Conceptual framework: Measurement

Question 1

Measurement bases of Financial reporting

Answer 1

• historical cost: the actual amount of cash paid or consideration given for the item
• current cost: the cash that would be paid to replace the asset at current values, reflecting the asset’s age and condition
• fair value: the amount the item would realise in an orderly arm’s length disposal
• value in use: the discounted value of future cash flows

Question 2

Features of the historical cost accounting

Answer 2

• accounting transactions are recorded at their original historical monetary cost
• ignore no monetary transactions
• income taken into account if it’s in monetary form or will be soon converted into cash
• profit is found by matching income against the cost of items

Question 3

Advantages of historical cost accounting

Answer 3

• easy to understand
• straightforward to produce
• historical cost accounts are objective and free from bias
• values are reliable and original values
• do not record gains until they are realised

Question 4

Disadvantages of historical cost financial statements

Answer 4

• carrying amount of non-current assets is often substantially below the current value
• Inventory in the statement of financial position reflects prices at the date of purchase or manufacture rather than those current at the year end
• statement of profit or loss expenses do not reflect the current value of assets consumed, so profit in real terms is exaggerated
• no account is taken of the effect of increasing prices on monetary items

Question 5

What is the net replacement cost?

Answer 5

• is the replacement cost of an asset less an appropriate amount of depreciation

Question 6

What is the net realisable value?

Answer 6

• also known as fair value less costs to sell
• is the estimated sales proceeds less any costs involved in selling the asset

Question 7

What is the economic value?

Answer 7

• value in use
• is the present value of the future cash flows from an asset

Question 8

What are the alternatives to historical cost accounting?

Answer 8

• constant purchasing power CPP
• current cost accounting CCA

Question 9

What are the key features of CPP?

Answer 9

• financial statements are adjusted to show all figures in terms of money with the same purchasing power
• a general price index is used for this, applying a general level of inflation
• figures in the statement of profit or loss and statement of financial position are adjusted by the CPP factor
• CPP factor = Index at the reporting date/Index at date of initial recognition

Question 10

What are monetary items?

Answer 10

• are those whose amounts are fixed by contract or otherwise in terms of numbers of units of currency, regardless of changes in general price levels
• cash, receivables, payables and loan capital

Question 11

What are non-monetary items?

Answer 11

• include such assets as inventory and non-current assets
• are assumed neither to gain nor to lose purchasing power by reason only of changes in the purchasing power of the unit of currency

Question 12

Advantaged of CPP accounts

Answer 12

• CPP accounting is both simple and objective. It relies on a standard index
  -it adjusts for changes in the unit of measurement and therefore is a true system of inflation accounting
• it measures the impact on the entity in terms of shareholders’ purchasing power

Question 13

Disadvantages of CPP accounts

Answer 13

• it fails to capture economic substance when specific and general price movements diverge
• the unfamiliarity of information stated in terms of current purchasing power units
• CPP does not show the current values to the business of assets and liabilities
• the general price index used is not necessarily appropriate for all assets in all businesses

Question 14

Key features of current cost accounting CCA

Answer 14

• it is based on deprival values or value to the business
• inventory and non-current assets are valued at deprival value
• monetary assets(cash, receivables, payables, loans) are not adjusted
• an additional charge to the statement of profit or loss reflects the deprival a value of inventory within cost of sales
• an additional charge in the statement of profit or loss reflects deprival value of non-current assets

Question 15

Advantages of CCA

Answer 15

• is its relevance to users
• users will be able to assess the current state or recent performance of the business
• assets are stated at their value to the business

Question 16

Disadvantages of CCA

Answer 16

• possibly greater subjectivity and lower reliability than historical cost
• lack of familiarity
• complexity
• CCA only adjusts values for non-monetary assets not all assets/liabilities.

Question 17

Practical problems of CCA

Answer 17

• it is not always easy to obtain an index which is perfectly suitable for measuring the movement in the current cost of a particular type of asset
• it is often difficult to obtain a suitable market value for specialist items, but indices may be constructed as an alternative
• there maybe no modern equivalent asset due to the advance of technology