The FASB Explores Accounting for Future Cash Flows

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

* Asset 1: $41,098 ($833.33 x 49.318)

* Asset 2: $39,930 ($10,000 x 3.993)

* Asset 3: $34,050 ($50,000 x 0.681)

* Asset 4: $39,930 ($10,000 x 3.993)

* Asset 5: $39,930 ($10,000 x 3.993)

Taking into account the time value of money in this way clearly provides values that are more relevant and reliable than those of the undiscounted cash flows.

The concepts statement lists five elements that a present-value measurement should include to fully represent the economic differences among assets (or liabilities):

* An estimate of the future cash flow, or in more complex cases, series of future cash flows at different times;

* Expectations about possible variations in the amount or timing of those cash flows;

* The time value of money, represented by the risk-free rate of interest;

* The price for bearing the uncertainty inherent in the asset or liability; and

* Other, sometimes unidentifiable, factors including illiquidity and market imperfections.

Of these five elements, the first two are accounted for in a traditional assessment of present value. By contrast, a traditional assessment of fair value captures all five elements. Thus, by similarly capturing all five elements, present value can serve as a more effective surrogate for fair value for those circumstances in which fair value is not observable in the marketplace.

Accounting for Uncertainty

The concepts statement states that the present values of assets should be adjusted to account for the relative degree of uncertainty associated with the future cash flows. The traditional present-value calculation, for example, shows that based strictly on the timing of the cash flows, Assets 2, 4, and 5 are identical. Yet all five assets involve differing degrees of uncertainty; that is, there are differing degrees of probability that the hospital will fully collect on each of the three notes receivable (Assets 1, 2, and 3), and each of the three notes involve a different degree of uncertainty compared with the likelihood that the pledge (Asset 4) will be fulfilled or the investment projections for Asset 5 will be realized.

Statement No. 7, therefore, suggests that the present values of each asset should be adjusted to account for such differences in degree of uncertainty. For example, the present value of Asset 1 could be adjusted to take into account factors that affect the probability that the hospital will collect on the note receivable, such as the creditworthiness of the patient and the hospital's historical track record of collecting on these types of notes. The present value of the notes receivable from Imaging, Inc. and Conglomerate Corp. (Assets 2 and 3) could be adjusted to take into account the credit standing of these two companies. The present value of the pledge receivable (Asset 4) could be adjusted to reflect the hospital's track record, if any, in collecting pledges from this particular individual, as well as the hospital's overall track record in collecting pledges. Finally, the present value of the investment in Asset 5 could be adjusted to reflect the probability of varying levels of return. Possible presen t values resulting from such adjustments are shown in Exhibit 1.