ACCT3321 Lecture Notes - Lecture 3: Income Approach, Risk Premium, Market Risk

FASB SFAS 157 was issued September 2006 for application tofinancial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years.This Statement, which applies to assets and liabilities, definesfair value, establishes a framework for measuring fair value ingenerally accepted accounting principles (GAAP), and expandsdisclosures about fair value measurements. The statement does notapply to assets acquired and liabilities assumed in an acquisitionof a business or non-profit activity by a not-for-profit entitythat are required to be measured at fair value under FASB StatementNo. 164. The objective of a fair value measurement is to determinethe price that would be received to sell the asset or paid totransfer the liability at the measurement date which is the exitprice. The fair value measurement assumes that the asset orliability is exchanged in an orderly transaction between marketparticipants. For assets, fair value measurement assumes thehighest and best use of the asset by market participants,considering the use of the asset that is physically possible,legally permissible, and financially feasible at the measurementdate. The highest and best use of the asset establishes thevaluation premise. For liabilities, it is assumed that theliability is transferred to a market participant at the measurementdate and that the nonperformance risk relating to that liability isthe same before and after its transfer. The fair value of theliability shall reflect the nonperformance risk relating to thatliability. As in our text, the position in the statement is thatvaluation techniques must be consistently applied. It emphasizesthose valuation techniques using the market approach, incomeapproach, and cost approach to measure fair value. In some cases asingle valuing technique may serve the purpose, however in others,using multiple techniques may be more appropriate. The informationthat is available will help to determine which method that shouldbe used. Examples are provided in Appendix A to illustrate thevarious approaches for certain transactions. The statement alsoestablishes a fair value hierarchy that prioritizes the inputs tovaluation techniques used to measure fair value by placing theminto three broad levels in order to increase consistency andprovide better comparability. Level 1 is given the highest priorityand is based on quoted prices (unadjusted) in active markets foridentical assets or liabilities that the reporting entity has theability to access at the measurement date. Level 2 is based oninformation other than quoted prices included within Level 1 thatare observable for the asset or liability, either directly orindirectly through substantiation with observable market data.Level 3 has the lowest priority and is based on unobservable inputsfor the asset or liability, primarily, inputs that reflect thereporting entity’s own assumptions.

Follow-Up Discussion Expand upon any of the points identified byyour classmates and/or ask for clarification on points that you donot understand.

I have provided the classmates response.

300 words

Derivatives Statement No. 133 Accounting for Derivative Instruments and Hedging Activities establishes accounting and reporting standards for derivative instrument embedded in other contracts and for hedging activities. The statement requires that an entity recognize all derivatives as either assets or liabilities in the statements of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as: (a) A hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment. (b) A hedge of the exposure to variable cash flows of a forecasted transactions or (c) A hedge of the foreign currency exposure a net investment in a foreign operation, an unrecognized firm commitment, an available for sale security or a foreign currency denominated forecasted transactions. Requirements Review Statement No. 133 and evaluate the standard in terms of the conceptual framework. Define a derivative from an accounting perspective. Provide at least three characteristics of a derivative. Name and describe three derivatives. When was the implementation date of the statement? Briefly summarize the statement.

Keeping an asset implies reinvestment in the asset. Finance theory is consistent with the notion that reinvestment is at current value, or replacement cost. Such a decision is presumably based on comparing expected future cash flows that will be generated by the asset and the cost of replacing it with a new one that could generate the same or different cash flows. According to the conceptual framework, the purpose of financial statements is to provide information regarding performance. Investment or reinvestment decisions are a part of that performance. Yet, the historical cost of fixed assets is retained and allocated over subsequent accounting periods.

b. Does cost allocation provide relevant information?

c. Would a current?value approach to measurement of fixed assets be preferable? Why?