Explain the main key points regarding asset and liability measurement made in SFAC No. 7.

Question

What will be an ideal response?

Answer 1

ANSWER:

The most important point about asset measurement is that present value measurements are intended to simulate fair value rather than the particular present value of the asset to the firm itself. If a firm does not know the specific market value of a particular asset, it should strive for that discount rate which would lead as closely as possible to estimated fair value. Discount rates should also include risk and uncertainty which would reflect the assessment of the market toward the asset’s value. If a particular asset has several possible cash flows within specific years, the expected cash flows should be determined (the individual cash flows should be multiplied by their expected probabilities) rather than using the single most likely cash flow.

The key point about liability measurement is that the discount rate must be tied to the credit standing of the firm. This means that if the firm’s credit standing worsens, the valuation of the liability decreases (because a poorer credit standing means that the applicable interest (discount) rate would rise). Hence any firm acquiring the liability from the original creditor would pay less to acquire the liability due to the debtor’s worsening credit standing.