Study Guide Vol 2 t/a Accounting: Tools for Business Decision Makers, 5th Edition

APPENDIX D

Time Value of Money

APPENDIX OVERVIEW

This appendix addresses the difference between simple interest, which is computed on principal only, and compound interest, which is computed on both principal and interest earned that has not been paid or withdrawn. Simple interest is the product of the principal, the rate, and the time, but the formula used for compound interest depends on whether you are solving for the present value or future value and whether the amount involved is a single sum or an annuity (a series of equal dollar amounts paid or received periodically).

LO1. Distinguish between simple and compound interest.

Interest is basically a rental charge for the use of another person's money. The amount of interest involved in any financing transaction is based on three elements:

1. Principal (p): the original amount borrowed or invested.

2. Interest Rate (i): an annual percentage of the principal.

3. Time (n): the number of periods that the principal is borrowed or invested.

Simple interest is computed on the principal amount only. Simple interest is usually expressed as:

Compound interest is computed on principal and on any interest earned that has not been paid or ...