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Accounts D
Accounts D
One of the key benefits to price level accounting is the ability to determine what has occurred with
the purchasing power associated with a given currency as the result of shifts in the economy.
Since the method calls for posting gains and losses that occur due to changing in pricing taking
place during a recession or a period of inflation, it is relatively easy to determine how that
purchasing power has been eroded or how it has managed to strengthen somewhat as the
economy moves through different phases. This is important for a business, since the data can
often make it easier to plan future consumption of goods and services in a manner that helps the
business remain financially stable, even in the face of a projected adverse economic situation.
In general, price level accounting helps to provide a more accurate basis for evaluating the
financial situation of a company or other entity. Allowing for shifts in purchasing power associated
with the currency used to maintain the accounting records, a company can use the data to
understand the real and true worth of its assets and plan for future expenditures accordingly. At the
same time, there are some limitations on price level accounting, in that the process of actually
calculating the shift in purchasing power and the value of assets based on the current status of the
currency can be somewhat complicated and somewhat subjective. In spite of the potential
drawbacks, carefully analyzing the impact of the economy on the value of the currency, then
applying that data to the financial assets of the business, is worth the effort and can often prove
very valuable to charting the future movement of the company.
In the past few years of high inflation, companies have reported very high profits on the one hand
but on the other they have faced real financial difficulties. This is so because in reality dividends
and taxes have been paid out of capital due to overstated figures of profits arrived at by adopting
historical cost concept. Thus a change from historical cost concept to price level or inflation
accounting has been recommended.
(1) It enables company to present more realistic view of its profitability because current revenues
are matched with current costs.
(2) Depreciation charged on current values of assets in inflation accounting further enables a firm
to show accounting profits more nearer to economic profits and replacement of these assets when
required.
(3) It enables a company to maintain its real capital by avoiding payment of dividends and taxes
out of its capital due to inflated profits in historical accounting.
(4) Balance Sheet reveals a more realistic and true and fair view of the financial position of a
concern because the assets are shown at current values and not on distorted values as in
historical accounting.
(5) When financial statements are presented, adjusted to the price level changes, it makes
possible to compare the profitability of two concerns set up at different times.
(6) Investors, employees and the public at large are not misled by inflated book profits because
inflation accounting shows more realistic profits. Higher paper profits without adjustment for price
level changes cause resentment among workers and they demand higher wages and also
excessive profits attract new entrepreneurs to enter the business. Inflation accounting helps in
avoiding further competition from prospective entrepreneurs.
(7) The financial statements prepared by a company adjusted to the price level changes also
improve its social image.
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(8) Inflation accounting also affects the investment market as it helps to establish a realistic price
for the shares of a company.
Some people are of the opinion that inflation accounting may create more problems than solving
them because of the following inherent disadvantages of the price level accounting:
(1) Adjusting accounts to price level changes is a never-ending process. It involves constant
changes and alterations in the financial statements.
(2) Price level accounting involves many calculations and makes financial statements so
complicated and confusing that it becomes very difficult for man of ordinary prudence to
understand, analyze and interpret them.
(3) The concept of price level accounting appears to have more theoretical importance than
practical because adjusting the accounts to the changes in the price levels may lead to window
dressing of accounts due to the element of subjectivity in it. People may adjust the accounts
according to the values most suited to them, thereby, making the financial statements more
inaccurate.
(4) Depreciation charged on current values of fixed assets is not acceptable under the Income Tax
Act, 1961 and hence adjusting it to price level changes does not serve any practical purpose.
(5) During deflation, when the prices are falling, adjustments of accounts to price level changes will
mean charging lesser depreciation and overstatement of profits.
Social accounting
Social accounting, also known as national income accounting, is a method to present statistically
the inter-relationships between the different sectors of the economy for a thorough understanding
of the economic conditions of the economy.
It is a method of studying the structure of the body economic. It is a method of studying the
structure of the body economic. It is a technique of presenting information about the nature of the
economy with a view not merely to get an idea of its prosperity, past or present, but also to get
guidelines for state policy to influence or regulate the economy.
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In the words of Edey, Peacock and Cooper: “Social accounting is concerned with the statistical
classification of the activities of human beings and human institutions in ways which help us to
understand the operation of the economy as a whole.
(1) A firm fulfills its social obligations and informs its members, the government and the general
public to enables everybody to form correct opinion.
(2) It counters the adverse publicity or criticism leveled by hostile media and voluntary social
organisations.
(4) Through social accounting the firm proves that it is not socially unethical in view of moral
cultures and environmental degradation.
(7) Social accounting is necessary from the view point of public interest groups, social
organisations investors and government.
1. Classical Approach:
The classical approach asserts that by maximizing the profits within the constraints of the existing
legal and ethical framework, business corporations are acting in the best interests of the society at
large. Milton Friedman (1961) advocated, “there is one and only one social responsibility of
business-to use its resources and engage in activities designed to increase its profits, as long as it
stays within the rules of the game, which is to say, engage in open and free competition, without
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deception or fraud.” However, in the changing environment and social parameters this approach is
no more acceptable.
2. Descriptive Approach:
This is the simplest and traditional method of reporting social information. According to this method
the social activities of business corporations are presented along-with financial statements in
narrative form. Usually, only positive social aspects of a firm are presented in a non-quantitative
form. Thus, the impact of social activities is not measured under this method.
This approach advocates the preparation of a social report comprising social benefits and social
costs.
P. Eichhorn in his book on ‘Social Accounting’, 1974 suggested the following corporate social
accounting framework:
According to this approach whenever any enterprise has some social objective to achieve, it has
some definite social programme, and plan to achieve the objectives and how the feedback and
control has been exercised, should be disclosed.
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5. Pictorial Approach:
Under this approach, photographs of health care center, schools and hospitals run by the company
are presented) in annual reports.
(9) Through social accounting, the management gets feedback on its policies aimed at the
welfare of the society.
Human resources are considered as important assets and are different from the physical assets.
Physical assets do not have feelings and emotions, whereas human assets are subjected to
various types of feelings and emotions. In the same way, unlike physical assets human assets
never gets depreciated.
Therefore, the valuations of human resources along with other assets are also required in order to
find out the total cost of an organization. In 1960s, Rensis Likert along with other social
researchers made an attempt to define the concept of human resource accounting (HRA).
Definition:
The American Association of Accountants (AAA) defines HRA as follows: ‘HRA is a process of
identifying and measuring data about human resources and communicating this information to
interested parties’.
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The need for human asset valuation arose as a result of growing concern for human relations
management in the industry.
Behavioural scientists concerned with management of organizations pointed out the following
reasons for HRA:
1. Under conventional accounting, no information is made available about the human resources
employed in an organization, and without people the financial and physical resources cannot be
operationally effective.
2. The expenses related to the human organization are charged to current revenue instead of
being treated as investments, to be amortized over a period of time, with the result that magnitude
of net income is significantly distorted. This makes the assessment of firm and inter-firm
comparison difficult.
3. The productivity and profitability of a firm largely depends on the contribution of human assets.
Two firms having identical physical assets and operating in the same market may have different
returns due to differences in human assets. If the value of human assets is ignored, the total valu-
ation of the firm becomes difficult.
4. If the value of human resources is not duly reported in profit and loss account and balance
sheet, the important act of management on human assets cannot be perceived.
5. Expenses on recruitment, training, etc. are treated as expenses and written off against revenue
under conventional accounting. All expenses on human resources are to be treated as
investments, since the benefits are accrued over a period of time.
Objectives of HRA:
1. Providing cost value information about acquiring, developing, allocating and maintaining human
resources.
Benefits of HRA:
There are certain benefits for accounting of human resources, which are explained as follows:
1. The system of HRA discloses the value of human resources, which helps in proper interpretation
of return on capital employed.
3. The implementation of human resource accounting clearly identifies human resources as valu-
able assets, which helps in preventing misuse of human resources by the superiors as well as the
management.
4. It helps in efficient utilization of human resources and understanding the evil effects of labour
unrest on the quality of human resources.
5. This system can increase productivity because the human talent, devotion, and skills are consid-
ered valuable assets, which can boost the morale of the employees.
6. It can assist the management for implementing best methods of wages and salary
administration.
1. The valuation methods have certain disadvantages as well as advantages; therefore, there is
always a bone of contention among the firms that which method is an ideal one.
2. There are no standardized procedures developed so far. So, firms are providing only as
additional information.
3. Under conventional accounting, certain standards are accepted commonly, which is not possible
under this method.
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4. All the methods of accounting for human assets are based on certain assumptions, which can
go wrong at any time. For example, it is assumed that all workers continue to work with the same
organization till retirement, which is far from possible.
5. It is believed that human resources do not suffer depreciation, and in fact they always
appreciate, which can also prove otherwise in certain firms.
6. The lifespan of human resources cannot be estimated. So, the valuation seems to be unrealistic.
It takes into account a part of the employees acquisition costs and thus ignores the aggregate
value of their potential services.
It is difficult to estimate the number of years over which the capitalised expenditure is to be
amortised.
The economic value of human resources increases over time as the people gain experience. But in
this approach, the capital cost decreases through amortisation.
2. Replacement Cost Approach –
This approach was first suggested by Rensis Likert, and was developed by Eric G. Flamholtz on
the basis of concept of replacement cost. Human resources of an organisation are to be valued on
the assumption that a new similar organisation has to be created from scratch and what would be
the cost to the firm if the existing resources were required to be replaced with other persons of
equivalent talents and experience. It takes into consideration all cost involved in recruiting, hiring,
training and developing the replacement to the present level of proficiency and familiarity with the
organisation.
This approach is more realistic as it incorporates the current value of company’s human resources
in its financial statements prepared at the end of the year. It is more representative and logical. But
it suffers from the following limitations:
This method is at variance with the conventional accounting practice of valuing assets.
There may be no similar replacement for a similar certain existing asset. It is really difficult to find
identical replacement of the existing human resource in actual practice.
This method can work for some of the people at shop floor and middle order management.
Moreover, the authors of this approach believe that a bidding process such as this is a promising
approach towards more optional allocation or personnel and a quantitative base for planning,
evaluating and developing human assets of the firm. But this approach suffers from the following
limitations:
It has specifically excluded from its preview the employees scarce or not being ‘bid’ by the other
departments. This is likely to result in lowering the morale and productivity of the employees who
are not covered by the competitive process.
The total valuation of human resources on the competitive bid price may be misleading or
inaccurate. It may be due to the reason that a person may be an expert for one department and
not so for the other department. He may be valuable person for the department in which he is
working and thus command a high value but may have a lower price in the bid by the other
department.
Under this method, valuation on the basis of opportunity cost is restricted to alternative use within
the organisation. In real life such alternative use may not be identifiable on account of the
constraints in an organisational environment.