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Chapter 24: Question 17Q (page 1452)

What is the fair value option? Explain how use of the fair value option reflects application of the fair value principle.

Short Answer

Expert verified

The fair value option is the option provided to the firms to use the fair value method while measuring financial assets and liabilities. The Financial Accounting Standards Board (FASB) believes that the fair value option used for measuring financial assets and liabilities provides appropriate and understandable information compared to the historical cost.

Step by step solution

01

Meaning of Fair Value

The fair value indicates the existing price of an asset which is acceptable by both the purchaser and the seller. With the use of the fair value method, valuations are more accurate, provide a true measurement of income, can adapt to various types of assets, and helps in the survival of the business.

02

Ways to show that the fair value option indicates the application of the fair value principle.

According to the Financial Accounting Standards Board, the fair value measurement for financial assets and liabilities provides information that is suitable and understandable as compared to historical cost.

Fair value is considered to be highly relevant as it shows the current value of cash equivalent of financial instruments.

Hence, firms now can use the option of recording fair value in their respective accounts for most financial tools comprising items like receivables, investments, and debt securities.

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Most popular questions from this chapter

What are diversified companies? What accounting problems are related to diversified companies?

Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below.

Edna Millay

2017 Industry

2015

2016

2017

Averages

Current ratio

2.09

2.27

2.51

2.24

Quick ratio

1.15

1.12

1.19

1.22

Inventory turnover

2.40

2.18

2.02

3.50

Net sales to stockholders鈥� equity

2.71

2.80

2.99

2.85

Return on common stockholders鈥� equity

0.14

0.15

0.17

0.11

Total liabilities to stockholders鈥� equity

1.41

1.37

1.44

0.95

Millay is being reviewed by several entities whose interests vary, and the company鈥檚 financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millay鈥檚 financial position.

Archibald MacLeish Bank. The bank is processing Millay鈥檚 application for a new 5-year term note. Archibald MacLeish has been Millay鈥檚 banker for several years but must reevaluate the company鈥檚 financial position for each major transaction.

Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warren鈥檚 clients.

Working Capital Management Committee. This is a committee of Millay鈥檚 management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company鈥檚 working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

Instructions

b) For each of the four entities, identify two financial ratios, from the ratios presented above that would be most valuable as a basis for its decision regarding Millay.

What is the difference between a CPA鈥檚 unqualified opinion or 鈥渃lean鈥� opinion and a qualified one?

鈥淭he significance of financial statement data is not in the amount alone.鈥� Discuss the meaning of this statement.

The following statement is an excerpt from the FASB pronouncement related to interim reporting. Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise. The usefulness of such information rests on the relationship that it has to the annual results of operations. Accordingly, the Board has concluded that each interim period should be viewed primarily as an integral part of an annual period. In general, the results for each interim period should be based on the accounting principles and practices used by an enterprise in the preparation of its latest annual financial statements unless a change in an accounting practice or policy has been adopted in the current year. The Board has concluded, however, that certain accounting principles and practices followed for annual reporting purposes may require modification at interim reporting dates so that the reported results for the interim period may better relate to the results of operations for the annual period.

Instructions

The following six independent cases present how accounting facts might be reported on an individual company鈥檚 interim financial reports. For each of these cases, state whether the method proposed to be used for interim reporting would be acceptable under generally accepted accounting principles applicable to interim financial data. Support each answer with a brief explanation.

d) Gansner Company realized a large gain on the sale of investments at the beginning of the second quarter. The company wants to report one-third of the gain in each of the remaining quarters.
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