Financial Reporting: Measurement Issue

Define and differentiate accounting and

economic profit Explain the definition, reasons and criticism of historical cost Explain the definition, reasons and criticism of current cost Explain the definition, reasons and criticism of exit price

Introduction
The profit measurement is probably the

most important function of financial accounting. Investors, bankers and others are interested in knowing how well the business is doing. (M W E Glautier,2001) Profit = measurement of performance of the managers in handling the resources entrusted to their care and use.

What is profit?
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Introduction
The issue is, how to determine the real value of net assets adopted and reported in the financial statement. The cost attached theory

- different perception between economist and accountants

 Displacement cost

- similar like opportunity cost

Embodied cost

- factor of production concern with what has been outlaid on input.

1. Historical Cost
Definition: original monetary value of an economic item. Assumptions: Flow of costs: trace the movement of cost attached to the goods and services Stewardship: accountable for the application of assets to operations

1. Historical Cost: Supports

a. Relevance
b. Verifiable c. Useful

d. Understandable
e. Objective f.

Insufficient evidence to reject HC

1. Historical Cost: Criticisms

i. Objectivity of accounting is too narrow Investors are interested to know about the original amounts invested directly or indirectly by the equity holders. ii. Information for decision making Insufficient to evaluate business decision

1. Historical Cost: Criticisms

iii. Basis of historical cost - Going concern assumption iv. Matching - No established concept exists to ascertain proper matching

2. Current Cost Accounting (CCA)

Definition: real time" price. Assets are valued at current market buying price However, market values are often unavailable

2. CCA : Criticism
Subjective determination
Fixed assets value Irrelevant if the company plan to use the

assets Anticipate profit, never realized Violates the traditional principles

3. Exit Price Accounting (EPA)

Definition: The price that would be received to sell an asset Valued at the net realizable amount that the firm would expect to obtain if they are disposed the assets

3. EPA: Supports
a. Useful information accountant should report all profits and losses and values as determined in competitive market
b. Relevant and reliable c. Adaptive decision making Attempt to adjust to the competitive business environment

d. Additivity monetary equivalent, result in more meaningful financial statement

3. EPA: Supports
e. Allocation free No cost allocation such as depreciation f. Reality g. Objectivity Exit value is less dispersion ( not so much different) compare if use HC

h. A measure risk If purchases of respective asset is high (exit price is significant), the company can reconsider the decision.

3. EPA: Criticism
a.

Profit concept Does not provide relevant data to match against revenue

b. Value in use vs value in exchange Ignores the concept of value in use

c. Additivity

Class Assignment
Which qualitative characteristics of

financial statement will affect if the company decides to use whether historical cost and current cost.