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Accounting Under Ideal Conditions
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[PLO 12] Menguasai prinsip dasar tentang ekonomi, bisnis dan

konsep penyusunan informasi akuntansi dengan memanfaatkan
teknologi informasi dan mengkomunikasikan hasilnya.

[CLO 2] Mampu menghubungkan dan menunjukkan konsep-konsep

Teori Akuntansi dalam merumuskan masalah sehingga dapat
dijadikan dasar mengidentifikasi solusi.

[Sub CLO 2.2] Mampu menghubungkan konsep current value,

present value, historical cost accounting, dan mixed measure
model dalam berbagai kondisi
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Ideal Conditions of Certainty

✔ Assumptions
• Known future cash receipts
• Given interest rate

✔ Basis of Accounting
• Present value

✔ Income Recognition
• As changes in present value occur
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Ideal Conditions of Certainty

Assumptions
✔ States of nature
▪ Known set
▪ State realization is publicly observable
✔ State probabilities
▪ objective
▪ publicly known
✔ Given interest rate
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Ideal Conditions of Certainty

✔ Basis of Accounting
• Expected present value
✔ Income Recognition
• As changes in expected present value occur
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Relevance versus Reliability

Relevant information
Information about future firm performance

Reliable information
Representationally faithful
Free from bias
Verifiable

Under ideal conditions, complete relevance and reliability is

attained
Why?
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Lack of Ideal Conditions

State probabilities are subjective, not objective

✔ Objective probabilities
• Rolling a pair of fair dice
✔ Subjective probabilities
• What if you are not sure the dice are fair?
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Lack of Ideal Conditions

Incomplete markets
Definition?
Significance
Cannot always use market value as a proxy for present value

Reasons for Incompleteness

thin markets
information asymmetry
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Implications of Lack of Ideal

Conditions

Estimates needed to apply current value accounting

Future state realizations may not be currently known, leading to the need for
Estimates of quantities of future sales and purchases
Estimates of prices of future sales and purchases
Estimates of the timing of future transactions
Estimates needed of (subjective) probabilities of future state realizations
Note current value = future quantity × future price × their probabilities
These probabilities are usually subjective
Estimates are subject to error and bias
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Conclusion re: Lack of Ideal

Conditions

Greater relevance requires more estimates

However, more estimates decrease the reliability
Relevance and reliability must be traded off
See next slide
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Relevance v. Reliability Tradeoff 2

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Comparing Different Measurement Bases

Current value accounting
Fair value v. present value approach?
Relevance v. reliability?
Recognition lag?

Historical cost accounting

Relevance v. reliability?
Recognition lag?
Matching and accruals?

Cash flow accounting

Relevance v. reliability?
Recognition lag?
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The Mixed Measurement Model

Current value accounting for some items

Accounts receivable, financial instruments
Pension and lease liabilities

Historical cost accounting for some items

Inventory
Long-term debt
Property, plant & equipment, purchased goodwill

Cash flow accounting for some items

Self-developed goodwill
Shows up in income statement as realized
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The Mixed Measurement Model

Why use different measurement bases?

Different trade offs between relevance and reliability
Some assets and liabilities require more estimates than others
If too many estimates, revert to historical cost to retain reasonable reliability
If reasonable reliability is still not attained, revert to a cash basis
E.g., research costs written off as incurred
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Reserve Recognition Accounting I

An application of present value accounting when ideal

conditions do not exist
SFAS 69
Applies to proved reserves only
Discounted at mandated rate of 10%
Revenue recognized as reserves are proved
Major adjustments to previous estimates usually needed
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Reserve Recognition Accounting II

Relevance of RRA information?

Reliability of RRA information?
Management’s Reaction to RRA
Concern about relevance and reliability
Concern about legal liability

Why is RRA reported as supplementary information?

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Reserve Recognition Accounting III

Canadian reserve recognition accounting

Text, Chapter 2, Problem 24, NI 51-101
Relevance compared to SFAS 69?
Reliability compared to SFAS 69?
Why do many large firms opt out in favour of SFAS 69?
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Conclusion

True net income does not exist

Why?
Implications for accountants
Accountants not needed if it did exist
Judgement required to estimate net income
Judgement is essence of a profession
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