Elliott - Chapter 7 - Accounting for price-level changes

Question 1

Inflation accounting: Current value accounting disadvantages (5)

Answer 1

1. destroys factual nature of HCA, which is transaction based
2. Not as objective as HCA as less verifiable
3. Entails recognition of unrealised profits
4. claimed improvement of compatibility is myth due to the subjectivity of valuing by each
5. Lack of single accepted method computing current values - one fault laden system is usurped by another

Question 2

Main three models for current income valuation?

Answer 2

1. Current purchasing power (CPP, GPP)
2. Current entry cost or replacement cost (RC)
3. Current exit cost or net reliable value (NRV)

Question 3

Orientation of four models:

Answer 3

CPP: Shareholder - CPP of shareholder funds
RCA: Management - replacement of assets

Question 4

Virtues of CPP (3)

Answer 4

• it is an objective measure since it is transaction based
• is is a measure of shareholders capital in turns of PP
• introduces concept of monetary items distinct from non-monetary

Question 5

Defects of CPP (4)

Answer 5

• HCA based but adjusted
• is not a currency value statement - inflation may be wrongly stated
• it creases alien units of measurement
• its concept of profit is dangerous

Question 6

RCA Virtues (3)

Answer 6

• It is a unit of measurement
• it identifies and isolates holding gains
• It introduces realistic current values

Question 7

RCA Defects (2)

Answer 7

• it is a subjective measure - replacement based on estimates
• it assumes replacement of assets - may not be replaced by replacement assets?

Question 8

NRVA Virtues (3)

Answer 8

• readily understood by user
• avoids need to estimate depreciation
• based on opportunity cost

Question 9

NRVA Defects (7)

Answer 9

• subjective measure
• not a realistic measure as most assets, except finished goods are possessed in order to be utilised, not sold.
• it is not always determinable
• it violates concept of going concern
• less reliable and less verifiable than hc
• comp income statement more volatile if NRV reported each year
• profits arising from NRV may not be realised

Question 10

Benefits of CCA (current cost accounting)

Answer 10

Inflationary price increases in raw materials are removed, and thus is more realistic to HCA profit
Gives HCA holding gains content - holding gains/losses are quite different to operating gains/losses and HCA dos not distinguish between the two

Question 11

CC profit is important because: (3)

Answer 11

1. It quantifies cost and sales of depreciation after allowing for changing price levels.
2. resources are maintained as a result of eliminating possibility of paying dividends out of real capital
3. yardsticks for management performance are more comparable as a time series within one entity and between entities.