CHAPTER 3

DATA, DECISIONS, AND MEASUREMENT

CHAPTER LEARNING OBJECTIVES

1. Understand how data and analytics tools are used in making and communicating decisions.

As more things become digitized, more and more data are being created by the minute. Infrastructure is continually being invested in to handle this data. Big data is data with the following five attributes: volume, velocity, variety, variability, and veracity. It may be structured or unstructured. Tools such as Excel and Power BI are used to analyze big data and create visualizations that are useful in decision-making. Good visualizations focus on content, presentation, and storytelling.

2. Use valuation techniques to measure financial statement elements. IFRS and ASPE incorporate a mixed-attribute measurement model including measurements that are cost-based (such as historical cost), those that are based on current value (such as fair value), and many hybrid measures that have attributes of both cost-based and current value measurements. Valuation techniques are used to help with measurement of financial statement elements. Common examples include market models and income models. Income models are widely used and include discounted cash flow methods and present value concepts. When using models, you must determine what inputs should be used. Common inputs include discount rates and cash flow estimates. The quality of these inputs affects the quality of the final measurement. Accountants often use probabilities to help deal with risk and uncertainty. Given the amount of judgement that goes into measuring financial statement elements, disclosures are very important.

3. Use IFRS 13 to measure fair value. IFRS 13 establishes a fairly detailed body of knowledge relating to measurement of fair value. Fair value measurement under IFRS 13 is a market-based approach that incorporates the specific attributes of the asset or liability being measured, the valuation premise (how the asset or liability is to be used), the principal market, and the valuation technique. Since market prices are not always available, valuation models are used to measure the value. Inputs to these models are either observable in the market or not observable. Observable inputs are the most useful since they are more objective. The fair value hierarchy establishes three levels of inputs, with level 1 being the highest and best type of input (based on observable market prices). Because level 3 inputs are more subjective, additional disclosures are required.

4. Understand and apply present value concepts. Present value concepts are used to acknowledge the time value of money. There are various techniques and tools to calculate present value, including formulas, tables, financial calculators, and spreadsheets. Inputs to the calculation include interest, payments, number of periods, and if the calculation involves an annuity, information about whether it is an ordinary annuity or an annuity due. Present value concepts are frequently used in measuring financial statement elements.

5. Identify differences in accounting between ASPE and IFRS. The main difference is that IFRS contains specific guidance in IFRS 13 regarding fair value measurements. Under ASPE, guidance is spread throughout the body of knowledge and is less detailed.

Multiple Choice QUESTIONS

Answer No. Description

d 1. Digitalization

a 2. Big data attributes

b 3. Data analytics

d 4. Data management value chain

d 5. Inputs to income model

b 6. Traditional discounted cash flow approach

d 7. Expected cash flow approach

c 8. Financial measurement categories

b 9. Hybrid measurement

c 10. Current value measurement

a 11. Discounted cash flow approach

a 12. Calculate present value

b 13. Impairment loss

d 14. Fair value of a bond

a 15. In-use value of an intangible asset

b 16. Valuation premise

c 17. Highest and best use concept

a 18. Cost model

d 19. Level 1 inputs

a 20. Fair value measurement under IFRS 13

d 21. Fair value measurement under IFRS 13

c 22. IFRS 13 valuation model

b 23. Simple interest

d 24. Compound interest

a 25. Interest-on-interest

c 26. Calculate rate of interest

a 27. Calculate quarterly payments

b 28. Calculate time period

a 29. Calculate present value

b 30. Calculate lease payment

a 31. Differences in accounting between ASPE and IFRS

Exercises

Item Description

E3-32 The three “Vs” of data

E3-33 Structured vs. unstructured data

E3-34 The data management value chain

E3-35 Expected cash flow approach

E3-36 Measurement of financial statement elements

E3-37 Estimated fair value and inputs under IFRS 13

E3-38 Calculate lease payments for beginning and end of period

E3-39 Calculate market price of a bond

E3-40 Present value of an annuity due

PROBLEMS

Item Description

P3-41 Analysis vs. analytics

P3-42 Simple and compound interest

P3-43 Calculate bond price

P3-44 Future value of lump sum and annuity

Multiple Choice QUESTIONS

1. The act of transforming processes that use new technologies and digital information is referred to as

a) digitization.

b) big data.

c) cloud computing.

d) digitalization.

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

2. Which of the following attributes of big data is critical in any decision-making model?

a) veracity

b) volume

c) velocity

d) variability

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

3. The CEO of your company has approached you in your role as controller and asked that you conduct some research regarding various optimization tools that can be implemented and applied to various models to enhance the senior executive team’s decision-making. The CEO is asking you to engage in what type of data analytics?

a) predictive

b) prescriptive

c) descriptive

d) diagnostic

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

4. According to the data management value chain, the individual in an organization that is responsible for who should have access to the data, tracing the origins and ensuring the validity of the data, and overseeing the legal changes related to using the data is referred to as the

a) data engineer.

b) data scientist.

c) strategic advisor.

d) data controller.

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

5. Inputs to income models include which of the following?

a) using a risk-free and risk-adjusted interest rate

b) adjusting cash flows and the discount rate in the same calculation

c) actual cash flows

d) time value of money

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

6. Under the traditional discounted cash flow approach,

a) the model is best used when cash flows are uncertain.

b) the stream of contracted cash flows is discounted.

c) the risk-free discount rate is used.

d) the method is best used when cash flows are variable.

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

7. Under the expected cash flow approach,

a) the model is best used where the element being measured does not have variable cash flows.

b) the projected cash flows reflect the certainty in terms of amount and timing.

c) the discount rate is adjusted to accommodate the riskiness of the cash flows.

d) the cash flow uncertainty is dealt with by using probabilities.

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

8. Which of the following is NOT used to measure financial statement elements?

a) cost-based measures

b) hybrid measures

c) cash flow measures

d) current value measures

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

9. Which of the following is an example of an item that would be measured under the hybrid measurement categorization?

a) investment properties

b) inventory measured at the lower of cost and net realizable value

c) biological assets

d) financial instruments carried at cost

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

10. Which of the following is an example of an item that would be measured under the current value measurement categorization?

a) inventory using various cost flow assumptions

b) inventory measured at the lower of cost and net realizable value

c) biological assets

d) financial instruments carried at cost

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

11. Which of the following statements regarding the traditional discounted cash flow approach is correct?

a) The discount rate is adjusted to accommodate the riskiness of the cash flows.

b) The cash flows have been adjusted to accommodate their riskiness.

c) This model is best used where cash flows are fairly uncertain.

d) None of these statements are correct.

Difficulty: Easy

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

12. Frontier Landscaping owns some equipment that is used for its operations. Management estimates that the equipment will last another three years and will generate the following future cash flows at the end of each year.

Calculate the present value of each of these future cash flows given a 4% discount rate.

a) $15,617

b) $9,394

c) $18,135

d) $35,165

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Feedback: ($4,000 x .96154) + ($6,000 x .92456) + ($7,000 x .88900) = $15,617

13. Frontier Landscaping owns some equipment that is used for its operations. Management estimates that the equipment will last another three years and will generate the following future cash flows at the end of each year.

Assuming Frontier Landscaping’s equipment has a carrying value of $16,000, how much of an impairment loss must Frontier record given a 40% discount rate?

a) none as there is no impairment

b) $383

c) $6,606

d) $2,518

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $16,000 – [($4,000 x .96154) + ($6,000 x .92456) + ($7,000 x .88900)] = $383

14. Billow Company has issued a 3% bond that is payable in 5 years and has a face value of $100,000. The risk-adjusted market rate is 4%. Calculate the fair value of the bond.

a) $82,193

b) $13,355

c) $68,838

d) $95,548

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Feedback: ($100,000 x .82193) + ($100,000 x .03 x 4.45182) = $95,548

15. Easy Composting signs a contract purchasing the right to use, manufacture, and sell a proprietary home use composting process developed by EverGreen Industries. Easy Composting estimates that it will earn $120,000 annually (at the end of each year) for the next 7 years. The current market interest rate is 5% for this type of contractual agreement, however, adjustments for uncertanities related to this specific process are estimated at 3%. What is the value in use of this contract to Easy Composting?

a) $624,764

b) $694,368

c) $747,636

d) $840,000

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: ($120,000 x 5.20637) = $624,764

16. Valuation premise does NOT refer to

a) the perceived value of the asset/liability.

b) the actual use of the asset/liability.

c) the highest and best use valuation in the market.

d) how the asset/liability is to be used.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

17. The highest and best use concept values the asset based on the highest value that the market would place on the asset, considering all possible uses that are

a) physically possible.

b) legally permissible.

c) financially feasible.

d) economically intolerable.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

18. The cost model attempts to reflect the amount that would be required to

a) replace the asset’s service capacity.

b) value older financial assets where there is no longer a market for the asset.

c) value the asset.

d) value older non-financial assets where there is a market for the asset.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

19. Level 1 inputs

a) are the lowest-quality inputs but provide the best-quality fair value.

b) are used when level 3 inputs are not available.

c) are generally not observable in various markets.

d) are more objective.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

20. A fair value measure under IFRS 13 is based on which view of fair value?

a) market participant view

b) shareholder view

c) fair value view

d) unbiased view

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

21. In order to measure fair value under IFRS13, an entity must determine

a) the item being measured, and how the item could or would be used.

b) the market the item would be (or is) bought and sold in.

c) which fair value model is being used to value the item.

d) All of the choices are correct.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Finance

CPA: Management Accounting

Bloomcode: Knowledge

AACSB: Analytic

22. The observable inputs as part of the IFRS 13 Valuation Model that reflect quoted prices for identical assets or liabilities in active markets are considered

a) ineffective and of little value.

b) highly subjective and must be disclosed.

c) to produce the best quality fair value measurement.

d) lack objectivity and should only be used if level 2 and 3 information is not available.

Difficulty: Easy

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Finance

CPA: Management Accounting

Bloomcode: Knowledge

AACSB: Analytic

23. Branson Company deposited $5,800 in an account paying 2.5% annual interest. How much simple interest would Branson earn in 3 years?

a) $5,945

b) $435

c) $145

d) $446

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: $5,800 x .025 x 3 = $435

24. Branson Company deposited $5,800 in an account paying 2.5% annual interest. How much compound interest would Branson earn in 3 years?

a) $6,235

b) $435

c) $145

d) $446

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: ($5,800 x 1.07689) – $5,800 = $446

25. Branson Company deposited $5,800 in an account paying 2.5% annual interest. How much interest-on-interest would Branson earn over 3 years?

a) $11

b) $33

c) $5.50

d) $22

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: ($5,800 x 1.07689) – ($5,800 x .025 x 3) – $5,800 = $11

26. Fiddler Company has a loan balance of $853.02 and must make equal payments of $100 at the end of each of the next 10 months. What is the monthly rate of interest that Fiddler Company is paying?

a) 2%

b) 2.5%

c) 3%

d) 4%

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: $853.02 / $100 = 8.5302 which is PV factor of an ordinary annuity at 3% for 10 periods.

27. Helvetica Corporation is interested in leasing a piece of machinery that has a fair value of $150,000. The market rate for financing is 8% and Helvetica plans to lease the machinery for the next five years. Calculate the quarterly lease payments.

a) $9,174

b) $15,278

c) $31,824

d) $37,569

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Financial Reporting

CPA: Finance

Bloomcode: Application

AACSB: Analytic

Feedback: PV of an ordinary annuity = $150,000 / 16.35143 = $9,174 given i = 2%, n = 20 periods.

28. Barkley Company will receive $400,000 in a future year. If the future receipt is discounted at an interest rate of 8%, its present value is $252,068. In how many years is the $400,000 received?

a) 5 years

b) 6 years

c) 7 years

d) 8 years

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Feedback: $252,068 ÷ $400,000 = 0.63017; 0.63017 is PV factor for 6 years at 8%

29. Pearson Corporation makes an investment today (January 1, 2023). It will receive $9,000 every December 31 for the next six years (2023–2028). If Pearson wants to earn 12% on the investment, what is the most it should invest on January 1, 2023?

a) $37,003

b) $41,443

c) $73,036

d) $81,801

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Feedback: $9,000 × 4.11141 = $37,003

30.Capricorn Inc. is in the process of negotiating a vehicle lease. The vehicle costs $32,000 and the dealership offers Capricorn a 4% interest rate compounded quarterly. Payments will also be made quarterly over 5 years. What is the quarterly lease payment?

a) $1,600.00

b) $1,773.29

c) $1,797.02

d) $1,847.80

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Feedback: PV $32,000, I/Y 1%, N 20, FV 0, PMT $1,773.29

31. The main difference in the accounting for measurement issues between IFRS and ASPE is that

a) IFRS has a well-developed framework for measuring fair values (IFRS13), whereas ASPE does not.

b) there is no difference between accounting for measurement issues between these standards.

c) guidance under ASPE is concentrated in a single area of the ASPE body of knowledge.

d) IFRS requires explicit disclosure of fair value amounts, whereas these disclosures under ASPE are optional.

Difficulty: Easy

Learning Objective: Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

EXERCISES

Ex. 3-32 The three “V’s” of data

You are currently working as a contoller for a small retail firm. The company you work for is in the process of digitalizing its customer data, enhance and specifically design marketing campaigns directed towards its target customer. The CEO understands there are two new “V’s” that have been added to the orginal three “V’s” but has no clue whether or not they are even important. The CEO is feeling frustrated with the entire project and just sees this as one more reason to delay moving forward. He would like to minimize costs and just does not want to add anymore work on the tech team.

Instructions

a) Identify and explain what the additional 2 “v’s” are.

b) Critical Thinking: In your opinion can the company reduce project costs by focusing on the original three “v’s” only? What is the implication of ignoring the additional two “v’s” if there is one? Explain why.

Solution 3-32

a) The additional two “v’s” include variability and veracity. Variability focuses on data flows and the changes to those flows, whereas veracity helps a system differentiate between high-quality and low-quality data.

b) Critical Thinking: It is not clear if the company can actually save project costs by ignoring the additional two “v’s”; however, it would not be in the company’s best interest to do so. Veracity in particular is critical in any decision-making model. Since this data is going to be used to specifically target customers, untrustworthy data could result in faulty decision making and the development of marketing campaigns that do not have the desired effect. In the long run it may cost the company money due to ineffective marketing strategies. Variability is also important since it will adjust for any change in data flows, ensuring that the correct information is being captured. This is also necessary when developing target customer profiles.

Difficulty: Medium

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Ex. 3-33 Structured vs. Unstructured data

Identify and explain the types of data that are being referred to under “Variety” as part of the three “v’s”. How is analysis effected by these types of data? What must the user of the information take into consideration?

Solution 3-33

Variety considers whether data is structured or unstructured. Structured data is highly structured and formatted. This generally includes tansactional data captured in a traditional data base or general ledger. Unstructured data includes everything else, examples include information from social media – comments, pictures, emails and videos. Structured data is easier to sue since it is already “clean” and formatted. Unstructured data needs to be further analyzed and may need advanced tools for analysis. This might include the use of artificial intelligence and machine learning.

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Comprehensive

AACSB: Analytic

Ex. 3-34 The data value management chain

Explain the various roles of the CPA in relation to the data value management chain. Clearly articulate how the CPA’s role supports each stage of the chain.

Solution 3-34

There are three roles the CPA may undertake within the data management value chain. These include the following:

1. Core role – this involves leveraging existing charters supporting the expansion of finacial data to include all data. The audit can span from a traditional audit to assessment of whether or not data is fit for its intended use. This is part of the data gathering and data sharing stages of the data management value chain.
2. Enhanced role – this involves leveraging or expanding the role of financial controller to include data controller. This expands stewardship to include protecting data assets, ensuring related laws are respected, and creating resource usage and models are aligned strategically to limit waste and mitigate risk. This is part of the data sharing and data insights stages of the data management value chain.
3. Earned role – this invovles leveraging the existing role of the CPA to include the contextual use of data and insights in decision-making internally and product development externally. This could result in the enhancement of current revenue streams or even the creation of new streams. This is part of the data insights and communication stages of the data management value chain.

Difficulty: Easy

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Comprehensive

AACSB: Analytic

Ex. 3-35 Expected Cash Flow Approach

Assume that Picnic Paper Co. has several minor lawsuits outstanding. To determine the amount of liability to recognize on the statement of financial position, Picnic decides to use expected cash flow techniques. Based on discussions with their lawyers, Picnic has developed the following cash flow estimates, and related probabilities:

Year Cash Flow Estimate Probability Assessment

2023 $2,300 30%

$4,500 45%

$8,200 25%

2024 $3,200 20%

$5,400 50%

$7,100 30%

Instructions

Based on these estimates, and assuming a risk-free rate of 5%, what is the present value of expected cash flows that Picnic should record on its statement of financial position at the end of 2022?

Solution 3-35

Year Cash Flow Estimate Probability Assessment Expected Cash Flow

2023 $2,300 30% $690

4,500 45% 2,025

8,200 25% 2,050

$4,765

2024 $3,200 20% $640

5,400 50% 2,700

7,100 30% 2,130

$5,470

Year Expected Cash Flow PV Factor i-5% Present Value

2023 $4,765 0.95238 $4,538.09

2024 5,470 0.90703 4,961.45

Total $9,499.54

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 3-36 Measurement of financial statement elements

Your client, Bench Company, has a few minor lawsuits outstanding. Your main contact, Michael Wood, has heard that though the amount is unknown, these lawsuits must be recorded on the financial statements. Explain briefly for Mr. Wood, the cash flow approach you would take to determining the amount to record on Bench Company’s financial statements.

Solution 3-36

The stream of expected cash flows related to Bench Company’s expected lawsuits will be paid out at a future time. To account for the time value of money, these cash flows are discounted to the present, using the discount rate reflecting the value of those dollars at present day. Two main cash flow approaches should be considered:

Traditional Approach

The stream of cash flows is discounted, and a discount rate used to accommodate the riskiness of the cash flows.

Expected Cash Flow Approach

Use the risk-free interest rate and adjust for cash flow uncertainty with probability weighting.

Since the traditional approach is best used when cash flows are fairly certain, the expected cash flow approach is recommended to Mr. Wood in this situation, since the amount and timing of Bench Company’s lawsuit payouts is relatively uncertain.

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

AACSB: Communication

Ex. 3-37 Estimated fair value and inputs under IFRS 13

Hood Company owns specialized equipment that was purchased in an acquisition of Riding Company. The equipment has a book value of $1,800,000, but according to IFRS it is assessed for impairment on an annual basis. To perform this impairment test, Hood must estimate the fair value of the equipment. It has developed the following cash flow estimates related to the equipment based on internal information. Each cash flow estimate reflects Hood's estimate of annual cash flows over the next 7 years. The equipment is assumed to have no residual value after the 7 years. (Assume the cash flows occur at the end of each year.)

Year Cash Flow Estimate

1–3 $240,000

4–6 365,000

7 425,000

Instructions

a) Hood determines, using its own assumptions, that the appropriate discount rate for this estimation is 6%. To the nearest dollar, what is the estimated fair value of the equipment?

b) Critical Thinking: What type of inputs are used by Hood Company under IFRS 13? As a result, what classification would be assigned to the specialized equipment?

Solution 3-37

a) ($240,000 x 2.67301) + ($365,000 x 2.67301 x .83962) + $425,000 x .66506

= $641,522.40 + $819,174.12 + $282,650.50

= $1,743,347

b) Critical Thinking: Hood used unobservable internal company data in their IFRS 13 valuation of specialized equipment acquired upon acquisition of Riding Company. Unobservable inputs such as a company’s own data or assumptions are considered Level 3 inputs, which are the most subjective of all three in the hierarchy, and hence require greater disclosures to give financial statement users greater information about the related uncertainty. Because Level 3 inputs are in use, the asset would be classified as a Level 3 asset.

Difficulty: Hard

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Communication

Bloomcode: Evaluation

AACSB: Analytic

Ex. 3-38 Calculate lease payments for beginning and end of period

Raleigh Inc. is considering leasing a piece of equipment with a fair value of $108,000 for three years. The current market interest rate for financing the equipment is 5% compounded semi-annually.

a) Calculate the semi-annual lease payment assuming that the payment is made at the beginning of the period (round to the nearest dollar).

b) Calculate the semi-annual lease payment assuming that the payment is made at the end of the period (round to the nearest dollar).

Solution 3-38

a) Semi-annual lease payment using annuity due of $108,000 for six periods at 2.5% ($108,000 / 5.64583) = $19,129.

b) Semi-annual lease payment using ordinary annuity of $108,000 for six periods at 2.5% ($108,000 / 5.50813) = $19,607.

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Ex. 3-39 Calculate market price of a bond

On January 1, 2023Lance Co. issued five-year bonds with a face value of $700,000 and a stated interest rate of 12% payable semi-annually on July 1 and January 1. The bonds were sold to yield 10%.

Instructions

Calculate the issue price of the bonds.

Solution 3-39

Present value of $700,000 discounted for 10 periods at 5% ($700,000 × .61391) = $429,737

Present value of $42,000 for 10 periods at 5% ($42,000 × 7.72173) = 324,313

Issue price of the bonds $754,050

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Ex. 3-40 Present value of an annuity due

How much must be invested now to receive $30,000 for ten years if the first $30,000 is received today and the rate is 8%?

Solution 3-40

Present value of an annuity due of $30,000 for ten periods at 8% ($30,000 × 7.24689) = $217,407.

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

PROBLEMS

Pr. 3-41 Analysis vs. analytics

Be Wary Insurance company is trying to find ways to generate estimates and better predict how many claims it will pay out each year, and what the value of each claim will be. Claims trends have been rising and the company wants to reverse this trend. It understands that it may be able to create more accurate projections using analytics. The company has hired you as a consultant to help.

Instructions

a) Identify and describe the four types of analytics that can be used to assist with strategic planning and financial forecasting?

b) Critical Thinking: Provide a recommendation to Be Wary regarding which of the four types of analytics will be the most important to the company’s planning processes and why.

Solution 3-41

a) The four types of analytics that can be used include the following:

1. Descriptive Analytics – examines historical data to answer questions.

2. Diagnostic Analytics – identifies patterns and discovers relationships in data.

3. Predictive Analytics – uses current and historical data to predict future activity.

4. Prescriptive Analytics – Applies rules and modelling for better decision making.

b) The most important type of analytics for the company is predictive analytics. Predictive analytics supports the company’s goal of trying to better generate estimates related to the number of future payout obligations and the estimated value of such obligations. It will provide the company with rules and modelling to assist with better decision making in order to mitigate risk related to large and unexpected payouts; whereby, reversing this trend of increased claims and payouts.

Difficulty: Medium

Learning Objective: Understand how data and analytics tools are used in making and communicating decisions.

Section Reference: Data and Decisions

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Pr. 3-42 Simple and compound interest

Flip Flop has just inherited $10,000 from a long lost relative and wants to invest it for the next 5 years.

Instructions

1. Calculate Flip Flop’s interest to be received and accumulated year end balances for each year assuming 4% annual simple interest.
2. Calculate Flip Flop’s interest to be received and accumulated year end balances for each year assuming 4% compound interest.

Solution 3-42

1. Annual interest = $10,000 x .04 = $400 per year

Year Beginning Amount Simple Interest Accumulated Year End Balance

1 $10,000 $400 $10,400

2 10,400 400 10,800

3 10,800 400 11,200

4 11,200 400 11,600

5 11,600 400 12,000

1. Annual interest is earned on the principal and interest.

Year Beginning Amount Compound Interest Accumulated Year End Balance

1 $10,000 $10,000 x .04 = 400 $10,400

2 10,400 10,400 x .04 = 416 10,816

3 10,816 10,816 x .04 = 433 11,249

4 11,249 11,249 x .04 = 450 11,699

5 11,699 11,699 x .04 = 468 12,167

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

Bloomcode: Application

AACSB: Analytic

P3-43 Calculate bond price

Blast from the Past issued 10-year bonds with a coupon rate of 3% paid semi-annually and a face value of $500,000. The market interest rate is 5%.

Instructions:

1. Calculate the present value of the bonds using PV tables assuming payments are made at the end of the period (round answer to the nearest dollar).
2. Calculate the present value of the bonds using PV tables assuming payments are made at the beginning of the period (round answer to the nearest dollar).

Solution 3-43

1. Present value of the face value amount of $500,000 for 20 periods at 2.5% ($500,000 x .61027) = $305,135.

Present value of an ordinary annuity of $7,500 ($500,000 x 1.5%) for 20 periods at 2.5% ($7,500 x 15.58916) = $116,919.

Total Present Value = $305,135 + $116,919 = $422,054.

1. Present value of the face value amount of $500,000 for 20 periods at 2.5% ($500,000 x .61027) = $305,135.

Present value of an annuity due of $7,500 ($500,000 x 1.5%) for 20 periods at 2.5% ($7,500 x 15.97889) = $119,842.

Total Present Value = $305,135 + $119,842 = $424,977.

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Pr. 3-44 Future Value of lump sum and annuity

Your friend has just recently graduated from college and started her first career job. Her position pays her a salary and an annual bonus at the end of the year. She is interested in buying a house in five years from now. The estimated cost of the type of house she would like to buy in five years from now is $350,000. She would like to have a 20% down payment to avoid the CMHC insurance costs the bank requires for down payments of less than 20%. She wants to know how much she would need to save yearly from her bonus to save the 20% down payment. She currently has $5,000 in her savings account allocated to the down payment. The current rate of return she is yielding in her high interest savings account is 3%.

Instructions

a) Calculate the yearly amount your friend must put into her savings account to reach her goal of a 20% down payment in 5 years using PV tables and assuming payments are made at the end of the period (round answer to the nearest dollar).

b) Critical Thinking: Your friend is seriously contemplating using all her savings for a vacation, since she believes that she would only need to save an additional $1,000 per year to replace her $5,000. Explain to her why this is not correct. Support your answer with calculations. (Round to the nearest dollar)

Solution P3-44

a) The down payment required in 5 years is $70,000 ($350,000 x 20%).

The value of the $5,000 lump sum at the end of five years is $5,796 (($5,000 x (1.03)⁵.

The remaining future value of the down payment to be saved is $64,204 ($70,000 – $5,796). The amount of the savings your friend must put in her account annually over the next 5 years at 3.0% to reach $64,204 is = $12,093 ($64,204 / 5.30914).

b) The friend would actually need to save $1,092 more each year. By spending the $5,000 in her savings account now to travel, she is essentially losing out on 5 years of compounded interest.

The amount of the savings she must put in her account annually over the next 5 years at 3.0% to reach $70,000 is = $13,185 ($70,000 /5.30914 ). By spending her current savings, your friend would need to increase her annual savings by $1,092.

Difficulty: Hard

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

AACSB: Analytic

Legal Notice

Copyright © 2022 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.