Differentiating a single cash flow from an annuity
We’re now into week 10 of the CPA semester and if you’re keeping on track with KnowledgEquity’s resources, you should be up to Module 6: Financial Instruments in Financial Reporting. I often receive questions from KnowledgEquity students on differentiating a single cash flow from an annuity (from Module 6). So I decided to write a quick blog to help you understand the concept. I’ve also thrown in some questions and answers to get you thinking about its application.
When performing present value and future value calculations using PV and FV tables, it is absolutely important to differentiate a single cash flow from an annuity. If you mistake one for the other, you would use the incorrect table and this would obviously mean that the final answer is also incorrect.
A single cash flow is one amount paid or received all at one time. An annuity on the other hand is an amount paid or received more than once on a periodic basis. For example, monthly or yearly.
Consider the following scenarios and evaluate which is a single cash flow and which is an annuity:
1. I am required to pay $30,000 in 3 years’ time.
2. I receive interest of $5,000 every year for 5 years.
3. I will receive rental income of $30,000 annually for 2 years.
4. I will receive $50,000 from the sale of my car but only in 2 years’ time.
The answers are as follows:
Scenario 1 – Single cash flow – it is one amount of $30,000 that is payable at one time.
Scenario 2 – Annuity – it is many amounts paid over many years. $5,000 in year 1, $5,000 in year 2, etc.
Scenario 3 – Annuity – this is more than one payment and it is paid in different years. $30,000 in year 1 and $30,000 in year 2.
Scenario 4 – Single cash flow – this is one amount payable at one time after 2 years.
To help you differentiate a single cash flow from an annuity, you can use the KnowledgEquity PV and FV tables in our LMS. Refer to the unit in Module 1 entitled: ‘FR 1 – Flowcharts and decision trees’.
You can access the PV and FV tables through KnowledgEquity’s Financial Reporting Support for your CPA courses. You can try our CPA Assist for Financial Reporting which includes 10 hours of free content, there are short explanatory videos, module quizzes, webinars and flowcharts to help you embed your knowledge and be able to understand the subject. Plus in our paid courses, you can access all the resources, including practice exams (marked) and an exam preparation webinar – learn more here, Financial Reporting courses. Once you have concepts like these embedded in your knowledge data bank, you will be ready to take on your CPA exam!