advanced financial accounting 7th edition_20 pptx

6 marks 21.3 a Explain the primary objective of current purchasing power accounting and outline b What do you consider are the advantages and disadvantages of current purchasing power ac

We started the chapter by reviewing the utility of current cost accounts and then, in the

second section, explained and illustrated how to prepare and present a fully stabilised set of

current cost accounts that take account of changes in the general price level as well as

changes in specific prices.

Next we examined an alternative approach based upon the use of net realisable value as

the main basis of asset valuation and introduced the ICAS research publication, Making

Corporate Reports Valuable, which, although published in 1988, remains a radical document

full of fresh ideas

The final section of the chapter is concerned with the way the ASB’s thinking on the

sub-ject of current cost accounting has developed over the last ten or so years We explain how it

has put into place a system capable of coping with a much more widespread use of current

values, which will undoubtedly occur over the coming decades

Recommended reading

Accounting Standards Committee, Accounting for the Effects of Changing Prices: a Handbook, ASC,

London, 1986

W.T Baxter, Inflation Accounting, Philip Allan, Deddington, 1984.

Institute of Chartered Accountants of Scotland, Making Corporate Reports Valuable, P.N McMonnies

(ed.), Kogan Page, London, 1988

D.R Myddleton, On a Cloth Untrue, Woodhead-Faulkner, Cambridge, 1984.

D Tweedie and G Whittington, The Debate on Inflation Accounting, Cambridge University Press,

(a) What do you consider to be the main weaknesses of historical cost accounting when

(b) State two ways in which firms have adopted different accounting policies for specific

items in historical cost accounts so that they partly reflect rising price levels.

(4 marks)

(c) The stewardship approach of traditional accounting has been said to have been

replaced by a user-orientated approach Briefly discuss this assertion in relation to

historical cost accounts. (6 marks)

ACCA Level 2, The Regulatory Framework of Accounting, June 1988 (20 marks)

21.2 In the ASC’s handbook, Accounting for the Effect of Changing Prices, accountants are faced

with a choice of systems of accounting when dealing with the effects of inflation

Requirements (a) Briefly describe the three factors which combine to make up these systems of

(b) Explain the main advantages and disadvantages of two such systems. (6 marks)

21.3 (a) Explain the primary objective of current purchasing power accounting and outline

(b) What do you consider are the advantages and disadvantages of current purchasing power accounting as a method of adjusting financial statements for price level

ACCA Level 2, The Regulatory Framework of Accounting, December 1988 (20 marks) 21.4 (a) Provide a definition of the deprival value of an asset. (2 marks)

(b) For a particular asset, suppose the three bases of valuation relevant to the calculation

of its deprival value are (in thousands of pounds): £12, £10 and £8.

Construct a matrix of columns and rows showing all the possible alternative ations and, in each case, indicate the appropriate deprival value. (6 marks)

situ-(c) Justify the use of deprival value as a method of asset valuation, using the matrix in (b) above to illustrate your answer. (12 marks)

ACCA Level 2, The Regulatory Framework of Accounting, December 1988 (20 marks) 21.5 An assistant accountant of Changeling plc has been requested to prepare a profit and loss

account using the CPP model for the year ended 31 March 1991 He has calculated the netoperating profit for the year and the remaining entries are yet to be completed

The profit and loss accounts for the year ended 31 March 1991 are set out below, ing the historic cost profit and loss account and partially completed CPP profit and lossaccount

Historic cost

£000Profit (loss) after tax 412

Gain (loss) on net monetary assets –

Gain (loss) on long-term loans –

––––

Net profit (loss) for year 412

––––

Retained profit (loss) for year 225

Retained profit brought forward 750

––––

Retained profit carried forward 975

––––

Balance sheet as at 31 March 1990

Historic Index CPP units Index CPP units

Balance sheet as at 31 March 1991

Historic Index CPP units as

(b) Explain what the method of indexing is attempting to deal with and discuss the process from the viewpoint of both the entity and the proprietors. (5 marks)

(c) Write a brief report to the principal shareholder of Changeling Ltd who holds 20%

of the issued share capital on the management of the company commenting on profitability, liquidity and financial structure. (10 marks)

21.6 ‘The recognition and correct treatment of holding gains in company financial statements are

vital for a proper understanding of the position and performance of the business entity.’

You are required (a) to explain briefly the significance of the treatment of holding gains for the measure- ment of business profit; (5 marks)

(b) to set out the arguments for and against the recognition or holding gains (10 marks)

21.7 The accountant of Newsprint plc has produced three sets of accounts for the year ended

31 December 1988 using the historic cost, replacement cost with specific index

adjust-ments and current purchasing power with general price index adjustadjust-ments

The historic and replacement cost accounts are set out below:

Profit and loss accounts for the year ended 31 December 1988

Historic cost Specific Replacement cost

Balance sheets as at 31 December 1988

Historic cost Specific Replacement cost

Note 1 £Stock 8 250Fixtures 786Lease 2 063

–––––

11 099––––––

Note 2

Closing Stock(71 500 × – 71 500) 11 916Fixtures

(49 500 × – 49 500) 7 071Lease

(49 500 × – 49 500) 18 562

––––––

37 549–––––––The historic and current purchasing power accounts are set out below

Profit and loss accounts for the year ended 31 December 1988

Historic cost General

––––––– –––––––– –––––––– ––––––––

89 375 209 000 110 000 242 000Depreciation

160

160–––

140

280–––

240

Balance sheets as at 31 December 1988

Historic cost General

(178 750 × 160/130 – 178750) 41250Fixtures

(55 000 × 160/100 – 55000) 33 000Lease

(55 000 × 160/100 – 55000) 33 000Expenses

(89 375 × 160/130 – 89375) 20 625Cash

(76 450 × 160/100 – 76450) (45 870)Sales

(b) Explain the case for and against the replacement cost model. (8 marks)

(c) Consider the implication of the replacement cost model figures for 1988 to the

man-agement of Newsprint plc. (8 marks)

(d) Explain to a shareholder why the historic cost net profit is different from the CPP

operating profit using the data in the question to illustrate your answer and explain

which figure is to be regarded as the base for calculating earnings per share under

ACCA Level 3, Advanced Financial Accounting, June 1989 (30 marks)

21.8 The Paraffin Supply Company Limited acquired freehold land as a depot for its delivery

vans and started business on 1 January 1986 It collected sufficient paraffin from a saler each day to satisfy known orders The wholesaler was paid in cash and the customerspaid cash on delivery The opening balance sheet at 1 January 1986 showed the following:

whole-Balance sheet of Paraffin Supply Company Limited as at 1 January 1986

£Freehold land for use as garage premises 100 000

–––––––

196 000–––––––

Financed by: Share capital 150 000

–––––––

196 000––––––––––––––

The company traded for 2 years until 31 December 1987 All profits had been retained inthe business There were no creditors, debtors or stocks At 31 December 1987 the direc-tors were considering whether to cease trading at31 December 1988

The accountant produced the following estimated accounts for the year ended

31 December 1988 with the 1986 and 1987 actual comparative figures:

Profit and loss accounts for the years ended 31 December

––––––– ––––––– –––––––

3 600 18 000 30 000––––––– ––––––– –––––––––––––– ––––––– –––––––

3 600 18 000 30 000Return on equity –––––– × 100 –––––– × 100 –––––– × 100

150 000 153 600 171 600

= 2.4% = 11.7% = 17.5%

In preparing the accounts the following conventions and policies had been followed:

(a) The capital maintenance concept is that capital will be maintained if the cost of assets representing the initial monetary investment is recovered against operations.

(b) The concept of profit is that profit for the year is regarded as any gains arising during the year which may be distributed while maintaining the amount of the shareholders’ interest in the company at the beginning of the year.

(c) The measurement unit used is the medium of exchange.

(d) Depreciation of delivery vans is over 4 years using the straight-line method.

The directors had recently attended a seminar on the treatment of inflation in financialreports and they required the profits to be calculated using the general purchasing powerincome model and the replacement cost model

The accountant obtained the following information to allow him to redraft the profit

and loss account using these two models:

(a) The retail price index was as follows:

31 December 1988 (Estimated) 130

(b) The replacement cost of the assets was:

Garage premises Delivery vehicles

(a) (i) Prepare the profit and loss account for the year ended 31 December 1988 using

the general purchasing power income model and explain the following:

The concept of capital maintenance used.

The concept of profit used.

The measurement unit used. (8 marks)

(ii) Mention four criteria for selecting an appropriate unit of measurement for

finan-cial reporting and briefly discuss whether the general purchasing power income

model satisfies these criteria. (8 marks)

(b) (i) Prepare the profit and loss account for the year ended 31 December 1988 using

the replacement cost model to show reported income on the assumption that

backlog depreciation is not deducted in arriving at this reported income and

explain the following:

The concept of capital maintenance used.

The concept of profit used.

The measurement unit used. (5 marks)

(ii) Discuss the arguments for and against excluding backlog depreciation when

cal-culating the reported income. (4 marks)

ACCA Level 3, Advanced Financial Accounting, December 1988 (25 marks)

21.9 Air Fare plc is the subsidiary of an American parent company It had been incorporated in

the United Kingdom in 1985 to provide in flight packed meals for American airlines on

return flights from the United Kingdom

The fixed assets in the annual accounts have been carried at cost less depreciation but

the directors have been considering the production of supplementary statements that are

based on current values and show a profit after maintaining the operating capital and also

a profit that encompassed gains on holding assets to the extent that these were real gains

after allowing for general/average inflation

The following information (i) to (vi) was available when preparing the supplementary

statements for the year ended 31 December 1993.

(i) Draft profit and loss account for the year ended 31 December 1993 prepared under thehistoric cost convention.

(ii) The current cost values of the net assets representing shareholders’ funds was

£25 million at 1 January 1993

(iii) Freehold premises had cost £8 million in 1985 and were being depreciated over

40 years which was the group policy specified by the American parent The currentgross replacement cost was £14 million at 31 December 1993 and £13.8 million at

(v) The retail price index had risen by 3% during the year

(vi) Stock at the beginning of the year was £660 000 at cost and £670 000 at current ment cost and stock at the end of the year was £750 000 at cost and £795 000 at currentreplacement cost

replace-The following information relates to a consideration not to provide for depreciation

on the freehold property.

The freehold property consisted of the premises where the meals were prepared andpacked When the directors were reviewing the information prepared for the current valuesupplementary statements they noted that the current value of the freehold propertyexceeded the book value and decided that it was appropriate not to provide for depreciation.The chief accountant advised them that it was probable that the auditor would qualifythe accounts if depreciation were not provided in accordance with the provisions of

SSAP 12 Accounting for Depreciation.

The directors had been discussing the problem over lunch at the local hotel and weresurprised when the owner of the hotel informed them that the auditor of the company thatowned the hotel had not required depreciation to be provided on the hotel premises.Further enquiry by the directors established that there were a number of companies thatwere not providing depreciation on freehold properties from a range of industries that

included hotels, retail shops and banks They even discovered that the Financial Reporting

Review Panel had accepted one company’s policy on non-depreciation of freehold

build-ings in respect of the accounts of Forte plc They had therefore formed the view that

non-depreciation was acceptable provided the auditors were offered and accepted the

company’s reasons

They accordingly requested the chief accountant to prepare a brief report for the board

of reasons to support a decision by the company to adopt an accounting policy of

non-depreciation which they could subsequently discuss with the auditors

Required

(a) (i) Prepare a profit and loss account that shows a result after maintaining the

oper-ating capital and also a result that encompasses the gains for the year on holding

assets to the extent that these are real gains after allowing for inflation.

(ii) Write a brief memo to the directors explaining the results disclosed in the profit

and loss account prepared in (i) (10 marks)

(b) As chief accountant, prepare a brief report for the board giving reasons to support a

decision by the company to adopt an accounting policy of non-depreciation of the

21.10 It has been stated that: ‘Current cost accounts allow for the impact of specific price changes

on the net operating assets and thus the operating capability of the business The same

tools of analysis as those applied to historical cost accounts are generally appropriate The

ratios derived from current cost accounts will often differ substantially from those

revealed in historical cost accounts but should be more realistic indicators when assessing

an entity or making comparisons between entities.’

Required

(a) Explain, with reasons, whether the value of the following ratios might differ if

calcu-lated using current cost accounts rather than the historical cost accounts.

(i) Return on capital employed (ROCE)

(ii) Stock turnover ratio (utilising the year end stock value)

(iii) Debtors turnover ratio

(iv) Gearing ratio (in the balance sheet) (8 marks)

(b) Explain the principal limitations of the specific historical cost ratios set out in part

(a) when utilising them for the purpose of inter-firm comparison. (11 marks)

(c) Briefly discuss whether you feel that current cost based ratios are more realistic

indi-cators of a company’s performance than those ratios based upon historical cost

21.11 You are a financial analyst specialising in the analysis of the profitability of organisations in

the engineering sector One such company is D Ltd The directors of D Ltd have always

been interested in the impact of price changes on the performance of their business and

have adopted the practice of including current cost accounts (using the ‘Real Terms’

system) alongside the historical cost accounts in the published financial statements

Extracts from the published financial statements for the year ended 31 March 1996 aregiven below:

Profit and loss accounts – year ended 31 March 1996

Historical cost Current cost

Holding gains arising during the year – 3 500Inflation adjustment to shareholders’ funds – (2 000)

–––––– –––––––

11 000 18 000–––––– –––––––

–––––– ––––––

(a) Compute (under both conventions) three accounting ratios for D Ltd which differ

under the two conventions. (6 marks)

(b) Explain, for each ratio you have computed, the reason why the current cost elements

included in the ratio differ from the historical cost elements. (9 marks)

(c) Explain the adjustments ‘Holding gains arising during the year’ and ‘Inflation

adjust-ment to shareholders’ funds’. (5 marks)

AAA (American Accounting Association), 3, 4

see also Accounting Standards Board, Statement

of Principles; see also individual principles

accounting bases/policies, 30

changes in, 30, 281

Accounting for the Effects of Changing Prices: A

Handbook, 73, 620, 621, 624

Accounting Regulatory Committee, 54

Accounting Standards Board (ASB), 33–6, 37, 527

and capitalisation of finance costs, 103

and CCA, 20, 666, 686–8

Consultation Paper IASB proposals for first-time

application of International Financial

Reporting Standards, 51

Consultation Paper IASB proposals to amend

certain International Accounting Standards,

53

discussion paper

Aspects of accounting for pension costs, 259

Business combinations, 376

Goodwill and intangible assets, 382–3

Pension costs in the employer’s financial

historical cost accounting and alternatives,views on, 18–19, 20

and IASB, 295, 406and legislation, 27and proposed Standards Board, 38, 86public hearings, 383

statement Interim reports, 557 statement Operating and Financial Review,

and investments, 403–4, 405–6and liabilities, 162–3

and prudence, 29, 136, 143and realisation, 84, 85, 86and recognition, 163, 178standards and, 86and value to the business, 98, 127and valuation, 98, 127, 653website, 295

working paper Goodwill and Intangible Assets, 383

Accounting Standards Committee (ASC), 10,31–3, 34, 37, 382, 405, 623, 644

Accounting for the Effects of Changing Prices: A Handbook, 73, 620, 621, 624

and accounting for inflation, 73, 553, 620, 621,

624, 651, 667, 670and reporting of profits, 83Accounting Standards Steering Committee, 6, 31,

528, 623

The Corporate Report, 6, 74, 528, 554

accounts, see financial statements

accruals concept, 26, 28–9and currency-related gains/losses, 483and deferred taxation, 343–4, 350

Index

accruals concept (continued)

and goodwill, 378and government grants, 147acquisition accounting, 367–77, 404, 414, 430and associates, 452–3

see also equity accounting and proportional

consolidationacquisitions, 281, 284–5defining date of, 411, 452

in stages, 414treatment in cash flow statement, 533, 542–3treatment in consolidated accounts, 411–19

see also business combinations

actuarial method (annuity method), 179, 180,181–2, 219, 226, 230–3

actuarial methods of valuation (pensionschemes), 252, 253–4, 260–2actuarial science, 250, 262

additivity, 678adjusted historical cost, 62–3adjusting events, 301, 302, 303adjustments, 30, 278, 280–1, 290–1current cost, 657, 659, 661historical summary and, 553AEI, 31

amalgamation, see business combinations America, United States of, see USA

American Accounting Association, 3, 4American Institute of Certified PublicAccountants, 495

American options, 192amortisation of goodwill, 378, 379, 382–3, 384,

390, 453

analysed reporting, see segmental reporting annuity method, see actuarial method

annuity method of depreciation, 111–12

ASB, see Accounting Standards Board ASC, see Accounting Standards Committee ASC Handbook, see Accounting for the Effects of

Changing Prices: A Handbook, under

Accounting Standards Committeeasset ratio test, 79

asset stripping, 361assets, 95–127, 133–49combinations and inter-relationships of,100–1, 104, 110, 113, 124, 386contingent, 165, 168–9

control of, 119current, 655definitions of, 18, 96, 208, 236, 384effects of inflation on, 629–30exchange of, 102

expropriation of, 280

fixed, tangible, see tangible fixed assets

goodwill and, 384historical cost, 62–3identifiability, 119, 412

intangible, see intangible assets leased, see leases

and measurement of wealth, 60, 61–73monetary/non-monetary, 629–30net operating, 657

and protection of creditors, 85

as proxy, 64, 657recognition and measurement of, 209following acquisitions, 411–14and segmental reporting, 297specific, 668–9, 679

tangible/intangible distinction, 96–7

see also intangible assets and tangible fixed

assetsvaluation of, 60, 61–5, 650, 651–6, 677, 678–9,

687, 688CPP accounting and, 641–2

see also recognition and measurement in this entry; see also revaluation

values to different parties, 360–1whether likely to be replaced, 98–9, 651, 652,653–4

see also investments and revaluation

assets and liabilities statement, proposed, 679,683–4, 685

associated undertakings, 298, 453–4

see also associates and joint ventures

associates and joint ventures, 428, 447–66treatment in cash flow statement, 544–5

see also JANE

Association of Chartered Certified Accountants,

31, 52Association of Corporate Treasurers, 194attained age method, 262

Australia, 96, 236, 621balance sheet, 685cash flow statement and, 530current cost, 656, 662–3formats, 49

goodwill and, 384leases and, 227, 236proposals for change, 199–200taxation and, 352, 355treatment of capital instruments, 178–9treatment of long-term contracts, 140–1, 143banks, 195

Baxter, W.T., 37, 72–3, 653, 670Bell, P.W., 61, 72, 622, 644–52