Nanyang Technological University

Nanyang Business School

AC2101 – Accounting Recognition and Measurement

Semester 1, 2017-18

Outline for Seminar 2:

Accounting Measurement and Income Concepts

Learning objectives:

 Examine the use of fair value in accounting measurement: definition, measurement

framework and disclosure
 Review the time value of money concepts and present value computations
 Perform measurement under ideal conditions and review its accounting implications
 Examine the differences between economic income and accounting income

Required readings:
 FRS 113
 Picker et al., Chapter 3
 Linsmeier (2011), Financial Reporting and Financial Crises: The Case for Measuring
Financial Instruments at Fair Value in the Financial Statements, Accounting Horizons,
June, p. 409-417.*
 Solomons (1961), Economic and Accounting Concepts of Income, The Accounting
Review, July 1961, pp 374-383 (read only pp 374 to 379 and ignore the 2nd half of the
article from Variable Income onwards).*
 Scott, Chapter 2 (exclude Sections 2.3 and 2.4)

* Available on course site

Seminar questions:

Seminar Question 1

What are the key issues or concerns raised by the Linsmeier (2011) article?

Seminar Question 2

FRS 113 Fair Value Measurement was issued in May 2011 and applies for annual
periods beginning on or after 1 January 2013. Given that various specific standards
already allude to “fair value”, why is there a need to issue the standard?

1
Seminar Question 3

You just won a jackpot prize of $1 million at MBS.

Part I: Assume that the prize is not taxable and a 5% interest rate, which of the
following payouts (a) to (d) would you prefer?

(a) A lump sum payment of $1 million today (1 Jan 2016)

(b)A lump sum payment of $1 million at the end of 10 years (31 Dec 2025)
(c) An annual payment of $100,000 starting 31 Dec 2016 for the next 10 years (i.e.,
an ordinary annuity)
(d)An annual payment of $100,000 starting 1 Jan 2016 for the next 10 years (i.e., an
annuity due)

Part II: What is the annual interest rate for which you will be indifferent between
payment (a) and an annual payment of $100,000 starting 31 Dec 2016 for the next 12
years?

Seminar Question 4 (Team Activity)

Suppose a firm commenced operations and purchased a machine on January 1, 20x1

for $1,000. The machine has a 2-year useful life (salvage value zero) and will generate
cash flows for the firm as follows: $600 in 20x1 and $550 in 20x2.

Assume the following:

a. All cash flows from operations occur discretely at end of each year.
b. All cash flows from operations in one period are declared and paid out as dividends
on the first day of the following period (assuming that dividends can be paid out
of share capital as well).
c. Accounting depreciation is calculated on an accelerated basis ($550 in 20x1 and
$450 in 20x2) based on accounting rules.
d. Economic depreciation is calculated as the difference in the value of the machine,
i.e. value of machine at the start of the year less the value of the machine at the
end of the year.
e. Interest rate is constant at 10% per annum.

Required:

(a) Verify that the value of the machine on January 1, 20x1 is $1,000.
(b) Compute the economic depreciation of the machine for 20x1 and 20x2.
(c) Compute the economic income of the firm for 20x1 and 20x2.
(d) Prepare the economic income statement and statement of financial position of the
firm for 20x1 and 20x2.
(e) Compute the accounting income and prepare the accounting income statement and
statement of financial position for 20x1 and 20x2.
(f) What lessons or observations can you draw from parts (c) and (d)

2
 Seminar 2 Team Activity

Based on the information in Seminar Question 4 and below, compute the economic
and accounting income and prepare the respective income statements and statements
of financial position for 20x1 and 20x2.

(a) Verify the value of the machine as of 1 January 20x1

(b) AEconomic Depreciation = Value of ASSET at start of the year - Value of ASSET
at end of the year

20x1: Value of asset at start of the year = 1,000

Value of asset at end of the year = Discounted future cash flows arising from asset
= ______________________

Economic depreciation = ____________________ = ______

20x2: Value of asset at start of the year = Discounted future cash flows arising from asset
= ______________________

Value of asset at end of the year = Discounted future cash flows arising from asset
= _______________________

Economic depreciation = ____________________ = ______

(c) Computation of Economic Income

Approach #1 to calculate Economic Income:

20x1 Economic income = Revenue – Economic depreciation

= 600 - 500 = 100

20x2 Economic income = Revenue – Economic depreciation

__________ = _____

3
Approach #2 to calculate Economic Income:

Recall earlier Hick’s Definition of Economic income: PV of the FIRM at the end of the
year – PV of the FIRM at the start of the year

20x1: Present Value of the firm at start of the year, after last year’s dividend distribution
(if any)
= Cash (if any) + Value of Machine = $0 + $1,000 = $1,000

Present Value of the firm at end of the year, prior to current year’s dividend
distribution (if any)
= Cash (if any) + Value of Machine = $600 + $500 = $1,100

Economic Income = $1,100 - $1,000 = $100.

20x2: Present Value of the firm at start of the year, after last year’s dividend distribution
(if any)
= Cash (if any) + Value of Machine =________________________= ________

Present Value of the firm at end of the year, prior to current year’s dividend
distribution (if any)
= Cash (if any) + Value of Machine =_______________________ =_________

Economic Income = ____________________

Approach #3 to calculate Economic Income:

Economic Income can also be determined by computing the return on the value of the net
assets at the start of the year, after last year’s dividend distribution (if any).

20x1 Economic income = 10% * PV of the net assets at the start of the year
= 0.1 * 1,000 = 100

20x2 Economic income = 10% * PV of the net assets at the start of the year =
__________ = _____

(d) Preparation of Economic Income Statement and Statement of Financial Position

Economic Income Statement

For the year ended
31/12/x1 31/12/x2
Revenue
Economic depreciationA
Total net income

4
 Statement of Financial Position (based on Economic Income)
As at
31/12/x1 1/1/x2 31/12/x2
Cash
Machine
Less: Accumulated
depreciation
Total assets

Beginning equity b/f 1,000

Add: Earnings for the year
Less: Dividend distribution
Total equity

(e) Computation and Preparation of Accounting Income Statement and Statement of

Financial Position

Accounting Income Statement

For the year ended
31/12/x1 31/12/x2
Revenue
Accounting depreciation
Total net income

Statement of Financial Position (based on Accounting Income)

As at
31/12/x1 1/1/x2 31/12/x2
Cash
Machine
Less: Accumulated depreciation
Total assets

Beginning Equity b/f

Add: Earnings for the year
Less: Dividend distribution
Total equity