Accounting theory

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Accounting theory by Mind Map: Accounting theory

1. System approach to accounting

1.1. Inputs

1.1.1. Measured elements of transactions

1.2. Throughput (method process)

1.2.1. Operations: the program classifying, selecting, matching

1.3. Outputs

1.3.1. Financial statements (disclosures)

2. Capital Maintenance

2.1. Amount of dollars that can be distributed as income without impairing capital

2.1.1. Determines total income

2.2. 2 major issues

2.2.1. 1. Preserve capital

2.2.2. 2. Distribute income

2.3. Types

2.3.1. Financial Capital

2.3.1.1. Can distribute BUSINESS INCOME (COP+RHG+UHG) and still maintain capital

2.3.2. Physical Maintenance

2.3.2.1. Can only distribute TRADING GAINS (COP)

2.4. Net Asset = C + RE

2.5. Impact on changing prices

2.5.1. General Price Index (Inflation)

2.5.1.1. Constant Dollar

2.5.1.1.1. Approach

2.5.1.1.2. Evaluaton

2.5.1.1.3. Criticism

2.5.1.2. Eg CPI

2.5.1.2.1. frequency and timeliness

2.5.2. Specific Price Index

2.5.2.1. Buying market

2.5.2.1.1. Input prices

2.5.2.2. Selling market

2.5.2.2.1. Historical entry price

2.5.2.2.2. Trading gain Realized cost change/ HG Unrealized cost change

2.5.2.2.3. Realized exit price

2.5.2.3. Measure in terms of operating capacity

2.5.2.3.1. Physical capital maintenance

2.6. What does CM Rule do?

2.6.1. 1. Determines lifetime income

2.6.2. 2. Defines measure of capital & measure of income

2.6.3. 3. Determines composition of OE Section of BS

2.6.3.1. Restates beg & earned capital balances into end of period units

2.6.3.2. Excess ending capital above the restated original capital is an increment income to earned capital

2.6.4. 4. Allocates increment btwn

2.6.4.1. Adjustment of opening capital

2.6.4.2. Income for the period

2.6.5. 5. Differentiates return on capital from return of capital

2.7. Comments

2.7.1. Timing problems

2.7.1.1. Entry Price (RC)

3. Measurement

3.1. Nominal Dollars

3.2. Constant Dollars

4. Accounting models

4.1. HC

4.1.1. Exchanges

4.1.1.1. Reciprocal flows of services

4.1.2. Dr = Cr

4.1.3. Yesterday

4.1.3.1. Verifiable, objective evidence

4.1.4. Fundamentals

4.1.4.1. 3 elements mandatory

4.1.4.1.1. Date set

4.1.4.1.2. Measure

4.1.4.1.3. Concept of entity

4.1.4.2. Systems approach

4.1.4.2.1. Services (flow concept)

4.2. CV

4.2.1. Elements of wealth

4.2.1.1. Sum of PnQn

4.2.2. Today

4.2.3. Entry Value

4.2.3.1. Replacement Cost

4.2.3.1.1. Based on hypothetical transaction

4.2.4. Exit Value

4.2.4.1. Net Realizable Value

4.2.4.1.1. FV accounting

4.2.5. Fundementals

4.2.5.1. Systems approach

4.2.5.1.1. Scare resources (stock concept)

4.3. PV

4.3.1. Expected CF

4.3.1.1. NPV

4.3.2. Tomorrow

4.3.3. Fundementals

4.3.3.1. Systems approach

4.3.3.1.1. Expected cash flows (stock concept)

5. Summary of CM & NAV

5.1. CM determines the adj factor for items which differ in timing

5.2. CM necessary & sufficient for calculating lifetime income

5.3. But CM not sufficient for calculating periodic income

5.4. Valuation of paid-in capital depends on CM rule

5.5. NAV rule determines amt and timing of HG/L

5.5.1. Explicitly governs A&L effects in IS

5.6. CM Concept determines extent to which these HG & HL avail for distribution

5.7. RE affected by both CM and NAV rules

5.7.1. Together determines periodic Y

6. GDP Topics

6.1. Accounting theories

6.2. Agency theory

6.3. Allocation

6.4. Economic Consequences

7. Net Asset Valuation

7.1. Types

7.1.1. Straight line method

7.1.2. Economic income

7.1.2.1. Certainty

7.1.2.1.1. Capital is a prerequisite to determining income

7.1.2.2. Uncertainty

7.2. What does NAV Rule do?

7.2.1. Determines total amt of OE section

7.2.1.1. Measure assets and liabilities at a specific point in time

7.2.1.2. Determines timing of income recognition

7.2.1.3. Allocates lifetime income to accounting periods

8. Current Entry Values

8.1. Edwards & Bell Model

8.1.1. Focus is to evaluate past decisions of managers and efficiency of firm

8.1.1.1. Operational decisions (pt of recognition)

8.1.1.2. Holding decisions & pre-recognition of values changes over time (b4 pt of recognition)

8.1.1.3. Eg, COP, PCM, measure of managers &not firm, unrealized income out of carol of managers Business income, measure of firm specific price changes

8.1.2. Entry value income

8.1.2.1. Reflect value added to resources

8.1.2.2. Reflect an adjustment to capital for CM

8.1.3. 3 types of holding gains based on types of resources

8.1.3.1. 1. Inventory HG

8.1.3.1.1. RHG

8.1.3.1.2. UHG in replacement cost of RM, WIP, FG

8.1.3.2. 2. Fixed Assets cost savings

8.1.3.2.1. RHG & UHG in RC of DEPRECIATED FA

8.1.3.3. 3. capital gains

8.1.3.3.1. RHG & UHG in RC of UNDEPRECIATED FA

8.1.4. Concept of Business Income

8.1.4.1. Accounting income HC (NI)

8.1.4.1.1. Ya = COP + RHG' + RHG

8.1.4.1.2. However, COP is measured in terms of PCM

8.1.4.2. Business income

8.1.4.2.1. Yb = COP + RHG + UHG

8.1.4.3. Once all gains are realized, Ya = Yb

8.1.4.3.1. Ya = Yb

8.1.4.4. FCM vs PCM

8.1.4.4.1. Concerns how much can be distributable income

8.1.4.5. Real business profit

8.1.4.5.1. Scale : CD

8.1.4.5.2. CM concept: current entry value in terms of PP

8.1.4.5.3. Example

8.1.4.6. RC model

8.1.4.6.1. Advantages of RC

8.1.4.6.2. Disadvantages of RC

8.1.4.6.3. Are HG income?

9. Current Exit Values & Realizable Income

9.1. Exit value income

9.1.1. Yr = D + (Rn - [Rn-1])

9.1.1.1. Yr: realizable income D: periodic distribution of Y Rn: closing capital on exit price basis

9.1.2. Critical issues

9.1.2.1. What selling price should b used?

9.1.2.1.1. Assumed liquidation of whole entity

9.1.2.1.2. Assumption of orderly liquidation (general view)

9.1.2.2. What state shud realizable values focus on?

9.1.2.2.1. Existing state

9.1.2.2.2. Finished state adjusted for future costs

9.1.3. Based on economic concept f opportunity cost

9.1.3.1. What it could acquire with cash IF it would have realized its existing resources

9.1.4. Arguments in support of Exit Value

9.1.4.1. Realizable values are measures of current sacrifices & alternatives choices

9.1.4.2. Emphasizes a vital economic decision, opportunity costs

9.1.4.3. Comparable data is required

9.1.4.3.1. Entry value reflects "value to owner" only

9.1.4.4. Entry values claimed to be invalid

9.1.4.4.1. Don't reflect info on alternative choices

9.1.4.4.2. RC reflects a static or holding positions

9.1.4.4.3. Sterling argues that entry value model is based on the invalid & unnecessary assumption of "going concern"

9.1.4.5. Exit values are understandable

9.1.4.5.1. Commonly interpreted as market values

9.1.4.6. Evidence of use of realizable values in practice

9.1.4.6.1. Chambers argues that we already use exit values in many current situations

9.1.5. Concept of Realizable income

9.1.5.1. Yr = RG + UG

9.1.5.1.1. Comprised 2 components in terms of exit values

9.1.5.2. Yr recognizes unrealized value changes in the period they arise

9.1.5.2.1. Thus doesn't include realized gains of previous period

9.1.5.3. Holding gains as realizable income

9.1.5.3.1. Capital in exit value model is an expression of the entity's overall command over gds & svcs

9.1.5.3.2. No intention to maintain PC

9.1.5.4. Case against Realizable Income

9.1.5.4.1. Does not pay attention to operational effectiveness of entity

9.1.5.4.2. Doesn't differentiate btwn those gains which are within control of mgmt

9.1.5.4.3. Apparent assumption of liquidation of entity's resources

9.2. CoCoA model (Chambers)

9.2.1. Scale: CD & ND

9.2.2. CM: FC in terms of PP

9.2.3. Attribute: qty of A & L in terms of selling price or NRV, Current Cash Equivalent (CCE) or command over cash

9.2.4. Objective: provide firm with adaptive capacity in a world of competing alternatives

9.2.5. I/S format Sales Less: CoGS GP Inventory price change Adjusted GP Adjustments: Change in NRV of assets Less operating expenses CM adjustment Profit

9.2.5.1. B/S features

9.2.5.1.1. CCE is a calculated for A&L

9.2.5.1.2. Assets must be separable (otherwise zero value)

9.2.5.1.3. Ct1 reflects a GPL adjustment

9.2.5.1.4. Note that if assets do not have a readily available market price, they are assumed to have a ZERO VALUE even though the asset may still be in use or be usable (VIU concept)

9.2.6. Contribution of model

9.2.6.1. Shows liquid position of firms in terms of a basket of cash

9.2.6.2. Gives relevant infor for

9.2.6.2.1. Making future decisions

9.2.6.2.2. Assessing present position of the firm

9.2.6.2.3. Evaluating firms past position

9.2.6.3. Model is allocation free

9.2.6.4. No additivity prob

9.2.6.4.1. Eliminates timing problem & measurement error

9.2.6.5. Basis for contemporary "mark-to-market" rule

9.2.6.6. Emphasizes a BS in terms of adaptive capital which means NRV

9.2.6.6.1. If environment changes, then firm must liquidate and replace with new assets to survive

9.2.6.7. No distinction made btwn operating and holding activities

9.2.6.8. No distinction btwn realized and unrealized profits

9.2.6.9. Periodic profits shud include net effect of GPL changes

9.2.7. Limitations

9.2.7.1. Based on a liquidation concept

9.2.7.2. Absence of markets vs assets in use

9.2.7.3. Aggregation problem (BS)

9.2.7.4. Problems interpreting BS

9.2.7.5. NRV don't predict future earnings

9.2.8. Criticisms

9.2.8.1. A new and too radical system

9.2.8.2. Subjectivity is hnacceptable

9.2.8.3. Value and use are completely ignored meaning FA can exist with zero value

9.2.8.4. E&B rejected NRV becoz it abandons going concern assumption

9.2.8.5. Sterling rejected Business income becoz it didn't reflect sacrifices ( opportunity cost)

10. Current Cost Accounting

10.1. Additional concepts used in CCA model

10.1.1. Uses mixed values

10.1.1.1. Value to the business

10.1.1.2. Deprivation value (RC) accounting

10.1.2. Major premises underlying: assets held for use or for resales

10.1.3. Multiple values approach

10.1.3.1. Each decision requires diff valuation

10.1.3.1.1. Upper limit to an asset's value is RC(deprival value)

10.1.3.2. Possible 3 valuation bases

10.1.3.2.1. RC, PV, NRV

10.1.3.2.2. Thus, 6 combinations are feasible

10.2. General requirements of CCA

10.2.1. Limited to very large firms classified by

10.2.1.1. Inventories and FA

10.2.1.2. Total assets after depreciation

10.2.2. Considered supplementary and not subject to audit

10.2.3. 5 key features

10.2.3.1. 1. Disclosure focused on GPP & CC data

10.2.3.1.1. CD info

10.2.3.1.2. Current cost info

10.2.3.2. 2. Value to biz

10.2.3.3. 3. Adj made to obtain income from continuing operations on a current cost basis

10.2.3.3.1. COGS adj

10.2.3.3.2. Dep adj

10.2.3.3.3. No monetary WC adj

10.2.3.3.4. No gearing adj

10.2.3.4. 4. No BS was required

10.2.3.5. 5. Dual concept of CM (FC & PC)

10.3. Evaluation

10.3.1. Ambiguous valuation rule which is contradictory

10.3.1.1. Concerned with use of value data for decisions abt buying, selling, and holding yet model measures past results

10.3.2. Deprival value is hypothetical

10.3.2.1. Entity assumed to be deprived of assets, but what abt people who want info from an on-going entity

10.3.3. Mixture of asset values and the additivity prob in computing CV income

10.3.4. Do firms adapt instantaneously to MP?

10.3.5. Individual purposes seem to be satisfied but what about overall utility?

10.3.5.1. No segregation of operating profits from HG

10.3.5.2. Does contribute to CV BS

10.3.5.3. Can be implemented to multiuser groups in practice

10.4. Dismissal of CCA

10.4.1. INFO useless, HC adequate

10.4.2. Info useful, but users inadequate

10.4.3. Info useful, but measurements inadequate

10.4.4. Info wld b useful, but wrong info disclosed

10.4.5. Info is useful, but empirical models are inadequate