Module in FM 2-Financial Analysis and Reporting

Module 1

ASSET AND LIABILITY VALUATION AND INCOME RECOGNITION

Financial statement analysis is

one important step in business
analysis. Business
analysis is the process of evaluating
a company’s economic prospects
and risks. This
includes analyzing a company’s
business environment, its strategies,
and its financial
position and performance.
Business analysis is useful in a
wide range of business
decisions such as investing in
equity or debt securities, extending
credit through short
or long term loans, valuing a
business in an initial public offering
(IPO), and evaluating
restructurings including mergers,
acquisitions, and divestitures.
Financial statement
analysis is the application of
analytical tools and techniques
to general-purpose
financial statements and related
data to derive estimates and
inferences useful in
business analysis. Financial
statement analysis reduces one’s
reliance on hunches,
guesses, and intuition for
business decisions. This
chapter describes business
analysis and the role of
financial statement analysis.
The chapter also introduces
financial statements and
explains how they reflect
underlying business activities.
Several tools and techniques of
financial statement analysis are
also introduced.
Application of these tools and
techniques is illustrated in a
preliminary business
What Is Assets and Liabilities In Simple Words?
Assets are items possessed by a businesses that will provide it’s benefits in the future. Liabilities usually means that
you are responsible for something, and it can also mean that you owe someone money or services.

What Is Valuation?
Valuation is the process of determining the present value of an asset. In a business context, it is often the hypothetical
price that a third party would pay for a given asset. Valuations can be done on assets or on liabilities.
Valuation is a technique that estimate the current worth of an asset or company. It is also the analytical process
of determining the current (or projected) worth of an asset or a company. It is a quantitative process of determining
the fair value of an asset, investment or firm.

Why Is Valuation Important?

Valuation is important because it provides prospective buyers with a idea of how much they should pay
for an asset or company and for prospective sellers, how much they should sell for.

What is the Importance of Valuation in Accounting?

Accounting Valuation is critical to the creation of accurate financial statement. Accounting valuation fixed assets
typically marked at its historical price, while marketable securities such as stocks and bonds are assessed at current
market prices.

What Is The Purpose Of Valuation?

The purpose of valuation is to determine the worth of an asset or company and compare that to the current
market price. This is done so for a variety of reasons, such as bringing on investors, selling the company,
purchasing the company, selling of assets or portions of the business, the exit of partner, or inheritance purposes.

What are the Components of Valuation

Methods of valuation of assets are as hereunder-

 COST PRICE- This is the cost price paid at the time of acquisition of assets plus the freight charges, octroi charges,
and commissioning and installation charges, etc. To bring that asset in usable condition.

 BOOK VALUE- This is the value as appearing in the books of accounts; the cost price less depreciation.

 REALIZABLE VALUE- A value which can be realized from the sale of assets.

 MARKET VALUE- A value on which an asset can be replaced.

 CONVENTIONAL VALUE- It means the cost price less depreciation written off ignoring any kind of fluctuation in
the price.

 SCRAP VALUE- If the assets is not in working condition and sold as scrap, then sale value of assets is scrap value.

What Is Asset Valuation?

Asset Valuation is the process of determining the current value of a company's assets, such as stocks, buildings,
equipment, brands, goodwill, etc. This process often happens as part of a wider business valuation, or before you
buy, sell or insure an asset.
What Is Valuation Of Liabilities?

 Liabilities are generally valued on the balance sheet at either:

 The amount of money needed to pay the debt or ,

 The FMV of goods and services that needed to be delivered

What Is Valuation Assets And Liabilities?

Valuation means estimation of various assets and liabilities. It is the duty of Auditor to confirm the that assets and
liabilities are appearing in the balance sheet exhibiting their proper and correct value. On the other hand, the absences
of proper valuation of assets and liabilities , they will exhibit either overvalued or undervalued.

Where Does Valuation of Assets And Liabilities Reflect?

 Historical Data -

 Current Information -

 Expectation of Future -

Table Of Assets And Liability Valuation Methods

I. Historical Method

a) Initial Present Value

 Monetary asset or liability

 Present Value computation uses a appropriate interest rates

Ex. Investments in bonds held to maturity (HLM), long term receivables and payables, non current
un earned revenue, current receivables and payable.

b) Acquisition Cost

 Includes all cost required to prepare the asset for its intended use

Ex. Sales tax, shipping , repair, and maintenance

 Excludes costs to operate the assets.

C. Adjusted Historical Cost - service potential is consumed gradually or immediately.

 The asset is reduced and expenses is increased.

Ex. Buildings, equipment and other depreciable asset , intangible with limited lives.

II. Combined Value Method- same as the current value

III. Current Value -

Fair Value-(FV)

 FASB - exit price ; IASB= Exit Price or Entry Price

 Obtaining the right price - different sources of fair Value estimates (3 - Tier Hierarchy) described in
Statement of Financial Accounting Standard (SFAS) No. 157 and International Financial
Reporting Standards (IFRS) No. 7.
Ex. of Fair Value

Investments in marketable equity and debts securities

Financial instruments and derivative instruments.

What is Income?
Income refers to the money that a person or entity receives in exchange for their labor or products. Its
definition encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of
an entity and is referred to by a variety of different names including sales, fees, interest, dividends,
royalties and rent. Gains represent increases in economic benefits and as such are no different in nature
from revenue. Hence, they are not regarded as constituting a separate element in this Framework.

What is Recognition?

Recognition is the process of incorporating in the balance sheet or income statement an item that meets
the definition of an element and satisfies the criteria for recognition set out in paragraph.The failure to
recognize such items is not rectified by disclosure of the accounting policies used nor by notes or
explanatory material.

What is Recognition of Income?

Income is recognized in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in
effect, that recognition of income occurs simultaneously with the recognition of increases in assets or
decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the
decrease in liabilities arising from the waiver of a debt payable).Such procedures are generally directed at
restricting the recognition as income to those items that can be measured reliably and have a sufficient
degree of certainty.

 Income Recognition is based on changes in economic value, not changes in cash. Therefore, before we
expand on the three approaches, a brief review of accrual accounting.
What are the three Approaches of Income Recognition that needed to enhance when you attempt to
create useful financial statements?

 APPROACHED 1

Recognized changes in economic value on the balance sheet and income statement when they are realized
in a market transaction (cash basis).

 APPROACHED 2

Recognized changes in economic value on the balance sheet and income statement when
they occur, even though they are not yet realized in the market transaction (accrual basis).
 APPROACHED 3

Recognized changes in economic value on the balance sheet and income statement when the value
changes occur overtime, but delay recognition in net income until the value are realized in the market
transaction.

What Is Accrual Accounting ?

 The recognition of revenues and expenses based on the underlying economic accomplishments and
sacrifices in a particular period rather than when cash in flows or out flows occur.

 General term that captures to distinct situation in which cash flows and economic do not align
accruals and deferrals.

When does accruals and deferrals occur?

 Accruals occur when economic activities precede cash flows.

 Deferrals occur when cash flows precede economic sacrifices.

What is Recognition of Assets?

An asset is recognized in the balance sheet when it is probable that the future economic benefits will flow
to the entity and the asset has a cost or value that can be measured reliably.

An asset is not recognized in the balance sheet when expenditure has been incurred for which it is
considered improbable that economic benefits will flow to the entity beyond the current accounting
period. Instead such a transaction results in the recognition of an expense in the income statement. This
treatment does not imply either that the intention of management in incurring expenditure was other than
to generate future economic benefits for the entity or that management was misguided. The only
implication is that the degree of certainty that economic benefits will flow to the entity beyond the current
accounting period is insufficient to warrant the recognition of an asset.
Recognition of liabilities

A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present obligation and the amount at which the
settlement will take place can be measured reliably. In practice, obligations under contracts that are equally
proportionately unperformed (for example, liabilities for inventory ordered but not yet received) are
generally not recognized as liabilities in the financial statements. However, such obligations may meet the
definition of liabilities and, provided the recognition criteria are met in the particular circumstances, may
qualify for recognition. In such circumstances, recognition of liabilities entails recognition of related assets
or expenses.

What are the reasons needed to understand how specific events and transactions affect the financial
statements:

 To be able to make appropriate interpretations about a firm's profitability and risk, you
must understand what the balance sheet and income statement tell you about various
transactions and events.

 Given the complexity of many transactions, effective financial statement analysis requires an ability
to deduce how they impact each of the financial statements, especially if your analysis leads you to
restate financial statements to exclude the effects of some event or to apply an alternative accounting
treatment.

The Mixed Attribute Measurement Model

Assets = Liabilities+ Shareholders’ Equity

 To simplify the complexity of valuation of assets and liabilities

in real companies.

 Proposes application of a standardized framework to analyze the impact of events and

transaction on financial statements.

 Recommended by U.S GAAP and IFRS.

 GAAP - Generally Accepted Accounting Principles is the accounting standard adopted by the U.S.
Securities and Exchange Commission and is the default accounting standard used by companies based
in the United States.

 IFRS - International Financial Reporting Standards, commonly called IFRS, are accounting
standards issued by the IFRS Foundation and the International Accounting Standards
Board.

What Is The Use Of Mixed Attribute Accounting Model?

 Provides an optimal mixed of relevant and reliable information in the financial statements.

 Allow users to translate the information much better:

 Assessment of the risk.

 Timing

 Amount of future cash flows (FCF).

REFERENCES
 https://economictimes.indiatimes.com/definition/liability

https://youtu.be/H_UGGDj7bDk

https://sg.docworkspace.com/l/sIOGu3oyoAeSUs58G

https://www.studocu.com/ph/document/batangas-state-university/finance/asset-and-liability-valuation/
37135220

PREPARED BY:
BSBA FM 1-D GROUP 1
Aballe, Jieza
Abella , Nathaniel Joji
Alegrado, Dianne Kyle
Almoete, Myls
Barbas, Annie Rose
Biera, Christine Joy
Calopez, Jenny
Casiple, Vivien Villaranda

THANK YOU!!!