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Chapter 4 - Normative Accounting Theories
Chapter 4 - Normative Accounting Theories
As Elliot states:
“An implicit and troublesome assumption in the historical cost model is that
the monetary unit is fixed and constant over time.
However, there are three components of the modern economy that makes
this assumption less valid than it was at the time the model was
developed.”
Point to note:
1. It has been argued that historical cost accounting information suffers
from problems of relevance in times of rising prices. At issue is
whether it is really logical to add together assets acquired in different
periods when those assets were acquired with dollars of different
purchasing power. (page 85)
CCA differentiates between profits from trading, and those gains that
result from holding an asset.
The current cost operating profit before holding gains and losses, and
the realised holdig gains, are both tied to the notion of realisation, and
hence the sum of two equates to histoical cost profit.
Holding gains are deemed to be different to trading income as they are
due to market-wide movements, most of which are beyond the control
of Management.
COP – is the excess of the current value of the output sold over the current
cost of the related inputs.
RCS – are the increase in the current cost of the assets held by the firm in
the current period.
The term we use for realizable cost saving is “holding gains /losses” which
can be realized or unrealized. (IAS Investment property – holding gain of
revaluation surplus is unrealized but is treated as business profit in income
statement).
In fact, the larger profit of Company A is not due to the efficiency of the
managers in operating the firm in the current years. Rather, it reflects the
efficiency of the manager of 10 years ago in starting the business and
purchasing the assets at that time.
Technologica Edward and Bell believe that Lemke wonders why “these
l changes even if condition changes, the long run prospects would be
(Current probability is great that the indicated by the prospects of
operating profit existing production process present mode of production
is primarily rep would generate a larger profit when it is becoming
of the long-term than alter processes if change obsolete.
profit capability is due to external factor.
of the firm)
Exit price accounting - its support advocator (Deegan page 109 - 115)
He argued that the purchase price, or current cost, does not reveal the
firm’s capability to go into the market with cash for the purpose of
adapting itself to present conditions – Current cash equivalent is the
price of the assets.
The concept of adaptive behavior sees the firms as always being ready
to dispose of the asset if this action is in its best interest. Adaptive
behavior, therefore, calls for knowledge of the cash and current cash
equivalents of the firm’s net assets. He admits that every asset has, in
principle, a value in exchange (market value) and a value in use.
Both historical cost and current cost advocates accuse exit price proponents
of ignoring the concept of value in use. The former (HCA) believes such
value is represented by acquisition cost and the later (CCA) current cost.
Rationale: An asset that is held rather than sold out must be worth more to
its owner than its exit price, otherwise, it would be sold.
It is argued that exit price represents the opportunity cost but this may not
always be justified. The opportunity cost of using an asset in the company
is derived by the value foregone of the next best alternative, which is not
necessarily to sell it.
A firm can consider an asset to have value because of its use in the business
rather than its sale
Topic 6 - Normative Accounting Theories
Exit price accounting - its criticism (Page 230 – 234 of Chapter 7 Current
cost accounting)
3. Additivity
Exit price proponent claims that accounting measurements, if they are to be
objective, must only be based on past and present events.
The concept of current cash equivalent, with its emphasis on sever ability of
assets, does not recognize the possibility of selling assets as one package.
Question
Currently there is little support for the various normative approaches to
accounting for changing prices. Discuss the reason for this. In the
discussion please consider the relevance of the various theories for
regulation to the lack of regulation for accounting changing prices.
Point to answer:
1. Who recommended the normative approaches to accounting for changing
prices and what is the normative approach?
2. Any regulator / regulated supported the changing prices accounting
perspective during the past thirty years?
3. What is the regulation theory applicable to the accounting approach –
Public interest, capture or Private interest?
Point to answer
He argued that the purchase price, or current cost, does not reveal the
firm’s capability to go into the market with cash for the purpose of adapting
itself to present conditions – Current cash equivalent is the price of the
assets.
The concept of adaptive behavior sees the firms as always being ready to
dispose of the asset if this action is in its best interest. Adaptive behavior,
therefore, calls for knowledge of the cash and current cash equivalents of
the firm’s net assets. He admits that every asset has, in principle, a value
in exchange (market value) and a value in use.
In the late 1970s and early 1980s, many accounting standard setters issued
recommendation that favored disclosure based on a mixture of current
purchasing power accounting and current cost accounting. E.g. The FASB
released SFAS 33 which required a mixture of information.