Chapter 7_Notes

Chapter 7_Notes - Chapter 7 Notes 7.1 Overview Despite the pressures for a measurement approach the movement of accounting practice in this

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Chapter 7 Notes 7.1 Overview Despite the pressures for a measurement approach, the movement of accounting practice in this direction encounters some formidable obstacles. The decision usefulness of current value-based financial statements will be compromised if too much reliability is sacrificed for greater relevance. Management’s skepticism carries over to current value accounting in general, particularly since the measurement approach implies that current values, and the volatility that accompanies them, are incorporated into the financial statements proper. Managers, investors, and auditors may prefer conservative accounting to current value accounting in some circumstances. Conservatism may contribute to investor decision-making, reduction of auditor liability and improvement of corporate governance. Two bases of current value measurement: fair value and value-in-use. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The basis of valuation is also termed exit price . Exit price measures the opportunity cost to the firm of the intended use of its assets and liabilities. By using them, the firm gives up the opportunity of putting them to their next-best use, which could be to sell them or redeem them at their exit price. Value-in-use can be measured, for example, by the discounted present value of cash expected to be received or paid with respect to the use of the asset or liability, or with respect to groups of assets and liabilities if they are used jointly. One might conclude that value-in-use is the ultimate in relevance, since it measures the expected cash flows to or from the firm. However, this is subject to a major qualification - management might change how it intends to use the asset or liability. With respect to reliability, value-in-use is subject to the problems of estimation errors and possible manager bias. In addition, it is subject to the possibility that management may bias the intended use of the asset or liability, thereby biasing expected future cash flows. Fair value is less subject to the change-of-use possibility than value-in-use. Its relevance derives from the fact that it measures the amount that market participants are willing to pay for the asset or liability under present economic conditions. Fair value is quite reliable if a well-working market value is available.
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Chapter 7 Notes Under historical cost accounting, net income is the result of the matching of costs and revenue, with revenue recognized when it is considered to be realized. Under value-in-use accounting, net income is simply accretion of discount, plus or minus changes in management’s estimates. Under fair value version of current value accounting, net income shifts towards a
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This note was uploaded on 12/14/2010 for the course ACC 706 taught by Professor Shadifarshad during the Winter '09 term at Ryerson.

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Chapter 7_Notes - Chapter 7 Notes 7.1 Overview Despite the pressures for a measurement approach the movement of accounting practice in this

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