Financial Accounting - income concepts - Flashcards in University Accounting

the central definition of income

income is the amount a person could spend in a period and still remain as well off at the end of the period

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1. income as interest

increase in value as discounted future services come nearer, product of capital value and given interest rate for the period

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2. capital maintenance (Hicks #1)

amount which could be spent in a period without depleting capital

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3. consumption maintenance ( nominal Hicks #2/ real Hicks #3)

amount that could be spent in a period (nominal/ real) and still permit the spending of the same amount in ensuing periods

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1. income as interest formula

capital x interest

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2. capital maintenance formula

capital at the end of the period - capital at the beginning

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3. consumption maintenance formula

(capital at end of period - income)(1+nomial/real IR next period)(nominal/real forever)

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ex ante/ ex post

ex ante: K0(at 0) or K1(at 0)/ ex post: K0(at 1) or K1(at 1)

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working out ex ante/ ex post answers...

(1) calculate the PV of CF at time 0 by discounting from IR and CF given (2) apply ex ante/ex post formulas

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Windfall definition

changes in value of capital arising from changed expectations (ex post - ex ante)

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Holding gains/ losses definition

changes in asset values which occur whilst an owner has possession of an asset, useful as helps to split day-to-day operations and market movements

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realised/ unrealised HG

realised if owner sells asset for money/ unrealised if asset is retained

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difference between windfall and HG

may make a HG on an asset but not a windfall as expectations may not have changed (expected market value to increase)

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3 fundamental issues in measuring business profit

(1) Capital maintenance concept (2) Valuation basis (3) Profit realisation

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Fundamental issue 1: capital maintenance concept

how 'welloffness' is to be measured, keeping capital that will maintain profits: (1) Financial Cap M (Hicks#1) (2) Physical Cap M (Hicks#2#3) (3) Hybrid

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Fundamental issue 2: Valuation basis

How are assets to be valued: (1)Historical cost (2)Value to the business (3)Fair value (assuming market) (4)Realisable value (5)Value in use (6)Recoverable amount

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Fundamental issue 3: Profit realisation

what determines accounting recognition of a transaction?: (1) contractual agreement (2) when MV changes (revaluation model) (3) when cash changes hand (very prudent)

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Entry value accounting (Current/ replacement cost accounting)

what you would pay to get identical replacement of asset/liab in the business

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CCA principles

(1) when wanting to continue in operational existence (2) SOFP (replacement cost at reporting date) (3) SOCI (replacement cost at transaction date)

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CCA SOFP

everything changes except monetary items (TR/ cash/ share capital/ TP)

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CCA SOCI Split

(1) Current operating profit (usual IS) (2) Current entity income (holding gains/losses) (3) Current ownership income (less interest charges and HG on debentures)

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CCA SCSE

same except retained earnings is now current ownership income

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T account equation

Asset + expenses = liabilities + owners equity + income

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CCA inventories method

(1) T account Dr +ve Cr -ve, (2) show realised (used up/sold) and unrealised (c/f) by splitting table into amounts under historic cost and under current cost

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CCA NCA (no depreciation) method using specific indices

(1) equation: closing CC = opening CC x (closing specific index/opening specific index), (2) T account Dr +ve Cr -ve, (3) calculate realised and unrealised

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CCA NCA (depreciation) method using specific indices

(1) equation (2) Depr in SOFP (closing CC less depr) Depr in SOCI T accounts (assume used evenly throughout year) (3) calculate realised and unrealised

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CCA Debentures method

want to replace set of cash flows with identical set (tied in) (1) SOFP (disc out future maturity amount to PV at CC of raising funds) (2) SOCI (expense current IR on valuation of debt, using CC, not what actually paid) (3) T account Dr -ve Cr +ve

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CCA methods to calc COS and HG on inventories

(1) continuously updating (NIFO one a/c) (2) NIFO (two a/c - historical cost and revaluation) (3) Cost of sale adjustment formula (for SOFP equation/SOCI historical COS + equation )

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CCA methods to calc COS: COSA equations

SOFP: historical cost of C/I x (index at rep date/index at avg date of acq of C/I) SOCI: COS= historical COS + COSA ((C-O) - Ia ((C/Ic)-(O/Ic)))

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CCA advantages

(1) provides more information (2) proper maintenance of operating capacity (3) figures relevant to balance sheet date (4) consistent with acc concepts (5) HG recognised and reported when occur (6) comparisons more valid + meaningful (7) practicable

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CCA disadvantages

(1) requires more subjectivity therefore less audit able (2) figures for assets not intended/can't be replaced (3) fails to show what business worth (selling) (4) doesn't take into account general inflation

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CCA real terms definition

strips out any gains from inflation in HG

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CCA real terms recognition

SOFP (share capital and ret earnings change) SOCI (capital maintenance adjustment which leads to real current ownership income) SCSE (inflate opening balance by capital maintenance adjustment, then use new b/f amount)

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Exit value accounting (COntinuously COntemporary Accounting) defintion

value using NRV (price you could sell asset for/ pay to settle liab - costs to get to that point)

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COCOA princicples

(1) price variation adjustments only (unrealised HG) as only occur at reporting date (2) capital maintenance adjustment included for inflation (3) no remeasurement of expenses (like CCA)

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COCOA advantages

(1) follows opportunity cost principle (rationality) (2) facilities comparison (common measure) (3) easy for non-accountants to understand (4) useful info to outsiders (decisions for creditors) (5) already widely used (6) don't include impairment

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COCA disadvantages

(1) most subjective (how to sell) (2) fails to follow going concern assumption (firms don't sell all) (3) concentrates only on short term (4) doest sow internal usefulness of asset (highly specialised)

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Deprival value to the business model (Assets) definition

different method which measures assets and liab at what they are worth to the business (how much worse off without the asset)

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DVB model (assets) diagram tree

(LOWER OF) replacement cost and recoverable amount (HIGHER OF) value in use and net realisable value

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DVB model (profitable/ unprofitable assets)

profitable (recoverable amount>replacement cost so would replace if deprived) unprofitable: (replacement cost>recoverable amount so wouldn't replace if deprived)

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Relief value to the business model (liab) definition

how much better off would the business be if relieve of a liability

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RVB (liab) diagram tree

(HIGHER OF) consideration and settlement amount (LOWER OF) cost of performance and cost of release

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RVB model (profitable/ unprofitable liab)

profitable (consideration>settlement amount so choose consideration - paid in cash to take on obligation) unprofitable (settlement > consideration so would be better off with settlement amount)

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Current purchasing power accounting definition

measurement of profit after allowing for the maintenance of the purchasing power of the share holders capital

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CPP principles

(1) revalues measurement basis (currency) (2) non-monetary shown at original cost x infl (3) monetary items at original cost (4) capita b/f and reserves inflated (5) SOCI indexed by amount came in at to rep date (6) infl loss on net monetary items

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CPP SOFP monetary and non monetary

monetary (amount x (RPI reporting/RPI acquisition)) non monetary (amount at historic cost)

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CPP SOCI

assume arose mid year (amount x (RPI reporting date/RPI half year)) net monetary items (split NMI start of period + impact of infl, assume o/b and c/b change mid year and inflate to end of year)

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CPP comparative SOFP

update ALL figure (monetary and non monetary) (Amount x (RPI current period reporting date/RPI prior period reporting date))

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CPP advantages

(1) facilitates proper comparison and usefulness (across time) (2) distinguishes between gains/losses on monetary A+L and operational gains/losses (3) objective and simple adjustment to historic costs so easily auditable

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CPP disadvantages

(1) general purchasing power has no direct relevance to particular person/ situation (2) contains most of negatives from Historic cost accounting (possibly even worse) (3) misleading SOFP value (4) therefore difficult to understand and interpret

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Financial Accounting - income concepts

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