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fairvalueaccounting

fairvalueaccounting - Fair Value Accounting Visionary...

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Aswath Damodaran 1 Fair Value Accounting: Visionary Thinking or Oxymoron? Aswath Damodaran
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Aswath Damodaran 2 Three big questions about fair value accounting Why fair value accounting? What is “fair value”? What are the first principles that should govern fair value accounting?
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Aswath Damodaran 3 Why fair value accounting? Three points of view… The Dreamer : To make accounting value (book value) a reasonable measure of the true value of a company. The Pragmatist : If we mark assets up to fair value, investors will have a better idea of what a firm is worth and there should be therefore less uncertainty about the true value and lower variance in that value. The Marginalist : Fair value accounting, even if imperfect and noisy, will provide investors with useful additional information which they can use to estimate value in a company or assess its risk.
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Aswath Damodaran 4 1. A New World Order Accountants as the final arbiters of value!! There are some (accountants, theorists and others) who believe that it is possible to replace the current accountant balance sheet with one that reflects the true value of the company. In their vision, investors would not look at the market to assess the fair value of a company but at accounting statements.
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Aswath Damodaran 5 The traditional accounting balance sheet… Assets are recorded at original cost, adjusted for depreciation. True intangible assets like brand name, patents and customer did not show up. The only intangible asset of any magnitude (goodwill) is a plug variable that is of consequence only if you do an acquisition. Valued based upon motive for investment – some marked to market, some recorded at cost and some at quasi-cost Equity reflects original capital invested and historical retained earnings.
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Aswath Damodaran 6 The intrinsic value balance sheet Recorded at intrinsic value (based upon cash flows and risk), not at original cost Value will depend upon magnitude of growth investments and excess returns on these investments Intrinsic value of equity, reflecting intrinsic value of assets, net of debt outstanding.
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Aswath Damodaran 7 The “market value” balance sheet Assets recorded at market value, i.e, what investors will be willing to pay for the assets today (rather than original cost or intrinsic value) Should equate to market value of equity, if publicly traded.
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Aswath Damodaran 8 Accounting Balance Sheet = Intrinsic value Balance Sheet The impossible dream! Even in a well functioning market, there will be a divergence between intrinsic and market value of both assets (and equity). The dreamer has to first decide which balance sheet he would like the accounting balance sheet to converge on. Even if we were able to write up every asset to intrinsic value, all that we will obtain is the fair value of the assets in place of a company.
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