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Alternative Measurement Models

Alternative Measurement Models. Present Value Net Cash Flow Original Transactions Value General Price Level Replacement Cost Market Value. TEN WAYS TO “COOK” THE BOOKS. 1 . Prematurely recognize income 2. Treat operating leases as sales

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Alternative Measurement Models

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  1. Alternative Measurement Models Present Value Net Cash Flow Original Transactions Value General Price Level Replacement Cost Market Value

  2. TEN WAYS TO “COOK” THE BOOKS 1. Prematurely recognize income 2. Treat operating leases as sales 3. Inflate inventory by improper application of LIFO inventory costing 4. Include fictitious amounts in inventory 5. Failure to recognize losses through write-offs and allowances

  3. TEN WAYS TO “COOK” THE BOOKS 6. Capitalize versus expense certain costs 7. Include non-recurring gains in operating income 8. Overvalue marketable securities 9. Create sham year-end transactions to boost reported earnings 10. Change accounting practices without disclosing the changes

  4. Information for Decisions I Scarce Unlimited Economic (allocation) decisions Resources Wants Accounting information

  5. Steps in the Decision Process Identify the Problem Identify Alternative Evaluate Alternatives Choice Take Action Felt Need

  6. AUTO REPLACEMENT PROBLEM You need a new set of wheels. Cost to operate present vehicle = $.25 per milr. (includes cost of oil, gas, depreciation, etc.) Est. annual roundtrip mileage = 24,000 miles. No bus routes to intended destination. Weather rules out purchase of motorcycle. You have a limited budget. Facts: Alt. 1 Alt. 2 Chevy (6 cyl.) Fiat (4 cyl.) Cost of pre-owned car $4,500 $6,900 Estimated useful life 3 yrs. 3 yrs. Est. operating expense: $.08/mile Year 1 $.10/mile Year 2 .11/mile .07/mile .12/mile Year 3 .06/mile Decision problem: Which auto should you buy? Computations: Chevy Fiat $sacrifices: $benefits:

  7. Identifying the problem: a. Specify an objective function= a statement that identifies those attributes of the alternatives that are directly related to your felt need. b. Identify decision constraints = factors which limit your ability to consider certain alternatives. c. Formulate a decision rule = a statement that helps us to choose among alternatives. What we are doing is setting up a model of investment choice that identifies what information is decision-relevant.

  8. Identifying Alternatives Predicting expected consequences associated with each alternative course of action

  9. ChevyFiat $costs 4,500 6,900 $savings (.25 - .10) 24,000 = 3,600 (.25 - .08) 24,000 = 4,080 (.25 - .11) 24,000 = 3,360 (.25 - .07) 24,000 = 4,320 (.25 - .12) 24,000 = 3,12010,080 (.25 - .06) 24,000 = 4,56012,960 Total net benefits 5,580 6,060

  10. Chevy Fiat Total net benefits 5,580/3 6,060/3 = $1,860/year = $2,020/year

  11. Information = any item of intelligence that improves our ability to predict future events

  12. Effective decision making involves achieving a proper balance between: a. expected outcome of a decision b. cost of making the decision

  13. Role of Accounting in Society 1. provide information useful for decision-making 2. provide information at a reasonable cost

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