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2.1 Overview
Present
Value Model
Recognition Accounting
Historical
The
A
Cost Accounting
CICA
Overview
Widely
Provides
Determines
Consider
Cash
flow
= $150 each yr for 2 yrs
Interest rate = 10%
Present Value at year 0 = PA0
PA0
=
PA0 = 136.36 + 123.97
PA0 = $260.33
Balance Sheet As at Time 0
Capital Asset,
at expected PV
$260.33
Shareholders
Equity
$260.33
Net
Similar
to a savings account
Net
Income
PA0 = 260.33 * 0.1
PA0 = $26.03
Accretion
of discount
Present
PA1
=
PA1 = 136.36
Balance Sheet at the End of Year 1
Assets
Shareholders Equity
Cash
$150
Capital Asset,
at PV
$136.36
Net Income
$286.36
$ 26.03
$286.36
Dividends
Net
Relevant
Arbitrage
Net
and Reliable
Profits
Important Points
States
States
Example
At
Assume
Ideal
Ideal Conditions
Taking
Example
Calculation
time 0:
PV0 = 0.5 () + 0.5 (
PV0 = (0.5 * $272.73) + (0.5 * $247.93)
PV0 = $136.36 + $123.97
PV0 = $260.33
Balance Sheet As at Time 0
Capital Asset,
at expected PV
$260.33
Shareholders
Equity
Example Continued
$260.33
Investors
Expected
Example Continued
Accretion
year 1
Calculated
$26.03
$150
$100
Net Loss
Under
($50.00)
($23.97)
Example Continued
At
Cash
Shareholders
Equity
$100.00
Opening Value
$260.33
$136.36
Net Loss
($23.97)
Capital Asset
End of Year Value
$236.36
Example Continued
$236.36
Accretion
Calculated
$26.03
$150
$200
Net Income
Example Continued
$50.00
$76.03
Shareholders
Equity
$200.00
Opening Value
$260.33
$136.36
Net Income
$76.03
Capital Asset
End of Year Value
$336.36
This
$336.36
Example Continued
Financial
Points to Consider
The
Subjective
Probabilities (formally
introduced in chapter 3): Individuals must
assess state of nature probabilities for
themselves, using whatever information is
available.
A more reasonable assumption than objective
probabilities because the future performance of
a business entity is much more complex and
difficult to predict than a simple two state
illustration.
Looking Ahead
2.4 Reserve
Recognition Accounting
An Example of RRA with Husky Energy Inc.
Reserve
When
RRA Continued
RRA
RRA Continued
Oil
RRA Continued
The
Present-day
Comparison of Different
Measurement Bases
Current
Comparison of Different
Measurement Bases
It
Cost
Relevance Low
Reliability High
Current
Value
Relevance High
Reliability Low
Current
Characteristics: Revenue
Recognition
Recognition
Historical
Cost
Matching
Current
Value
Current
However
Presence
However,
Frustrating
difficulty of agreeing on
accounting policies
Different users will desire tradeoffs between
relevance and reliability
Several different accounting policies
Fascinating
Additional Reading:
A Matter of Principles
Al Rosen
Difficult
to interpret
Not
Old
CICA Handbook:
Section 1100
Generally Accepted Accounting Principles
This
Accounting
Consistent
Jeopardy