The FASB Explores Accounting for Future Cash Flows

Healthcare Financial Management, March, 2001 by Randall W. Luecke, David T. Meeting

The FASB's Statement of Financial Accounting Concepts No. 7, Using Cash Flow Information and Present Value in Accounting Measurements (Statement No. 7), presents the board's views regarding how cash-flow information and present values should be used in accounting for future cash flows when information on fair values is not available. Statement No. 7 presents new concepts regarding how an asset's present value should be calculated and when the interest method of allocation should be used.

The FASB proposes a present-value method that takes into account the degree of uncertainty associated with future cash flows among different assets and liabilities. The FASB also suggests that rather than use estimated cash flows (in which a single set of cash flows and a single interest rate is used to reflect the risk associated with an asset or liability), accountants should use expected cash flows (in which all expectations about possible cash flows are used) in calculating present values.

In February 2000, after considerable delay and debate, the FASB issued Statement of Financial Accounting Concepts No. 7, Using Cash Flow Information and Present Value in Accounting Measurements (Statement No. 7), outlining its views regarding how financial managers should use cash-flow information and present-value calculations in accounting for future cash flows. The FASB began its deliberation on this topic in October 1998, and issued two exposure drafts before publishing the final Statement No. 7.

Healthcare financial managers use cash-flow information and present-value calculations whenever cash is to be received or paid by the healthcare entity The practice is applicable to a broad variety of transactions, including payments under a long-term debt arrangement, receipts from a long-term note (eg, note receivable, three-year note, or interest-bearing note) payments in conjunction with a capital or operating lease, accumulated and projected payments under a defined-benefit pension plan, accumulated and expected postretirement benefit obligations, as well as pledges receivable. As a consequence, healthcare financial managers should be aware of the contents of Statement No. 7, and the direction in which the FASB is heading regarding this important financial issue.

Purpose and Scope of Statement No. 7

To understand the FASB's intent in issuing Statement No. 7, one must be aware of where FASB Statements of Financial Accounting Concepts (concepts statements) fit in the overall scheme of generally accepted accounting principles (GAAP). Concepts statements are not intended to establish accounting standards. Rather, their purpose is to provide insights into the FASB's current thinking and philosophy on a given accounting topic. These views are not binding on past pronouncements of the board, but they indicate positions that the board is likely to take in future pronouncements and, thus, provide a basis for evaluating both existing and future accounting standards and practices.

Statement No. 7 provides general principles that govern the use of present value, especially when the amount of future cash flows, their timing, or both, are uncertain. The concepts statement provides a framework for using information on future cash flows as the basis for accounting measurements at initial recognition of assets or liabilities, for fresh-start measurements, and for amortization using the interest method of amortization.

"Measurements at initial recognition" refers to measurements performed at the start of an asset's or liability's life. For example, assume a piece of equipment is purchased by issuing a note payable that does not specify an interest rate, but rather requires the payment of $15,000 at the end of each year for 10 years. For measurements at initial recognition, the asset (equipment) and the liability (note payable) would be recorded at the present value of the payments discounted at the appropriate discount rate.

"Fresh-start measurements" are measurements in periods following the initial recognition that establish new carrying amounts unrelated to previous amounts. For example, the FASB provides that fresh-start measurements must be used every accounting period in accounting for investments, [a] and whenever an exception or event requires the assessment of impairment of assets. [b]

The interest method of amortization is used when amortizing the premium or discount of bonds payable and notes payable.

Statement No. 7 deals with accounting measurement issues; it does not address recognition issues specifically nor does it specify when fresh-start measurements are appropriate. Among the topics discussed in Statement No. 7 are new approaches to calculating the present value of an asset or liability and factors that, if present, suggest that an interest method of allocation should be considered.

Fair Value versus Present Value

Statement No. 7 addresses circumstances in which accounting for cash flows associated with assets or liabilities at initial recognition or for fresh-start measurements cannot be based on their fair value and, therefore, must be based on their present value.