Summary of Statement of Financial Accounting Concepts 7 - Assignment Example

In most of the accounting measurements, the observable marketplace-determined amount is used nevertheless; the accountants use the estimations of future cash flows in accounting measurements very often. The present value measurements are not required when the price of an asset or liability s observed in a marketplace because marketplace assessment of present value if already embodied in these prices. The present value formula determines the time value of money and contributes to the foundations of economics and corporate finance.

In accounting measurement, the use of present value is intended to capture the economic difference between sets of cash flows. For example, the price of unlike assets may appear similar when it is measured through undiscounted cash flow method however, present value helps to distinguish between the unlike assets by providing more relevant information through the incorporation of uncertainty in the estimation of future cash flows. Present value can be computed by using cash flows and interest rates and for financial reporting purpose it must represent any observable measurement attribute of asset or liability otherwise the limited information to the users of financial statements may mislead the users.

The five components of present value include an estimation of the future cash flows, expected variations in the amount or timing of cash flows, time value of money, price for bearing the inherent uncertainty in the asset or liability and other factors like illiquidity and market imperfections. When present value is used at initial recognition and fresh-start measurements, its objective is to measure the fair value. The market‘s pricing mechanism facilitates the marketplace participants because it ensures that like items do not appear different and unlike items do not appear alike.

The accountants typically accepts actual exchange prices as fair value in the measurement of transactions when the exchange of cash happens near to the date of transaction however, using a measurement becomes necessary when the stated price is not the actual representative of fair value. In other words, when the transaction of an asset or a liability is not accompanied by a cash transaction, the accountants look for the techniques for the initial measurement of the asset or liability. However, the measurement objective in both the cases remains same.

Since the Board could not identify the logic for using a different view in fresh-start measurements therefore, the principles for the initial recognition also apply to fresh-start measurement. It is also possible that an entity’s best estimate of presence value of future cash flows is not equal to the fair value. Some reasons have been identified because of which the entity may pay cash flows different from the expected cash flows in the marketplace. The primary reason is the perceived advantage or disadvantage of the entity relative to others in the marketplace.

Although the expectations of the management of entity can be informative and useful however, the final arbiter of values of assets and liabilities is the marketplace. Therefore, sometimes the entity pays the market’ prices regardless of its expectations and sometimes it completely relies on its own expectations. The inherent uncertainties in the estimated cash flows should be reflected in the accounting measurements that used the present value technique; or else, the assets or liabilities with different risks may