CH 07

Financial Accounting Theory and Analysis
Text and Cases
Fourteenth Edition
Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey
Chapter 7
Financial Statements II: The Balance Sheet and the

Statement of Cash Flows
Introduction
• Financial reports can be divided into two categories
1. Results of the flows of resources over time (flows)
2. The status of resources at a point in time (stocks)
• Chapter will describe…
o Income statement
o Statement of retained earnings
o Statement of cash flows
o Balance sheet
Copyright ©2023 John Wiley & Sons, Inc. 7-2

Past Emphasis
• Income statement
o Based on the assumption that flows were more important than stocks
• Frequently resulted in the measurement of stocks at residual values
• The FASB
o Asset - Liability approach
o Changes in balance sheet amounts becoming more important in income
determination

The Balance Sheet
• Should disclose wealth of a company at a point in time
• Wealth is present value of all
o Resources
o Less obligations
• This measurement technique is limited
• Consequently, a variety of measurement techniques are used to measure the
elements of the balance sheet
• Historical (Historical cost)
• Current oriented (Current value)
• Future oriented (Expected realizable value)
Balance Sheet Elements
• An asset is a present right of an entity to an economic benefit that has two
essential characteristics:
1. It is a present right
2. The right is to an economic benefit
• A liability is a present obligation of an entity to transfer an economic benefit
• A liability has two essential characteristics:
1. It is a present obligation
2. The obligation requires an entity to transfer or otherwise provide economic benefits to
others
• Equity is the residual interest in the assets of an entity that remains after
deducting its liabilities
Balance Sheet Elements Continued
• Definitions arise from the FASB’s asset - liability approach to income
determination
• Departure from previous definitions that resulted in valuations arrived at
via the residual effect of income determination
• The definitions of assets and liabilities presented by the Accounting
Principles Board (APB) in Statement No. 4:
o Assets are economic resources of an enterprise that are recognized and measured in
conformity with generally accepted accounting principles including certain deferred
charges that are not resources
o Liabilities are economic obligations of an enterprise that are recognized and
measured in conformity with generally accepted accounting principles
Classification of Balance Sheet Elements
Assets • Current assets
• Investments
• Property, plant, and equipment
• Intangible assets
• Other assets
Liabilities • Current liabilities
• Long-term liabilities
• Other liabilities
Equity • Capital stock
• Additional paid-in capital
• Retained earnings

Current Assets
• According to the Committee on Accounting Procedure, current assets are assets
that may reasonably be expected to be realized in cash, sold, or consumed
during the normal operating cycle of the business or one year, whichever is
longer
• The operating cycle is defined as the average time it takes to acquire materials,
produce the product, sell the product, and collect the proceeds from customers
• Current assets are presented on the balance sheet in the order of their liquidity
• Companies are required to classify temporary investments in all debt securities
with readily determinable fair values as trading, available for sale, and held to
maturity

Current Assets Continued
• Accounts receivable arise from the sale of products or services on credit
o Typically reported at amounts that “approximate” their expected present values
o This amount is reduced to the expected net realizable value
• Inventories and prepaid expenses present some additional valuation issues
• The inventory valuation process has become secondary to the matching of
expired inventory costs to sales (LIFO, FIFO, and so on)
• Prepaid items are valued at historical cost, and an appropriate amount is
charged to expense each year until they are consumed
• Two problems arise when we attempt to classify an asset as current
1. The period of time over which it is to be consumed
2. The proper valuation technique
Investments
• Investments are expected to be held for longer than a year
• Investments may be divided into three categories
1. Securities acquired for specific purposes
2. Assets not currently in use by the business organization
3. Special funds to be used for special purposes in the future
• When a company has a controlling interest in an investee company, GAAP
requires a consolidation of the financial statements of the two companies
into a single set of financial statements
• All long-term investments in equity securities are accounted for under the
cost method when they have no readily determinable fair values
Property, Plant, and Equipment and Intangibles
• Although property, plant, and equipment and intangibles are physically
dissimilar assets, the valuation procedures associated with them are similar
• Except for land, the original cost of these assets is allocated to the various
accounting periods benefiting from their use
• Various methods of depreciation and amortization are available

Other Assets
• Items such as fixed assets held for resale or long-term receivables may be
included under this category
• The valuation of these assets is generally their carrying value on the
balance sheet at the time they were originally reported in the other assets
category
• The amounts associated with these items are normally immaterial

Asset Measurement Basis
Asset Measurement Basis
Cash Current value
Accounts receivable Expected future value
Marketable securities Fair value or amortized cost
Inventory Current or past value
Investments Fair value, amortized cost, or the result of applying
the equity method
Property, plant, and equipment Past value adjusted for depreciation
Intangibles Past value adjusted for amortization

Current Liabilities
• Current liabilities have been defined as “obligations whose liquidation is
reasonably expected to require the use of existing resources properly
classified as current assets or the creation of other current liabilities”
o Operating cycle is implied because the definition of current liabilities depends on the
definition of current assets
• Current liabilities are usually measured and reported at liquidation value
because their period of existence is relatively short
• Under APB Opinion No. 10 (see FASB ASC 210-20-05-1), “It is a general
principle of accounting that offsetting of assets and liabilities in the balance
sheet are improper except where a right of offset exists”

Long-Term and Other Liabilities
• Long-term liabilities are obligations that will not require the use of current
assets within the current year or operating cycle
o These obligations include bonds, notes, mortgages, and capital lease obligations
• GAAP requires that premiums or discounts on long-term obligations should
be written off over the life of the obligation
• The long-term liability section may also include long-term prepayments on
contracts, deferred income taxes, and, in some cases, contingent liabilities
o Each of which has an associated measurement problem

Liability Valuation
• Most current liability measurements ignore the time value of money
• Their typical balance sheet measurement is equal to the amount of
resources that it will ultimately take to satisfy the obligation
• The initial measurement of most long-term liabilities is equivalent to the
present value of future payments discounted at the yield rate existing on
the date of

Equity
• State laws and corporate articles of incorporation make generalizations
about the equity section of the balance sheet somewhat difficult
• Certain practices have become widespread enough to discuss several
generally accepted standards of reporting

Equity Continued
• Common stock
o Common stock is measured at historical cost
o Any differences between selling price and par value are then reported under the
caption “additional paid-in capital”
o Companies may also issue more than one class of common stock
• Preferred stock
o These shares generally have preference as to dividends
o The measurement basis of preferred stock is similar to that of common stock
• Treasure stock
o When companies reacquire stock, these shares are termed treasury stock
o They are typically reported at the historical cost paid to reacquire them
Retained Earnings and Other Comprehensive Income
• Ownership interest in a corporation may be defined as the residual interest in the
company’s assets after the liabilities have been deducted
• Reported in stockholders’ equity as retained earnings and accumulated other
comprehensive income
• Most states require that dividends not exceed the balance in retained earnings
• A retained earnings appropriation is measured as the amount of retained earnings
set aside for the stated purpose
• Companies are also required to disclose the components of other comprehensive
income
• The measurement of equity can be said to be based primarily on the
measurement of specific assets and liabilities
Fair Value Measurements
• In September 2007, the FASB issued SFAS No. 157, “Fair Value
Measurements” (see FASB ASC 820)
• The most important aspects of SFAS No. 157 are as follows
1. New definition for fair value
2. Fair value hierarchy for sources of information
3. New disclosures of assets and liabilities
4. Modification of presumption of transaction price
• SFAS No. 157 is to be applied to any asset or liability that is measured at fair
value under current GAAP

Definition of Fair Value
• SFAS No. 157 defined fair value as “the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date”
• This definition is based on exit price
• An entry price for an asset is the price at which it would be bought
• Additionally, SFAS No. 157 specified that fair value is market-based rather
than entity-specific

Hierarchy of the Quality and Reliability of Information Used to
Determine Fair Values
Level 1: Quoted market prices for identical assets Company A common stock traded quoted on the New York Stock
or liabilities in active markets Exchange
Level 2: Observable market-based inputs, other Company B common stock traded quoted only on an inactive market in
than Level1 quoted prices (or unobservable an emerging country
inputs corroborated by market data)
A privately placed bond of Z whose value is derived from a similar Z
bond that is publicly traded
An over-the-counter interest rate swap, valued based on a model
whose inputs are observable, such as LIBOR (London Interbank Offered
Rate) forward interest rate curves
Level 3: Unobservable inputs (not corroborated A long-dated commodity swap whose forward price curve, used in a
by observable market data) valuation model, is not directly observable or correlated with
observable market data
Shares of a privately held company whose value is based on projected
cash flows

Modification of the Transaction Price Presumption
• SFAS No 157 did away with presumption
• Entities should consider whether certain factors might indicate that transaction
price does not represent fair value
• SFAS No. 157 cites four examples that might indicate that the transaction price
does not represent fair value:
1. The transaction is between related parties
2. The transaction occurs under duress or the seller is forced to accept the price in the
transaction because of urgency
3. The unit of account represented by the transaction is different from the unit of account
for the asset or liability measured at fair value
4. The market in which the transaction occurs is different from the principal market in which
the reporting entity would sell or otherwise dispose of the asset or transfer the liability
Disclosures
• The disclosure requirements are designed to indicate the relative reliability of fair
value measurements
• SFAS No. 157 required separate disclosures of items that are measured at fair
value on a recurring basis
• Major disclosure requirements:
1. For items that are measured on a nonrecurring basis at fair value, a separate table is
required for assets and for liabilities
2. For items measured on a recurring basis at fair value, tables similar to those for
nonrecurring items are required
• SFAS No. 157 requires disclosures about the fair value measurements in a tabular
format for each major category of assets and liabilities measured at fair value on a
nonrecurring basis
Accounting Standards Update 2018–13
• In December 2015, the FASB announced proposed changes to the fair value
measurement disclosure requirements that attempt to improve their
effectiveness
• Later in August 2018, the Board issued FASB ASC 2018-13, “Fair Value
Measurement (Topic 820) Disclosure Framework – Changes to the
Disclosure Requirements for Fair Value Measurement”
• This ASU removes, modifies, and adds certain disclosure requirements in
FASB ASC 820 based the concepts contained in the FASB Concepts
Statement Conceptual Framework for Financial Reporting, “Chapter 8:
Notes to Financial Statements”

Removals
• The amount of and reasons for transfers between Level 1 and Level 2 of the
fair value hierarchy
• The policy for timing of transfers between levels
• The valuation processes for Level 3 fair value measurements
• For nonpublic entities, the changes in unrealized gains and losses for the
period included in earnings for recurring Level 3 fair value measurements
held at the end of the reporting period

Modifications
• In lieu of a roll forward for Level 3 fair value measurements, a nonpublic
entity is required to disclose transfers into and out of Level 3 of the fair
value hierarchy and purchases and issues of Level 3 assets and liabilities
• For investments in certain entities that calculate net asset value, an entity is
required to disclose the timing of liquidation of an investee’s assets and the
date when restrictions from redemption might lapse only if the investee
has communicated the timing to the entity or announced the timing
publicly
• The amendments clarify that the measurement uncertainty disclosure is to
communicate information about the uncertainty in measurement as of the
reporting date
Additions
• The changes in unrealized gains and losses for the period included in other
comprehensive income for recurring Level 3 fair value measurements held
at the end of the reporting period
• The range and weighted average of significant unobservable inputs used to
develop Level 3 fair value measurements

FASB Staff Position FAS No. 157-4
• Some critics of SFAS No.157 maintained that it caused or exacerbated the
2007–2008 market crises by forcing a downward spiral of valuations based
on distressed institutions
o Concerned also that as a result of SFAS No. 157 and SFAS No. 115, financial
institutions were forced to book losses on securities that may have value after the
credit market crisis has passed
• However, proponents of the standard maintained that suspending or
revising SFAS No. 157 would be a disservice

FASB Staff Position FAS No. 157-4 Continued
• As a result of these differing viewpoints, financial institutions, accounting
groups and others requested guidance from the SEC and the FASB on how
to determine fair value measurements in the then-current economic
climate
• On December 30, 2008, the SEC issued a study on fair value accounting
• This study recommended that existing fair value accounting and mark-to-
market standards, including SFAS No. 157, should not be suspended
• Later, after some contentious hearings in Congress, where the FASB’s
standard-setting authority was threatened by some of its members, the
FASB amended SFAS No. 157 by issuing FASB Staff Position (FSP)
• FSP FAS 157-4 provided guidance on how to determine when the volume
and level of activity for an asset or liability has significantly decreased and
identified the circumstances in which a transaction is not orderly
• Subsequently, after considering the significance and relevance of each of
the factors, judgment should be used to determine whether the market is
active and if a significant adjustment to the transactions or quoted prices
may be necessary to estimate fair value

• Both proponents and opponents of amendment expected it to have a
major impact
• Expectation was
1. A resulting revaluation upward of troubled assets, especially mortgage-based
securities, by lowering their fair value hierarchy measurements from level 2 to level
3; and
2. Bank profits increase by as much as 20 percent
• However, as noted in Chapter 1, a subsequent study of the impact of the
adoption of FSP FAS 157-4 on seventy-three of the largest U.S. banks found
that a large majority of the banks reported no material impact from the
adoption of the new requirements
Accounting Standards Update 2011-04
• May 2011: FASB issued Accounting Standards Update 2011‐04, Fair Value Measurement
(Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRS
• Intent: to provide greater transparency particularly for Level 3 measurements
• Specifically,
o Provide quantitative information about significant unobservable inputs used in fair value
measurements
o Description of the valuation processes used by an entity for Level 3 measurements
o Provide a narrative description of the sensitivity of the Level 3 fair value measurements to changes, if
a change in those inputs to a different amount might result in a significantly higher or lower fair value
measurement
o Disclosure of the amounts of any transfers between Level 1 and Level 2 of the fair value hierarchy,
the reasons for those transfers, and the reporting entity’s policy for determining when transfers
between levels are deemed to have occurred
Evaluating a Company’s Financial Position
• The return-on-assets (ROA) ratio measures the percentage return on the
asset employed by a company

Suggested Improvements to ROA
1. Determining sustainable income by removing the after-tax effects of
nonrecurring (transitory) items from net profit
2. Eliminating interest expense after tax to improve interfirm comparability
by removing the impact of capital structure on the ratio
3. Making adjustments that incorporate the effects of off–balance sheet
financing

Evaluating a Company’s Financial Position Continued
• ROA can be broken into two components: the profit-margin ratio (PMR) and
the asset-turnover ratio (ATR)

Beta
• The risk of investing in a company’s stock may be measured by calculating
its beta (β)
o A stock with a β of 1.0 is considered to offer an average amount of risk
• During fiscal 2020, Hershey’s β was approximately 0.20 and Tootsie Roll’s
was approximately 0.3
o During that year, the industry average was approximately 0.50
• An investment in the average company in the Candy and Other
Confectionary Products industry is viewed as less risky than an average
investment

Evolution of the Statement of Cash Flows
• Prior to 1971
o Only two required financial statements
• Firms were preparing funds statements
• No guidelines - Methods of preparing statement:
1. Cash
2. Working capital
3. All financial resources
• APB No. 3 - recommended
• APB No. 19 - mandatory - all financial resources

Accounting Principles Board Opinions No. 3 and No. 19
1. The statement may be prepared in such a manner as to express the financial
position in terms of cash, cash and temporary assets, quick assets, or working
capital so long as it utilizes the all-financial-resources concept and gives the
most useful portrayal of the financing and investing activities of the entity
2. In each case the statement should disclose the net change in the cash, cash
and temporary investments, quick assets or working capital, depending on
the form of presentation
3. The statement should disclose outlays for long-term assets, net proceeds
from the sale of long-term assets, conversion of long-term debt or preferred
stock to common stocks, issuances and repayments of debts, issuances or
repurchases of capital stock and dividends
Questions to Answer Based on Financial Statements
1. Where did the profits go?
2. Why weren’t dividends larger?
3. How was it possible to distribute dividends in the presence of a loss?
4. Why are current assets down when there was a profit?
5. Why is extra financing required?
6. How was the expansion financed?
7. Where did the funds from the sale of securities go?
8. How was the debt retired?
9. How was the increase in working capital financed?
Cash Flow Information
• Should enable financial statement users to
o Predict the amount of cash that is likely to be distributed as dividends or interest
o Evaluate risk
• Presentation of cash flow information assists in evaluating
o Liquidity
• Nearness to cash
o Solvency
• Going concern
o Financial flexibility
• React to crisis

SFAS No. 95
• Discussion Memorandum
o “Reporting Funds Flows, Liquidity, and Financial Flexibility”
o Preceded the issuance of SFAS No. 95
• Questions raised in this DM included:
1. Which concept of funds should be adopted?
2. How should transactions not having a direct impact on funds be reported?
3. Which of the various approaches should be used for presenting funds flow information?
4. How should information about funds flow from operations be presented?
5. Should funds flow information be separated into outflows for
• Maintenance
• Expansion of operating capacity, and
• Non-operating purposes
SFAS No. 95 Continued
• Exposure Draft
o “Reporting Income, Cash Flows and Financial Position of Business Enterprises”
• SFAC No. 5
o “Recognition and Measurement in Financial Statements of Business Enterprises”
o Issued in 1987

Purposes of the Statement of Cash Flows
• Provide relevant information about cash receipts and cash payments of an
enterprise
• SFAC No. 5 indicated that a full set of financial statements should show cash
flows for the period
• Objectives of accounting originally discussed in SFAC No’s. 1 and 5 led to
conclusion
o Statement of cash flows should replace the previously required statement of changes
in financial position

Statement Format
• Report changes during an accounting period in cash and cash equivalents
for
o Net cash flows from operations
o Investing transactions
o Financing transactions
• Cash equivalents are defined as highly liquid investments that are both
readily convertible to known amounts of cash and so near to maturity that
they present insignificant risk

Cash Flows From Operating Activities
• Cash effect from transactions that enter into the determination of net
income
o Exclusive of financing and investing activities
• Direct vs. Indirect method
o Reporting gross cash receipts and payments is termed the direct method
o Reporting the same amount of operating cash flow by adjusting net income to
reconcile it with operating cash flow is called the indirect method
• SFAS No. 95
o Encouraged companies to report operating activities in major classes

Direct Method Classes of Operating Cash Receipts and Payments
1. Cash collected from customers

2. Interest and dividends received
3. Other operating cash receipts
4. Cash paid to employees and other suppliers of goods and services
5. Interest paid
6. Income taxes paid
7. Other operating cash payments

Cash Inflow from Investing Activities
1. Receipts from the collection or sales of loans made to other entities
2. Receipts from the collection or sale of other companies’ debt instruments
3. Receipts from the sales of other companies’ equity instruments
4. Receipts from the sales of property, plant, and equipment and other
productive assets

Cash Outflow from Investing Activities
1. Disbursement for loans made by the enterprise to other entities
2. Payments to acquire other companies’ debt instruments
3. Payments to acquire other companies’ equity instruments
4. Payments to acquire property, plant, and equipment and other productive
assets

Cash Flows from Financing Activities
• Obtaining resources from owners
• Providing owners with a return of and a return on their investment
• Borrowing money and repaying the amount borrowed
• Obtaining and paying for other resources from long-term creditors

Subsequent Guidance
• Topic 230 was criticized as lacking consistent principles for evaluating the
classification of cash payments and receipts in the statement of cash flows
for certain items
• This led to diversity in practice and, in certain circumstances, financial
statement restatements

FASB ASU 2016-15
1. Debt prepayment or debt extinguishment costs
2. Settlement of zero-coupon bonds
3. Contingent consideration payments made after a business combination
4. Proceeds from the settlement of insurance claims
5. Proceeds from the settlement of corporate-owned life insurance (COLI)
policies and bank-owned life insurance (BOLI) policies
6. Distributions received from equity method investees
7. Beneficial interests in securitization transactions
8. Separately identifiable cash flows and application of the predominance
principle
FASB ASU 2016-18
• Include in the cash and cash-equivalent balances in the statement of cash flows those
amounts that are deemed to be restricted cash and restricted cash equivalents
• When the statement of financial position includes more than one-line item for cash,
cash equivalents, restricted cash, and restricted cash equivalents, disclose a
reconciliation between the statement of financial position and the statement of cash
flows
• Changes in restricted cash and restricted cash equivalents that result from transfers
between cash, cash equivalents, and restricted cash and restricted cash equivalents
should not be presented as cash-flow activities in the statement of cash flows
• An entity with a material balance of amounts generally described as restricted cash
and restricted cash equivalents must disclose information about the nature of those
restrictions
Financial Analysis of Cash-Flow Information
• A major objective of accounting
o To provide data allowing the presentation of cash flows to investors and creditors
o To allow evaluation of risk
• Net income is not directly associated with cash
• Investors expect return equal to market rate of interest for investments
with equal risk
• Past cash flows are the best indicators of future cash flows
• Empirical research indicates cash flow information
• Has an incremental value over earnings and is superior to disclosure of
changes in working capital
Financial Analysis of Cash-Flow Information Continued
• Free cash flow is the amount of annual financing needed to sustain annual
activities
• This metric is useful in gauging a company’s cash flow beyond that necessary
to grow at the current rate
• Unfortunately, the amount of capital expenditures necessary to maintain
current growth cannot be determined from a review of a company’s financial
statements
• Revised formula is:
• The resulting amount is a measure of a company’s financial flexibility

International Accounting Standards
1. Discussed the Statement of Financial Position and the various measurement
bases used in financial statements and has defined assets, liabilities, and equity
in its “Framework for the Preparation and Presentation of Financial Statements”
2. Discussed the information to be disclosed on the balance sheet and statement
of cash flows in its revised IAS No. 1, “Presentation of Financial Statements”
3. Clarified the presentation of liabilities in “Classification of Liabilities as Current
or Non-current
4. Discussed the presentation of the statement of cash flows in IAS No. 7,
“Statement of Cash Flows” and issued an amendment to IAS No. 7
5. Discussed the presentation of fair value measurements in IFRS No. 13, “Fair
Value Measurement”
Framework for the Preparation and Presentation of Financial
Statements
• Economic decisions made by users require an evaluation of the ability of an
enterprise to generate cash
• Financial position of an enterprise is affected by its
o Financial structure
o Liquidity and solvency
o Capacity to adapt to change (financial flexibility)
• Measurement bases include
o Historical cost (most common)
o Current cost
o Realizable value
o Present value
• Definitions of assets, liabilities and equity are similar to U. S. GAAP
IAS No. 1
• Recommends disclosures similar
to U. S. GAAP
• Revised IAS No. 1
o Requires assets to be classified as current and noncurrent
o Unless a liquidity presentation provides more relevant and reliable information
o Recognizes that there are differences in the nature and function of assets, liabilities
and equity
• Fundamental so they should be presented on the face of the balance sheet
• Specifies specific categories of items to be disclosed

Categories to be Disclosed
• Property, plant, and equipment • Trade and other payables
• Investment property • Financial liabilities provisions
• Intangible assets • Liabilities and assets for current tax
• Financial assets • Deferred tax liabilities and assets
• Equity method investments • Equity capital and reserves
• Biological assets • Minority interest
• Receivables inventories • Issued capital and reserves
• Cash and cash equivalents attributable to equity holders of the
parent
Classification of Liabilities as Current or Non-current,
Amendments to IAS 1
1. The classification of liabilities as current or non-current should be based
on rights that are in existence at the end of the reporting period and they
align the wording in all affected paragraphs to refer to the "right" to defer
settlement by at least twelve months and make explicit that only rights in
place "at the end of the reporting period" should affect the classification
of a liability
2. The classification is unaffected by expectations about whether an entity
will exercise its right to defer settlement of a liability
3. Settlement refers to the transfer to the counterparty of cash, equity
instruments, other assets or services

IAS No. 7
• Operating, financing and investing activities are to be disclosed
• Indirect or direct method of disclosing operating activities may be used
o Stated a preference for the direct method
• Cash flows from extraordinary items required to be disclosed separately as
operating, investing or financing
• Acquisition or disposal of subsidiaries
• Adoption of new financial statement presentation standard will significantly
change presentation of statement of cash flows

To Be Disclosed
i. Changes from financing cash flows
ii. Changes arising from obtaining or losing control of subsidiaries or other
businesses
iii. The effect of changes in foreign exchange rates
iv. Changes in fair values
v. Other changes

IFRS No. 13
• Applies to IFRSs that require or permit fair value measurements or
disclosures
• IFRS No. 13 achieves convergence with U. S. GAAP. Specifically, it:
o Defines fair value
o Provides framework for measuring fair value
o Requires disclosures about fair value measurements
• Objective is to estimate the price at which an orderly transaction to sell the
asset or to transfer the liability would take place between market
participant at the measurement date under current market conditions

IFRS No. 13: Fair Value Hierarchy
• Also established a fair value hierarchy
• Level 1 inputs
o Quoted prices in active markets for identical assets or liabilities
• Level 2 inputs
o Inputs other than quoted market prices that are observable for the assets or liability
• Level 3 inputs
o Unobservable inputs for the asset or liability

IFRS No. 13: Fair Value Hierarchy Continued
• Requires an entity to disclose information that helps users of its financial statements
assess both of the following:
o For assets and liabilities that are measured at fair value on a recurring or nonrecurring basis in the
statement of financial position after initial recognition, the valuation techniques and inputs used to
develop those measurements
o For fair value measurements using significant unobservable inputs (Level 3), the effect of the
measurements on profit or loss or other comprehensive income for the period
• To meet the disclosure objective, the following minimum disclosures are required for
each class of assets and liabilities measured at fair value in the statement of financial
position after initial recognition:
o The fair value measurement at the end of the reporting period
o For nonrecurring fair value measurements, the reasons for the measurement
o The level of the fair value hierarchy within which the fair value measurements are categorized in
their entirety (Level 1, 2, or 3)
Three Widely Used Valuation Techniques
1. Market approach: Uses prices and other relevant information generated
by market transactions involving identical or comparable (similar) assets,
liabilities, or a group of assets and liabilities (e.g., a business)
2. Cost approach: Reflects the amount that would be required currently to
replace the service capacity of an asset (current replacement cost)
3. Income approach: Converts future amounts (cash flows or income and
expenses) to a single current (discounted) amount, reflecting current
market expectations about those future amounts

Minimum Disclosures
• The fair value measurement at the end of the reporting period
• For nonrecurring fair value measurements, the reasons for the measurement
• The level of the fair value hierarchy within which the fair value measurements
are categorized in their entirety (Level 1, 2, or 3)
• For assets and liabilities held at the reporting date that are measured at fair
value on a recurring basis, the amounts of any transfers between Level 1 and
Level 2 of the fair value hierarchy
• For fair value measurements categorized within Level 2 and Level 3 of the fair
value hierarchy, a description of the valuation technique(s) and the inputs
used in the fair value measurement

Minimum Disclosures Continued
• For recurring fair value measurements categorized within Level 3 of the fair
value hierarchy, a reconciliation from the opening balances to the closing
balances
• Total gains or losses for the period recognized in profit or loss
• Total gains or losses for the period recognized in other comprehensive
income
• Purchases, sales, issues, and settlements
• The amounts of any transfers into or out of Level 3 of the fair value
hierarchy

Minimum Disclosures Continued
• For fair value measurements categorized within Level 3 of the fair value
hierarchy, a description of the valuation processes used by the entity
• For recurring fair value measurements categorized within Level 3 of the fair
value hierarchy: a narrative description and impact of changes
• If the highest and best use of a nonfinancial asset differs from its current
use, an entity shall disclose that fact and why the nonfinancial asset is
being used in a manner that differs from its highest and best use

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Financial Accounting Theory and Analysis

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Financial Statements II: The Balance Sheet and the

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1. Cash collected from customers

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• The resulting amount is a measure of a company’s financial flexibility

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