Future Value of an Annuity
The future value of an annuity means that you compute the sum of all payments plus the accumulated compound interest on the payments. The amount of an annuity and the interval between receiving and paying the annuity always has to be the same. Then you compound interest once during each interval.
Here, you first find out how to calculate the future value of an ordinary annuity. Then you do the same for an annuity due. Ready to get started? Get out that calculator and proceed.
Future value of an ordinary annuity
Let’s say that you plan to deposit $1,500 at the end of each six-month period for the next two years, earning 8 percent interest annually. First, this is indeed an annuity because you are depositing the same amount ($1,500) over a constant period of time (every six months). So how much will you have at the end of the two years? To figure this out, you use the future value of an ordinary annuity of 1 table.
In this example, your number of periods is four (remember, you’re depositing the investment every six months, which is two times a year multiplied by two years). Similarly, your interest rate must be halved because the interest rate is in annual, not semiannual, terms (8% / 2 = 4%).
Using the figure, going to the intersection of 4 percent for four periods gives you a factor of 4.24646. At the end of the two years, your money will grow to $6,369.69 ($1,500 @@ts 4.24646). Total cash out of hand for you is $6,000 ($1,500 x 4), and interest income is $369.69 ($6,369.69 – $6,000).
Future value of an annuity due
Using the same principal, time, and rate information from the previous section, it’s time to figure out the future value of an annuity due. Remember, with an annuity due, the payments start at the beginning of the six-month period instead of at the end.
So guess what? The amount of interest you earn on the investment will be higher. You can thank the time value of money, as your investment is accruing interest six months sooner than with an ordinary annuity. Time to work through the numbers.
You still use the future value of an ordinary annuity of 1, but you increase the factor by 1 plus the interest rate. So your factor for an annuity due is 4.41631 (4.24645 x 1.04). $1,500 x 4.41631 is $6,624.47, an increase of $254.78 ($6,624.47 – $6,369.69). Not a lot of money, but consider the implications for businesses that conduct transactions in the millions of dollars.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
