Topic 2 Measurement and Valuation

Question 1

What are the 5 scales of measurement?

Answer 1

1. Binary
2. Nominal
3. Orginal
4. Internal
5. Ration

Question 2

Explain Binary?

Answer 2

1 of 2 options. on/off. 0/1. guilty/not guilty.

Question 3

Explain Nominial?

Answer 3

Counts the items in question. eg 4 bananas, 3 apples & 5 oranges.

Question 4

Explain Ordindal?

Answer 4

Includes ratings or rankings. Being higher in the list is better then lower. Tennis 15-30

Question 5

Explain Interval?

Answer 5

Measures intervals between ranks. eg inches, miles.

Question 6

Explain ratio?

Answer 6

Same as interval but has a true zero, cannot go to negative. eg time.

Question 7

Components of measurement?

Answer 7

• is a quantitative statement of fact
• involves counting
• is objective
• is based on historical cost

Question 8

What is money?

Answer 8

Money measures prices, costs, values. It is a medium of exchange, a store of value. It’s not fixed in purchasing power so its own value declines over time due to inflation.

Question 9

What are the 4 units of valuation?

Answer 9

1. Historical cost
2. Current Purchasing Power - CPP
3. Current Cost & Deprival Value
4. Fair Value

Question 10

What is Historical Cost Accounting?

Answer 10

• it is an objective measurement approach
• it is a record of all receipts and payments previously made.
• it is a statement of fact as it is evidenced by documents.
• it is factual and reliable

Question 11

What is Current Purchasing Power (CCP)?

Answer 11

When the currency is in hyperinflation meaning purchasing power of money falls to much during the year that its usefulness to compare prices over a period is destroyed. Accounts then have to be restated in line with the IAS.

Question 12

What is backlog depreciation?

Answer 12

When the accounts have to be restated due to the decline in current purchasing power the same needs to be done to depreciation. When adjustments from previous hear are recalculated and adjusted in the current year.

Question 13

What is Current Cost Accounting (CCA)?

Answer 13

It is the replacement cost or deprival value to replace an item you already hold. It is an entry price not exit. Current cost is always higher then historic cost unless inflation has affected it, but it needs to be adjusted up in the comphrehensive income.

Question 14

What is fair value (FV)?

Answer 14

Is the price that would be received to sell an asset, or paid to trans a liability. It is more relevant and useful to decision makers.

Question 15

What are the 3 Fair Value valuation approaches?

Answer 15

1. Market approach - uses price & other relevant info generated by active markets.
2. Cost approach - reflects the amount that would be required currently to replace the item. (current replacement cost).
3. Income approach - converts future amounts to a single current (discounted) amount. Net Profit Value is used as there is no active market.

Question 16

What are the main theoretical assumptions of the measurement approach?

Answer 16

• markets are semi strong form efficient (market efficiency states that all info in a market, whether priv/public is accounted for in a stock’s price.)
• CAPM holds so only systematic (market) risk holds. (CAPM helps investors understand the rtns they can expect given the level of risk they assume). Unsystematic risk is company risk.
• Value in use is irrelevant to market & cost approach. (NPV)
• Value is instantaneous not continuous.
• Markets are the ultimate determinent of values.

Question 17

What are the 2 valuation approaches?

Answer 17

1. Information approach - uses historical cost accounting. Is more concerned with the P&L and how well the manager has managed things. PROFIT.
2. Measurement approach - uses fair value accounting. Is more concerned with the Bal Sheet and obtaining a value as close as possible to the stock price.

Question 18

What is clean surplus theory?

Answer 18

It supports the measurement approach. The clean surplus theory excludes equity-related transactions like dividends, share repurchases, and share offerings from the income statement. Instead, the earnings report shows changes to the fair value of assets and liabilities.

Question 19

What are the advantages & disadvantages of historical cost?

Answer 19

Adv
- it is reliable because it can be verified.
- it is easily understood.
- the cost of measuring is minimal (no need for valuations).

Disadv
- relevance.
- what you have paid for an item is not relevant to future decisions.
- it provides no indication of the value of an item.
- it fails to take into account the time value of money.

Question 20

What is current cost?

Answer 20

Current cost of an item is the lowest amount that would be paid at the current time to provide/replace the future economic benefits.

Question 21

What is replacement cost?

Answer 21

Is the present cost of replacing an asset with an indentical or similar asset or modern equivalent.

Question 22

What are the advantages and disadvantages of current and replacement costs?

Answer 22

Adv
Both are reliable as market prices determine the price & it is less able to be manipulated by management.

Disadv
Can take time to gather all infor on replacing something especially if you need to rebuild a site or the item is unique in some way.

Question 23

What are the advantages and disadvantages of a fair value?

Answer 23

Adv
It is reliable in the sense that it is objective as determined by market forces and less open to management manipulation. There may not be any re-sale value for entity 1 but it might generate high income for entity 2.

Disadv
Unless there is an active market, estimating fair value can be very subjective.

Question 24

What are the advantages and disadvantages of using present value?

Answer 24

Adv
Measures value as the present value of the future net cash flows. (time value of money)

Disadv
Lack of reliability. How to predict amounts & timing of future cash flows. How to allocate cash flows between assets. Choice of discount/interest rate in calculating NPV.