DEFINITION OF TERMS

ANNUITY is a type of annuity where the payments are made at the beginning of each payment
interval, unlike the ordinary simple annuity the payment interval starts at the end of each period.
For example, when equipment or property is leased, the regular lease payments are usually paid
in advance. Another example is educational plan wherein you need to pay it advance in regular
period with fixed amount.
ORDINARY ANNUITY - An ordinary annuity is a series of equal payments made at the end of
consecutive periods over a fixed length of time. While the payments in an annuity can be made
as frequently as every week, in practice, ordinary annuity payments are made monthly, quarterly,
semi-annually or annually. The opposite of an ordinary annuity is an annuity due, where
payments are made at the beginning of each period.
ANNUITY DUE - A form of annuity where periodic receipts or payments are made at the
beginning of the period and one period of the annuity term remains after the last payment.
DEFERRED ANNUITY - is a type of annuity contract that delays payments of income,
installments or a lump sum until the investor elects to receive them. This type of annuity has
two main phases: the savings phase in which you invest money into the account, and the
income phase in which the plan is converted into an annuity and payments are received. A
deferred annuity can be variable or fixed.

DEPRECIATION - is an accounting method of allocating the cost of a tangible asset over

its useful life. Businesses depreciate long-term assets for both tax and accounting
purposes. For tax purposes, businesses can deduct the cost of the tangible assets they
purchase as business expenses; however, businesses must depreciate these assets in
accordance with IRS rules about how and when the deduction may be taken.

DOUBLE DECLINING BALANCE METHOD - The double declining balance depreciation

method is generally used when an asset is depreciating at a faster rate at the beginning of its
lifespan or where the organization intends to shift profits further into the future by accounting for
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larger amounts of depreciation at the beginning of the assets life span. The double declining
balance of depreciation is a little more complicated to calculate than the straight line method and
it requires that the straight line depreciation rate be calculated first.
SUM-OF-THE-YEAR-DIGIT (SYD) METHOD - Sum-of-the-years'-digits is an accelerated
method for calculating an asset's depreciation. This method takes the asset's expected life and
adds together the digits for each year, so if the asset was expected to last for five years, the sum
of the years' digits would be obtained by adding: 5 + 4 + 3 + 2 + 1 to get a total of 15. Each digit
is then divided by this sum to determine the percentage by which the asset should be depreciated
each

year,

starting

with

the

highest

number

in

year

1.

RELATED SITUATIONS
ANNUITY
Russell is 60 years old, retired, unmarried, and wants to travel the world to surf. He has
approximately $1.1 Million in retirement funds that were once in stocks. However, Russell managed
to liquidate his stocks before the 2008 crash and placed virtually all of his money in CDs.
Unfortunately, Russell has seen very little growth with his bank CDs and needs to be able to
guarantee a lifetime income of at least $60,000/year.
Solution for Russell
Russells CDs are coming due at different intervals over the next 2 years. Russel could buy a
mixture of Immediate and a single Fixed Indexed Annuities (FIA) with an Income Rider Provision.
The FIA would be purchased immediately for $400k. Russell would receive a 10% bonus ($40,000)
making it grow to $440,000 on day one. With the right annuity product, that annuity can grow at a
guaranteed rate of 8% compounded interest every year until he intends to begin payments in 5
years. In 5 years, the annuity income rider will provide guaranteed for life payments of $26,928/year.
Also, in year one, Russell had $800k in CDs coming due which he converted into immediate
annuities. The payments of the immediate annuities provided him with annual immediate income of
$53,220. Russel did not hit his first year goal of $60K, but he was able to get acceptably close at
$53,200.
In year 2, Russell had another CD come due of $205k which was also converted into an immediate
annuity. That gave him a total income of $67,800. The $67,800 annual income would continue until

year 5. In year 5, the FIA with Income Rider was activated and added to his current income. His
new guaranteed income will be $94,728. Russell plans to also begin receiving social security
payments of $31,200 which brings his new lifetime income to $125,928.00.

ORDINARY ANNUITY
Examples of ordinary annuities are interest payments from bond issuers, which are
generally paid semi-annually, and quarterly dividends from a company that has maintained stable
payout levels for years. The present value of an ordinary annuity is largely dependent on the
prevailing interest rate. Because of the time value of money, rising interest rates reduce the
present value of an ordinary annuity, while declining interest rates increase its present value. This
is because the value of the annuity is based on the return you can get elsewhere. If you can get a
higher interest rate somewhere else, the value of the annuity in question goes down.
ANNUITY DUE
An annuity due may arise due to any recurring obligation. Many monthly bills, such as
rent, mortgages, car payments and cellphone payments, are annuities due if the payment is
required at the beginning of the billing period. Expenses for insurance are typically annuities due
as the payment is required at the start of each period in which the individual or business is
covered. Annuity due situations also typically arise relating to saving for retirement or putting
money aside for a specific purpose.
DEFERRED ANNUITY
A deferred annuity is a contract between an individual and a life insurance company in
which funds are exchanged for a promise to provide a competitive rate of interest with a
minimum interest rate guarantee. The contract also guarantees the principal investment. Because
annuities are classified as nonqualified retirement instruments, they receive a tax benefit in the
form of tax deferral on earnings. Earnings are taxed as ordinary income upon withdrawal or
annuitization.
For example; when funds are deposited with a life insurer, they are credited to an
accumulation account in the name of the annuity owner. The life insurer then credits the account
balance with a fixed rate of interest. In most cases, the fixed interest rate is guaranteed for a
certain period of time, from one year to 10 years. When that period expires, the interest rate is
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reset by the insurer, typically for one-year periods. Most annuity contracts include a minimum
rate guarantee that ensures if interest rates fall too low, the rate credited to the account does not
fall below the minimum.
Withdrawals are allowed in most contracts with certain limitations. In a typical contract,
the withdrawal provisions allow for one annual withdrawal. If any withdrawal exceeds 10% of
the value of the account, the insurer charges a surrender fee on the excess. The fee can range
from 7 to 15% on a declining schedule. Each year, the surrender fee drops by one percentage
point until it reaches zero. At that point the surrender period ends and the annuity owner can
withdraw funds without penalty. However, withdrawals are taxed as ordinary income, and
withdrawals made prior to age 59 are subject to a 10% penalty. A deferred annuity can be
annuitized to provide guaranteed income payments for a set period of time or for life of the
annuitant. It also includes a death benefit component that ensures the beneficiaries receive no
less than the principal investment plus any gains in the account. The death benefit proceeds are
taxable to the beneficiary as ordinary income.
DEPRECIATION
For depreciation expense does not represent a cash transaction, but it indicates how much
of an asset's value has been used up over time. For example, if a company buys a piece of
equipment for Php50,000, it can either write the entire cost of the asset off in year one, or it can
write the value of the asset off over the life of the asset, which is 10 years. This is why business
owners like depreciation. Most business owners prefer to expense only a portion of the cost,
which artificially boosts net income. In addition, the equipment can be scrapped for Php10,000,
which means it has a salvage value of Php10,000. Using these variables the analyst calculates
depreciation expense as the difference between the cost of the asset and the salvage value,
divided by the useful life of the asset. The calculation in this example is: (Php50,000 Php10,000) / 10, which is Php4,000.
This means the company's accountant does not have to write off the entire Php50,000,
even though it paid out that amount in cash. Instead, the company only has to expense Php4,000
against net income. The company expenses another Php4,000 next year, and another Php4,000
the year after that, and so on, until the value of the equipment is completely written off in year
10.
4

DOUBLE DECLINING BALANCE METHOD

This approach is reasonable under either of the following two circumstances: (1) When
the utility of an asset is being consumed at a more rapid rate during the early part of its useful
life; or (2) When the intent is to recognize more expense now, thereby shifting profit recognition
further into the future (which may be of use for deferring income taxes).
For the instance, when a company purchases an expensive asset that will be used for
many years, it doesnt deduct the entire purchase price as a business expense in the year of
purchase but instead deducts the price over several years.
For example, if a business purchased a delivery truck for $30,000 that it expected to last
for 10 years, after which it would be worth $3,000 (its salvage value), the company would deduct
the remaining $27,000 as $2,700 per year for 10 years under straight-line depreciation. Using the
double declining balance method, however, it would deduct 20% (double 10%) of $27,000 in
year one ($5,400), 20% of $21,600 ($27,000 minus $5,400) in year two ($4,320), and so on.
Because the double declining balance method results in larger depreciation expenses near
the beginning of an assets life and smaller depreciation expenses later on, it makes sense to use
this method with assets that lose value quickly.
SUM-OF-THE-YEARS' DIGITS METHOD
The sum of the years' digits method is used to accelerate the recognition of depreciation.
Doing so means that most of the depreciation associated with an asset is recognized in the first
few years of its useful life. This method is also called the SYD method.
The SYD is found by estimating an assets useful life in years, assigning consecutive
numbers to each year, and totaling these numbers. For n years, the short-cut formula for
summing these numbers is SYD =n(n + 1)/2. The yearly depreciation is then calculated by
multiplying the total depreciable amount for the assets useful life by a fraction whose numerator
is the remaining useful life and whose denominator is the SYD. Thus annual depreciation equals

FORMULAS
ANNUITY
P=PV

r
1(1+r )n

P is the value of each payment

PV is the Present Value of Annuity

r is the interest rate as a decimal

n is the number of periods

ORDINARY ANNUITY

R is the size of each annuity payment

i is the Interest rate per compounding period

t is the time period of the loan

n is the number of payments in the annuity

j is the nominal interest

m is the number of conversion per year

Table 1.1: Ordinary Annuity Formula

Sn is the future value of an n-payment
(Computing the Future Value)
An is the present value of an n-payment
(Computing the Present Value)

(1+i)n1
S n=R
i

A n=R

Formula for computing the Periodic Payment

Of the Future Value

R=

Formula for computing the Periodic Payment

Of the Present Value

R=

1(1+i)
i

Sni
n

(1+i) 1
An i
1(1+i)n

Sn i
+1
R
n=
log (1+i)

Formula for computing the Term or time

Of the Future Value

Formula for computing the Term or time

Of the Present Value

Ani
R
n=
log(1+i)

log

log 1

ANNUITY DUE

R is the size of each annuity payment

i is the rate per compounding period

t is the time period of the loan

n is the number of periods

j is the nominal interest

m is the number of conversion per year

Table 1.2: Annuity Due Formula

S(due) is the future value of an n-payment
(Computing the Future Value)

S (due )=R

( 1+ i )n 1
(1+ i)
i

A(due) is the present value of an n-payment

(Computing the Present Value)

A (due)=R

Formula for computing the Periodic Payment

Of the Present Value

R=

1( 1+i )n
(1+i)
i
A (due )

1( 1+i )n
(1+i)
i
S(due)

Formula for computing the Periodic Payment

Of the Future Value

R=

Formula for computing the number of periods

Of the Present Value

log 1
n=

[ ]

( 1+i )n
(1+i )
i

A due i
R ( 1+ i )

log ( 1+ i )

)]

+1

Formula for computing the number of periods

Of the Future Value

log
n=

[(

Sdue i
+1
R ( 1+i )

)]

log (1+i )

DEFERRED ANNUITY

C is the cash flow per period

i is the rate per compounding period

n is the number of payments

Table 1.3: Deferred Annuity Formula

FDA is the future value of an n-payment
(Computing the Future Value)

F DA =C

PDA is the present value of an n-payment

(Computing the Present Value)

]
[

(1+i ) 1
i

1(1+i)
PDA =C
i

DEPRECIATION

A=P 1

R
100

n is the number of years the asset has been depreciated

A is the book value of the asset after n years
P is the initial cost of asset
R is the rate of depreciation per annum

Find the depreciation amount by using the formula,

D=PA

D is the depreciation amount

A is the book value of the asset after n years
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P is the initial cost of asset

DOUBLE DECLINING BALANCE METHOD

Double Declining Balance Rate Book value at the beginning of the year.
So to calculate the value, we need to calculate the straight-line depreciation rate of the
asset and we need to know the book value of the asset at the beginning of that particular year.
To calculation for the Straight Line Depreciation Method using this formula:
Depreciation = (Cost - Residual value) / Useful life

SUM-OF-THE-YEARS' DIGITS METHOD

Depreciationexpence =( CostSalvageValue ) Fraction

Fraction for the first year = n / (1+2+3+...+ n)

Fraction for the second year = (n-1) / (1+2+3+...+ n)
Fraction for the third year = (n-2) / (1+2+3+...+ n)
...
Fraction for the last year = 1 / (1+2+3+...+ n)
n represents the number of years for useful life.

SAMPLE PROBLEMS
ANNUITY

Problem: A 5-year ordinary annuity has a present value of Php1,000. If the interest rate is 8
percent, what is the amount of each annuity payment?
Given:
PV = Php1000, r = 8%/0.08, n = 5yrs
Formula:

Solution:

P=PV

1000

r
0.08
0.08
=Php1000
=1000
n
5
1(1+r )
1(1+0.08)
1(1.08)5

0.08
0.08
=1000 0.02504564545
=1000
0.319416803
1(0.680583197)

250.4564545 Php 250.46 annuity payment

ORDINARY ANNUITY
Problem: How long will it take for annual year-end contributions of Php60, 000 to an Education
Plan to grow Php1, 000,000 if the Plan earns 15% compounded annually?
Given:
R = Php60,000, m = 1, Sn = Php1,000,000, j = 15%/0.15, i = j/m = 0.15/1 = 0.15
Formula:

Solution:

] [

] [

Sn i
1,000,000(0.15)
150,000
+1 log
+1 log
+1
R
60,000
60,000
log [ 3.5 ]
0.5440680444
n=
=
=
=
=
=8.9635486418
log(1+i)
log(1+0.15)
log(1.15)
log( 1.15) 0.06069784035
log

ANNUITY DUE
Problem: Calculate the future value of 12 monthly deposits of Php1, 000 if each payment is
made on the first day of the month and the interest rate per month is 1.1%. Also calculate the
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total interest earned on the deposits if the whole amount is withdrawn on the last day of 12th
month.
Given:
R = Php1, 000, i = 1.1%/0.011, n = 12
Formula:

( 1+i )n1
( 1+ 0.011 )121
( 1.011 )121
0.140286196
S (due )=R
( 1+i )=1000
(1+0.011 )=1000
( 1+0.011 )=1000
i
0.011
0.011
0.011

DEFERRED ANNUITY
Problem: Have I got a deal for you! If you lend me $100,000 today, I promise to pay you back in
twenty-five annual installments of $5,000, starting five years from today (that is, my first
payment to you is five years from today). You can earn 6% on your investments. Will you lend
me the money?
Given: C = $5, 000, n = 25, i = 6%/0.06
Formula:
PV4 = $5,000 (PV annuity factor for N=25 and i=6%)
PV4 = $5,000 (12.7834)
PV4 = $63,916.78
PV0 = $63,916.78 / (1 + 0.06)4 = $50,628.08
You probably shouldn't lend the money under these terms. If you lend me $100,000, I am
repaying you using terms such that the value of my repayment is $50,628.08.
DEPRECIATION
Problem: A Blackberry Bold 9780 is purchased for $460, if its depreciation is calculated as 5%
per annum; find the amount by which it depreciates over 3 years?
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Given: P = $460, R = 5%, n = 3

Formula:

A=P 1

Solution:
R n
5 3
3
=460 1
=460 ( 0.95 ) =460 ( 0.857375 )=394.3925$ 394.39 value of asset after 3 years
100
100

D=PA=$ 460$ 394.39=$ 65.61 depreciation amount

DOUBLE DECLINING BALANCE METHOD

Problem: An asset costing $20,000 has estimated useful life of 5 years and salvage value of
$4,500. Calculate the depreciation for the first year of its life using double declining balance
method.
Solution
Straight-line Depreciation Rate = 1 5 = 0.2 = 20%
Declining Balance Rate = 2 20% = 40%
Depreciation = 40% $20,000 = $8,000
SUM-OF-THE-YEARS' DIGITS METHOD
Problem: Company A purchased the following asset on January 1, 2011. What is the amount of
depreciation expense for the year ended December 31, 2011?
Given:
Acquisition cost of the asset = $100,000
Useful life of the asset = 5 years
Residual value (or salvage value) at the end of useful life = $10,000
Solution:
Calculation of depreciation expense
Sum of the years' digits = 1+2+3+4+5 = 15
Depreciation for 2011 = ($100,000 - $10,000) x 5/15 = $30,000
Depreciation for 2012 = ($100,000 - $10,000) x 4/15 = $24,000
Depreciation for 2013 = ($100,000 - $10,000) x 3/15 = $18,000
Depreciation for 2014 = ($100,000 - $10,000) x 2/15 = $12,000

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Depreciation for 2015 = ($100,000 - $10,000) x 1/15 = $6,000

Sum of the years' digits for n years
= 1 + 2 + 3 + ...... + (n-1) + n = (n+1) x (n / 2)
Sum of the years' digits for 500 years
= 1 + 2 + 3 + ...... + 499 + 500
= (500 + 1) x (500 / 2) = (501 x 500) / 2 = $125,250
ANNUITY
Formula
Although the present value (PV) of an annuity can be calculated by discounting each
periodic payment separately to the starting point and then adding up all the discounted
figures, however, it is more convenient to use the 'one step' formulas given below.
PV of an Ordinary Annuity = R
PV of an Annuity Due = R

1 (1 + i)-n
i
1 (1 + i)-n
(1 + i)
i

Where,
i is the interest rate per compounding period;
n are the number of compounding periods; and
R is the fixed periodic payment.
Examples
Example 1: Calculate the present value on Jan 1, 2011 of an annuity of $500 paid at the end
of each month of the calendar year 2011. The annual interest rate is 12%.
Solution
We have,
Periodic Payment
R = $500
Number of Periods
n = 12
Interest Rate
i = 12%/12 = 1%
Present Value
PV = $500 (1-(1+1%)^(-12))/1%
= $500 (1-1.01^-12)/1%
$500 (1-0.88745)/1%
$500 0.11255/1%
$500 11.255
$5,627.54

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ANNUITY DUE
Example 2: A four-year lease agreement requires payments of $10,000 at the
beginning of every year. If the interest rate is 6% compounded monthly,
what is the cash value of the lease? (Focal Date) Now 2 3 4 10,000 10,000
10,000 10,000 |_________|_________|________| BGN, P/Y = 1, C/Y = 12 (PY CY,
therefore this is an general annuity due) PMT= 10,000(+/-), N=4, I/Y=6,
CPT=PV (36,647.36) Therefore, the cash value of the lease is $36,647.36
DEFERRED ANNUITY

BIBLIOGRAPHY

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(n.d.). Retrieved from https://www.retirementworks2.com/pdfs/Annuities-UNU.pdf

(n.d.). Retrieved from http://www.annuityfyi.com/basics/what-is-an-annuity/
(n.d.). Retrieved from
https://www.valic.com/valic/internet/us/en/buyersguide_kentucky1_tcm3240524241.pdf
(n.d.). Retrieved from http://www.mathalino.com/reviewer/engineeringeconomy/types-annuities
Articles, P. L. (n.d.). Retrieved from http://www.akingagency.com/Annuities.pdf
Associate, H. &. (n.d.). Retrieved from http://www.ohioinsureplan.com/annuityincome-rider-examples/
Inc., A. F. (n.d.). Retrieved from https://www.ameriprise.com/research-marketinsights/financial-articles/retirement/ways-to-use-annuities-at-any-stage-in-life/
InvestingAnswers, I. (n.d.). Retrieved from
http://www.investinganswers.com/financial-dictionary/insurance/annuity-1274
Jan, I. (n.d.). Retrieved from http://accountingexplained.com/misc/tvm/fv-annuity
Life, P. (n.d.). Retrieved from
http://www.annuities.pacificlife.com/public/sandbox/13096.pdf
McLaughlin, D. R. (n.d.). Retrieved from
http://www.uwyo.edu/uwe/passiton/passingitonchapter7g-annuities.pdf
Ord, T. (n.d.). Retrieved from http://www.mysmp.com/fundamentalanalysis/depreciation.html
Pritchard, J. (n.d.). Retrieved from https://www.thebalance.com/definition-ofdeferred-annuity-315094
Prudential Financial, I. (n.d.). Retrieved from
http://www.prudential.com/media/managed/documents/pruannuities_investor/dams_
444901.pdf

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Seeker, A. (n.d.). Retrieved from http://annuityseeker.com/real-world-annuityexamples/

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