Chapter 3: Measurement Flashcards
Why is measurement important?
It affects income and key ratios
When is measurement required?
- On initial recognition
- On subsequent valuation
Cost-based measures
- Property, plant, equipment carried at cost or book value
- Financial instruments carried at cost or amortized cost (using effective interest or straight-line methods)
- Financial instruments are monetary contracts between parties. - Inventory using various cost flow assumptions
Current value measures
- Financial instruments/investments carried at fair value
- Biological assets
- Investment properties
- More volatility
Hybrid measures
- Impaired property, plant, and equipment measured at the recoverable amount (higher of the value in use and fair value)
- Inventory measured at the lower of cost and net realizable value
- Impaired notes receivable measured using management’s best estimate of revised cash flows
Disclosures Relating to Measurement
- Sources of measurement uncertainty
- Accounting policies related to measurement
- Assumptions made about the future
- Other information regarding the “softness” of the numbers
Sources of measurement uncertainty
Assumptions about:
- Future cash flows when determining impairments
- Amount recoverable for obsolete inventory
- Outcome of litigation settlements
- Litigation is the process of taking legal action.
- Interest rates
Valuation Techniques
Income model—widely used; includes PV and cash flows
Market model—uses publicly available values from similar market transactions
Cost model—reflects the amount required to replace an asset’s service capacity
Valuation Models
Models have three components: Inputs –> Model/Technique –> Outputs
- The quality of the measure (output) depends on the quality of the information used (inputs) and the model
- When measuring the value of a financial statement element, an accountant must ask:
- Which model or technique should be used?
- Which inputs should be used?
- Does the resulting measurement result in useful information?
Which Model?
It depends on the item being measured
- Unique items may not have a comparable in the market
- Input information might not be readily available
- Income models frequently used in practice
Examples of PV-based measurements
- Valuing non-current receivables that carry no stated interest
- Determining the value of goodwill in business combinations
- Valuing investments at amortized cost
- Valuing assets to be capitalized under leases
- Determining the amount of future obligations for asset retirements
Which Inputs?
- Inputs and assumptions that are more reliable
- Amounts (like interest rates) that are readily available
Inputs for income-based models include
- Estimates of cash flows—may require assumptions on how the asset is used
- Time value of money—an interest rate for discounting cash flows
- Uncertainty or risk—mitigated by adjusting either the cash flows or the interest rate; applying probabilities
Resulting Quality?
- Measurement should provide useful information to the users of financial statements
- Must be relevant and faithfully represent the assets or liabilities being valued
- Provide the best information possible within the cost/benefit constraint
“Values in Use” Measurements
Entity-specific measure based on the entity’s plans for using the assets not the market participant view
- Used when determining asset impairment: when carrying amount is greater than recoverable amount
- Recoverable amount is the greater of the asset’s fair value less cost to dispose and its value in use (IFRS)
- Can also be used for valuing intangibles
- To calculate value in use
- Estimate the future cash flows
- Calculate the present value of these flows
Measuring Fair Value
- Fair value under IFRS is an exit price
- Fair value measurement would look at the value potential buyers would attribute
- It’s the selling price from the company’s perspective
- According to IFRS, in order to measure fair value an entity must determine:
1. The item being measured
2. How the item would be or could be used by market participants
3. The market in which the item would be bought and sold
4. What model is being used to measure fair value
