685","Text":"But now measured at the latest market rate of 4 percent."},{"Start":"11:36.685 ","End":"11:39.350","Text":"That\u0027s 100,000 is the outflow."},{"Start":"11:39.350 ","End":"11:42.410","Text":"We divide that by 1 plus whatever the market rate is,"},{"Start":"11:42.410 ","End":"11:46.760","Text":"that\u0027s 1.04 and that 1.04 is to the power"},{"Start":"11:46.760 ","End":"11:51.580","Text":"of the number of periods before that outflow is actually due to be paid."},{"Start":"11:51.580 ","End":"11:54.720","Text":"It\u0027s 3 years to the date it\u0027s due to be paid."},{"Start":"11:54.720 ","End":"11:57.630","Text":"It\u0027s 1.04^3."},{"Start":"11:57.630 ","End":"12:01.875","Text":"You solve for that and it\u0027s 88,899.64."},{"Start":"12:01.875 ","End":"12:04.310","Text":"Then we have the present value of the annuity."},{"Start":"12:04.310 ","End":"12:07.115","Text":"The annuity payment is 3,000 a year."},{"Start":"12:07.115 ","End":"12:10.460","Text":"There\u0027re going to be 3 years of it that are still due."},{"Start":"12:10.460 ","End":"12:12.730","Text":"It doesn\u0027t matter that we\u0027re not actually paying it"},{"Start":"12:12.730 ","End":"12:15.980","Text":"on those individual 3 years because we\u0027re repurchasing it."},{"Start":"12:15.980 ","End":"12:18.320","Text":"Remember what we\u0027re doing here is we\u0027re calculating how much we"},{"Start":"12:18.320 ","End":"12:21.530","Text":"actually owe based on what we had committed to paying."},{"Start":"12:21.530 ","End":"12:23.675","Text":"It\u0027s 3,000 per year."},{"Start":"12:23.675 ","End":"12:26.360","Text":"We still have 3 years worth of"},{"Start":"12:26.360 ","End":"12:32.220","Text":"annuity payments to pay and the market rate is at 4 percent."},{"Start":"12:32.220 ","End":"12:34.290","Text":"Remember, not 6."},{"Start":"12:34.290 ","End":"12:38.460","Text":"There\u0027s the formula. Let\u0027s populate this formula."},{"Start":"12:38.460 ","End":"12:41.520","Text":"Put in the payment 3,000,"},{"Start":"12:41.520 ","End":"12:46.590","Text":"wherever you see the n put in the 3 years and wherever you see the r,"},{"Start":"12:46.590 ","End":"12:55.330","Text":"you put in the 0.04 for the 4 percent and you solve, that\u0027s 8,325.27."},{"Start":"12:55.970 ","End":"13:01.140","Text":"That is the present value of our liability on the 31 December,"},{"Start":"13:01.140 ","End":"13:05.310","Text":"20X3 or the 1st of the 1st 20X4,"},{"Start":"13:05.310 ","End":"13:08.615","Text":"3 years before the redemption date."},{"Start":"13:08.615 ","End":"13:14.810","Text":"That comes to 97,224.91 and that is the amount that"},{"Start":"13:14.810 ","End":"13:17.720","Text":"we would have to pay our bond investors if we were"},{"Start":"13:17.720 ","End":"13:21.050","Text":"to repurchase the bond on their debt, which is what we did."},{"Start":"13:21.050 ","End":"13:25.145","Text":"That is your answer, 97,224.91"},{"Start":"13:25.145 ","End":"13:29.260","Text":"is the amount we would have paid in cash in order to clear our debt."},{"Start":"13:29.260 ","End":"13:35.370","Text":"Then part d determines the gain or loss it would recognize on the repurchase of the bond."}],"ID":31021},{"Watched":false,"Name":"Exercise 12","Duration":"15m 41s","ChapterTopicVideoID":29399,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:05.850","Text":"Hello and welcome to an exercise on non-current liabilities brought to you by Proprep."},{"Start":"00:05.850 ","End":"00:09.915","Text":"This exercise deals with the bond that was issued at par."},{"Start":"00:09.915 ","End":"00:13.170","Text":"On the 1st of January 20X1 Vigil issues"},{"Start":"00:13.170 ","End":"00:17.430","Text":"a 6-year bond with a face value of 50,000 currency units."},{"Start":"00:17.430 ","End":"00:23.070","Text":"The bond is issued at par when the market priced it at 4 percent."},{"Start":"00:23.070 ","End":"00:26.955","Text":"The coupon is paid on 31st December each year."},{"Start":"00:26.955 ","End":"00:32.250","Text":"We\u0027re required to assuming the financial year is 31st December, a,"},{"Start":"00:32.250 ","End":"00:39.330","Text":"calculate the interest expense and the coupon payment in both 20X3 and 20X4."},{"Start":"00:39.330 ","End":"00:42.620","Text":"Then b, and then assuming further information on"},{"Start":"00:42.620 ","End":"00:47.000","Text":"31st December 20X3 after the third coupon payment was made,"},{"Start":"00:47.000 ","End":"00:49.265","Text":"Vigil then repurchased the bond."},{"Start":"00:49.265 ","End":"00:52.655","Text":"On the state the market priced it at 5 percent."},{"Start":"00:52.655 ","End":"00:56.195","Text":"Notice the market priced it originally at 4 percent."},{"Start":"00:56.195 ","End":"00:59.870","Text":"We\u0027re to determine the gain or loss that Vigil"},{"Start":"00:59.870 ","End":"01:04.955","Text":"recognize on this repurchase. Let\u0027s start with Part A."},{"Start":"01:04.955 ","End":"01:08.330","Text":"Here we\u0027re required to calculate the interest expense and"},{"Start":"01:08.330 ","End":"01:13.195","Text":"the coupon payment in both years, 20X3 and 20X4."},{"Start":"01:13.195 ","End":"01:16.220","Text":"Now the problem is the question doesn\u0027t give us"},{"Start":"01:16.220 ","End":"01:19.935","Text":"the coupon rate which is what we need in order to calculate"},{"Start":"01:19.935 ","End":"01:22.850","Text":"coupon payments and the question also doesn\u0027t give us"},{"Start":"01:22.850 ","End":"01:28.449","Text":"the issue value which we need in order to calculate the interest expense."},{"Start":"01:28.449 ","End":"01:30.890","Text":"Let\u0027s have a look at the coupon payments."},{"Start":"01:30.890 ","End":"01:35.690","Text":"When we work out the coupon payments we take that face value or par value,"},{"Start":"01:35.690 ","End":"01:40.990","Text":"same thing and we multiply it by the coupon rate that gives us the coupon payment."},{"Start":"01:40.990 ","End":"01:43.475","Text":"Similarly when we\u0027re working out our interests"},{"Start":"01:43.475 ","End":"01:47.000","Text":"expense we need to know what that issue value is."},{"Start":"01:47.000 ","End":"01:50.750","Text":"Another term for the issue value is present value because we need to"},{"Start":"01:50.750 ","End":"01:54.970","Text":"multiply that by the market rate that gives us that the interest expense."},{"Start":"01:54.970 ","End":"01:56.930","Text":"However, we can work this out"},{"Start":"01:56.930 ","End":"02:00.185","Text":"because although the question doesn\u0027t give us a coupon rate,"},{"Start":"02:00.185 ","End":"02:03.011","Text":"and it doesn\u0027t give us the issue value,"},{"Start":"02:03.011 ","End":"02:05.600","Text":"we are told that it was issued at par,"},{"Start":"02:05.600 ","End":"02:09.244","Text":"and that means that the issue value equaled"},{"Start":"02:09.244 ","End":"02:13.825","Text":"its face value or par value which we know is 50,000."},{"Start":"02:13.825 ","End":"02:19.685","Text":"Thus, this means that the market rate would have also equaled the coupon rate."},{"Start":"02:19.685 ","End":"02:22.265","Text":"Because otherwise the issue value and"},{"Start":"02:22.265 ","End":"02:25.795","Text":"the face value or par value wouldn\u0027t have been the same."},{"Start":"02:25.795 ","End":"02:30.380","Text":"This means that the coupon payments will equal the interest expense each year,"},{"Start":"02:30.380 ","End":"02:33.733","Text":"and we\u0027re going to work it out now we\u0027re going to find out that it is 2,000 a year,"},{"Start":"02:33.733 ","End":"02:35.360","Text":"and that will be your answer."},{"Start":"02:35.360 ","End":"02:41.870","Text":"But how do we work it out? It\u0027s a step by step coupon payments are calculated as"},{"Start":"02:41.870 ","End":"02:44.960","Text":"the face value or par value which we are"},{"Start":"02:44.960 ","End":"02:50.115","Text":"given multiplied by the coupon rate which we\u0027re going to deduce."},{"Start":"02:50.115 ","End":"02:56.105","Text":"The interest expense, remember is the issue value or the present value,"},{"Start":"02:56.105 ","End":"02:57.980","Text":"same thing which we are going to have to"},{"Start":"02:57.980 ","End":"03:02.270","Text":"deduce multiplied by the market rate which we are actually given."},{"Start":"03:02.270 ","End":"03:07.310","Text":"It sounds complicated but hopefully as we go through it step by step it won\u0027t be."},{"Start":"03:07.310 ","End":"03:09.500","Text":"Let\u0027s compare these 2."},{"Start":"03:09.500 ","End":"03:14.915","Text":"The face value and the issue value are the same."},{"Start":"03:14.915 ","End":"03:19.004","Text":"The face value was given at 50,000,"},{"Start":"03:19.004 ","End":"03:23.945","Text":"face value and the issue value they\u0027re going to be the same as explained above."},{"Start":"03:23.945 ","End":"03:27.115","Text":"Now the face value we were given as"},{"Start":"03:27.115 ","End":"03:31.430","Text":"50,000 and then we\u0027re told that it was issued at par value,"},{"Start":"03:31.430 ","End":"03:33.215","Text":"par value and face value mean the same thing."},{"Start":"03:33.215 ","End":"03:36.625","Text":"So we can deduce that the issue value is 50,000."},{"Start":"03:36.625 ","End":"03:42.800","Text":"We\u0027re then told that the market rate was given as 4 percent."},{"Start":"03:42.800 ","End":"03:47.720","Text":"Therefore, because our issue value and our face value were the same,"},{"Start":"03:47.720 ","End":"03:50.610","Text":"we could deduce that that meant"},{"Start":"03:50.610 ","End":"03:54.960","Text":"our coupon rate was also 4 percent otherwise it wouldn\u0027t have been the case."},{"Start":"03:54.960 ","End":"04:01.390","Text":"Our coupon payments at 2,000 and our interest expense are therefore 2,000."},{"Start":"04:01.550 ","End":"04:05.420","Text":"It\u0027s going to be that for both 20X3 and 20X4"},{"Start":"04:05.420 ","End":"04:09.000","Text":"because the liability goes up by 2,000 and goes down by 2,000."},{"Start":"04:09.000 ","End":"04:12.890","Text":"Up by 2,000 and down by 2,000 so just it\u0027s never going"},{"Start":"04:12.890 ","End":"04:14.480","Text":"to change because the opening balance and"},{"Start":"04:14.480 ","End":"04:17.350","Text":"closing balance of the liability are going to remain the same."},{"Start":"04:17.350 ","End":"04:19.245","Text":"Let\u0027s look at that again."},{"Start":"04:19.245 ","End":"04:21.980","Text":"Since the coupon payments and the interest expense are the same each year,"},{"Start":"04:21.980 ","End":"04:24.725","Text":"the present value of our liability remains unchanged."},{"Start":"04:24.725 ","End":"04:27.920","Text":"Our opening balance as I said just now will equal"},{"Start":"04:27.920 ","End":"04:32.155","Text":"the closing balance thus our liability will remain at 50,000."},{"Start":"04:32.155 ","End":"04:34.580","Text":"Let\u0027s look at what it will look like in the table."},{"Start":"04:34.580 ","End":"04:38.360","Text":"In 20X1, the beginning of 20X1 we start with 50,000,"},{"Start":"04:38.360 ","End":"04:44.405","Text":"2,000 is the 4 percent market rate multiplied by the 50,000 opening balance."},{"Start":"04:44.405 ","End":"04:48.410","Text":"Then we\u0027ve got the repayment also 2,000 here the way it\u0027s worked out as you\u0027re"},{"Start":"04:48.410 ","End":"04:52.475","Text":"taking the coupon rate which we know to be equal to the market rate."},{"Start":"04:52.475 ","End":"04:57.320","Text":"The coupon rate of 4 percent multiplied by 50,000 is going to be 2,000."},{"Start":"04:57.320 ","End":"05:01.400","Text":"You can see it goes up by 2,000 down by 2,000 so the closing balance will equal"},{"Start":"05:01.400 ","End":"05:03.560","Text":"the opening balance and that then becomes"},{"Start":"05:03.560 ","End":"05:06.030","Text":"the opening balance in the next year, and so on."},{"Start":"05:06.030 ","End":"05:11.420","Text":"It just keeps on maintaining that liability balance of 50,000 and then you can see in"},{"Start":"05:11.420 ","End":"05:17.330","Text":"the very final analysis at the end of 20X6 we would pay the 50,000,"},{"Start":"05:17.330 ","End":"05:20.795","Text":"and so our total payments for the year will be 62,000,"},{"Start":"05:20.795 ","End":"05:23.765","Text":"and you compare it to your opening balance of 50,000,"},{"Start":"05:23.765 ","End":"05:25.940","Text":"and you can see we receive 50,000,"},{"Start":"05:25.940 ","End":"05:31.340","Text":"we repay a total of 62,000 so we\u0027re paying an extra 12,000 and you can see in"},{"Start":"05:31.340 ","End":"05:37.470","Text":"our interests column that is reflected as the total interest expense over the 6 years."},{"Start":"05:37.470 ","End":"05:41.330","Text":"If you wanted to prove the opening and closing balances remained unchanged"},{"Start":"05:41.330 ","End":"05:45.350","Text":"using the formula instead of that table that we looked at a moment ago,"},{"Start":"05:45.350 ","End":"05:49.820","Text":"you could take any of the opening balances at any stage during that 6-year period,"},{"Start":"05:49.820 ","End":"05:52.850","Text":"and check if they reflect the relevant present value."},{"Start":"05:52.850 ","End":"05:56.875","Text":"For example, let\u0027s consider the balance at the end of 20X2."},{"Start":"05:56.875 ","End":"05:58.680","Text":"This is after 2 payments."},{"Start":"05:58.680 ","End":"06:01.290","Text":"Remember it\u0027s a 6-year bond so that means that there are"},{"Start":"06:01.290 ","End":"06:04.730","Text":"4 payments left and then the repayment,"},{"Start":"06:04.730 ","End":"06:08.690","Text":"the actual redemption is going to occur at the end of the 6th year is now going to be"},{"Start":"06:08.690 ","End":"06:13.470","Text":"4 years away from now being the end of 20X2 remember?"},{"Start":"06:13.470 ","End":"06:17.805","Text":"That\u0027s what we\u0027re going be working it on 4 coupon payments."},{"Start":"06:17.805 ","End":"06:21.065","Text":"We\u0027re going to work out the present value of those 4 remaining coupon payments,"},{"Start":"06:21.065 ","End":"06:23.930","Text":"and then we\u0027re going to work out the present value of the repayment"},{"Start":"06:23.930 ","End":"06:27.430","Text":"or redemption at the end of the 4th year."},{"Start":"06:27.430 ","End":"06:30.540","Text":"Remember we\u0027re going to use market rate of 4 percent."},{"Start":"06:30.540 ","End":"06:36.380","Text":"The present value of the repayment of 50,000 after 4 years at 4 percent will simply be"},{"Start":"06:36.380 ","End":"06:41.990","Text":"50,000 divided by 1.04 to the power of 4,"},{"Start":"06:41.990 ","End":"06:46.745","Text":"the letter 4 being the 4 years and that will give you 42,740.51."},{"Start":"06:46.745 ","End":"06:50.930","Text":"Then you would calculate the present value of the annuity of"},{"Start":"06:50.930 ","End":"06:57.158","Text":"2,000 per year for 4 years at 4 percent,"},{"Start":"06:57.158 ","End":"07:03.170","Text":"and using that rather long formula it would be 7,259.29."},{"Start":"07:03.170 ","End":"07:05.215","Text":"29 and you add those 2 together,"},{"Start":"07:05.215 ","End":"07:07.165","Text":"it will give you 50,000."},{"Start":"07:07.165 ","End":"07:09.655","Text":"You can do that for any one of those years."},{"Start":"07:09.655 ","End":"07:12.490","Text":"Now let\u0027s look at part b. On 31.12."},{"Start":"07:12.490 ","End":"07:15.160","Text":"20X3, after the 3rd coupon payment,"},{"Start":"07:15.160 ","End":"07:18.490","Text":"Vigil then repurchase its bond and on this date,"},{"Start":"07:18.490 ","End":"07:21.160","Text":"the market price is at 5 percent and we are to"},{"Start":"07:21.160 ","End":"07:24.175","Text":"determine that gain or loss on that repurchase."},{"Start":"07:24.175 ","End":"07:29.350","Text":"We are buying back the bond or repaying the bond early."},{"Start":"07:29.350 ","End":"07:33.550","Text":"This is 3 years early and the market rate has now changed."},{"Start":"07:33.550 ","End":"07:35.965","Text":"The market rate has gone up,"},{"Start":"07:35.965 ","End":"07:40.540","Text":"so we know our present value is going to go down."},{"Start":"07:40.540 ","End":"07:44.860","Text":"Just to recap, the due date of the bond is 31.12.X6,"},{"Start":"07:44.860 ","End":"07:47.080","Text":"but we are now paying it 3 years early."},{"Start":"07:47.080 ","End":"07:51.655","Text":"We\u0027ve got 3 years of payments left and because we\u0027ve got a change in market rate,"},{"Start":"07:51.655 ","End":"07:55.150","Text":"always remember, you must use the latest market rate,"},{"Start":"07:55.150 ","End":"07:58.135","Text":"so we\u0027re going to be using 5 percent in these calculations."},{"Start":"07:58.135 ","End":"08:02.545","Text":"The total amount that we\u0027re going to repay our investors or"},{"Start":"08:02.545 ","End":"08:07.810","Text":"lenders when we repurchase this bond early is going to be based on the discounted value,"},{"Start":"08:07.810 ","End":"08:09.745","Text":"another way of saying present value,"},{"Start":"08:09.745 ","End":"08:11.770","Text":"of all the remaining payments,"},{"Start":"08:11.770 ","End":"08:16.619","Text":"pretending one is standing on the date 31.12.20X3,"},{"Start":"08:16.619 ","End":"08:19.480","Text":"and remember to use your latest market rate,"},{"Start":"08:19.480 ","End":"08:21.070","Text":"which is 5 percent."},{"Start":"08:21.070 ","End":"08:22.720","Text":"What are the remaining payments?"},{"Start":"08:22.720 ","End":"08:26.335","Text":"We\u0027ve got the present value of the redemption payment of 50,000,"},{"Start":"08:26.335 ","End":"08:30.625","Text":"which is due after 3 years and it\u0027s a single amount,"},{"Start":"08:30.625 ","End":"08:36.325","Text":"plus we have the present value of the coupon payments of 2,000 per year for 3 years,"},{"Start":"08:36.325 ","End":"08:39.580","Text":"that\u0027s the remaining portion of the annuity."},{"Start":"08:39.580 ","End":"08:43.975","Text":"Let\u0027s calculate the present value of those future cash outflows."},{"Start":"08:43.975 ","End":"08:46.480","Text":"Let\u0027s start with the single amount,"},{"Start":"08:46.480 ","End":"08:50.290","Text":"the redemption payment, which is now due after 3 years."},{"Start":"08:50.290 ","End":"08:54.250","Text":"Remember, we\u0027re looking now at 31.12.X3."},{"Start":"08:54.250 ","End":"08:59.050","Text":"Due to the fact that the due date of redemption is 31.12.X6,"},{"Start":"08:59.050 ","End":"09:00.865","Text":"we\u0027ve got 3 years left and remember,"},{"Start":"09:00.865 ","End":"09:02.755","Text":"the market rate has changed."},{"Start":"09:02.755 ","End":"09:04.540","Text":"It\u0027s now 5 percent,"},{"Start":"09:04.540 ","End":"09:06.325","Text":"so you use the 5 percent."},{"Start":"09:06.325 ","End":"09:09.160","Text":"The present value of the 50,000 redemption after"},{"Start":"09:09.160 ","End":"09:12.490","Text":"3 years at 5 percent is simply 50,000 the outflow,"},{"Start":"09:12.490 ","End":"09:14.260","Text":"divide by 1.05,"},{"Start":"09:14.260 ","End":"09:16.150","Text":"being the market rate and the"},{"Start":"09:16.150 ","End":"09:22.585","Text":"1.05^3 years because they have 3 years left before their payment is actually due,"},{"Start":"09:22.585 ","End":"09:26.500","Text":"so that gives us 43,192."},{"Start":"09:26.500 ","End":"09:29.740","Text":"Then let\u0027s look at the present value of the coupon payments,"},{"Start":"09:29.740 ","End":"09:33.685","Text":"which are 2,000 per annum for those remaining 3 years."},{"Start":"09:33.685 ","End":"09:36.100","Text":"Remember we\u0027re using 5 percent."},{"Start":"09:36.100 ","End":"09:38.545","Text":"The present value of the annuity,"},{"Start":"09:38.545 ","End":"09:42.160","Text":"the variables in this calculation are 2,000 for the cash flow,"},{"Start":"09:42.160 ","End":"09:43.480","Text":"3 years left,"},{"Start":"09:43.480 ","End":"09:45.594","Text":"market rate 5 percent."},{"Start":"09:45.594 ","End":"09:47.755","Text":"Let\u0027s populate that."},{"Start":"09:47.755 ","End":"09:50.050","Text":"The payment is 2,000,"},{"Start":"09:50.050 ","End":"09:51.250","Text":"then the numerator,"},{"Start":"09:51.250 ","End":"09:55.820","Text":"1 plus the market rate of 5 percent, so 1.05,"},{"Start":"09:55.920 ","End":"09:58.510","Text":"that to the power of 3,"},{"Start":"09:58.510 ","End":"10:00.130","Text":"because there\u0027s 3 years left,"},{"Start":"10:00.130 ","End":"10:04.225","Text":"minus 1, denominator is the same,"},{"Start":"10:04.225 ","End":"10:13.240","Text":"1.05^3 and this is multiplied by the market rate of 0.05."},{"Start":"10:13.240 ","End":"10:18.550","Text":"You solve for that and you get the present value of your annuity is 5,446."},{"Start":"10:18.550 ","End":"10:21.130","Text":"Remember you got to add those 2 present values together."},{"Start":"10:21.130 ","End":"10:23.590","Text":"The present value of the 50,000,"},{"Start":"10:23.590 ","End":"10:28.030","Text":"the single amount, plus the present value of the annuity,"},{"Start":"10:28.030 ","End":"10:33.130","Text":"add the 2 together and you get a closing balance at the 31.12.X3,"},{"Start":"10:33.130 ","End":"10:41.080","Text":"which is the same thing as saying the balance on the 1.1.20X4 is 48,638."},{"Start":"10:41.080 ","End":"10:47.710","Text":"What we\u0027re asked for is what was the gain or loss in the repurchase?"},{"Start":"10:47.710 ","End":"10:52.030","Text":"Well, we can see here that we are actually going to be required to"},{"Start":"10:52.030 ","End":"10:56.350","Text":"pay 48,638 if we\u0027re wanting to get out of this bond,"},{"Start":"10:56.350 ","End":"11:00.955","Text":"in other words, repurchase it or repay it on that 1.1.20X4."},{"Start":"11:00.955 ","End":"11:03.340","Text":"Based on the market rate of 5 percent,"},{"Start":"11:03.340 ","End":"11:06.250","Text":"we\u0027re going to be required to pay 48,638,"},{"Start":"11:06.250 ","End":"11:10.510","Text":"and we\u0027re told that we do purchase it on 1.1.20X4,"},{"Start":"11:10.510 ","End":"11:13.555","Text":"so we do pay 48,638."},{"Start":"11:13.555 ","End":"11:16.285","Text":"As you could see in part a,"},{"Start":"11:16.285 ","End":"11:17.500","Text":"we actually looked at the table,"},{"Start":"11:17.500 ","End":"11:21.190","Text":"the liability opening balance on the first of the 1.1.20X4 is 50,000."},{"Start":"11:21.190 ","End":"11:24.250","Text":"In fact, it was the opening balance and closing balance did not change,"},{"Start":"11:24.250 ","End":"11:25.795","Text":"they were all 50,000."},{"Start":"11:25.795 ","End":"11:28.315","Text":"On the 1.1.20X4,"},{"Start":"11:28.315 ","End":"11:30.100","Text":"the opening balance was 50,000,"},{"Start":"11:30.100 ","End":"11:34.060","Text":"but we get to clear it by paying 48,638."},{"Start":"11:34.060 ","End":"11:38.604","Text":"The liability balance got smaller by the difference,"},{"Start":"11:38.604 ","End":"11:43.960","Text":"which is 1,362 and obviously if your liability gets smaller, that\u0027s a good thing."},{"Start":"11:43.960 ","End":"11:46.645","Text":"We recognize that as a gain."},{"Start":"11:46.645 ","End":"11:49.975","Text":"For any of you who are interested in the debits and credits,"},{"Start":"11:49.975 ","End":"11:51.790","Text":"when you reduce your liability,"},{"Start":"11:51.790 ","End":"11:54.760","Text":"the liability normally has a credit balance,"},{"Start":"11:54.760 ","End":"12:01.165","Text":"when you reduce it, you debit it and you would credit a gain as a form of income,"},{"Start":"12:01.165 ","End":"12:02.815","Text":"so you would credit it,"},{"Start":"12:02.815 ","End":"12:04.630","Text":"income is always credited."},{"Start":"12:04.630 ","End":"12:08.245","Text":"If you wanted to see all of this in terms of the table,"},{"Start":"12:08.245 ","End":"12:13.480","Text":"you can see our opening balance plus the interest of 2,000 every year,"},{"Start":"12:13.480 ","End":"12:14.619","Text":"less the repayment,"},{"Start":"12:14.619 ","End":"12:16.600","Text":"coupon payment, 2,000,"},{"Start":"12:16.600 ","End":"12:19.105","Text":"so your closing balance remained at 50,000,"},{"Start":"12:19.105 ","End":"12:20.965","Text":"and that stayed the same for 20X1,"},{"Start":"12:20.965 ","End":"12:22.975","Text":"\u00272, and \u00273."},{"Start":"12:22.975 ","End":"12:30.865","Text":"That\u0027s the end of 20X3 and then the very next day on the 1.1.20X4, we repurchased it."},{"Start":"12:30.865 ","End":"12:37.915","Text":"That\u0027s 48,638 that we paid for it and you can see our liability decreased"},{"Start":"12:37.915 ","End":"12:44.974","Text":"from 50,000 to 48,638, 1,362."},{"Start":"12:44.974 ","End":"12:47.530","Text":"That was the answer to question b."},{"Start":"12:47.530 ","End":"12:49.930","Text":"Just to complete the whole table though,"},{"Start":"12:49.930 ","End":"12:52.270","Text":"just so that you can see the whole picture,"},{"Start":"12:52.270 ","End":"12:54.294","Text":"I\u0027ll just complete it."},{"Start":"12:54.294 ","End":"13:00.951","Text":"We\u0027re told that we repurchased this bond,"},{"Start":"13:00.951 ","End":"13:03.160","Text":"sorry, and perhaps it was the 31.12.20X3,"},{"Start":"13:03.160 ","End":"13:05.995","Text":"not the 1.1.20X4, but no matter."},{"Start":"13:05.995 ","End":"13:09.100","Text":"It\u0027s a couple of hours difference and it makes no difference."},{"Start":"13:09.100 ","End":"13:12.070","Text":"You put it in the 48,638,"},{"Start":"13:12.070 ","End":"13:14.800","Text":"add it to the previous payments that we\u0027ve made,"},{"Start":"13:14.800 ","End":"13:16.360","Text":"2,000, 2,000,"},{"Start":"13:16.360 ","End":"13:20.890","Text":"and 2,000, and you get total payments of total outflows that"},{"Start":"13:20.890 ","End":"13:26.290","Text":"the company has had to pay, 54,638."},{"Start":"13:26.290 ","End":"13:28.105","Text":"If we look at the interest column,"},{"Start":"13:28.105 ","End":"13:30.640","Text":"you can see that adds up to 6,000."},{"Start":"13:30.640 ","End":"13:33.880","Text":"But now what you must look at here is in 20X1,"},{"Start":"13:33.880 ","End":"13:35.500","Text":"the opening balance is 50,000,"},{"Start":"13:35.500 ","End":"13:39.880","Text":"so we receive 50,000 and you look at the repayment column,"},{"Start":"13:39.880 ","End":"13:43.045","Text":"you can see the total is 54,638."},{"Start":"13:43.045 ","End":"13:46.705","Text":"You can see the difference is 4,638."},{"Start":"13:46.705 ","End":"13:48.805","Text":"Now, that needs to go through"},{"Start":"13:48.805 ","End":"13:52.345","Text":"our income statement as an income or expense, whatever that is."},{"Start":"13:52.345 ","End":"13:56.680","Text":"Clearly, if you receive 50,000 and pay 54,638,"},{"Start":"13:56.680 ","End":"13:58.930","Text":"you\u0027re paying more than you received,"},{"Start":"13:58.930 ","End":"14:02.200","Text":"so that must be recognized as an expense."},{"Start":"14:02.200 ","End":"14:04.420","Text":"Yet if you look at your interest column,"},{"Start":"14:04.420 ","End":"14:09.695","Text":"we\u0027ve got 6,000 reflected as an interest expense and that doesn\u0027t make any sense."},{"Start":"14:09.695 ","End":"14:13.430","Text":"However, if you then take your 6,000 interest"},{"Start":"14:13.430 ","End":"14:18.255","Text":"expense and you subtract the gain of 1,362,"},{"Start":"14:18.255 ","End":"14:22.300","Text":"you get your net expense of 4,638,"},{"Start":"14:22.300 ","End":"14:27.495","Text":"so it all does make sense in the end."},{"Start":"14:27.495 ","End":"14:30.080","Text":"We can see there\u0027s a problem because the difference"},{"Start":"14:30.080 ","End":"14:32.345","Text":"between the opening balance and closing balance is"},{"Start":"14:32.345 ","End":"14:37.070","Text":"4,638 and that needs to go through our income statement and obviously,"},{"Start":"14:37.070 ","End":"14:40.340","Text":"it needs to go through as an expense and why do I say that?"},{"Start":"14:40.340 ","End":"14:45.420","Text":"Because well, we\u0027ve received 50,000 and we\u0027ve paid 54,638,"},{"Start":"14:45.420 ","End":"14:48.710","Text":"so we\u0027ve paid out more than we actually received, so that\u0027s not a good thing."},{"Start":"14:48.710 ","End":"14:51.170","Text":"That difference, 4,638,"},{"Start":"14:51.170 ","End":"14:52.850","Text":"is going to be an expense."},{"Start":"14:52.850 ","End":"14:55.640","Text":"However, if you look at your interest column,"},{"Start":"14:55.640 ","End":"14:59.840","Text":"you can see that we\u0027re going to be recognizing an interest expense of 6,000 over"},{"Start":"14:59.840 ","End":"15:05.125","Text":"those 3 years to the date that we repurchased the bond and that doesn\u0027t make sense."},{"Start":"15:05.125 ","End":"15:06.665","Text":"However, don\u0027t forget,"},{"Start":"15:06.665 ","End":"15:11.940","Text":"we\u0027ve got the gain on the repurchase of 1,362."},{"Start":"15:11.940 ","End":"15:16.385","Text":"If you take your interest expense of 6,000 and you subtract the gain,"},{"Start":"15:16.385 ","End":"15:17.780","Text":"so one\u0027s an expense,"},{"Start":"15:17.780 ","End":"15:19.130","Text":"the other is income,"},{"Start":"15:19.130 ","End":"15:23.805","Text":"you get your net expense of 4,638."},{"Start":"15:23.805 ","End":"15:26.465","Text":"But remember part b didn\u0027t actually ask for that."},{"Start":"15:26.465 ","End":"15:27.665","Text":"All they wanted to know is,"},{"Start":"15:27.665 ","End":"15:31.290","Text":"what was the gain or loss on the repurchase?"},{"Start":"15:31.290 ","End":"15:33.650","Text":"You can see our liability balance got smaller,"},{"Start":"15:33.650 ","End":"15:37.475","Text":"so that\u0027s a gain, and it got smaller by 1,362."},{"Start":"15:37.475 ","End":"15:42.770","Text":"There\u0027s your answer, a gain of 1,362."}],"ID":31022},{"Watched":false,"Name":"Exercise 13","Duration":"15m 35s","ChapterTopicVideoID":29400,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:05.485","Text":"Hello, and welcome to an exercise on non-current liabilities brought to you by Proprep."},{"Start":"00:05.485 ","End":"00:10.110","Text":"This exercise deals with a lease liability."},{"Start":"00:10.110 ","End":"00:16.035","Text":"On the 1st of January 20X1 ICM enters a lease contract with a term of 5 years."},{"Start":"00:16.035 ","End":"00:19.320","Text":"The non-cancellable agreements requires,"},{"Start":"00:19.320 ","End":"00:21.840","Text":"lease payments at the end of each financial year,"},{"Start":"00:21.840 ","End":"00:28.335","Text":"31 December, of 10,018.26 currency units."},{"Start":"00:28.335 ","End":"00:33.210","Text":"The equipment that was being leased has a fair value on the first of the"},{"Start":"00:33.210 ","End":"00:38.230","Text":"first 20X1 when the lease contract gets entered into are 40,000."},{"Start":"00:38.230 ","End":"00:41.690","Text":"It\u0027s estimated economic life is 8 years."},{"Start":"00:41.690 ","End":"00:45.215","Text":"There is a purchase option at the end of the fifth year at an additional"},{"Start":"00:45.215 ","End":"00:50.705","Text":"10,000 but ICM does not intend to exercise the purchase option."},{"Start":"00:50.705 ","End":"00:53.390","Text":"They consider the straight-line depreciation method to"},{"Start":"00:53.390 ","End":"00:56.330","Text":"be the most appropriate for the leased equipment."},{"Start":"00:56.330 ","End":"01:00.905","Text":"Required, determined the implied interest rate."},{"Start":"01:00.905 ","End":"01:06.965","Text":"B, determine the balance of the lease liability on 31 December 20X1,"},{"Start":"01:06.965 ","End":"01:10.820","Text":"and distinguish between the current and non-current portions."},{"Start":"01:10.820 ","End":"01:16.505","Text":"C, determine the carrying value of the right to use asset,"},{"Start":"01:16.505 ","End":"01:19.610","Text":"which is the equipment on 31st,"},{"Start":"01:19.610 ","End":"01:23.660","Text":"December 20X2, notice the dates always,"},{"Start":"01:23.660 ","End":"01:28.420","Text":"and D, determine the interest expense in 20X3."},{"Start":"01:28.420 ","End":"01:30.800","Text":"You can see just, with regard to dates,"},{"Start":"01:30.800 ","End":"01:35.620","Text":"just watch out for silly mistakes that one might make in an exam."},{"Start":"01:35.620 ","End":"01:39.720","Text":"B is asking for 20X1 lease liability balance,"},{"Start":"01:39.720 ","End":"01:42.860","Text":"C is asking for the right to use asset balance at 31st,"},{"Start":"01:42.860 ","End":"01:47.245","Text":"December 20X2, and interest expense for 20X3."},{"Start":"01:47.245 ","End":"01:50.630","Text":"In this example, they\u0027ve given us information"},{"Start":"01:50.630 ","End":"01:55.130","Text":"regarding a lease where there is an annuity payment,"},{"Start":"01:55.130 ","End":"02:00.800","Text":"and also there is a potential for a single cashflow payment at the end of the 5 years."},{"Start":"02:00.800 ","End":"02:03.215","Text":"I\u0027ll show you the full formula here."},{"Start":"02:03.215 ","End":"02:06.335","Text":"When you calculate the present value of an annuity,"},{"Start":"02:06.335 ","End":"02:08.330","Text":"remember it\u0027s the actual payment."},{"Start":"02:08.330 ","End":"02:10.835","Text":"What we do is that\u0027s the annual payment,"},{"Start":"02:10.835 ","End":"02:15.040","Text":"then we multiply that by 1 plus the rate,"},{"Start":"02:15.040 ","End":"02:16.865","Text":"whatever the interest rate is,"},{"Start":"02:16.865 ","End":"02:19.835","Text":"and that 1 plus the rate is to the power of n,"},{"Start":"02:19.835 ","End":"02:22.550","Text":"where n is the number of periods during which"},{"Start":"02:22.550 ","End":"02:27.020","Text":"that annual payment gets made or could have been an inflow but in this case,"},{"Start":"02:27.020 ","End":"02:28.220","Text":"we\u0027re dealing with liabilities."},{"Start":"02:28.220 ","End":"02:31.310","Text":"So they are outflows and then you subtract 1."},{"Start":"02:31.310 ","End":"02:34.160","Text":"Then we divide that by the denominator,"},{"Start":"02:34.160 ","End":"02:35.315","Text":"which is very similar."},{"Start":"02:35.315 ","End":"02:37.250","Text":"It\u0027s 1 plus the rate,"},{"Start":"02:37.250 ","End":"02:40.865","Text":"with 1 plus the rate is in brackets and it\u0027s to the power of n,"},{"Start":"02:40.865 ","End":"02:42.740","Text":"where n is the number of periods,"},{"Start":"02:42.740 ","End":"02:44.680","Text":"again that this annual payment occurs."},{"Start":"02:44.680 ","End":"02:48.245","Text":"Then we multiply that by r. Now,"},{"Start":"02:48.245 ","End":"02:51.350","Text":"in this case, as I said, we\u0027ve got 2 different kinds of cashflows."},{"Start":"02:51.350 ","End":"02:56.690","Text":"We\u0027ve got the annuity cash flow and then there\u0027s a potential single cashflow."},{"Start":"02:56.690 ","End":"02:58.280","Text":"What does that formula look like?"},{"Start":"02:58.280 ","End":"03:00.110","Text":"Well, remember when there\u0027s a single cashflow"},{"Start":"03:00.110 ","End":"03:01.970","Text":"and you\u0027re trying to work out the present value."},{"Start":"03:01.970 ","End":"03:03.590","Text":"It\u0027s the single cashflow."},{"Start":"03:03.590 ","End":"03:05.900","Text":"In this case, it\u0027s an optional purchase payment"},{"Start":"03:05.900 ","End":"03:09.680","Text":"divided by 1 plus r, whatever the rate is."},{"Start":"03:09.680 ","End":"03:13.220","Text":"Then the n in this case is the number of periods before"},{"Start":"03:13.220 ","End":"03:17.420","Text":"that single cashflow is going to take place but now, in this case,"},{"Start":"03:17.420 ","End":"03:25.785","Text":"the company is not intending to take up the option of purchasing the equipment."},{"Start":"03:25.785 ","End":"03:30.630","Text":"We\u0027re not going to add that extra aspect of the present value calculation."},{"Start":"03:30.630 ","End":"03:33.515","Text":"We\u0027re just going to be looking at the first part of that calculation."},{"Start":"03:33.515 ","End":"03:35.720","Text":"Instead of calculating the present value,"},{"Start":"03:35.720 ","End":"03:40.715","Text":"what we\u0027re doing here is we\u0027re going to be solving for the r in that equation instead."},{"Start":"03:40.715 ","End":"03:44.254","Text":"Let\u0027s populate this equation with the information."},{"Start":"03:44.254 ","End":"03:46.865","Text":"We know that the present value is 40,000,"},{"Start":"03:46.865 ","End":"03:51.630","Text":"the rental payments are 10,018.26."},{"Start":"03:51.630 ","End":"03:56.310","Text":"We multiply that by 1 plus r to the power of 5,"},{"Start":"03:56.310 ","End":"04:00.654","Text":"where 5 is the number of annual payments that are going to be minus 1."},{"Start":"04:00.654 ","End":"04:04.230","Text":"Then below the line is 1 plus r to the power of 5 again,"},{"Start":"04:04.230 ","End":"04:07.820","Text":"because they are 5 payments times the R. Now you see the r,"},{"Start":"04:07.820 ","End":"04:09.665","Text":"we don\u0027t know what the r is,"},{"Start":"04:09.665 ","End":"04:12.410","Text":"so that\u0027s what we\u0027re going to solve for."},{"Start":"04:12.410 ","End":"04:16.785","Text":"Here you\u0027re going to need Excel or just a calculator."},{"Start":"04:16.785 ","End":"04:20.000","Text":"When you use your Excel or your calculator,"},{"Start":"04:20.000 ","End":"04:23.375","Text":"you\u0027re going to find that r is 8 percent and that\u0027s rounded."},{"Start":"04:23.375 ","End":"04:26.750","Text":"When we do our tables just now in the solution,"},{"Start":"04:26.750 ","End":"04:32.585","Text":"you\u0027ll see that the tables won\u0027t round exactly down to 0 at the end of the period."},{"Start":"04:32.585 ","End":"04:34.985","Text":"If you\u0027re looking at the Excel function,"},{"Start":"04:34.985 ","End":"04:37.055","Text":"remember we\u0027re looking for rate."},{"Start":"04:37.055 ","End":"04:39.470","Text":"That\u0027s what we\u0027re looking for, that\u0027s what we don\u0027t know."},{"Start":"04:39.470 ","End":"04:43.480","Text":"Then n, when you put an n, it\u0027s 5."},{"Start":"04:43.480 ","End":"04:45.420","Text":"They\u0027re 5 annual payments,"},{"Start":"04:45.420 ","End":"04:47.040","Text":"what is the amount of the payment?"},{"Start":"04:47.040 ","End":"04:50.325","Text":"The payment is 10,018.26,"},{"Start":"04:50.325 ","End":"04:54.570","Text":"and then the present value is minus 40,000."},{"Start":"04:54.570 ","End":"04:59.665","Text":"Notice the direction, it\u0027s a minus 40,000."},{"Start":"04:59.665 ","End":"05:02.120","Text":"Now let\u0027s look at B."},{"Start":"05:02.120 ","End":"05:10.250","Text":"B wanted us to calculate the lease liability balance at the 31st, December 20X1,"},{"Start":"05:10.250 ","End":"05:14.330","Text":"and they also asked us to break that balance down into how much would be"},{"Start":"05:14.330 ","End":"05:16.640","Text":"presented as a non-current liability and how"},{"Start":"05:16.640 ","End":"05:20.010","Text":"much will be presented as a current liability."},{"Start":"05:20.150 ","End":"05:22.580","Text":"What is the formula?"},{"Start":"05:22.580 ","End":"05:27.470","Text":"We\u0027ve just used it in part A where we were solving for r,"},{"Start":"05:27.470 ","End":"05:29.360","Text":"but now what we\u0027re looking for is we\u0027re going to calculate"},{"Start":"05:29.360 ","End":"05:32.485","Text":"that present value at 31st, December 20X1."},{"Start":"05:32.485 ","End":"05:34.120","Text":"Remember in part A,"},{"Start":"05:34.120 ","End":"05:36.380","Text":"we were able to use the same formula,"},{"Start":"05:36.380 ","End":"05:38.460","Text":"calculate what the rate was."},{"Start":"05:38.460 ","End":"05:42.710","Text":"That\u0027s because we were calculating the rate at"},{"Start":"05:42.710 ","End":"05:47.540","Text":"31st of December 20X0 or the first of January 20X1,"},{"Start":"05:47.540 ","End":"05:48.680","Text":"if you like, in other words,"},{"Start":"05:48.680 ","End":"05:50.350","Text":"at the beginning of the lease."},{"Start":"05:50.350 ","End":"05:53.030","Text":"In that case, we knew that the present value was 40,000,"},{"Start":"05:53.030 ","End":"05:57.760","Text":"40,000 being the fair value of the equipment."},{"Start":"05:57.760 ","End":"06:01.970","Text":"Now we\u0027re looking for the present value at 31st,"},{"Start":"06:01.970 ","End":"06:06.260","Text":"December 20X1, which is 1 year after we entered into the lease agreement."},{"Start":"06:06.260 ","End":"06:08.105","Text":"What is the payment?"},{"Start":"06:08.105 ","End":"06:11.986","Text":"The payment is 10,018.26,"},{"Start":"06:11.986 ","End":"06:13.228","Text":"then we multiply that by,"},{"Start":"06:13.228 ","End":"06:15.350","Text":"now the numerator is 1 plus,"},{"Start":"06:15.350 ","End":"06:17.015","Text":"now we know it\u0027s 8 per cent,"},{"Start":"06:17.015 ","End":"06:19.580","Text":"so it\u0027s 0.08, or if you like,"},{"Start":"06:19.580 ","End":"06:22.865","Text":"in brackets, it\u0027ll be the 1.08."},{"Start":"06:22.865 ","End":"06:25.160","Text":"It\u0027s now no longer to the power of 5 is to"},{"Start":"06:25.160 ","End":"06:27.525","Text":"the power of 4 because we\u0027re 1 year into the lease"},{"Start":"06:27.525 ","End":"06:32.405","Text":"so that means that there are only 4 payments of 10, 018.26 leftover."},{"Start":"06:32.405 ","End":"06:36.165","Text":"Take that numerator and minus 1."},{"Start":"06:36.165 ","End":"06:39.350","Text":"Now we\u0027re going to divide that by again,"},{"Start":"06:39.350 ","End":"06:43.850","Text":"1.08 to the power of 4 for"},{"Start":"06:43.850 ","End":"06:49.205","Text":"the same reasoning as above and then we\u0027re going to multiply it by the rate of 0.08,"},{"Start":"06:49.205 ","End":"06:54.095","Text":"and that gives us 33,181.75."},{"Start":"06:54.095 ","End":"06:56.810","Text":"That is the lease liability,"},{"Start":"06:56.810 ","End":"07:00.395","Text":"the total lease liability balance on 31 December 20X1."},{"Start":"07:00.395 ","End":"07:05.345","Text":"Question asks us to then break it down into what is current and what is non-current."},{"Start":"07:05.345 ","End":"07:10.175","Text":"Well, first thing to do is to work out how much is going to be non-current."},{"Start":"07:10.175 ","End":"07:14.848","Text":"The first thing we\u0027re going to do is work out how much of that is non-current."},{"Start":"07:14.848 ","End":"07:18.639","Text":"Then the difference between the total balance of that lease liability"},{"Start":"07:18.639 ","End":"07:23.320","Text":"minus the non-current portion will be what we call our current portion."},{"Start":"07:23.320 ","End":"07:27.940","Text":"Now, what is non-current?"},{"Start":"07:27.940 ","End":"07:29.380","Text":"Let\u0027s start with current rather."},{"Start":"07:29.380 ","End":"07:30.655","Text":"What is current?"},{"Start":"07:30.655 ","End":"07:35.320","Text":"Current is the portion that will be repaid within 1 year."},{"Start":"07:35.320 ","End":"07:39.670","Text":"That then means that the non-current portion is"},{"Start":"07:39.670 ","End":"07:44.035","Text":"the portion of the liability that we\u0027ll still be owing after a year."},{"Start":"07:44.035 ","End":"07:47.530","Text":"We\u0027ll then calculate that non-current liability"},{"Start":"07:47.530 ","End":"07:51.680","Text":"first and then we\u0027re going to balance to the current."},{"Start":"07:51.960 ","End":"07:56.455","Text":"We will alter the balance for lease liability on 31 December, 20X1."},{"Start":"07:56.455 ","End":"07:58.135","Text":"What we need to know is,"},{"Start":"07:58.135 ","End":"08:01.990","Text":"how much do we still owe 1 year later?"},{"Start":"08:01.990 ","End":"08:05.410","Text":"Because if we still owe it 1 year later it means it hasn\u0027t been"},{"Start":"08:05.410 ","End":"08:09.520","Text":"paid and it means it is a non-current portion."},{"Start":"08:09.520 ","End":"08:13.060","Text":"The balance of the lease liability on 31st December,"},{"Start":"08:13.060 ","End":"08:15.745","Text":"20X2 is the next calculation."},{"Start":"08:15.745 ","End":"08:20.232","Text":"We\u0027re using the same formula that we used above,"},{"Start":"08:20.232 ","End":"08:22.270","Text":"but you\u0027ll see it\u0027s very similar."},{"Start":"08:22.270 ","End":"08:28.660","Text":"Figures are the same, except for the power to n. Those 2,"},{"Start":"08:28.660 ","End":"08:31.288","Text":"the numerator and the denominator,"},{"Start":"08:31.288 ","End":"08:33.685","Text":"both have 1 plus 0.08."},{"Start":"08:33.685 ","End":"08:36.430","Text":"That\u0027s to the power of, in this case,"},{"Start":"08:36.430 ","End":"08:40.480","Text":"3 because if you\u0027re calculating the balance of your lease liability on 31st December,"},{"Start":"08:40.480 ","End":"08:43.330","Text":"20X2, that\u0027s 2 years into the lease."},{"Start":"08:43.330 ","End":"08:44.965","Text":"The lease is 5 years,"},{"Start":"08:44.965 ","End":"08:48.115","Text":"so that means that there are 3 years remaining."},{"Start":"08:48.115 ","End":"08:52.510","Text":"If you solve that you get 25,818.03,"},{"Start":"08:52.510 ","End":"09:01.240","Text":"so that 33,181.75 is the total lease liability balance on 31 December, 20X1,"},{"Start":"09:01.240 ","End":"09:08.380","Text":"of which that 25,818.03 is going to be the non-current portion of"},{"Start":"09:08.380 ","End":"09:12.370","Text":"that lease liability because that is going to be the total lease liability"},{"Start":"09:12.370 ","End":"09:16.375","Text":"that will be presented in our balance sheet on 31st December, 20X2."},{"Start":"09:16.375 ","End":"09:20.890","Text":"In other words, it won\u0027t have been paid back within a year."},{"Start":"09:20.890 ","End":"09:23.229","Text":"That must be non-current."},{"Start":"09:23.229 ","End":"09:29.594","Text":"The difference between the 33,181.75 and what we\u0027ll still be owing a year later,"},{"Start":"09:29.594 ","End":"09:34.765","Text":"25,818.03, is 7,363.72."},{"Start":"09:34.765 ","End":"09:40.000","Text":"That\u0027s the portion that would have been paid by the end of 31st December, 20X2."},{"Start":"09:40.000 ","End":"09:43.848","Text":"In other words, within a year of our year-end,"},{"Start":"09:43.848 ","End":"09:47.140","Text":"and the year-end we\u0027re dealing with is 31 December, 20X1."},{"Start":"09:47.140 ","End":"09:51.625","Text":"That 7,363.72 is our current portion."},{"Start":"09:51.625 ","End":"09:54.085","Text":"Just for interest, here is the table"},{"Start":"09:54.085 ","End":"09:56.410","Text":"if you want to look at it from a tabular point of view."},{"Start":"09:56.410 ","End":"09:59.680","Text":"We started the lease with the opening balance being 40,000."},{"Start":"09:59.680 ","End":"10:03.819","Text":"That is the fair value of the equipment that we leased."},{"Start":"10:03.819 ","End":"10:06.250","Text":"The interest that we worked out in part A was 8 percent,"},{"Start":"10:06.250 ","End":"10:10.780","Text":"so we take 8 percent of 40,000 and that gives us 3,200."},{"Start":"10:10.780 ","End":"10:17.005","Text":"I\u0027ve just rounded it up."},{"Start":"10:17.005 ","End":"10:23.860","Text":"We\u0027re told that we repay 10,018.26."},{"Start":"10:23.860 ","End":"10:28.795","Text":"I think it was that but rounded, it\u0027s 10,019."},{"Start":"10:28.795 ","End":"10:33.820","Text":"Our closing balance is 33,181."},{"Start":"10:33.820 ","End":"10:39.850","Text":"That is our lease liability balance in total at the end of 20X1."},{"Start":"10:39.850 ","End":"10:43.060","Text":"That then becomes our opening balance in 20X2."},{"Start":"10:43.060 ","End":"10:48.430","Text":"We take 8 percent of the 33,181 we get 2,654."},{"Start":"10:48.430 ","End":"10:55.765","Text":"We then subtract the repayment of 1,009 roughly and that gives us 25,817."},{"Start":"10:55.765 ","End":"10:58.570","Text":"That 25,817 is the closing balance."},{"Start":"10:58.570 ","End":"11:00.340","Text":"It will show total closing balance of"},{"Start":"11:00.340 ","End":"11:03.760","Text":"the liability that will show in our balance sheet at the end of 20X2."},{"Start":"11:03.760 ","End":"11:07.180","Text":"We can tell that we\u0027re still going to pay that off a year later."},{"Start":"11:07.180 ","End":"11:09.400","Text":"That will be non-current."},{"Start":"11:09.400 ","End":"11:14.530","Text":"Therefore, if you take the total lease liability balance at the end of X1,"},{"Start":"11:14.530 ","End":"11:19.405","Text":"consider the fact that you still owe 25,817 a year from now,"},{"Start":"11:19.405 ","End":"11:25.420","Text":"that means the difference that it dropped by in that 1 year is the current portion."},{"Start":"11:25.420 ","End":"11:27.970","Text":"The current portion of a liability is the portion"},{"Start":"11:27.970 ","End":"11:31.255","Text":"that will be repaid within 12 months of your year-end."},{"Start":"11:31.255 ","End":"11:36.280","Text":"The year-end we would ask about what\u0027s 31st December 20X1."},{"Start":"11:36.280 ","End":"11:39.595","Text":"During 20X2, being the 12-month period,"},{"Start":"11:39.595 ","End":"11:43.645","Text":"we\u0027ve got 7,364 that is going to be repaid."},{"Start":"11:43.645 ","End":"11:47.840","Text":"That\u0027s our current liability at 20X1."},{"Start":"11:48.470 ","End":"11:51.540","Text":"Just to finish off this table just for interest,"},{"Start":"11:51.540 ","End":"11:54.630","Text":"25,817 as the closing balance at X2"},{"Start":"11:54.630 ","End":"11:57.660","Text":"becomes our opening balance in X3 and we add the interests,"},{"Start":"11:57.660 ","End":"12:00.000","Text":"subtract the repayment, get a closing balance,"},{"Start":"12:00.000 ","End":"12:01.680","Text":"do that for 20X4,"},{"Start":"12:01.680 ","End":"12:03.780","Text":"do that for 20X5."},{"Start":"12:03.780 ","End":"12:06.735","Text":"Because I had rounded the interests to"},{"Start":"12:06.735 ","End":"12:11.640","Text":"8 percent and also the repayments wasn\u0027t quite 10,019,"},{"Start":"12:11.640 ","End":"12:13.037","Text":"it was a little bit less."},{"Start":"12:13.037 ","End":"12:17.520","Text":"You can see that we\u0027ve got a bit of a rounding error but you can see"},{"Start":"12:17.520 ","End":"12:22.379","Text":"using the table you could have picked up your closing balances of your liabilities,"},{"Start":"12:22.379 ","End":"12:25.575","Text":"you could have worked out the current portion and the non-current portion."},{"Start":"12:25.575 ","End":"12:31.235","Text":"C asked us what the carrying amount of the leased equipment,"},{"Start":"12:31.235 ","End":"12:33.895","Text":"which is called a right of use asset,"},{"Start":"12:33.895 ","End":"12:38.140","Text":"what that carrying amount would be at 31st December, 20X2."},{"Start":"12:38.140 ","End":"12:42.355","Text":"Now, we entered into the lease on the 1st of the 1st, 20X1."},{"Start":"12:42.355 ","End":"12:45.340","Text":"We\u0027ve been asked to calculate the carrying amount of"},{"Start":"12:45.340 ","End":"12:49.270","Text":"the leased asset 2 years into the lease."},{"Start":"12:49.270 ","End":"12:53.530","Text":"Now, the leased asset is measured at"},{"Start":"12:53.530 ","End":"12:57.580","Text":"the fair value that it had on the date we entered into the lease,"},{"Start":"12:57.580 ","End":"12:59.470","Text":"and that was 40,000."},{"Start":"12:59.470 ","End":"13:02.350","Text":"When we actually enter into the leases,"},{"Start":"13:02.350 ","End":"13:04.795","Text":"for those of you who are interested in the debits and credits,"},{"Start":"13:04.795 ","End":"13:07.060","Text":"you would debit the asset with"},{"Start":"13:07.060 ","End":"13:11.740","Text":"40,000 and you would credit the lease liability with 40,000."},{"Start":"13:11.740 ","End":"13:13.195","Text":"Let\u0027s get back to part C,"},{"Start":"13:13.195 ","End":"13:16.405","Text":"which was to calculate the carrying amount of the equipment."},{"Start":"13:16.405 ","End":"13:21.655","Text":"40,000 is our fair value or the cost of our equipment."},{"Start":"13:21.655 ","End":"13:23.500","Text":"It\u0027s considered to be the cost."},{"Start":"13:23.500 ","End":"13:25.900","Text":"We would subtract any residual value."},{"Start":"13:25.900 ","End":"13:28.300","Text":"They didn\u0027t mention anything about residual values,"},{"Start":"13:28.300 ","End":"13:32.080","Text":"such as simply 40,000 divide by the useful life."},{"Start":"13:32.080 ","End":"13:36.325","Text":"Now, because we\u0027re not going to extend the lease by another year or purchase it,"},{"Start":"13:36.325 ","End":"13:39.940","Text":"we\u0027ve got a lease contract of 5 years."},{"Start":"13:39.940 ","End":"13:43.360","Text":"We\u0027re only going to have access to this asset for 5 years,"},{"Start":"13:43.360 ","End":"13:48.700","Text":"and therefore it needs to be depreciated by the end of those 5 years."},{"Start":"13:48.700 ","End":"13:52.600","Text":"So 40,000 divided by 5 is 8,000 a year."},{"Start":"13:52.600 ","End":"13:56.410","Text":"The accumulated depreciation at 31 December, 20X2,"},{"Start":"13:56.410 ","End":"14:02.920","Text":"after the 2 years is 8,000 per year depreciation times 2, that\u0027s 16,000."},{"Start":"14:02.920 ","End":"14:04.585","Text":"That\u0027s still not the carrying amount."},{"Start":"14:04.585 ","End":"14:06.970","Text":"That is accumulated depreciation."},{"Start":"14:06.970 ","End":"14:10.150","Text":"The carrying amount of that right to use asset or"},{"Start":"14:10.150 ","End":"14:13.510","Text":"the leased equipment on 31 December, 20X2,"},{"Start":"14:13.510 ","End":"14:17.620","Text":"is the cost less the accumulated depreciation to date and"},{"Start":"14:17.620 ","End":"14:22.600","Text":"you subtract the accumulated depreciation of 16,000."},{"Start":"14:22.600 ","End":"14:29.290","Text":"That gives us a carrying amount of 24,000 at 31 December, 20X2."},{"Start":"14:29.290 ","End":"14:33.770","Text":"Then part D, we\u0027re asked for the interest expense in the year 20X3."},{"Start":"14:33.770 ","End":"14:36.530","Text":"To work out the interest expense in any 1 year you take"},{"Start":"14:36.530 ","End":"14:40.785","Text":"the opening balance of your liability and you multiply it by the interest rate."},{"Start":"14:40.785 ","End":"14:43.520","Text":"If we want to work out the interest for 23 you need"},{"Start":"14:43.520 ","End":"14:47.790","Text":"the opening balance of your lease liability in 20X3."},{"Start":"14:48.220 ","End":"14:51.275","Text":"We\u0027ve just calculated that"},{"Start":"14:51.275 ","End":"14:57.810","Text":"the opening balance of the lease liability in 20X3 is 25,818.03."},{"Start":"14:57.810 ","End":"15:00.950","Text":"We actually calculated that in part B,"},{"Start":"15:00.950 ","End":"15:08.010","Text":"where we were calculating the non-current portion of the lease liability."},{"Start":"15:08.010 ","End":"15:13.390","Text":"If you go back to part B you\u0027ll see where we calculated the 25,818.03."},{"Start":"15:13.390 ","End":"15:15.725","Text":"All we now need to do is take the"},{"Start":"15:15.725 ","End":"15:20.820","Text":"25,818.03 and multiply it by the interest rate of 8 percent."},{"Start":"15:20.820 ","End":"15:24.630","Text":"There we have it, 2,064.44."},{"Start":"15:24.630 ","End":"15:29.360","Text":"Just for interest\u0027s sake, you could have picked up that interest expense for 20X3 from"},{"Start":"15:29.360 ","End":"15:34.770","Text":"your table if you had chosen to do the calculations using a tabular approach instead."}],"ID":31023},{"Watched":false,"Name":"Exercise 14","Duration":"15m 53s","ChapterTopicVideoID":29401,"CourseChapterTopicPlaylistID":291059,"HasSubtitles":true,"ThumbnailPath":null,"UploadDate":null,"DurationForVideoObject":null,"Description":null,"MetaTitle":null,"MetaDescription":null,"Canonical":null,"VideoComments":[],"Subtitles":[{"Start":"00:00.000 ","End":"00:03.870","Text":"This exercise deals with a lease liability."},{"Start":"00:03.870 ","End":"00:06.240","Text":"On the 1st of January 20X1,"},{"Start":"00:06.240 ","End":"00:12.315","Text":"4M enters a non-cancellable lease contract with a term of 5 years."},{"Start":"00:12.315 ","End":"00:14.700","Text":"The fair value of the equipment,"},{"Start":"00:14.700 ","End":"00:19.905","Text":"that\u0027s the content of the lease, is 45,006."},{"Start":"00:19.905 ","End":"00:24.720","Text":"The estimated economic life is 8 years."},{"Start":"00:24.720 ","End":"00:30.630","Text":"The annual rent payments of 10,000 are due on 31st December of each year,"},{"Start":"00:30.630 ","End":"00:34.275","Text":"which happens to coincide with the financial year-end."},{"Start":"00:34.275 ","End":"00:41.960","Text":"There is a purchase option at the end of year 5 at an additional 9,400 currency units,"},{"Start":"00:41.960 ","End":"00:44.835","Text":"which 4M intends to exercise."},{"Start":"00:44.835 ","End":"00:48.800","Text":"4M also uses the straight-line depreciation method."},{"Start":"00:48.800 ","End":"00:51.065","Text":"Now, the required is, a,"},{"Start":"00:51.065 ","End":"00:54.055","Text":"determine the implied interest rate,"},{"Start":"00:54.055 ","End":"01:00.590","Text":"b is determine the balance of the lease liability on 31st December 20X1,"},{"Start":"01:00.590 ","End":"01:04.534","Text":"and distinguish between the current and non-current portions."},{"Start":"01:04.534 ","End":"01:09.290","Text":"Then c, calculate the carrying value of the right to"},{"Start":"01:09.290 ","End":"01:14.263","Text":"use asset as at the 31st, December 20X2."},{"Start":"01:14.263 ","End":"01:21.155","Text":"Then d, calculate the interest expense in 20X3."},{"Start":"01:21.155 ","End":"01:25.505","Text":"Let\u0027s look at the solution to the lease liability exercise,"},{"Start":"01:25.505 ","End":"01:32.035","Text":"starting with a, where we were required to determine the implied interest rate."},{"Start":"01:32.035 ","End":"01:35.510","Text":"We\u0027re going to use the formula for"},{"Start":"01:35.510 ","End":"01:38.780","Text":"the present value calculation to solve for the implied interest rate."},{"Start":"01:38.780 ","End":"01:41.300","Text":"Now, when we do the present value calculation,"},{"Start":"01:41.300 ","End":"01:43.385","Text":"or put together the present value formula,"},{"Start":"01:43.385 ","End":"01:45.950","Text":"we need to consider the types of cash flow."},{"Start":"01:45.950 ","End":"01:47.330","Text":"There are 2 types of cash flows,"},{"Start":"01:47.330 ","End":"01:48.620","Text":"and we\u0027ve got both of them here."},{"Start":"01:48.620 ","End":"01:50.840","Text":"1 is the annual cash flow,"},{"Start":"01:50.840 ","End":"01:52.865","Text":"so an annuity,"},{"Start":"01:52.865 ","End":"01:55.475","Text":"and the other is the single cash flow."},{"Start":"01:55.475 ","End":"02:00.905","Text":"The reason why we have both here is because we not only have annual rent payments,"},{"Start":"02:00.905 ","End":"02:07.775","Text":"but we also have a single cash flow at the end of the lease contract,"},{"Start":"02:07.775 ","End":"02:11.315","Text":"which is optional, but which the company intends to use."},{"Start":"02:11.315 ","End":"02:14.630","Text":"We are going to have 2 aspects to this present value formula."},{"Start":"02:14.630 ","End":"02:19.129","Text":"This is the formula for the present value of an annuity."},{"Start":"02:19.129 ","End":"02:22.040","Text":"It\u0027s the rental payment or the annual payment,"},{"Start":"02:22.040 ","End":"02:28.045","Text":"multiplied by the (1 plus the rate) to the power of n minus 1,"},{"Start":"02:28.045 ","End":"02:33.230","Text":"and we divide that by 1 plus the interest rate to the power of"},{"Start":"02:33.230 ","End":"02:39.230","Text":"n multiplied by r. So n there refers to the number of annual payments,"},{"Start":"02:39.230 ","End":"02:42.590","Text":"the number of rental payments, if you like."},{"Start":"02:42.590 ","End":"02:48.290","Text":"Then we add the formula for the present value of a single cash flow."},{"Start":"02:48.290 ","End":"02:53.000","Text":"We have an optional purchase payment at the end of the 5 years"},{"Start":"02:53.000 ","End":"02:57.800","Text":"and that\u0027s going to be divided by 1 plus the rate to the power of n. Now,"},{"Start":"02:57.800 ","End":"03:05.905","Text":"that n refers to how many periods there will be before the single cash flow falls due."},{"Start":"03:05.905 ","End":"03:09.530","Text":"We had 1 annuity on the left-hand side and"},{"Start":"03:09.530 ","End":"03:13.145","Text":"we have 1 single cash flow on the right-hand side,"},{"Start":"03:13.145 ","End":"03:16.510","Text":"making up the 2 aspects to this present value formula."},{"Start":"03:16.510 ","End":"03:17.810","Text":"Now, remember that"},{"Start":"03:17.810 ","End":"03:22.543","Text":"that optional purchase payment is being included in the present value calculation,"},{"Start":"03:22.543 ","End":"03:25.565","Text":"and that is because the company intends to"},{"Start":"03:25.565 ","End":"03:30.220","Text":"exercise their option to purchase that leased asset."},{"Start":"03:30.220 ","End":"03:32.625","Text":"Let\u0027s populate this then."},{"Start":"03:32.625 ","End":"03:35.465","Text":"We have a present value that we actually know."},{"Start":"03:35.465 ","End":"03:36.890","Text":"The reason we know it,"},{"Start":"03:36.890 ","End":"03:40.670","Text":"is that it always reflects the fair value of the leased asset,"},{"Start":"03:40.670 ","End":"03:44.435","Text":"which we were given at 45,006."},{"Start":"03:44.435 ","End":"03:48.760","Text":"Then we know that the annual rental payment is 10,000,"},{"Start":"03:48.760 ","End":"03:52.800","Text":"then we multiply that by 1 plus r. Now, you see,"},{"Start":"03:52.800 ","End":"03:55.010","Text":"we just call it r because we don\u0027t know what the rate is,"},{"Start":"03:55.010 ","End":"03:56.405","Text":"that\u0027s what we\u0027re looking for."},{"Start":"03:56.405 ","End":"03:58.685","Text":"The 1 plus r is to the power of 5,"},{"Start":"03:58.685 ","End":"04:01.205","Text":"because there are going to be 5 annual payments of 10."},{"Start":"04:01.205 ","End":"04:06.000","Text":"We subtract 1, divided by 1 plus r^5,"},{"Start":"04:06.250 ","End":"04:09.425","Text":"multiply by r. Now,"},{"Start":"04:09.425 ","End":"04:10.790","Text":"the single cash flow."},{"Start":"04:10.790 ","End":"04:15.350","Text":"Here, the single cash outflow will be 9,400 and again,"},{"Start":"04:15.350 ","End":"04:18.610","Text":"we\u0027re dividing it by 1 plus r^5,"},{"Start":"04:18.610 ","End":"04:22.460","Text":"where this 5 refers to how many periods will there"},{"Start":"04:22.460 ","End":"04:26.820","Text":"be before that single cash flow falls due."},{"Start":"04:27.620 ","End":"04:32.890","Text":"You\u0027re going to have to use Excel or a calculator,"},{"Start":"04:32.890 ","End":"04:38.210","Text":"we find that our r equals 9 percent, slightly rounded."},{"Start":"04:38.210 ","End":"04:40.930","Text":"Let us check that our 9 percent actually works."},{"Start":"04:40.930 ","End":"04:42.520","Text":"This is always a useful tool."},{"Start":"04:42.520 ","End":"04:47.020","Text":"Here\u0027s our table. In 20X1, we enter into the lease."},{"Start":"04:47.020 ","End":"04:48.610","Text":"At the beginning of 20X1,"},{"Start":"04:48.610 ","End":"04:52.090","Text":"we start with an opening balance of 45,006."},{"Start":"04:52.090 ","End":"04:55.930","Text":"It\u0027s always going to be the fair value of the asset that you\u0027re leasing."},{"Start":"04:55.930 ","End":"04:59.620","Text":"For those who are interested in the debits and credits, at this point,"},{"Start":"04:59.620 ","End":"05:01.900","Text":"what we\u0027re doing is we\u0027re debiting the asset with"},{"Start":"05:01.900 ","End":"05:05.935","Text":"45,006 to say here we have this right-of-use asset,"},{"Start":"05:05.935 ","End":"05:12.340","Text":"and then we credit the lease liability with 45,006."},{"Start":"05:12.340 ","End":"05:15.910","Text":"Then we add interest."},{"Start":"05:15.910 ","End":"05:18.050","Text":"Interest is 9 percent,"},{"Start":"05:18.050 ","End":"05:19.470","Text":"which you just calculated,"},{"Start":"05:19.470 ","End":"05:24.030","Text":"so 9 percent of 45,006 gives us 4,051."},{"Start":"05:24.030 ","End":"05:27.230","Text":"For those of you who are interested in the debits and credits,"},{"Start":"05:27.230 ","End":"05:29.270","Text":"we take that 4,051,"},{"Start":"05:29.270 ","End":"05:35.140","Text":"we debit the interest expense and we credit the lease liability."},{"Start":"05:35.140 ","End":"05:39.230","Text":"The lease liability is getting bigger by 4,051."},{"Start":"05:39.230 ","End":"05:41.780","Text":"Then we have the repayment."},{"Start":"05:41.780 ","End":"05:47.375","Text":"What\u0027s happening here is we\u0027re reducing our lease liability because we\u0027re paying it off."},{"Start":"05:47.375 ","End":"05:49.970","Text":"For those of you interested in the debits and credits,"},{"Start":"05:49.970 ","End":"05:54.838","Text":"what we\u0027re doing here is we are debiting the lease liability to reduce it,"},{"Start":"05:54.838 ","End":"05:56.825","Text":"and the credit goes to the bank because"},{"Start":"05:56.825 ","End":"05:59.680","Text":"your payments go on the credit side of your bank account."},{"Start":"05:59.680 ","End":"06:02.150","Text":"What\u0027s left in the lease liability account?"},{"Start":"06:02.150 ","End":"06:04.370","Text":"The liability started at 45,006,"},{"Start":"06:04.370 ","End":"06:07.540","Text":"it went up by the interest of 4,051,"},{"Start":"06:07.540 ","End":"06:10.150","Text":"and it went down by the cash payment of 10,000."},{"Start":"06:10.150 ","End":"06:16.190","Text":"So the closing balance in the lease liability is 39,056."},{"Start":"06:16.190 ","End":"06:20.180","Text":"That becomes our opening balance in 20X2, and we do the same thing,"},{"Start":"06:20.180 ","End":"06:22.444","Text":"we add the interest, subtract the repayment,"},{"Start":"06:22.444 ","End":"06:24.320","Text":"and we get 32,571."},{"Start":"06:24.320 ","End":"06:26.810","Text":"That becomes our opening balance in 20X3, and so on."},{"Start":"06:26.810 ","End":"06:30.155","Text":"We do that for 20X3, 20X4, 20X5."},{"Start":"06:30.155 ","End":"06:33.124","Text":"Then don\u0027t forget, in this scenario,"},{"Start":"06:33.124 ","End":"06:35.700","Text":"the company intends to exercise their option,"},{"Start":"06:35.700 ","End":"06:40.245","Text":"so there is another payment of 9,400."},{"Start":"06:40.245 ","End":"06:42.170","Text":"At the end of 20X5,"},{"Start":"06:42.170 ","End":"06:44.215","Text":"they\u0027re going to make 2 payments,"},{"Start":"06:44.215 ","End":"06:46.800","Text":"10,000 and the 9,400."},{"Start":"06:46.800 ","End":"06:50.000","Text":"So they\u0027re going to make a payment of 19,400,"},{"Start":"06:50.000 ","End":"06:52.565","Text":"bringing the liability balance to 0."},{"Start":"06:52.565 ","End":"06:58.280","Text":"You can see that 9 percent payment that we calculated is indeed correct."},{"Start":"06:58.280 ","End":"07:01.652","Text":"Our repayments add up to 59,400."},{"Start":"07:01.652 ","End":"07:06.295","Text":"If you go back and look at the opening balance is 45,006,"},{"Start":"07:06.295 ","End":"07:08.860","Text":"you subtract that 1 from the other."},{"Start":"07:08.860 ","End":"07:16.360","Text":"We can see we\u0027ve paid 14,394 more than we originally received in terms of value."},{"Start":"07:16.360 ","End":"07:21.385","Text":"That 14,394, using an interest rate of 9 percent,"},{"Start":"07:21.385 ","End":"07:23.890","Text":"adds up to the interests,"},{"Start":"07:23.890 ","End":"07:27.205","Text":"the total of the interests that we are going to recognize over those 5 years."},{"Start":"07:27.205 ","End":"07:29.365","Text":"Then if you look at the closing balance column,"},{"Start":"07:29.365 ","End":"07:35.855","Text":"you can see comes down to 0 when we pay that last payment of 9,400."},{"Start":"07:35.855 ","End":"07:37.680","Text":"Now let\u0027s look at part b."},{"Start":"07:37.680 ","End":"07:41.520","Text":"Here we were required to determine the balance of"},{"Start":"07:41.520 ","End":"07:46.170","Text":"the lease liability on 31 December 20X1,"},{"Start":"07:46.170 ","End":"07:49.720","Text":"1 year into the lease contract."},{"Start":"07:49.720 ","End":"07:52.870","Text":"We were also required to distinguish between"},{"Start":"07:52.870 ","End":"07:57.130","Text":"the current and non-current portion of that lease liability balance."},{"Start":"07:57.130 ","End":"08:00.595","Text":"If you have a look at that table that we drafted a moment ago,"},{"Start":"08:00.595 ","End":"08:03.310","Text":"you can see that at the end of 20X1,"},{"Start":"08:03.310 ","End":"08:07.355","Text":"the lease liability balance is 39,056,"},{"Start":"08:07.355 ","End":"08:11.625","Text":"sets the answer to part of the answer to part b."},{"Start":"08:11.625 ","End":"08:16.785","Text":"The next step was to determine how much of that was a current portion,"},{"Start":"08:16.785 ","End":"08:20.285","Text":"and how much of that would be presented as a non-current portion?"},{"Start":"08:20.285 ","End":"08:23.950","Text":"Well, the non-current portion is the portion that\u0027s not current."},{"Start":"08:23.950 ","End":"08:29.320","Text":"The current portion is the portion that\u0027s going to be repaid within 1 year."},{"Start":"08:29.320 ","End":"08:35.260","Text":"Using that logic, you can see that whatever is paid within a year of 20X1\u0027s,"},{"Start":"08:35.260 ","End":"08:37.480","Text":"closing balance is current,"},{"Start":"08:37.480 ","End":"08:39.970","Text":"whatever remains is our liability balance."},{"Start":"08:39.970 ","End":"08:43.510","Text":"In other words, it\u0027s not yet paid that will be our non-current portion."},{"Start":"08:43.510 ","End":"08:46.180","Text":"Have a look at 20X2,"},{"Start":"08:46.180 ","End":"08:49.690","Text":"our closing balance will be 32571."},{"Start":"08:49.690 ","End":"08:53.290","Text":"That\u0027s the non-current portion because it\u0027s still going to be owing"},{"Start":"08:53.290 ","End":"08:57.385","Text":"a year from the end of 20X1. That\u0027s non-current."},{"Start":"08:57.385 ","End":"08:59.650","Text":"If that\u0027s non-current, well,"},{"Start":"08:59.650 ","End":"09:02.230","Text":"then we know what the current portion is."},{"Start":"09:02.230 ","End":"09:06.955","Text":"It\u0027s the total liability that we\u0027re going to show at the end of 20X1 of 39056,"},{"Start":"09:06.955 ","End":"09:10.030","Text":"less how much we know is going to be the non-current portion."},{"Start":"09:10.030 ","End":"09:15.070","Text":"In other words, it\u0027s still gonna be owing a year from now, 32,571."},{"Start":"09:15.070 ","End":"09:19.600","Text":"That means 6,485 will be repaid during 20X2,"},{"Start":"09:19.600 ","End":"09:25.255","Text":"which is the 12 months immediately after our year-end of 31st December 20X1."},{"Start":"09:25.255 ","End":"09:30.010","Text":"But we could also use the formula if you prefer to use the formula instead of the tables."},{"Start":"09:30.010 ","End":"09:32.230","Text":"If you use the formula to calculate the balance of"},{"Start":"09:32.230 ","End":"09:35.215","Text":"the lease liability on 31 December 20X1."},{"Start":"09:35.215 ","End":"09:36.670","Text":"It\u0027s the 10,000,"},{"Start":"09:36.670 ","End":"09:40.465","Text":"which is our annual payments as part of our annuity."},{"Start":"09:40.465 ","End":"09:44.440","Text":"We multiply that by 1 plus the 9 percent."},{"Start":"09:44.440 ","End":"09:48.280","Text":"The 1.09 is to the power of 4."},{"Start":"09:48.280 ","End":"09:51.009","Text":"That\u0027s because they\u0027re going to be 4 more of these payments."},{"Start":"09:51.009 ","End":"09:56.170","Text":"If you considering that you\u0027re on the timeline and your 1-year into a 5-year timeline,"},{"Start":"09:56.170 ","End":"09:59.350","Text":"we\u0027ve only got full year\u0027s worth of repayments due."},{"Start":"09:59.350 ","End":"10:01.285","Text":"You subtract 1."},{"Start":"10:01.285 ","End":"10:04.900","Text":"Then you divide by 1.09 to the power 4,"},{"Start":"10:04.900 ","End":"10:07.780","Text":"and you multiply it by 0.09."},{"Start":"10:07.780 ","End":"10:12.985","Text":"Then to that you add the single cash or the present value of the single cash flow."},{"Start":"10:12.985 ","End":"10:14.410","Text":"The reason for that, remember,"},{"Start":"10:14.410 ","End":"10:20.290","Text":"is because the company intends to exercise that option to purchase the asset."},{"Start":"10:20.290 ","End":"10:25.690","Text":"The payment at the end of year 5 as the lease is 9,400."},{"Start":"10:25.690 ","End":"10:29.830","Text":"But you can divide that by 1.09 to the power of"},{"Start":"10:29.830 ","End":"10:34.645","Text":"4 because there are 4 periods or 4 years left before their payment falls due."},{"Start":"10:34.645 ","End":"10:38.410","Text":"That comes to 39,056.4."},{"Start":"10:38.410 ","End":"10:40.480","Text":"To work out the non-current portion,"},{"Start":"10:40.480 ","End":"10:44.095","Text":"you now go 1-year further into your lease,"},{"Start":"10:44.095 ","End":"10:47.950","Text":"1-year further into the lease as 31st, December 20X2,"},{"Start":"10:47.950 ","End":"10:52.075","Text":"and you calculate what the balance of the liability will be on that date."},{"Start":"10:52.075 ","End":"10:57.700","Text":"The formula looks almost identical except notice what\u0027s been highlighted here."},{"Start":"10:57.700 ","End":"11:00.130","Text":"When we put it to the power of n,"},{"Start":"11:00.130 ","End":"11:03.355","Text":"It\u0027s no longer to the power of 4 is to the power of 3."},{"Start":"11:03.355 ","End":"11:05.080","Text":"If you look at the second formula,"},{"Start":"11:05.080 ","End":"11:07.645","Text":"it looks very much like the previous formula."},{"Start":"11:07.645 ","End":"11:11.305","Text":"The only difference being where you see to the power of n,"},{"Start":"11:11.305 ","End":"11:13.510","Text":"it\u0027s now no longer to the power of 4,"},{"Start":"11:13.510 ","End":"11:14.965","Text":"it\u0027s to the power of 3."},{"Start":"11:14.965 ","End":"11:18.580","Text":"The reason for that is because we are now 2 years,"},{"Start":"11:18.580 ","End":"11:22.360","Text":"we\u0027re looking at the balance of liability at 31st, December 20X2."},{"Start":"11:22.360 ","End":"11:26.318","Text":"We\u0027re looking at it 2 years into the lease contract,"},{"Start":"11:26.318 ","End":"11:29.845","Text":"so there are now only 3 years of the annuity lift."},{"Start":"11:29.845 ","End":"11:32.740","Text":"In terms of that 9,400 payment,"},{"Start":"11:32.740 ","End":"11:34.960","Text":"the single cash-flow is not an annuity."},{"Start":"11:34.960 ","End":"11:38.560","Text":"There are 3 years before that single cash flow falls due."},{"Start":"11:38.560 ","End":"11:44.665","Text":"That means that 39056.4 is the balance of 31st December X1,"},{"Start":"11:44.665 ","End":"11:51.505","Text":"but 32,571.47 will be the balance at the end of 31st December 20X2."},{"Start":"11:51.505 ","End":"11:55.990","Text":"The current portion is the portion by which that liability balance at"},{"Start":"11:55.990 ","End":"12:03.145","Text":"31st December 20X1 decreased within the 12 months to 31st December 20X2."},{"Start":"12:03.145 ","End":"12:07.860","Text":"It decreased by 6,484.93."},{"Start":"12:07.860 ","End":"12:13.410","Text":"In other words, it\u0027s the 39056.4 is the total liability at 31st December X1,"},{"Start":"12:13.410 ","End":"12:17.850","Text":"less what we consider to be the non-current portion because that\u0027s how much"},{"Start":"12:17.850 ","End":"12:22.380","Text":"our liability will still be reflected at a year down the line,"},{"Start":"12:22.380 ","End":"12:27.675","Text":"32571.74, that means it\u0027s still going to be paid 12 months onwards."},{"Start":"12:27.675 ","End":"12:32.635","Text":"That must mean total liability less the non-current portion,"},{"Start":"12:32.635 ","End":"12:35.020","Text":"portion will still be owed 12 months down the line."},{"Start":"12:35.020 ","End":"12:37.120","Text":"That must mean that within the 12 months,"},{"Start":"12:37.120 ","End":"12:40.930","Text":"6,484.93 had been repaid."},{"Start":"12:40.930 ","End":"12:45.820","Text":"Then we look at part c, the annual depreciation expense had to be calculated."},{"Start":"12:45.820 ","End":"12:50.275","Text":"Now here we need to be careful because we\u0027re going to take the fair value,"},{"Start":"12:50.275 ","End":"12:52.345","Text":"which is the cost of the asset."},{"Start":"12:52.345 ","End":"12:53.890","Text":"But you\u0027ve got to be careful, what is"},{"Start":"12:53.890 ","End":"12:56.830","Text":"the useful life we\u0027re going to use for depreciation purposes?"},{"Start":"12:56.830 ","End":"13:01.330","Text":"The asset itself has a useful life of 8 years,"},{"Start":"13:01.330 ","End":"13:05.680","Text":"and the lease contract had a period of 5 years."},{"Start":"13:05.680 ","End":"13:07.450","Text":"Now, which do you use?"},{"Start":"13:07.450 ","End":"13:09.520","Text":"Is it an 8-year life or a 5-year life?"},{"Start":"13:09.520 ","End":"13:11.725","Text":"Well, because the company intends to"},{"Start":"13:11.725 ","End":"13:15.850","Text":"exercise its option to purchase the asset at the end of the lease."},{"Start":"13:15.850 ","End":"13:20.665","Text":"We disregard the lease contract period of 5 years,"},{"Start":"13:20.665 ","End":"13:25.105","Text":"and we go with the asset\u0027s useful life of 8 years."},{"Start":"13:25.105 ","End":"13:27.505","Text":"We take the cost of the asset,"},{"Start":"13:27.505 ","End":"13:31.990","Text":"which is the fair value of 45006,"},{"Start":"13:31.990 ","End":"13:35.110","Text":"we subtract any residual value,"},{"Start":"13:35.110 ","End":"13:38.335","Text":"we weren\u0027t told about it though in this example."},{"Start":"13:38.335 ","End":"13:43.465","Text":"We divide it simply by the useful life of 8 years,"},{"Start":"13:43.465 ","End":"13:46.570","Text":"and that comes to 5625.75."},{"Start":"13:46.570 ","End":"13:50.080","Text":"But now remember, we are asked not for the depreciation per"},{"Start":"13:50.080 ","End":"13:54.325","Text":"year and we\u0027re asked for the carrying amount not at 31st December 20X1,"},{"Start":"13:54.325 ","End":"13:56.755","Text":"but the 31st of December 20X2."},{"Start":"13:56.755 ","End":"14:01.645","Text":"We need to calculate how much depreciation has accumulated to that date."},{"Start":"14:01.645 ","End":"14:04.040","Text":"That\u0027s 2 years down the track because"},{"Start":"14:04.040 ","End":"14:07.340","Text":"the lease contract was entered into in the first of January 20X1,"},{"Start":"14:07.340 ","End":"14:10.070","Text":"so it\u0027s a whole of 20X1 and the whole of 20X2,"},{"Start":"14:10.070 ","End":"14:12.930","Text":"is 2 years worth of usage of that asset."},{"Start":"14:12.930 ","End":"14:20.445","Text":"We will have depreciated 5625.75 by 2, which is 11,251.5."},{"Start":"14:20.445 ","End":"14:26.350","Text":"The carrying amount of the right to use asset on 31st December 20X2 is the cost,"},{"Start":"14:26.350 ","End":"14:29.335","Text":"which is the fair value of 45,006,"},{"Start":"14:29.335 ","End":"14:33.520","Text":"less accumulated depreciation of 11251.51."},{"Start":"14:33.520 ","End":"14:43.780","Text":"The final answer is the carrying amount at 31 December 20X2 is 33,754.5."},{"Start":"14:43.780 ","End":"14:46.855","Text":"Then part d was the final requirement,"},{"Start":"14:46.855 ","End":"14:50.830","Text":"which was to calculate the interest expense in 20X3."},{"Start":"14:50.830 ","End":"14:53.530","Text":"To work out the interest expense in any year is to"},{"Start":"14:53.530 ","End":"14:56.230","Text":"take the opening balance of that year multiplied by the interest rate."},{"Start":"14:56.230 ","End":"14:59.335","Text":"We\u0027re looking for the interests expense in 20X3,"},{"Start":"14:59.335 ","End":"15:02.955","Text":"which means we need the opening balance of the lease liability in 20X3,"},{"Start":"15:02.955 ","End":"15:05.330","Text":"which will just simply multiply by the interest rate."},{"Start":"15:05.330 ","End":"15:08.330","Text":"Well, in part b, if you go back to part b,"},{"Start":"15:08.330 ","End":"15:12.689","Text":"you\u0027ll see we actually have already done part of this calculation."},{"Start":"15:12.689 ","End":"15:19.370","Text":"We calculated the lease liability at the end of 31 December, 20X2,"},{"Start":"15:19.370 ","End":"15:22.520","Text":"and that therefore is the opening balance in 20X3."},{"Start":"15:22.520 ","End":"15:26.690","Text":"That amount was 32,571.47."},{"Start":"15:26.690 ","End":"15:28.520","Text":"It\u0027s calculated in part b."},{"Start":"15:28.520 ","End":"15:30.230","Text":"Then we multiply by 9 percent,"},{"Start":"15:30.230 ","End":"15:34.663","Text":"which is the interest rate that we calculated in part a,"},{"Start":"15:34.663 ","End":"15:36.530","Text":"and if you multiply those 2,"},{"Start":"15:36.530 ","End":"15:42.485","Text":"we get to the interest expense in 20X3 of 2931.43."},{"Start":"15:42.485 ","End":"15:44.975","Text":"If you\u0027d use the table approach,"},{"Start":"15:44.975 ","End":"15:47.225","Text":"you could\u0027ve picked this straight up from the table."},{"Start":"15:47.225 ","End":"15:53.310","Text":"There it is, 20X3\u0027s interest is 2,931."}],"ID":31024}],"Thumbnail":null,"ID":291059}]

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