Auditing & Assurance Services (Auditing and Assurance Services)
Auditing & Assurance Services (Auditing and Assurance Services)
7th Edition
ISBN: 9781259573286
Author: Timothy J Louwers, Allen Blay, David Sinason Associate Professor, Jerry R Strawser, Jay C. Thibodeau Associate Professor
Publisher: McGraw-Hill Education
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Chapter C11, Problem 1DQ
To determine

Describe the discounted cash flow approach and analyze the underlying assumptions made by the companies while ascertaining the Level 3 fair value estimates using this approach.

Expert Solution & Answer
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Explanation of Solution

Discounted cash flow approach: The discounted cash flow approach compares the initial cash outflow with the present value of the cash inflow.

Level 3 assets: The Level 3 asset refers to the fair-value asset possessing one or more unobservable measures of value.

The evaluation of the value of Level 3 asset:

  • To Level 3 assets are generally evaluated through discounted cash flow method.
  • The company at times projects the future cash flow as well as their discounted rates, to estimate the value of the assets.

The assumptions underlying this approach are:

  • The future cash flow is not known.
  • Presence of the risk of default.
  • Application of the discount rate is difficult to estimate.
  • Prominence of future cash flows and default rate is a significant estimate.
  • Difficulty in understanding risk component.

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