Present Value

Question 1

What is the object of Present Value?

Answer 1

to estimate fair value

Question 2

Fair Value captures what 5 elements?

Answer 2

1. estimate of future cash flow(s)
2. expectations about possible variations in the amount of timing of those cash flows
3. the time value of money, represented by the risk-free rate of interest
4. the price for bearing the uncertainty inherent in the asset or liability (risk adjustment)
5. Other (sometimes unidentifiable) factors including illiquidity and market imperfections

Question 3

What is the traditional approach to present value?

Answer 3

tends to use a single set of estimated cash flows and a single rate of interest. the discounted rate includes 1. expectations about possible variations in the amount of timing of those cash flows

2. the time value of money, represented by the risk-free rate of interest
3. the price for bearing the uncertainty inherent in the asset or liability (risk adjustment)
4. Other (sometimes unidentifiable) factors including illiquidity and market imperfections

Question 4

What is the expected cash flow approach to present value?

Answer 4

the time value of money, represented by the risk-free rate of interest is included in the discount rate

Question 5

With regard to liabilities, what is the most relevant measurement related to present value?

Answer 5

credit standing of the entity

Question 6

What is the “interest method of allocation”?

Answer 6

related changes in reported amounts of assets or liabilities to changes in the present value of cash inflows or outflows

Question 7

When is the “interest method of allocation” used? (4 criteria)

Answer 7

1. transaction giving rise to the asset/liab is commonly viewed as a borrowing and lending
2. period-to-period allocation of similar assets/liab employs an interest method
3. a particular set of estimated future cash flows is closely associated with the asset/liab
4. measurement at initial recognition was based on present value

Question 8

If estimated cash flows are to be changed, what are the 3 techniques used to reflect those changes?

Answer 8

1. prospective approach
2. catch-up approach
3. retrospective approach

IFRS does not contain a similar concept stmt but allows it as one of the acceptable measurement bases

Question 9

What is the prospective approach to changes in estimated cash flows?

Answer 9

a new effective interest rate is computed based on carrying amount and remaining cash flows

Question 10

What is the catch-up approach to changes in estimated cash flows?

Answer 10

the carrying amount is adjusted to the present value of the revised estimated cash flows, discounted at the original effect interest rate (FASB preferred method)

Question 11

What is the retrospective approach to changes in estimated cash flows?

Answer 11

new effective interest rate is computed based on the original carrying amount, actual cash flows to date and remaining estimated cash flows. The new effective interest rate is then used to adjust the carrying amount to the present value of the revised estimated cash flows, discounted at the new effective interest rate