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FINANCIAL INSTRUMENTS Comparative Analysis Qualitative Characteristic Historical Cost Fair Value Income Recognition Relevance – Pros supporters contend that it’s is determined in a competitive provides a richer basis for Info. must have the most relevant measure as open market economics and analysis than cost or mixed the capacity to help it focuses on the decisions embodies all available information cost. It facilitates the predictive users make decisions. and resulting actions to buy up to the measurement date. and stewardship purposes of or sell assets and to incur or Financial instruments. settle a liability. measures as a going concern reflects the markets assessment FV provides a richer basis for whereas FV will reflect a of the effects on financial instrum. prediction as it reflects the liquid measurement. of current economic conditions. effects of changes in conditions and events occurring during the reporting period. Manufacturing Co’s use HC does not depend on whether or FV recognizes income when in order to be competitive and when it is intended to dispose events take place which enables reflect accurate profits & costs. of an asset or liability. analysis of economic causes (changes in market rate of int.) and their I/S effects. if mgmt intends to hold the it is the same no matter which FV maintains the PV of the fin. Inst. until maturity the enterprise has an asset or liab markets expectations of future opportunity for gains/losses if both enterprises have access cash flows to be generated by are irrelevant as they will to the same markets. the asset discount at the current eventually will net each other available market rate. out. would reduce the anomalies of the existing mixed cost acctg. therefore reduce the need for complex and subjective hedge acctg. reduces the opportunity for mgmt to manipulate earnings. recognize derivatives with no cost as they are for performance in the future – the contract could become a large asset or liab. Qualitative Characteristic Historical Cost Fair Value Income Recognition Relevance – Cons measures only the effects of if an active market does not gains and losses resulting from Information must have the conditions that existed when have a price available FV will changes in the fin. instru. Are capacity to help users the transaction took place and be measured based on the info likely to be volatile and non- make decisions. only the effects of price and techniques that provides recurring and often temporary. changes are reflected only the best available est. Provides no basis for prediction only when they are realized of future income and cash flows. or settled. impedes comparability as it the date used to measure a concern is expressed that such makes like instruments look fin. instr. could be outdated gains/losses may actually serve diff. and diff. instru. look as soon as statements are to inhibit the ability of users to alike. issued. evaluate the sustainable earnings of an enterprise. does not reflect current less relevant as it reflects the unrealized gains/losses recog- market conditions. effects of trans. and events nised in the I/S in one period in which the entity did not may reverse to become a loss directly participate. in future periods – how relevant was the gain? ignores the effects of mgmts decisions to hold a fin. instr. as it reflects the effects of changes in FV only when assets are sold or relief from a liab. is obtained not during the period the fin. instr. is held or owned. Qualitative Characteristic Historical Cost Fair Value Income Recognition Reliability – Pros information is outdated but if there is no observable mkt. allows investors to evaluate Information must be reflects the actual decisions price FV can be est using tech. past gains/losses in assessing the objective and verifiable and resulting transactions. that incorporates capital market potential variability of future and should faithfully pricing principles and info. returns as well as future income. represent what it purports about current mkt. conditions. to do. no need for mkt. prices or est there are already est that are reports gains/losses as income as all financial assets and liab. accepted in acctg. today when they occur increases the are recorded at original cost. eg. defined benefit oblig. assessment of managements therefore can be verified. and certain liab provisions. performance as it attributes reasonable est is an essential gains/losses to mgmt in place part of the preparation of F/S when such gains/losses occur and does not undermine their rather than possibly to a diff. reliability. team who may realize them at a later date. uses both amortization and cash flow expectations related directly reflects the gains/losses impairment which help to to fin. instruments are more from assuming particular financ. reduce the value of the fin. faithfully reflected. risks (int rate and credit risks) instrument. when the underlying market condition change. software is now available that enables many types of compu- tations to be made at a reasonable cost. Qualitative Characteristic Historical Cost Fair Value Income Recognition Reliability – Cons requires complex computations market prices are not always subject to significant est variab. Info. must be objective and methods in order to try to available and the est may be therefore until they are realized and verifiable and should est. current mgmt. strategies. unreliable if they are not or until the est uncertainty has faithfully represent what based on observable market been resolved unrealized gains/ it purports to do. prices. losses s/b presented separately outside the I/S. provides mgmt the opportunity concerns about the ability of reliable forecasts of the future to manipulate earnings – eg a an enterprise to develop FV I/S effects of a fin. instr. are company could play the game estimates that could be unlikely to be possible from of “cherry picking” – mgmt sufficiently reliable for simple extrapolations of past can improve reported income financial accounting in gains and losses. by selecting L/T fin. instr. all situations. with unrealized gains to be sold or to be reclassified as S/T investments. does not convey the cash measurement might not be gains/losses realized by FV flow risks of the company practical for certain private takes the markets unbiased on a timely basis as it only equity investments. measure of the economic recognizes when realized. events. can be misleading when although active mkts exist for mgmt has to decide when to many fin. instr. there is no mkt settle of hold fin. instr. for loans and deposits. Qualitative Characteristic Historical Cost Fair Value Income Recognition Cost-benefit no additional costs involved software is now available that est. of variability (risk) is based Considerations - in measuring fin. instr. at FV enables many types of compu- on past experience with int rates Pros tations to be made at a and loan defaults – models have reasonable cost. been developed to utilize statis- tical data on past experience to aid analysis. no additional implementation allows for measuring and by showing as unrealized gains/ issues eg training users and reporting the results of an losses it allows for measuring prepares. enterprise mgmt strategy and reporting the results of an enterprises mgmt strategy. supplies info to see if mgmt provides investors with investors and analysts can be is meeting operational budgets valuable info for their decision expected to want to evaluate or forecasts. making – eg FV at retirement past gains/losses in assessing the date, changes in the value and potential var. or future returns as the components of that change. well as in assessing future future income expectations. enhances comparability by costs are no greater than those retaining HC of the fin. instr. associated with a purchase/sale (provides a trail). of any asset. Manuf. Co’s rely on HC so investors are already used to they can compute a cost that some fin. instru. being measured relates to the original cast of at FV – RRSP statements. the raw materials. Qualitative Characteristic Historical Cost Fair Value Income Recognition Cost-benefit increase mgmts opportunity to if there is no active mjt avail. gain/losses resulting in the FV Considerations - manipulate earnings therefore for valuing a fin. instr. as est. of fin. instr. are likely to be Cons provides less relevant info to users could incur excessive costs to volatile and non-recurring make reliable est. of the FV of results of the unexpected there- financial instruments. fore can’t be used for predicting future income. does not recognize derivatives there would be an added cost add’l cost involved in measuring with no initial cost therefore lacks of training both users and financial instruments at FV relevance to risk mgmt decisions. prepares (implementation issue) companies are comparing them- est. and assumptions must be least benefit to manuf. Co’s. as selves globally to become more made on a reasonably reliable they need HC to compute selling competitive, with fin. instr. and consistent basis resulting prices to stay competitive. increasing and trying to manage in an enterprise establishing a risk exposure HC doesn’t supply system of FV measurement the total picture to investors and policies and procedures – users. increased costs. costs to users of incomplete info. added costs of revaluing fin. (need to obtain info not provided instruments at FV even if an by the F/S) active market is available. provides the least benefit to users.
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