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Unformatted text preview: The Chapter focuses on the following basic questions: 1) Are all economic assets and liabilities recorded on the B/S? No. 2) What attributes must economic assets or liabilities possess to be recorded? 3) How is the amount of that asset or liability measured? 4) What does the balance sheet structure tell us about how the management of the company has chosen to finance assets? How is managements financing choice (debt vs. equity) related to the nature of the industry in which the company operates? 5) What are some of the methods we can use to answer the question asked in #4? Introduce ratio analysis. Asset- company owns or controls use of the item; right to use item comes from past transaction or exchange (intention to buy something does not count; no executory contracts or simple exchange of promises); future benefit can be measured with sufficient reliability. (Leaves out a lot of intangible assets because benefits cannot be measured reliably: internally developed customer lists, brand names, trademarks, expertise of employees, etc. Only if these items are purchased from another company, can they be recorded as assets because there is a purchase price. Note- Pharmaceutical industry has huge amounts invested in research and development hence a lot of their assets are not recorded. Auditors tend to be conservative (understate assets and earnings) in order to avoid getting sewed. Companies tend to adjust for this. Points you need to remember: subjective judgment is required which varies; figures tends to be conservative. They are not recognized if unreliable due to fear of legal action if assets are overstated; constant tension between reliability (free from error or bias) and relevance (results in a change in expectations); political influence has a part to play e.g. lobbying efforts by banks. Alternative Ways to Measure Assets 1. Acquisition (historic) cost Purchase price of asset including all associated costs such as installation, transportation, interest. The buyer sets the Lower bound on expected future benefits of the asset. Most reliable way to measure; used for most assets. (USGAAP, IFRS) 2. Current Replacement Cost- What a company would have to pay to replace an asset (entry value) that is no longer functioning. Used primarily for inventories; if current replacement cost declines below acquisition cost record decrease in carrying value on the B/S. (If the price of inventory goes up, nothing gets recorded due to inflation as supply price and selling price go up at the same rate)....
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- Spring '11