Chapter-07 Conceptual framework- Measurement
Historical cost accounting-
It means that assets are recorded at the amount they originally cost and
liabilities are recorded at the proceeds received in exchange for the
obligation.
Advantages-
➢ Easy to understand
➢ Straightforward to produce
➢ Results in comparable financial statements
➢ There is less possibility for manipulation by using creative
accounting in asset valuation.
Disadvantages-
➢ The carrying value of assets is often substantially different to
market value.
➢ No account is taken of inflation meaning that profits are
overstated and assets understated.
➢ Financial capital is maintained but not physical capital.
➢ Ratios like return on capital employed are distorted.
➢ It doesn’t measure any gain/loss of inflation on monetary items
arising from the impact
➢ Comparability of figures is not accurate as past figures are not
restated for the effects of inflation.
Other asset values-
Replacement cost-
➢ It is the cost to the entity of replacing the asset.
➢ In non-current assets, it needs to determine the asset’s net
replacement costs.
➢ Net replacement cost is the replacement cost of an asset less an
appropriate amount of depreciation.
Net realisable value- It is the estimated sales proceeds less any costs
involved in selling the assets.
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Economic value- It is the present value of the future cashflows from an
asset.
Types of historical cost accounting-
➢ Constant purchasing power (CPP)
➢ Current cost accounting (CCA)
a. Constant purchasing power (CPP)-
➢ Financial statements are adjusted to show all figures in terms of
money with the same purchasing power.
➢ A general price index is used for applying a general level of
inflation.
➢ Figures in the statement of profit or loss and statement of financial
position are adjusted by the CPP factor.
➢ CPP factor = Index at the reporting date/ Index at date of initial
recognition
Advantages-
➢ It is both simple and objective and relies on a standard index.
➢ It adjusts for changes in the unit of measurement and is a true
system of inflation accounting.
➢ It measures the impact on the entity in terms of shareholder’s
purchasing power.
Disadvantages-
➢ It fails to capture economic substance when specific and general
price movements diverge.
➢ The unfamiliarity of information stated in terms of current
purchasing power units.
➢ CPP doesn’t show the current values to the business of assets and
liabilities.
➢ The general price index used is not necessarily appropriate for all
assets in all businesses.
b. Current cost accounting (CCA)-
➢ It is based on deprival values or values to the business.
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➢ It is equal to the loss suffered if deprived of the asset and is
usually represented by the replacement cost.
➢ Inventory and non-current assets are valued at deprival value.
➢ Monetary assets are not adjusted.
➢ An additional charge to the statement of profit or loss reflects the
deprival value of inventory within cost of sales.
➢ An additional charge in the statement of profit or loss reflects
deprival value of non-current assets.
Advantages-
➢ Relevance to users.
➢ Users will be able to assess the current state or recent performance
of the business.
Disadvantages-
➢ Greater subjectivity and lower reliability than historical cost.
➢ Lack of familiarity.
➢ Complexity
➢ Adjusts values for non-monetary assets not all assets/liabilities.
➢ Practical problems.
