Question

The argument among accountants and financial statement users over the proper valuation procedures for assets and liabilities resulted in the release of SFAS No. 115 (see FASB ASC 320-19). The statement requires current-value disclosures for all investments in debt securities and for investments in equity securities that have readily determinable fair values and for which the investor does not have significant influence. The chairman of the Securities and Exchange Commission termed historical cost valuations “once-upon-a-time accounting.” Historical cost accounting also has been criticized as contributing to the savings and loan crisis of the 1980s. During that period, these financial institutions continued to value assets at historical cost when they were billions of dollars overvalued. Critics of current-value accounting point out that objective market values for many assets are not available, current values cannot be used for tax purposes, using current values can cause earnings volatility, and management could use current value to “manage earnings.”

Determine how current values might be determined for investments, land, buildings, equipment, patents, copyrights, trademarks, and franchises.

How might the use of current values in the accounting records cause earnings volatility?

Discuss how management might manage earnings using current cost data. d. How do the requirements originally established by SFAS No. 157 affect the use of fair value measurement in financial statements?

Answer 1

1. Determine how current values might be determined for investments, land, buildings, equipment, patents, copyrights, trademarks, and franchises.

There are generally three techniques are used determine current values for investments, land, buildings, equipment, patents, copyrights, trademarks, and franchises. The first would be the market approach. This approach uses the quoted prices in the active market such as market multiples of comparable assets or matrix pricing. The second approach would be the income approach. This approach uses the various techniques to find the current value of the future cash flow such as net present value. The third approach is the cost approach. This approach is the most simple and is the amount that it would cost to replace the current assets.

2. How might the use of current values in the accounting records cause earn-ings volatility?

The use of current values in the accounting records cause earnings volatility because the current value is changing so frequently or it is too difficult to ascertain a reliable figure that investors can count on. There is also the threat of managers using current value for earnings management and issues like these can cause significant fluctuation.

3. Discuss how management might manage earnings using current cost data.

Managers will value their assets when that certain asset is very scarce and the price to replace it is very high, or vice versa. If the assets are placed at a higher or lower value that can drastically affect certain ratios or other assessment tools. If the figures are being placed at the amount that managers would like them then there is really no indication of what the true value is to the company.

4. How do the requirements originally established by SFAS No. 157 affect the use of fair value measurement in ?nancial statements.

There are four main aspects to SFAS No. 157 that affect the use of fair value measurement in financial. (1) It provides a new definition of fair value. (2) A fair value hierarchy used to classify the source of information used in fair value measurements. (3) A new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy.