Current Cost Accounting

Learning Objectives
• At the conclusion of this lecture, you should have an appreciation of:
- business profit, holding gains and the importance of measuring these concepts
- the debate regarding financial and physical concepts of capital
- the current cost accounting standards that have been recommended or are used throughout the world
- the criticisms of current cost accounting
- the counter-arguments by current
cost theorists
- the results of empirical studies

Rationale for current cost accounting
• Edwards and Bell
• the expansion problem
• the composition problem
• the financing problem

Rationale for current cost accounting
• Edwards and Bell
– Evaluation by managers of their past decisions in order to make the best possible decisions for the future
– Evaluation of managers by shareholders, creditors and others

Rationale for current cost accounting
• Concept of business profit
– Holding decisions
– Operating decisions
• Edwards and Bell
– ‘business profits
• Current operating profit
• Realisable cost savings
– holding gains and losses

Rationale for current cost accounting
• Holding gains and losses
– In some cases holdings gains and current operating profit are not independent of each other (Drake and Depouch , Prakash and Sunder)
Revsine
A cost saving measures a firm’s cash position advantage relative to other firms in the industry that were not fortunate to hold the given asset while its price rose. When these other firms do buy the asset, they will have to do so at higher prices. As a consequence their cash outflow will exceed the cash outflow of the firm which experienced the cost saving.

Why holding gains are a component of profit Current Cost Accounting
• Holding gains represent a cost savings due to having purchased the assets at a lower price. The comparison is between the actual acquisition cost of the asset and the current cost.
• Holding gains represent an increase in the value of the assets. This is an economic event that has an effect on profit. The company is economically ‘better off’, because its assets are worth more.
• Holding gains represent changes in the future cash inflow expected to be generated because of the use of the assets
• Financial capital v. physical capital

In support of physical capital
• denotes firm’s operating capability
• criticisms of physical capital
• different units
• decreasing costs
• same markets
• partial investment

Criticisms of current cost
- Advocates of historical cost
– The traditional revenue-gain recognition principle is violated when unrealised holding gains are reported (financial capital view).
– Changes in the price of fixed assets are not relevant, because the firm intends to use the assets, not sell them.
– Determining the current cost of items, especially fixed assets, is subjective
– The usefulness of current cost data is questionable.

- Advocates of exit price
- Current cost is not the opportunity cost.
- Thomas (allocation problem)
- Lemke (technologically improved assets are likely to replace existing assets, so that current operating profits, based on the existing mode of production, would be poor predictors of future profits)
- Current cost accounting involves the problem of the ‘additivity’ of numbers

In support of current cost

- recognition principle Current cost advocates argue that holding gains represent an actual
economic phenomenon. By definition, a change in the net value of assets is profit if profit is an increase in wealth or ‘well-offness’.
- The determination of profit should be based on what actually happens in the current period.
- Objectivity or subjectivity, however, is relative. For items whose market prices are relatively easy to obtain, the objectivity of their current cost appears to be acceptable to accountants
- Supporters of current cost say that the actual statistics indicate that the difference between current cost profit (physical capital view) and historical cost profit is significant

- For assets where the firm is normally the buyer, using exit price would be to report ‘unusual’ values. Some assets have value in use, but little if any exchange value
- Current cost advocates argue that allocation is part of accounting as we know it today. It is still debatable whether allocated data are not useful
- The claim that current cost profit, based on existing facilities, ignores the impact of technological improvements is false, because such improvements will also affect the price of the old (existing) facilities.
- It depends on the purpose for which calculations are made. People find these different figures added together or subtracted from each other to be meaningful