Question

At a recent meeting of the accounting staff in your company, the controller raised the issue of using present value techniques to conduct impairment tests for some of the company's fixed assets. Some of the more senior members of the staff admitted having little knowledge of present value concepts in this context, but they had heard about a FASB Concepts Statement that may be relevant. As the junior staff in the department, you have been asked to conduct some research of the authoritative literature on this topic and report back at the staff meeting next week.

(a)  

Identify the concept statement that addresses present value measurement in accounting.

(b)  

What are some of the contexts in which present value concepts are applied in accounting measurement?

(c)  

Provide definitions for the following terms:

• 1.Best estimate.

• 2.Estimated cash flow (contrasted to expected cash flow).

• 3.Fresh-start measurement.

• 4.Interest methods of allocation

Answer 1

(a) Concept no. 7 "Using Cash Flow Information and Present Value in Accounting Measurements" issued by FASB addresses present value measurement in accounting.

(b) Present value concepts are the basis for stock pricing, bond pricing, financial modeling, banking, insurance, pension fund valuation, and even lottery payouts. Assets should be tested for impairment regularly to prevent overstatement on the balance sheet,

(c) The definitions as provided in Concept No. 7 are mentioned below:

1. Best Estimate: The single most-likely amount in a range of possible estimated amounts is referred as the best estimate. In the past, accounting pronouncements have used the term best estimate in a variety of contexts that range in meaning from “unbiased” to “most likely.” As per concept no. 7 issued by FASB, best estimate refers to 'most likely'

2. Estimated cash flow refers to a single amount to be received or paid in the future. On the other hand, Expected cash flow refers to the sum of probability-weighted amounts in a range of possible estimated amounts, the estimated mean or average.

3. Fresh Start measurements: Measurements in periods following initial recognition that establish a new carrying amount unrelated to previous amounts and accounting conventions.

4. Interest methods of allocation: Reporting conventions that use present value techniques in the absence of a fresh-start measurement to compute changes in the carrying amount of an asset or liability from one period to the next. The term interest methods of allocation refers both to the convention for periodic reporting and to the several approaches to dealing with changes in estimated future cash flows.