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CHAPTER 7 CURRENT COST ACCOUNTING

ACT 4191 : ACCOUNTING THEORY & PRACTICES. CHAPTER 7 CURRENT COST ACCOUNTING. PRESENTERS: NOR HASNI BINTI YUSUF 123263 NAZIHAH BINTI MAT NAYAN 123266 NASIHAH BINTI DAUD 127006. POINT OF VIEW OF CHAPTER 7 (CCA)/ LEARNING OBJECTIVES.

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CHAPTER 7 CURRENT COST ACCOUNTING

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  1. ACT 4191 : ACCOUNTING THEORY & PRACTICES CHAPTER 7CURRENT COST ACCOUNTING PRESENTERS: NOR HASNI BINTI YUSUF 123263 NAZIHAH BINTI MAT NAYAN 123266 NASIHAH BINTI DAUD 127006

  2. POINT OF VIEW OF CHAPTER 7 (CCA)/ LEARNING OBJECTIVES • 1st methodical presentation of FV (contra with ‘Historical cost’-Chapter 6) • Business profit, holding gains & advantages of measuring these concepts – LEARNING 1 • Financial capital Vs. Physical capital (learn in Chapter 5) & significantly affects the derived measure of profit - LEARNING 2

  3. Cont’d.. • Support in a global context & international accounting standards - LEARNING 3 & 4 • Critically evaluated - LEARNING 4 & 5 • Empirical evidence reviewed - LEARNING 6 • Issues in Malaysia

  4. What is current cost accounting (CCA)? • Assets are valued at current market buying prices (con. with historical- real prices) • Profit determined by allocation based on current costs • i.e current cost to buy

  5. Why use CCA? • Edwards & Bell: ‘kinds of decisions managers are faced’-allocate resources-max profit Expansion problem Composition problem 3 Q of fundamental problem

  6. Cont’d.. • Information needs of management (accounting information objectives): -evaluate the performances by both internal & external -provide a sound & equitable basis for taxation

  7. LEARNING OBJECTIVE 1.0 1.1 Business profit 1.2 Holding gains & losses 1.3 Why holding gains are a component of profit

  8. 1.1 Concept of business profit Edwards & Bell: “Business profit” comprising • Current operating profit • Realisable cost saving

  9. 1.2 Holding gains & losses • CCA-mixing holding & operating gains/losses are confused. • So, allows the separation • Drake & Dopuch, and Prakash & Sunder- interrelated (separation not meaningful)

  10. 1.3 Why holding gains are component of profit? • Edwards & Bell: ‘a saving attributable to the fact that the input was acquired in advance of use. This saving is attributable to holding activities..’

  11. Cont’d… • Revsine: ‘..benefit from the increase in the price of assets…cost saving is a component of income (opportunity gain)…’ -Current cost profit-lead indicator of future cash flows

  12. LEARNING OBJECTIVE 2.0 FINANCIAL CAPITAL VS. PHYSICAL CAPITAL

  13. Financial vs. Physical capital • Market value accounting systems- calculation ofprofit depends on the measure of capital. • Profit more precisely defined as the change in capital over the reporting period (con. with historical-multitude of accounting convention)

  14. Cont’d… • CCA provide 2 fundamental & competing views: -THE FINANCIAL CONCEPT (FC) -THE PHYSICAL CONCEPT (PC) • Main difference between FC & PC: ‘whether or not holding gains (losses) are included in profit’ • Refer illustration provide on pg 178.

  15. Cont’d… • Argument by supporters of FC: -a firm invests financial resources (with expectation-create a higher level of cash inflow) -recovery amount invest is a ROC. -cash flow in excess of financial invest are ROC. -  in financial resources to maintain physical operating capability ≠  in financial resources to expand the physical operating capability.

  16. Cont’d… • Argument by supporters of PC: -physical units denoting the firm’s operating capability (Chap. 5 recap) -2 arguments (holding gains as profit): (i) cost savings (ii) represent  in the future cash flow of the asset

  17. Cont’d… -Samuelson: ‘changes in the current cost should be a capital maintenance adjustment’ –holding gains should not be included in profit.

  18. Cont’d… • Major features of the physical capacity system: (1) Capital maintenance (2) Non-monetary items (e.g; land) (3) Monetary items & loan capital (4) Non-monetary assets bought & sold on the same market (e.g; shares & commodities)

  19. Cont’d… • Criticisms of physical capital: -Sterling: ‘profit under the physical capital view is meaningful only if these 4 condition are met’ (1) continues to replace identical units (2) faces continuously increasing costs (3) buy & sells in different markets (4) is fully invested in the physical unit

  20. Cont’d… • -if 4 condition in the previous slide not met, serious measurement problems are encountered. Which are: (1) Different units (2) Decreasing costs (3) Same markets (4) Partial investment

  21. LEARNING OBJECTIVE 3.0 CURRENT COST – A GLOBAL PERSPECTIVES

  22. Current cost in the United States • 1976-US SEC amended Rule 3-17 of Regulation S-X to require that certain replacement cost data be disclosed in the 10-K reports filed by firms with inventories and productive assets totalling more than UK$100m and consulting more than 10% of total assets. • This requirement was published in ASR 190. • 1979-FASB issued Statement 33-required supplementary disclosures of constant dollar and current cost data • Because of this, SEC issued ASR 271. • Then, FASB issued Statement 89 in 1986. • In Statement 33, the FASB required companies to disclose information on: 1) profit from continuing operations on a current cost basis for the current financial year, using nominal dollars 2) the current cost of inventory and property, plant and equipment at the end of the current financial year, using nominal dollars 3) changes in the current cost for the current financial year of inventory and property, plant and equipment, using a constant dollar basis

  23. Current cost in the US (cont’d)….. • Companies must disclose the following current cost information on a nominal dollars basis for each of the most recent 5 years: 1) profit from continuing operations 2) profit per ordinary share from continuing operations 3) net assets at financial year-end • Nov 1984-Statement 82, eliminated the requirement to report historical cost/constant dollar information for companies that disclose current cost information.

  24. Current cost in the United Kingdom • 1975-Sandilands Committee recommended a system of CCA. • Based on a concept of ‘value to the business’. • Holding gains reflect current economic conditions, should be disclosed but not included in profit. • The proposal endorsed by gov and accepted by Accounting Standards Steering Committee (Acctg. Stand. Committee) • 1976-IASG established • March 1980-ASC issued a statement (SSAP 16). • 1985-ASC withdrew the mandatory status of SSAP 16.

  25. Current cost in Australia • Oct. 1976-Issued DPS 1.1, Statement of Provisional Acctg. Stand. (PAS). • Aug. 1978-Amendment version based on maintaining the firm’s operating capacity intact. • Nov 1983-Acctg. Practice SAP 1 was issued due to criticisms, lobbying by firms and individuals and lack of any material. • A distinction is made between a ‘statement of acctg. practice’ and ‘Australian acctg. stand.’ • SAP 1-not widely adopted

  26. International accounting standards and current costs • Some countries implement some form of CCA but not widely adopted. • 15 July 2004-AASB voted to adopt international acctg. stand. for all reporting entities preparing general purpose financial reports after Jan 2005. • IASB and FASB agreed that the best measurement is fair value. • E.g. Under IAS 16/AASB 116 Property, Plant and Equipment the fair value is the cost price at the date on which the acquirer obtains of assets must decide the measurement model to be used.

  27. LEARNING OBJECTIVE 4 CRITICISM OF CURRENT COST

  28. Two different camps: 1)Those who subscribe to historical cost - Reject CCA because violates the traditional realisation principle. - CCA anticipates operating profit. - The subjectivity of determining the amount of the increase in cost.

  29. 2) Those who believe in exit price accounting - The term ‘cost’ implies the opportunity cost or sacrifice of the next best alternative. - The current sacrifice faced by a company to sell the asset rather than use it, but not to buy it because the company already has it. - Thomas : allocation problem - Lemke : technologically improved assets are likely to replace existing assets, so that current operating profits, based on existing mode of production, would be poor predictors of future profits. - CCA entails mathematical problem of additivity (variety of measurement methods). - Chambers : figures must be the same nature or of the same domain, use of specific price index - Irrelevant to most investment decisions, not focus on the firm’s ability to command financial resources in the firm’s quest to adapt itself to the environment.

  30. LEARNING OBJECTIVE 5 & 6

  31. THE COUNTER-ARGUMENTS BY CURRENT COST THEORIST • Recognition Principle • - current cost and financial capital theorists • - historical cost and physical capital theorists • 2. Objectivity of Current Cost • - historical cost theorists • - current cost theorists • 3. Technological Changes • - Edward and Bell • - current cost theorists • - Lemke • - Revsine

  32. Cont’d…. • Current Cost versus Exit Price • - current cost theorists • - Edward • Comparison of the Results with Historical Cost • - TABLE 7.1, page 192 • - TABLE 7.2, page 193

  33. EMPIRICAL STUDIES 1. From Australia

  34. 2. From United States

  35. 3. From New Zealand

  36. 4. From United Kingdom

  37. Recent research related to IFRS • -IASB decided to report income on a comprehensive basis Other Comprehensive Income Comprehensive Income Net Income = + e.g :unrealised gain and losses on financial investments and non-current assets, and changes in foreign currency translation reserves, pension reserves, extraordinary items, and other sundry reserve adjustment items -debate from other scholar: i) Barth and Clinch (Australia) ii) O’Hanlon and Pope (United Kingdom) iii) Dhaliwal, Subamanyam and Trezevant (United States) iv) Cahan et al. (New Zealand)

  38. Issue 1: PNB on firms’ privatisation Move will unlock fair value • SOURCE:THE STAR ONLINE(http://biz.thestar.com.my/news/story.asp?file=/2007/6/27/business/18140923&sec=business) • DATE: 27 JUNE, 2007 ‘KUALA LUMPUR: Permodalan Nasional Bhd's (PNB) decision to privatise the companies it controls is based solely on strategic investment principles and not for the sake of owning the firms per se, said chief executive officer Tan Sri Hamad Kama Piah. Speaking after announcing the income distribution for Amanah Saham Didik (ASD) yesterday, he said the de-listing exercises were aimed at unlocking the fair value of the companies that PNB was familiar with. “It's better to focus on growing companies with strong potential than investing in the stocks of companies that are alien to us,” Hamad said. He said PNB went for prudent long- term investment in companies, mainly those that consistently returned the desired dividends which in turn were distributed to its unit trust holders.’

  39. Issue 2:Oil and gas sector capex cycle to benefit Scomi • SOURCE:THE STAR ONLINE (http://biz.thestar.com.my/news/story.asp?file=/2007/10/12/business/19147956&sec=business) • DATE: 12 OCTOBER, 2007 ‘Scomi Group Bhd may be a beneficiary of a capital expenditure (capex) cycle in the oil and gas sector, where there is sustained earnings growth for select equipment companies due to high oil prices. The price of crude has hovered around US$80 per barrel in the last few weeks. Scomi Group, which has four other listed companies in Singapore and Malaysia, has businesses in oil services and energy logistics. It has a current order book of RM1.6bil. in a statement, US-based investment bank Goldman sachs said the exploration and production capex trade was a developing theme and that Scomi Group was among the companies in the sector that would benefit. It recommended buying the stock at RM2.25 based on sum-of-parts net asset valuation with a potential fair value of between RM2.10 and RM2.20, implying a 45% to 50% upside.’

  40. T.Q.

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