Question

How is present value related to the concept of a liability?

Short answer

Interest included in payables and receivables, makes us consider future value at their current value. The present value of liability shows the debt, excluding the interest factor.

Step-by-step solution

Definition of Present Value

The present value concept in liability is an estimation of future liability at a discounted rate. It represents the amount that should be invested at present, at a particular rate of interest, to add to a future amount.

Relationship between present value and concept of a liability

The present value is calculated to check the fairness of the liabilities that will be availed or to compare the difference between the present value of the investment income and the nominal value of the liability.

The present value method indicates that the value of money today is greater than its future value. An amount that is not invested in an investment today may lose its value in the future due to inflation or the rate of return by applying an annualized rate. Hence, risks and uncertainties; regarding the events and situations should be considered while estimating provision.

Hence, the present value of liability considers the time value of money including interest. If the time value of money is ignored while considering liability then it will actually be wrong as a factor of inflation changes with time. Thus, it is necessary to consider the present value of liabilities.