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ACTG 4P11 (6)
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Chapter 7

Chapter 7 Notes (Key takeaways from the chapter) - .docx

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Department
Accounting
Course
ACTG 4P11
Professor
Brown
Semester
Winter

Description
Chapter 7 – MeasurementApplications - Measurement approach is more decision useful (chapter 6) Value in use - More relevant (since discounting future cash flows  more information about future performance) - Not very reliable since realistic conditions are uncertain o Error and possible bias in estimating o Management may change intended use - IFRS 9 o May value certain financial assets at value-in-use if firm’s business model is to hold the assets to generate future cash flows from interest and principal o Controls management ability to change intended use Fair Value (Exit price) - Ideally market value, but market incompleteness complicates the measurement - Fair value hierarchy o Level 1 – well working market o Level 2 – no market for specific asset but there is for a similar asset o Level 3 – no market or similar market so management is asked to imagine what the fair value would be in a well working market - Reliability decreases as moving from level 1 – 3 - Exit price measures opportunity cost of retaining asset/liability in firm (hence stewardship aspect) Longstanding Measurement Examples - Accounts receivable/payable – net realizable value - Amortized cost – effective interest rate o Assumes interest rate does not change so not a reliable method - Lower of cost or market - conservatism - Revaluation option for PPE – option to value at fair value - Ceiling tests – valued at recoverable amount if less than book value - Post-employment benefits – valued at present value Financial Instruments - Contract that creates a financial asset of one firm and a financial liability or equity instrument of another firm - Increases decision usefulness as the information is relevant and reasonably reliable - IAS 39 assets o Available for sale – FV G/L through OCI o Loans and receivables – valued at cost, subject to impairment, may be written up o Held-to-maturity – similar to loans and receivables, FV does not matter o Trading – FV G/L - IAS 39 liabilities o Trading – FV o Other – valued at cost or amortized - Cannot simply value all financial instruments at fair value due to: o Reliability – difficult to fair value some items  No market value may be available (thinly traded, or not traded at all) Chapter 7 – MeasurementApplications - Mismatch – problem of excess financial statement volatility under a mixed measurement model o Ideally, financial statements should reflect the real volatility facing the firm o Under mixed measurement, financial statement volatility can exceed real volatility o To control excess volatility  Fair value option  Some unrealized gain/losses included in OCI  Some financial items can be valued at cost - Should a firm’s long-term debt be revalued following a credit downgrade, hereby reporting a gain? o If firm’s debt is downgraded, some firm assets must have declined in value o But these assets may be valued at cost, or not valued at all o Reporting a gain creates mismatch Fair Value vs. Historical Cost - 2007 – 2008 m
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