ACCT 2310: Intermediate Accounting I
The signature assignment for ACCT 2310 used the time-value of money to show our understanding of one of the key concepts of accounting.
Problem: On a rainy afternoon two years ago, John Smiley left work early to attend a family birthday party. Eleven minutes later, a careening truck slammed into his SUV on the freeway causing John to spend two months in a coma. Now he can’t hold a job or make everyday decisions and is in need of constant care. Last week, the 40-year-old Smiley won an out-of-court settlement from the truck driver’s company. He was awarded payment for all medical costs and attorney fees, plus a lump-sum settlement of $2,330,716. At the time of the accident, John was president of his family’s business and earned approximately $200,000 per year. He had anticipated working 25 more years before retirement.
John’s sister, an acquaintance of yours from college, has asked you to explain to her how the attorneys came up with the settlement amount. “They said it was based on his lost future income and a 7% rate of some kind,” she explained. “But it was all ‘legal-speak’ to me.”
Questions:
1. How was the amount of the lump-sum determined? Create a calculation that might help John’s sister understand.
2. Was the settlement fair? Explain.
3. Write a brief reflection of how this assignment fits into your program and prepares you for your field of study.
Answers:
1. The lump-sum of John’s settlement was determined by using the formula for the present value of an ordinary annuity. If John had continued working, he would have made a salary of $200,000 per year and would have continued to work for 25 more years. The calculation for the present value of an ordinary annuity assumes equal payments at equal periods at a constant interest rate. If John’s salary of $200,000 was invested at the end of every year for 25 years at 7% interest rate, the amount would grow to $2,330,716.
The formula for present value of an ordinary annuity is:
PVA = 1 –[ 1/(1+i)^n]
i
Where i = 7%, n = 25
2. The settlement was fair because not only did the truck company pay the amount John would have made over the next 25 years, they assumed that the money John earned would increase in value over time at a 7% rate. The truck company also paid all of John's medical costs and attorney’s fees.
3. The concept of the time-value of money is important in the accounting field because many situations require the calculation of the present value or the future value of money or annuities. Examples include rent, leases, pensions, and other investments. These concepts are important in making business decisions and in valuing assets and liabilities in financial reporting. This assignment has taught me the importance of gaining a foundation in the time-value of money to build upon during the remaining accounting classes in my degree program. Since many accounting processes rely on this concept, this assignment has enabled me to understand the time-value of money concepts and accurately calculate and report the present or future values of money and annuities.
The signature assignment for ACCT 2310 used the time-value of money to show our understanding of one of the key concepts of accounting.
Problem: On a rainy afternoon two years ago, John Smiley left work early to attend a family birthday party. Eleven minutes later, a careening truck slammed into his SUV on the freeway causing John to spend two months in a coma. Now he can’t hold a job or make everyday decisions and is in need of constant care. Last week, the 40-year-old Smiley won an out-of-court settlement from the truck driver’s company. He was awarded payment for all medical costs and attorney fees, plus a lump-sum settlement of $2,330,716. At the time of the accident, John was president of his family’s business and earned approximately $200,000 per year. He had anticipated working 25 more years before retirement.
John’s sister, an acquaintance of yours from college, has asked you to explain to her how the attorneys came up with the settlement amount. “They said it was based on his lost future income and a 7% rate of some kind,” she explained. “But it was all ‘legal-speak’ to me.”
Questions:
1. How was the amount of the lump-sum determined? Create a calculation that might help John’s sister understand.
2. Was the settlement fair? Explain.
3. Write a brief reflection of how this assignment fits into your program and prepares you for your field of study.
Answers:
1. The lump-sum of John’s settlement was determined by using the formula for the present value of an ordinary annuity. If John had continued working, he would have made a salary of $200,000 per year and would have continued to work for 25 more years. The calculation for the present value of an ordinary annuity assumes equal payments at equal periods at a constant interest rate. If John’s salary of $200,000 was invested at the end of every year for 25 years at 7% interest rate, the amount would grow to $2,330,716.
The formula for present value of an ordinary annuity is:
PVA = 1 –[ 1/(1+i)^n]
i
Where i = 7%, n = 25
2. The settlement was fair because not only did the truck company pay the amount John would have made over the next 25 years, they assumed that the money John earned would increase in value over time at a 7% rate. The truck company also paid all of John's medical costs and attorney’s fees.
3. The concept of the time-value of money is important in the accounting field because many situations require the calculation of the present value or the future value of money or annuities. Examples include rent, leases, pensions, and other investments. These concepts are important in making business decisions and in valuing assets and liabilities in financial reporting. This assignment has taught me the importance of gaining a foundation in the time-value of money to build upon during the remaining accounting classes in my degree program. Since many accounting processes rely on this concept, this assignment has enabled me to understand the time-value of money concepts and accurately calculate and report the present or future values of money and annuities.