Definition of Present Value
In accounting, present value refers to the amount after discounting future cash amounts to the present. The present is depicted on a timeline as the point 0, which is the beginning of period 1.
The discounting process involves removing the time value of money or future interest which is contained (is implicit) within the future cash amounts.
Accountants record the present value of a future amount when the cash amount, cash equivalent amount, or fair market value at the time of the transaction is not known.
Example of Present Value
Assume Website Services Corp (WSC) completed extensive and unique services for a client and agreed to a single payment of $100,000 to be made two years from now. The client's financial condition would require it to pay interest of 20% in order to borrow the money from a lender.
WSC does not know the cash value of the unique services it provided nor does it know the market value. As a result, WSC discounts the future $100,000 by using the interest rate of 20% for two years to arrive at the present value of $69,400. WSC will record current revenues of $69,400 and a net receivable of $69,400 (Receivable of $100,000 minus Discount on Receivable of $30,600). As WSC earns the $30,600 of interest over the next two years, it will credit Interest Income and debit Discount on Receivable.