Question

Is it possible that an asset or liability can exist and can be relevant even if the probability of an outflow or inflow of economic benefit is low?

a) No, low probability means it's not relevant.
b) Yes, relevance depends on the specific circumstances.
c) Yes, but it's irrelevant when probability is low.
d) No, it's always irrelevant with low probability.

Answer 1

Yes, an asset or liability is relevant even if the probability of economic benefit flow is low because relevance depends on specific circumstances. A bank's listed assets often include funds lent out, which are not physically in the bank. When purchasing loans, various factors such as payment history, economic interest rates, and borrower's financial health influence the price.

Step-by-step explanation:

The answer to the question is b) Yes, relevance depends on the specific circumstances. An asset or liability can indeed be relevant even if the probability of an inflow or outflow of economic benefits is low. The accounting recognition criteria include the notion of 'probable' economic benefits, but this does not translate into disregarding potential assets or liabilities purely due to low probability. All facts and circumstances must be considered to assess the relevance of the information for decision-making purposes.

Regarding the bank balance sheet, the money listed under assets may not actually be present physically in the bank because it could be lent out to customers as loans or cash. This is due to the banking practice known as fractional-reserve banking, where banks keep only a fraction of deposits as reserves and use the majority of deposited money for lending purposes.

When buying loans in the secondary market, one would consider the following factors:

• If a borrower has been late on a number of loan payments, one may pay less for that loan because the risk of default is higher.
• If interest rates have risen since the loan was made, one might pay less, since the existing loan's interest rate may be lower than current market rates, making it less attractive.
• If the borrower is a firm with a high level of declared profits, one might pay more for the loan as the borrower's creditworthiness is enhanced, indicating lower risk.
• If interest rates have fallen since the loan was made, one might pay more for the loan because it now offers a higher interest rate than new loans being issued at current lower rates.