2.

Note: The purpose of this question is to discuss why deferred revenue does not exist under full current cost
accounting. a. Under historical cost accounting, the income statement is the primary financial statement. Net
income for a period represents the difference between revenue recognized during the period and the historical
costs of earning that revenue. When revenue is received in advance, it is deferred on the balance sheet to future
periods when it will be matched with the costs of earning that revenue. In effect, this deferred revenue is viewed
as an accrual to defer revenue that is not yet earned. Revenue each period can be determined by amortizing the
deferred revenue on some systematic basis such as straight line. Under the measurement approach, the balance
sheet assumes greater importance. The role of the income statement is to explain changes in the current values
of assets and liabilities during the period. Revenue received in advance is viewed as a liability to be measured at
current value. One way to measure this value is to determine the amount the firm would be willing to pay to be
relieved of this service obligation. Revenue for the period is recognized as the decline in this value during the
period.
b. The firm could calculate the discounted present value of the costs expected to meet its contractual liability for
updates and virus protection. This is the amount the company would be rationally willing to pay to be relieved of
this obligation. However, if there is a market for the required services, and the market value of the services is less
than the company’s cost estimate, the obligation would be valued at the lower amount. This is now the amount
that the company would rationally pay to be relieved of the obligation. Either way, the liability would be
remeasured at each period end over the three years, to show the expected cash outflows remaining.
c. The approach suggested in b is more relevant than the matching approach since it measures expected future
cash flows. Under historical cost accounting, the balance sheet measure of the obligation does not measure
future cash flows but rather the portion of the deferred revenue remaining to be allocated to future periods. The
approach suggested in b is less reliable that the matching approach. Allocation over three years is a
straightforward calculation, whereas an estimate of discounted future expected cash flows is subject to
estimation error and possible bias.

13. a. Net income calculated this way would add nothing to what the market already knows. If security markets
are efficient, the share prices would already incorporate all that the market knows. If markets are not fully
efficient, that is, shares are mispriced, the suggestion would simply perpetuate the mispricing.
b. This suggestion suggests a limit to the extension of fair value accounting. While fair valuation of individual
assets and liabilities may be decision useful, fair valuation of all of them, including self-developed intangibles,
would not be decision useful, as per a. The reason is that the fair value of self-developed goodwill captures the
ability of management to earn a return in excess of cost of capital on the tangible and intangible net assets used
to operate the business. The fair value of self developed goodwill merely records the market’s estimate of this
excess earnings ability, and thus adds nothing to what the market already knows.
However, value-in-use (i.e., present value) of self-developed goodwill would be decision useful if relevance
outweighed problems of reliability, since present value would reveal inside information about management’s
expectations of future firm performance.