Role of the Time Value of Money in Financial Reporting

To some observers, the current treatments of the time value of money in financial reporting appear to be mutually inconsistent. Generally accepted accounting principles (GAAP) specifically forbid or require discounting for certain items, but problems may arise in interpreting silence on the subject of discounting. A single conceptual set of criteria consistent with the historical cost accounting models is discussed. The rate appropriate for discounting is an estimate of the rate the market would use to value a financial instrument issued by the firm. This is not the same as the rate the firm incurs when it raises funds - its average cost of capital - or the rate the firm uses in making its capital budgeting decisions for projects of average risk for the firm. The current state of accounting for the time value of money is a result of exceptional lobbying power on the part of banks and other financial institutions and the apparent discomfort of many accountants with compound interest arithmetic.