Class 7 Slides Flashcards
How can one detect earnings management?
- Detection of red flags (one issue at a time)
2. Beneish Model (a mathematical model that raises the possibility that a firm may be violating GAAP through EM).
Describe the Fair Value Hierarchy.
The Fair Value Hierarchy is used to measure the FV of assets. There are 3 levels.
Level 1 (Most reliable): valued at direct market prices, based on active trading of identical instruments (mark-to-market)
Level 2: Valued using observable market inputs (prices for similar assets)
Level 3 (least reliable): Valued using a financial model, such as discounted cash flows (income approach)
What are the arguments supporting FV accounting?
The objective of financial reporting is to provide stakeholders with information to assess future cash flows. Since FV embodies the present value of future cash flows, it serves this objective. Fair values can provide relevant measures when based on observable market prices.
What are the arguments against fair value?
When FV cannot be determined from observed market prices, then it’s estimated. Past experience and research indicates that managers can always find a way to make financial reporting work in their favor, no matter which method in the FV hierarchy is chosen.
