Consider a two-period world with two states of nature tomorrow -call them a and
ID: 2661720 • Letter: C
Question
Consider a two-period world with two states of nature tomorrow -call them a and b – and two assets – call them A andB. Asset A promises to pay $1, if a occurs, and $1, if boccurs. Asset B promises to pay $2, if b occurs (nothingotherwise). The price of asset A is $3 while the price of asset Bis $2. The price, at date 1, of the asset/liability portfolio thatyields a payoff of nothing, if a occurs, and $1, if b occurs,is:
(a) $1.
(b) $2.
(c) $3.
(d) $4.
Can anyone please help me? I need to be able to explain out thecorrect answer. I don't know what they mean by the price of theasset/liability portfolio let alone how to do the question. I'llgive a lifesaver rating if you can explain correctly but I'll giveyou a rating anyway if you answer! Thanks.
Explanation / Answer
Recognition implies inclusion of an element in financialstatements by describing in words and monetary amount.
TheRecognition Process
Ø Initial recognition: Recognitionof an element in financial statements for the first time.
Ø Subsequent measurement:Measurement of already recognised assets and liabilities at the endof each reporting period. This might result in change in theircarrying amount. For example, investments are measured at the endof each reporting period to determine the appropriate amount atwhich they should be carried in the balance sheet.
Ø Derecognition: An element that wastill then recognised, ceases to be recognised either due toconsumption or impairment or retirement or disposal of the asset orextinguishment or settlement of the liability. For example,‘finished goods’ carried forward from the previousreporting period are derecognised, if sold during the reportingperiod.
Examples of events other than Transactions that Result inRecognition or De-recognition of Assets andLiabilities
Ø Imposition of penalty by a courtmay result in recognition of a liability
Ø Dumping by foreign manufacturersmay result in reduction in the recoverable amount of finished goodsresulting in reduction in its carrying amount.
Ø Outcome of research anddevelopment activities’ within the organization may lead torecognition of an asset.
Ø A fire in the factory premisescausing damage to property may result in de-recognition ofassets.
Ø Lapse of time may result inde-recognition of a liability as it is considered ‘timebarred’.
Elements in balancesheet and profit and loss account are interrelated, for example,recognition of an asset in the balance sheet without any decreasein other assets or increase in liabilities results in simultaneousrecognition of income. Cash received against services rendered isan example of a transaction that results in simultaneousrecognition of an asset and an income.
Phase in Recognition of an Asset/Liability
1. The first phase in therecognition process is to analyse the effect of an event on thereporting enterprise’s assets and liabilities.
2. In the second phase, ifthe transaction has resulted in a new asset or liability orincrease in an already recognized asset or liability, the reportingenterprise assesses whether it meets the recognition criteria.
3. In the third phase, thereporting enterprise determines the amount at which the new assetor liability, or the increase or decrease in an already recognizedasset or liability, is to be recognized.
Most evidence in accounting ispersuasive, and therefore in most situations it may not resolvequestions conclusively. Moreover it may not always be possible toproduce documentary evidence: even past experiences of thereporting enterprise or other enterprises in a similar situationmight be considered as adequate evidence. However, documentaryevidence is always considered superior as compared to any otherevidence. Similarly, external evidence is considered superior tointernal evidence.
According to the problem at date 1, of the asset/liabilityportfolio that yields a payoff of nothing if a occurs, and $1, if boccurs,
So the answer is (a) $1