Prepared by Arabella Volkov
University of Southern Queensland
References
• Text – Chapter 7
Current cost accounting
Learning Objectives
• At the conclusion of this lecture, you
should have an appreciation of:
– business profit, holding gains and the
advantages of measuring these
concepts
– the debate regarding financial and
physical concepts of capital
Learning Objectives
• At the conclusion of this lecture, you
should have an appreciation of:
– the current cost accounting standards
that have been recommended or are
used throughout the world
– the criticisms of current cost accounting
Learning Objectives
• At the conclusion of this lecture, you
should have an appreciation of:
– the counter-arguments by current
cost theorists
– the results of empirical studies
Rationale for Current Cost
Accounting
• Edwards and Bell
• the expansion problem
• the composition problem
• the financing problem
Rationale for Current Cost
Accounting
• Edwards and Bell
– Evaluation by managers of their past
decisions in order to make the best
possible decisions for the future
– Evaluation of managers by shareholders,
creditors and others
Rationale for Current Cost
Accounting
Concept of business profit
• Holding decisions
• Operating decisions
Business profits
– Current operating profit
– Realisable cost savings = holding
gains/losses
(Edwards and Bell)
Rationale for Current Cost
Accounting
Holding gains and losses
• In some cases holdings gains and
current operating profit are not
independent of each other
– Confuses management evaluation
– Hinders resource allocation
– Are holding activities successful?
– Comparing firm performance
Rationale for Current Cost
Accounting
Justifying including holding gains as
profit (Revsine):
A cost saving measures a firm’s cash
position advantage relative to other
firms in the industry that were not
fortunate to hold the given asset while
its price rose. When these other firms
do buy the asset, they will have to do so
at higher prices. As a consequence their
cash outflow will exceed the cash
outflow of the firm which experienced
the cost saving.
Why Holding Gains are a
Component of Profit
Expected income
= Market rate of return x Beginning
value of net assets
Unexpected income = Sporadic increases or decreases in
present value of net assets due to
change in expectations regarding the
level of future cash flows
Financial Capital versus
Physical Capital
CCA and calculating capital:
• Valuation method accepted as
current market buying prices but:
– 2 definitions of capital and profit
measurement
– Basic difference is whether or not
holding gains are included in profit
Financial Capital versus
Physical Capital
Sales revenue (100 x $18)
Cost of Sales (100 x $12)
Current operating profit
Holding gain (100 x $2)
Profit
Paid as dividends
Financial
Physical
capital view capital view
$1,800
$1,800
1,200
1,200
600
600
200
0
$800
$600
$800
$600
Financial Capital versus
Physical Capital
• In support of physical capital
• denotes firm’s operating capability
• Major features of physical capital
– Capital maintenance
– Valuation principles
• Non-monetary items
• Monetary items and loan capital
• Non-monetary assets bought & sold
on the same market
Financial Capital versus
Physical Capital
• Criticisms of physical capital
– different units
– decreasing costs
– same markets
– partial investment
Current Cost – A Global
Perspective
Current cost in the United States
• 1976 SEC amended Rule 3.17
Regulation S-X
• 1979 FASB Statement 33
Current Cost – A Global
Perspective
United Kingdom
• 1975 Sandilands Committee
• 1976 Inflation Accounting Steering Group
(IASG)-ED 18
• 1980 SSAP 16
• 1985 mandatory status of SSAP 16
withdrawn
Current Cost – A Global
Perspective
Australia – SAP 1 (1983)
• Statement of accounting practice
– Not mandatory
– Recommended the presentation of
CCA statements
• As supplementary information
• Or as a replacement to HC
• Not widely adopted in Australia
Current Cost – A Global
Perspective
International Accounting Standards
• IASB and FASB agree that best basis
of measurement is fair value
• Various fair value measurement
models are used by IASB in
standards
• No mention of capital maintenance
Criticisms of Current Cost
Advocates of historical cost
– CCA violates realisation principle
– Subjectivity of increase
Advocates of exit price
– Cost implies opportunity cost
– Allocation problem (Thomas)
– Current operating profits could be poor
predictors of future profits (Lemke)
– Additivity problem (Chambers)
In support of Current Cost
• Recognition principle
– Holding gains should be recognised if
there is objective evidence of a price
change
• Objectivity of current cost
– Depends upon visibility of market price
item
In support of Current Cost
• Technological changes
– Is profitability expected to be higher
with new technology?
• Current cost v. exit price
– Current cost is the normal valuation
method
In support of Current Cost
Comparison of the results with
historical cost
In support of Current Cost
Empirical studies
• Australia
• United States
• New Zealand
• United Kingdom
• Research related to the IFRS
Empirical Evidence
• Capital markets research
– Supplementary current cost data not
useful
– Not value relevant for stock prices
– Financial capital not used for valuation
• Watts & Zimmerman alternative
interpretations of results
• Financial asset current costs appear
to have more value relevance
Summary
• Proponents of CCA believe it provides
more useful information.
– Financial capital concept
– Physical capital concept
• This view is not supported by empirical
studies.
– Watts and Zimmerman offer four alternative
interpretations
• Companies argue the cost of providing
CCA information outweighs any benefit.
Key Terms and Concepts
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Current cost
Holding gains and losses
Business profit
Physical capital
Recognition principle
Where to get more
information
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Other courses
List books
Articles
Electronic sources