EXIT PRICE ACCOUNTING

1. EXIT PRICE ACCOUNTING CHAPTER 8

2. PREPARED FOR :DR. HASRI BIN MUSTAFA PREPARED BY : ADLIN SABRINA BT RAZALI 125503 AMILIA BT AB. WAHAB 123259 ASMAHWATI BT. ABDOL RAHIM 123297 NOOR AZIZAH BT ISHA 123329 NORFAEDATUN HASNAH BT JUMRI 123271

3. Exit Price Accounting • a system of accounting which uses market selling price to measure the firm’s financial position and financial performance. Two major departures: • A value of non-monetary assets are adjusted • Changes in the general purchasing power of money are taken into consideration • Assets in the b/s are restated at exits value ~ represent the fair market value to the firm in an orderly liquidation

4. Chambers distinction: • Measurement is obtaining price objectivity and independently from the measure ‘whereas’ • Valuation is concerned with the expectations of future benefit that could be generated by the underlying assets • The distinction is made between the past (historical cost), the future (valuation) and the present (contemporaneous exit price) • Use exit price as-Valuation of assets at the time they sale the assets

5. In Support of Exit Price Accounting Providing useful information • MacNeal concluded that, Conventional accounting principles were based on ‘primitive conditions’ that have largely ceased to exits. • He divided accounting theory into 3 phases: - 1st era (12th century to 17th century) - 2nd era (18th century to 19th century) - 3rd era (20th century onwards)

6. 1st era…. • 12th to 17th century The role of accounting was to provide information to the business owner manager about the total costs incurred in ventured and projects • Cost were calculated using original or historical cost

7. 2nd era…. • 18th and 19th century Business firms were more established and transactions did not involved as great a risk as in the first era • More stable business enable creditors to lend the money on the basis of owner’s net worth. • Creditor- required f/s from the owner • In order to ensure the f/s reliable- prepared by independent accountant • Public accountant as s profession was born • Accountant- prepared f/s only to the owner’s and creditors

8. 3rd era…. • 20th century onward • Firm grew larges- became companies with the multiple s/holder and hired mangers • Important function to provide external financial reporting to the multiple s/holders • According to MacNeal; conventional acctg principle based on historical cost provided potentiality false and misleading f/s that did not serve the decision-oreanted s/holders – they do not learn the current value of the assets of the company that they held share

9. Cont’d…. MacNeal suggestion : • Marketable assets at market price (exit price) • Non-marketable, non-reproducible assets at historical cost • Occasional non-marketable, non-reproducible assets at historical cost ~ the π should include all the realised and unrealised π and losses in accordance with the clean surplus principle

10. Concept & Advantages Of Adaptive Behavior • Adaptive decision making • Relevant & reliable information • Other advantages - Additivity - Allocation - Reality - Objectivity

11. What is adaptive behavior? • Adaptive behavior is a type of behaviorthat is used to adapt to another type of behavior or situation. (Wikipedia)

12. Adaptive Decision Making (Chambers) • The notion of adaptive behavior implies a continual attempt to adjust to the competitive business environment for the sake of survival. • Chambers presented a comprehensive proposal for Exit Price Accounting : Continuously Contemporary Accounting (CoCoA) Current Cash Equivalent (CCE)

13. Adaptive Decision Making • Business as an adaptive entity engage in buying and selling goods and services. • Governed by manager who are aware of owner objective to increase financial wealth.

14. Adaptive Decision Making • Ultimately Chambers argue – all the main group interested in personal cash receipts from their association with the firm. • How to increase wealth ? - must continue the business • To continue business, firm must be able to engage in market transaction and this reveal by its financial position.

15. Adaptive Decision Making • Monetary value of assets and liabilities can be determined by refer to market price (selling and purchase price) • Selling price of non monetary asset is the asset’s realisable price on the basis of an orderly liquidation. (Chamber’s – CCE) • Market selling price is the only way to find the money (cash) equivalent of assets.

16. Adaptive Decision Making • Chambers state ; “ the single financial property which is uniformly relevant at point of time for all possible future action in markets is the market selling price or realisable price of any or all goods held.” • He admits that every asset has in principle value in exchange (exit price) and value in use.

17. Adaptive Decision Making EXAMPLE : • When a firm purchase a non current asset, it will change firm ability to adapt. Either purchase for cash or credit. • Adaptive behavior concept sees the firms as always being ready to dispose of the asset if this action is in the best interest. • Keep when present value future NCF > present value of expected CF from an alternative investment of the exit value of the asset.

18. Relevant And Reliable Information (Sterling) • Believes that there is one method to determine profit that is superior to all others. • The problem of income measurement is one of the valuation • Information content of valuation method • Decision usefulness

19. Relevant And Reliable Information • Using model of wheat trader to predict the consequences of currently available alternative course of action • Three decision problem 1) the continuing decision to enter and stay in the market 2) the continuing decision to holder either cash or wheat 3) the evaluation of past decisions

20. Relevant And Reliable Information • Sterling determined the following items are relevant to the decisions : - the expected future price of wheat - expected future price of other alternatives - the present selling price of wheat - present buying price of other alternative - the price at the last evaluation - the quantity of wheat and money at the last evaluation - the present quantities

21. Relevant And Reliable Information Sterling concludes that present selling price of wheat is the one item of information relevant to all decisions.

22. Relevant And Reliable Information • Sterling state - present market method of valuation is: - relevant to all user - reliable - empirically meaningful - additive - temporally consistent - more informative

23. Additivity (Chambers) • key factor in support of CCE accounting. • The present market method of valuation is the most suitable method to obtain meaningful balance sheet ‘because’ it is additive in the sense that the sum of the parts is equal to the independent measurement of the whole.

24. Additivity • Chambers comment : “… balance sheet is a series of particular statement which yield aggregates of features of the whole company… and that the aggregate can quite properly be related to one another. • One rule can be applied consistently as the valuation is at money equivalents (exit values)

25. Allocation (Thomas) • Positive feature of exit price accounting is that the financial statement are allocation-free. • Because – income statement is not report of changes, but of asset inflows and changes in the exit values of firm’s asset and liabilities in given period.

26. Reality • Involves reference to real-world examples. • Two constraints corroborated by real-world evidence : - exchangeability - existence of selling price • Exchangeability is part of the definition of an asset, so that the goodwill which cannot be sold separately, is exclude from consideration.

27. Reality • Depreciation may not incur in some year if price of the non current assets or remain constant • If no realisable value can be attributed to an item, then the item will have a zero balance. • Work in process in some cases may not have realisable value, therefore the cost will be written off

28. Objectivity • Market price are more objective • Parker – research study on the relative comparability and objectivity of exit values and historical cost carrying amounts. • result – exit value revealed less dispersion than carrying amounts . • Lack of objectivity of carrying amounts was the dispersion of accounting estimates on useful life and residual value.

29. Objectivity • McKeown conclude from statistical analysis – methods use to determine exit prices were more objective (verifiable) than the methods under GAAP.

30. Objectivity • McKeown compared four proposed models with methods under GAAP for their objectivity : 1) the CCE (exit price) 2) current replacement cost 3) historical cost adjusted for changes in the specific price level 4) historical cost adjusted for changes in the general price level • McKeown conclude – CCE model was the most objective.

31. A Measure of Risk • Exit price and changes in exit prices are often argue to be the indication of financial risk of purchasing an asset. • Example : * if exit value of an asset differ significantly from entry prices, then the asset is a risky proposition. * if exit prices rise dramatically, the opportunity cost of return increase an it must be operated more efficiently.

32. Criticisms Of Exit Price Accounting 1) Profit Concept • Bell – “Certain assets were purchased with a plan of operations in mind. That plan, those operations indeed people who developed that plan must first be evaluated before alternatives about the future can be considered, and it is the accountant’s task to provide the data for that evaluation.”

33. Criticisms Of Exit Price Accounting • After evaluation firm can decide whether to continue to use the assets or sell them and use their proceeds in some other alternative. • After expected plan is evaluated in terms of the profit made can we proceed to the next stage of deciding whether the plan should be changed and the assets sold.

34. Criticisms Of Exit Price Accounting • To comply with Bell, exit price measurement requires a concept of profit where the plan would always be to maximize the cash equivalent of the net assets over successive short term periods. • Accounting must measure past event, those that actually happened, rather than those that might happen if a firm does something other than what was planned.

35. Criticisms Of Exit Price Accounting • Weston - argues that exit price accounting provides relevant information only if the company plans to liquidate its assts. • Continue- is not relevant • In real world, unrealistic to assume decision on a continual basis. • Therefore, financial statement on an exit price basis not warranted.

36. Criticisms Of Exit Price Accounting • He also argues that using exit price accounting does not have a meaningful profit. Because inventories are restated at exit price, the effective profit from sale is zero. • The criticism implies Weston’s disfavour for exit price accounting because it has a forward-looking, decision-usefulness objective rather than a stewardship objective.

37. Criticisms Of Exit Price Accounting 2) Additivity • Anticipatory calculations cannot be added together with current figures. • But,Chambers’s– current cash equivalent of assets is to be determined on the assumptions of a gradual and orderly liquidation. • The future events must be assumed when the current cash equivalent is recorded on the balance sheet.

38. Criticisms Of Exit Price Accounting • The realisable value for an asset that has to be sold immediately in a forced liquidation may deviate greatly from that in a gradual orderly liquidation. • If cannot ascertaining current cash equivalent, then the exit price model itself violates the principle of exclusion of anticipatory calculations

39. Criticisms Of Exit Price Accounting • Larson and Schattke – indicated that the cash equivalents of individual assets sold separately and the same assets sold as a package may be quite different. • This is due to intangible factors, positive or negative usually categorized as goodwill in accounting. • They conclude that current cash equivalents are themselves not additive and Chamber’s theory does not recognized the ability of the firm to adapt in terms of combinations of assets.

40. Criticisms Of Exit Price Accounting • Staubus – contends that the result of the different measurement methods applied to an assets are substitutes for its present value. • Maybe imperfect, that does not mean they are useless. • He argues to pass up the most relevant data available because of the additivity argument ‘would indeed be foolish’.

41. Criticisms Of Exit Price Accounting • He believes that imperfect measures derived from different methods do meet the technical requirements for additivity, because they all refer to a common property, present value. • The usefulness of all accounting measurements depends on future events. Even the realisable value of an asset is not useful information unless it can be relied n as representative of what can or will happen.

42. Criticisms Of Exit Price Accounting • Staubus believes that imperfect measures derived from different methods do meet the technical requirements for additivity, because they all refer to a common property, present value. • The usefulness of all accounting measurements depends on future events. Even the realisable value of an asset is not useful information unless it can be relied on as representative of what can or will happen.

43. Other Weaknesses • Chambers – bonds payable should be stated at face value, rather than market value => Inconsistency of treatment, because should be stated at market value • Critics not persuaded the defence by Chambers because of by his definition, financial position indicates the firm’s ability to engage in transactions => logically implies the ability of firm to go into market to purchase its own bonds at the market price

44. Other Weaknesses • Inconsistent with principle current cash equivalent • Chamber – receivable = value by count after excluding amount uncollectable. • But, Iselin – receivable = factor price (amount obtainable if receivable sold to a factor)

45. Other Weaknesses • Staubus – CCE more concentrate solely on a balance sheet approach with emphasis on liquidity and current spending power or value in exchange. • Reject other theories which may also provide valuable information.

46. Value In Use Vs Value In Exchange • Adam Smith – distinction btw VUI and VIE • Exit price - ignore concept of value in use • Solomon - value to owner is relevant perspectives - flaw in Chambers’s theory – failure to recognise asset that is not for sale not directly cause its owner to suffer if its exit price is drops • Value in use - more emphasis on a long-term approach of valuation • Benchmark - external investor, interested in the prospects for future cash flow rather than current cash flow

47. Value In Use Vs Value In Exchange • Value in exchange - more concentrate on a short-term performance of the firm • Takes the viewpoint of an internal manager that is responsible to make decisions concerning of the liquidity of the firm and current spending power • Staubus : - market prices are more relevant for financial decision making - reliability and additivity are required of the measurement systems - conventional historical cost accounting has many defects

48. Value In Use Vs Value In Exchange • Barton - outputs are similar for entry and exit prices even though there is very little friction between both prices. • When prices vary significantly both system are required to give important (but different) information on value in use and value in exchange • A choice has to be made => cost-effective system to the firm

49. Mixed Measurement System & International Standards • Used for convergence in accounting policies around the world. • Supported by IASB • Miller & Loftus argues that: - market price makes financial statement more relevant - but, piecemeal standard-by-standard resulted in a lack of consistency in the valuation bases. • This reflected in the different measurement concepts used in the standards. • Examples: FRS 102, 116, 129, 136, 137 & 140.

50. Conclusion • Use exit price as valuation of assets at the time they sale the assets with the expectations of future benefit. • Has be used for liquidation to increase current cash equivalent not for profit (Weston). • Can measure the risk of financial performance (purchase an asset). • Does not relate to the firm’s performance (operating efficiency), but concerns to the price changes (financial liquidity).