Chapter 7 - measurement applications Flashcards
(38 cards)
What is the concept of Business model in IFRS 9
- 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
- Restricts management ability to change intended use.
What is fairvalue?
Exit price (opportunity cost): ideally market value but market incompleteness complicates this.
Describe the fairvalue hierarchy
Level 1: reasonably well working market exists
Level 2: price inferred from market price similar items
Level 3: estimate how much prospective buyer would pay
–> reliability decreases as move from level 1 to 3
What does exit price measure?
the opportunity cost of retaining asset/liability in firm
What is exposure draft?
expanded supplementary disclosures so outside parties can see how fair value has been arrived at
Name some longstanding measurement examples
1) Accounts receivable and payable approximates value in use if time is short (Discount factor is negligible).
2) Amortized cost: present value using effective interest rate (i.e. long-term debt)
3) Lower of cost or market rule: Inventory may be written up but not above cost (represents conservatism and a partial application of current value accounting)
4) PP&E: option to value at fair value if can be done reliably (FV must be kept to date. not avail under FASB)
5) Ceiling test: value at recoverable amount if less than book value (protect auditor against liab)
6) Post-employment benefits: valued at present value.
What’s recoverable amount?
The greater of 1) FV less costs to sell and 2) value in use/
Can impairment losses be reversed?
Yes but not above original BV.
What’s a financial instrument
A contract that creates a financial asset of one firm and a financial liability or equity instrument of another firm
Why FV financial statements?
1) increase usefulness (relevance)
2) many financial instruments traded on well-working markets (reasonably reliable)
3) control gains trading
IAS 39 (Assets)
Applies to debt and equity
4 financial asset categories:
1) AFS: Fair valued, fains/losses in OCI (transferred to NI on disposition)
2) Loans & Reeivables (no active market values): Valued at cost, subject to impairment test (written down, impairment loss in NI). May be written up again to Book value of fairvalue rises
3) HTM: Valued similar to loans and receivables.
4) Trading (and derivatives no held for hedging): fair valued, gain/losses in net income.
ASC 325-10
IN US. No reversal of writedown.
IAS 39 (liabilities)
1) trading: valued at fair value
2) Other: Valued at cost or amortized cost. (Bond outstanding or demand deposits)
What happens if firm sells/reclassifies HTM seurities?
The use of HTM category prohibited for 2 years.
Why not simply value all Financial instruments at fair value?
Reliability: Demand deposits difficult to value due to core deposit intangibles.
- No market value may be available (some are thinly traded or not traded at all)
- hard to reliably estimate timing of withdrawals
Core deposit intangible
arises form customers’ acceptance of lower than market rate of interest due to goodwill, habits, and etc.
What’s the major problem with mixed measurement model (some financial instruments FVed and some not)?
mismatch may lead to the problem of excess financial statement volatility. financial statement volatility may exceed real volatility.
How can the excess volatility from a mixed measurement model be controlled?
1) fair value option (choose to fair value long term debt to match)
2) include some unrealized gains/losses in OCI
3) some financial items (loans & receivables and HTM) can be valued at cost (subject to ceiling test)
Should a firm’s long-term debt be revalued following a credit downgrade, thereby reporting a gain?
credit downgrade means that the FV of the firm’s debt falls.
-if firm debt is downgraded, some firm assets must have declined in value. These assets may be valued at cost or not valued at all: then recording a gain creates mismatch.
This also represents a wealth transfer: shareholders gain because of lower value of firm debt but debtholder lose because of higher risk.
Why did the 2007/2008 market meltdowns generate serious complaints about fair value accounting?
1) Banks had to writedown longterm assets to liquidity price and volated legal capital requirement. In this situation, historical costing is socially preferred since it avoids financial contagion.
2) if value in use is low (bad economic condition), historical cost preferred, if high, fair value preferred by shareholders.
Describe IFRS 9
replaced IAS 39
1) Financial assets are recorded at FV on acquisition.
2) Subsequent valuation on amortized cost if objective is to hold asset (business model)
3) Proposed new standards for Derecognition, consolidation and increased disclosure
Derecognition (IFRS 9)
(of assets or liabilities form balance sheet). i.e. if Accounts receivables were securitized and sold to off balance sheet entities.
–> Allowed to derecognize if transferring firm retains NO future benefit OR obligation.
Consolidation (IFRS 9)
Power and risk ( consolidate if owns shares and shares entity's profit and loss) Regard SPEs (little equity capital and formed for special purpose) as consistent with CONTROL.
Derivative
A contract whose value depends on some underlying. May not require initial cash outlay and is generally settled in cash.
- -> little or no cost means that all or part of contract is off balance sheet (require supplemental disclosure.
- -> A lot of protection or speculation can be acquired with little cost.
