1. Current Purchasing Power Accounting (CPPA)
2. Current Cost Accounting (CCA)
3. Continuously Contemporary Accounting (exit price accounting) (CoCoA)
Descriptions CPPA CCA CoCoA
Definition CPPA adjusts to the changes in general price level over the period of time such as during inflation, purchasing power reduces and during deflation purchasing power increases. CPPA restates historical costs in the form of current purchasing power, which makes is comparable and additive. CCA uses value to business or deprival values for the measurement where business value means the current replacement cost and the recoverable amount (greater of net realisable value and economic value). CCA helps to maintain the capital of a firm in its operating capability.
CoCoA is a normative approach which focuses on measuring exit prices of firm’s assets and liabilities. Central objective is to provide information about the firm’s ability to adapt the changing circumstances. Even the profits are connected to the current exit prices.
Assumptions • A general price index is used for CPPA.
• CPP Factor is used to adjust income statement and financial position.
• Monetary and non-monetary item plays important role in CPPA.
• Specific index of prices used to reflect current value of asset and liabilities.
• Fixed assets and their depreciation are recorded at replacement value.
• Revaluation surplus are not distributed to shareholders but reserved as CCA reserve. • All the transactions in the firm are done at present.
• The monetary value of assets, liabilities and equity at balance date based on current exit price.
• Depreciation expenses is not reflected in CoCoA as the valuation of assets is recorded on their current cash equivalents.
Advantages • It retains all the characteristics of historical cost accounting except for the change in unit of measurement, so it possesses the qualities of objectivity and comparability.
• CPA measures income properly as a result of the matching of dollars of different size (purchasing power) on the income statement.
• CPPA presents to users, in general, the impact of general inflation on profit and provides more realistic return on investment.
• CCA provides more useful information that guides management and shareholders.
• CCA helps to main the operating capabilities of the firm during inflation.
• CCA determines the reliability of the value of an item in the firm as the ratios derived from CCA are more realistic than HCA. • It helps in decision making so called as “decision usefulness approach”.
• Entity unable to adapt changes in circumstances are likely to fail because purchasing power is current and continuously changing.
Examples Adam purchased a machine at a cost of $10,000 when the price index was at 80. He anticipated that the machine could be sold later at a profit. Three years later (price index at 130), he was offered $25,000.
Adjusted cost of machine = $10,000 x 130/80 = $ 16,250
Total gain = $ 25,000 – $ 10,000 = $15,000
Real gain = $ 25,000 – $ 16,250 = $ 8,750
Purchasing power gain = $ 15,000 – $ 8,750 = $ 6,250
Suppose A Ltd asset for 2016 was $40,000 with no liabilities so the equity will also be $40,000. During 2016, it sells its asset for $55,000. Under HCA the profit will be $ (55,000 – 40,000) = $15,000 and closing equity will be $55,000 that matches asset in form of cash. If $15,000 is distributed as dividend, equity would remain same. In CCA, profit would differ because of the factor of inflation. The replacement cost of the asset would be $45,000(suppose), then the profit would be $10,000. This is because $45,000 is required to retain the asset in the firm. Central goal of CCA is the maintenance of the firm’s physical capital. Suppose A ltd had equity of $10,000 and it acquired computer at a cost of $2,000 which had market price at $4,000 at the end of 30 June 2017. Prices rose by 10% throughout the period.
As per CoCoA, the net profit will be:
Cost of Sales ($2,000)
Trading income $2,000
Capital maintenance adjustment
($10,000 * 10%) ($1,000)
Net Profit $1,000
The viable alternatives to HCA are all of the above-mentioned alternatives but the best one is CoCoA method because it evaluates the net profit on the basis of current market sales price and adjusts it against the net increase or decrease in the price throughout the period. CPPA and CCA ignores the fact that the prices can move in any direction and variable rate, they only provide partial treatments in price levels and index despites they are better off HCA.
Question 2 – 4 marks (750 words)
Conceptual framework leads to a consistent standard followed in preparation of financial statements, through its interrelated objectives and fundamentals. As per AASB/IASB conceptual framework, the financial report varies on the basis of characteristics of the users of those statements. Financial statement should be prepared in order to guide the economic decisions by its users. The preparation and presentation of the financial statement as per IASB Conceptual Framework are for external users such as investors (current and potential), creditors and lenders. IASB 1989 recognised the users as current and potential users as well as all those stakeholders who had direct financial interest in the company such as stockbrokers, lawyers, analysts or regulatory bodies. Identifying the users as having financial interest is not enough, they should have knowledge and skills to understand and analyse the financial statements.
There are two types of users of financial information: Primary users such as management, employees, owners, etc. and Secondary users such as government, customers, investors, creditors, etc.
The main users of accounting referred to within the AASB/IASB conceptual framework are external users such as:
• Current and potential investors: Current investors are the primary users who have already invested their capital in any firm and the potential investors are those who are likely to invest in that particular firm.
• Creditors and Lenders: Creditors and lenders are secondary users who provide credit to the firm or lend their money to the firm.
Identification of the users within conceptual framework have some implications for the future of accounting measurement because not every aspect of accounting is relevant information for the users. In the conceptual framework AASB/IASB, the issues related to measurement is still under controversy and as per the conceptual framework among the nine potential measurement bases, only two has been recommended by it, which are historical cost accounting and fair values accounting. Current and potential investors and creditors and lenders are the component of secondary users of accounting information who are more interested in the present value of the firm’s assets and liabilities in which they are linked directly. The objectives of users have a significant effect on the measurement bases. The present value of the firm is measured with the fair value accounting instead of historical cost accounting. Fair value of accounting measures the market value of the assets and liabilities of the firm, how liquid is the firm and what is the current earnings of the firm from the present selling price of those assets and liabilities. For example, creditors are interested to know what is the current worth of the firm, they are not interested in any past cost of the firm because if the firm goes bankrupt then the current market value of the asset will be what the creditors will be interested in rather than analysing the gain on sale obtained from difference of selling and purchasing price.
Historical cost accounting: It does not provide relevant information about a financial asset such as derivative. It gives information about what was the cost of any asset or liability in the past, it helps to generate the profit on disposal, which is the topic of interest for the primary users. Current and potential investors as well as creditors are interested in the current trading value of the firm, so that they can earn capital-gain instead of dividend out of profit (which is management decision to either distribute dividend or not) and historical cost accounting hides it. Historical cost accounting can hide the effect of current market conditions on the performance of the firm. There is a difference in the value of assets on the firm’s book and actual market valuation of that asset.
Fair value accounting: It provides improved accuracy of financial information as it provides accurate representation of the fair value of the firm’s financial worth at the present date as well as provides accurate valuation of the investments affected due to current state of the market. These information helps the investors to make informed decisions in relation to their investments and provides the clear idea of how their investment is performing in the current market conditions. Investors prefer more accurate valuation method which is provided by fair value measurement. For example, potential investors want to know the share price of the firm, in the market in current time, adjusted to all market changes affecting it. This is because when they sell the share in the market they will know their true gain if it was measured using fair value measurement.
Question 3 – 4 marks (750 words)
(a) Conceptual Framework is a standard guideline that assists in general purpose reporting through more complete, clear and updated set of concepts. The advantages for accounting that can result from the development of conceptual frameworks are as follows:
• Accounting standards prescribed in the conceptual framework provides more consistent and logical accounting process which is based on agreed principles. For example, accountants preparing balance sheet as per conceptual framework is consistent throughout the world.
• Conceptual framework development provides the accountants to be clear about what they did and why did they do. For example, using fair value accounting for plant and equipment keeps accountants on comfortable position to explain why they chose that method for that asset.
• Increased international compatibility of accounting standards
• Conceptual framework provides the standard-setters to be more accountable for their decisions as they will be following the stable framework described in the conceptual framework. For example, standard setters have provided the clear link between the users and methods of measurement in accounting.
• Communication between standard- setters and their constituents is enhanced because their proposed accounting standards is open for public comment and also prevents from political attack.
• There will be simpler resolution of the accounting dispute because of standard formats and economical decision making.
• Where CF’s cover a particular issue, there might be a reduced need for additional accounting standards to be proposed.
(b) As per Hines in the “Accounting, Auditing and Accountability Journal, 2 (2). Pp.72-92, the professional accountants has the most gain from the development of conceptual framework because their work is now independently recognized, different from other professions such as law, engineers. As per the conceptual framework, expertise in accounting professionals are those who possess the formal knowledge base which helps to define individual, situation, predict consequences, make decisions, and derive practices and standards. Conceptual framework gives the social constructionist perspective rather than functionalist perspective of expertise in profession which is used as a political resource in reducing the government intervention and competing with other groups in order to maintain and increase social mobility and professionalization.
Hines has defined the progress of accounting profession from a penmanship, where accountants were regarded as keeping the cost records with pen and counter, basically a good book-keeper to professional accountant different from all other profession due to the development of the conceptual framework. Below are some of the benefits identified by Hines in his journal which compares and contrasts to the general advantages of conceptual framework:
• In the past accounting system, it was difficult to find homogeneity in the works of accountants from different fields and different transactions due to which accountants were not held accountable for their works and even their work was not clear to the public mind. But conceptual framework holds the accountant accountable and clear to the work they are doing as well as the standards facilitates even the public to understand the accounting works.
• Conceptual framework helps to establish equality and distinctiveness from the legal profession as the accounting profession requires common sense, diligence, honesty, respectability, etc. It also helps to overcome the loss of attributes, which causes threat to the successful advancement or social reproduction of the profession.
• The accounting knowledge are easy to be articulated by the users of accounting information also besides professional accountants as conceptual framework prescribes standard formats of accounting which obtains legitimacy of accounting standards, and standards not derived from perceived body of knowledge but from due process procedures.
• Conceptual framework enhances comparability, completeness and consistency as necessary qualities of accounting information.
• Having conceptual framework as a backbone of accounting professionals, it continues to operate in a way that protects their franchise and ensures credible financial statements. The expertise, authority and independence of auditors can be questioned if there is any audit failures.
• Conceptual Framework acts as a political resource in the conflict over control of occupational territory when accountants are competing with other groups, combating government intervention, securing the generation of work by the government action and lobbying for control of it, because CF recognises the appearance and image of accounting knowledge.
• In contrast conceptual framework projects are specific to the countries in which accountants have succeeded to a substantial degree in their professionalization project, are largely self-regulates and have achieved a monopoly in audit work and near monopoly over many other areas and command positions of significant control over the appropriation of capital and allocation of resources.
• Conceptual frameworks are used as a strategic resource in competition with other groups which are pursuing professionalization and threatening the autonomy and monopoly of entrenched organisation.
The primary purpose for the development of Conceptual Framework is to enhance the development of unique accounting standards. The important rationale for undertaking Conceptual Framework was not functional or technical. It was a strategic plan for providing validity to standard-setting boards and the accounting profession during periods of competition or threatened government intervention.
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