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The Main Ideas:
- Definition of Income.
- The Purpose &Importance of Income Reporting..
- Limitations of the Income Statement
- Capital Maintenance Concepts.
- Current purchasing power accounting (CPPA).
- Calculating indices.
- Performing, Disadvantages and Advantages current purchase power adjustments.
- Current cost accounting (CCA)
- Adjustments using CCA approach.
- Criticisms Advantages of current cost accounting
- Conclusion?
- Substitute title?
Definition of Income
The maximum amount that can be consumed during the period while still expecting to be as well off at the end of the period as at the beginning of the period (Hicks 1946)
Consideration of ‘well-offness’ relies on a notion of capital maintenance
Different notions of capital maintenance will provide different perspectives of income
The Purpose of Income Reporting
- Income is used as the basis of one of the principal forms of taxation.
- Income is used in public reports as a measure of the success of a corporation’s operations.
- Income is used as a criterion for the determination of the availability of dividends.
- Income is used by rate-regulating authorities for investigating whether those rates are fair and reasonable.
- Income is used as a guide to trustees charged with distributing income to a life tenant while preserving the principal for a remainderman .
- Income is used as a guide to management of an enterprise in the conduct of its affairs.
- Importance of Income Reporting
Economic Vs. Accounting Income:
Related sciences, concerned with the activities of business firms and use similar variables - differences over the timing and measurement of income
Relative importance of income statement (accounting) and balance sheet (economics)
Limitations of the Income Statement
Items that cannot be measured reliably are not reported in the income statement.
Income numbers are affected by the accounting methods employed.
Income measurement involves judgment.
Capital Maintenance Concepts
- Financial capital maintenance
- Historical cost effect
- purchasing power capital maintenance
- Adjusted historical cost
- Physical capital maintenance
Inflation accounting
Historical cost accounting
The income and financial capital maintenance
Support for historical cost accounting
Predominant method used so tended to maintain support of profession
If not found useful business entities would have abandoned it
Nevertheless, recent accounting standards being released have embraced ‘fair values’ as the basis of measurement. However, various assets are still measured on an historical cost basis
e.g. inventory, which is measured at the lower of cost and net realisable value, and property, plant and equipment where the ‘cost model’ and not the ‘fair-value model’ has been adopted
Adjusted historical cost or CPPA
Instability of the accounting measuring unit is due to the effects of inflation or deflation.
General purchasing power adjustments
Current purchasing power accounting (CPPA)
Also called general purchasing power accounting; general price level accounting; constant dollar accounting
Based on the view that in times of rising prices, if an entity were to distribute unadjusted profits based on historical costs, in real terms the entity could be distributing part of its capital
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