Chapter 14

Alternative assetvaluation and

income-determination
models

Attributes that may be

measured
There are four attributes of assets and
liabilities that may be measured:
1. historical cost
2. current entry price
3. current exit price
4. capitalised or present value of
expected cash flows

Units of measure
Two units of measure may be used to
measure assets and liabilities:
money
purchasing power

Asset valuation and income

determination models
1.
2.
3.
4.
5.
6.

Historical-cost accounting
Replacement-cost accounting
Net-realisable-value accounting
Present-value accounting
General price-level accounting
General price-level replacement cost
accounting
7. General price-level net realisable-value
accounting
8. General price-level present-value
accounting

Present-value models
Although theoretically considered the best
accounting models, present-value models
have recognised practical deficiencies:
they require the estimation of future net
cash receipts and the timing of those
receipts, as well as the selection of the
appropriate discount rates
when applied to the valuation of individual
assets, they require the arbitrary allocation
of estimated future net cash receipts and
the timing of those receipts as well as the
selection of the appropriate discount rates

Present-value models (contd)

when applied to the valuation of individual
assets, they require the arbitrary
allocation of estimated future net cash
receipts among the individual assets

Definition of four attributes

1. Historical cost refers to the amount
of cash or cash-equivalent that
would be paid to acquire an asset, or
the amount of cash-equivalent
liability
2. Replacement cost refers to the
amount of cash or cash-equivalent
that would be paid to acquire an
equivalent or the same asset
currently, or that would be received
to incur the same liability
concurrently

Definition of four attributes (contd)

3. Net realisable value refers to the
amount of cash or cash-equivalent
that would be obtained by selling the
asset currently, or that would be paid
to redeem the liability currently
4. Present or capitalised value refers to
the present value of net cash flows
expected to be received from the use
of the asset, or the net outflows
expected to be disbursed to redeem
the liability

Classification of attributes
They may be classified with respect to
whether they focus on the past, present
or future
They may be classified with respect to
the kind of transactions from which they
are derived
They may be classified with respect to
the nature of the event that originates
the measure

Different price levels

A change in the general price level refers to
changes in the prices of all goods and
services throughout the economy
A change in the specific price level refers to
a change in the price of a particular product
or service
A change in the relative price level of a
commodity refers to the part of the specific
price change that remains after the effects of
the general price-level change have been
eliminated

Criteria for comparison and

evaluation: timing errors
The criteria for determining what attributes of
the elements of financial statements should
be measured should favour the attribute that
avoids timing errors, because:
timing errors result when changes in value
occur in a given period but are accounted
for and reported in another period
a preferable attribute would be the
recognition of changes in value in the same
period that they occur

Measuring-unit errors
The criteria for determining what unit of
measure should be applied to attributes of
the elements of financial statements
should favour the unit of measure that
avoids measuring-unit errors, because:
these occur when financial statements
are not expressed in units of general
purchasing power
a preferred measuring unit would
recognise the general price-level
changes in the financial statements

First criterion: interpretability

The resulting statement should be
understandable in terms of meaning and use
Given that we have two possible units of
measure, the interpretation of the accounting
models will be one of the following:
if it measures using units of money, its results
are expressed in the number of dollars (NOD)
if it measures historical cost in units of general
purchasing power, its results are still
expressed in NOD
if it measures current values in units of
general purchasing power, its results are
expressed in the command of goods (COG)

Second criterion: relevance

The resulting financial statements should be
useful
Focus on what ought to be measured COG or
NOD?:
from a normative point of view, the answer is
COG, because it expresses changes in both
the specific and general price levels
COG can be defined, in terms of the input
market, as price-level adjusted replacement
cost; and, in terms of the output market, as a
price-level-adjusted net realisable value

Historical-cost accounting
Historical-cost accounting is characterised
primarily by four aspects:
1. the use of historical cost as the attribute of
the elements of financial statements
2. the assumption of a stable monetary unit
3. the matching principle
4. the realisation principle
Accordingly, historical-cost income, or
accounting income, is the difference between
realised revenues and their corresponding
historical cost

Historical-cost financial
statements
Historical-cost financial statements:
contain timing errors
contain measuring-unit errors
are interpretable because they are based on
the concept of money maintenance, and the
attribute being expressed is the number of
dollars (NOD)
are not relevant because the command of
goods (COG) is not measured

Replacement-cost accounting
Replacement-cost accounting is
characterised primarily by five aspects:
1. the use of replacement cost as the
attribute of the elements of financial
statements
2. the assumption of a stable monetary unit
3. the realisation principle
4. the dichotomisation of operating income
and holding gains and losses
5. the dichotomisation of realised and
unrealised holding gains and losses

Replacement-cost financial
statements
Replacement-cost financial statements:
contain timing errors in operating profit
contain measuring-unit errors
are interpretable as NOD for profit-andloss statement figures and COG for
asset figures
provide relevant measures of COG only
for asset figures

Net-realisable-value accounting
Net-realisable-value accounting is
characterised primarily by four aspects:
1. the use of net-realisable value as the
attribute of the elements of financial
statements
2. the assumption of a stable monetary unit
3. the abandonment of the realisation
principle
4. the dichotomisation of operating income
and holding gains and losses

Net realisable-value financial

statements
Net realisable-value financial statements:
contain no timing errors
contain measuring-unit errors
are interpretable as NOD for net
income and as COG for asset figures
provide relevant measures of COG
only for asset figures

Alternative accounting models

Three models of accounting reflect
changes in the general price level:
general price-level-adjusted
historical-cost accounting
general price-level-adjusted
replacement-cost accounting
general price-level-adjusted netrealisable value accounting

General price-level-adjusted
historical-cost accounting
This type of accounting is characterised primarily
by four aspects:
1. the use of historical cost as the attribute of the
elements of financial statements
2. the use of general purchasing power as the
unit of measure
3. the matching principle
4. the realisation principle
Accordingly, it is the difference between realised
revenues and their corresponding historical costs,
both expressed in units of general purchasing
power

General price-level-adjusted
historical-cost financial
statements
General price-level-adjusted historicalcost financial statements:
contain timing errors
contain no measuring-unit errors
are interpretable
provide relevant measures of COG
only for cash figures (and monetary
assets and liabilities)

General price-level-adjusted
replacement-cost accounting
General price-level-adjusted replacement-cost
accounting is characterised primarily by five
aspects:
1. the use of replacement cost as the attribute of
the elements of financial statements
2. the use of general purchasing power as the
unit of measure
3. the realisation principle
4. the dichotomisation of operating income and
real realised holding gains and losses
5. the dichotomisation of real realised and real
unrealised holding gains and losses

General price-level-adjusted
replacement-cost financial
statements
General price-level-adjusted,
replacement-cost financial statements:
contain timing errors
contain no measuring-unit errors
are interpretable
provide relevant measures of COG in
the input market

General price-level-adjusted
net-realisable-value accounting
This type of accounting is characterised primarily
by five aspects:
1. the use of net-realisable value as the attribute
of the elements of financial statements
2. the use of general purchasing power as the
unit of measure
3. the abandonment of the realisation principle
4. the dichotomisation of operating income and
real holding gains and losses
5. the dichotomisation of real realised and real
unrealised gains and losses

General price-level-adjusted
net-realisable-value financial
statements
General price-level-adjusted netrealisable-value financial statements:
contain no timing errors
contain no measuring-unit errors
are interpretable
provide relevant measures of COG in
the output market

The current-value accounting

tradition in Australia
The 1970s was a particularly active period
in Australian accounting, fuelled by:
high inflation rates
a growing body of Australian and
international literature recommending
abandonment of the historical-cost
model
movement towards a system of currentvalue accounting by international
standard-setting bodies

Exposure drafts on currentvalue accounting

Three exposure drafts (EDs) were
released by the AARF between 1974 and
1978:
1. ED 7 Accounting for Changes in the
Purchasing Power of Money
2. ED 9 A Method of Current Value
Accounting
3. ED 10 The Recognition of Gains and
Losses on Holding Monetary Resources
in the Context of Current Value
Accounting

SAP 1 Current Cost

Accounting
A Statement of Provisional Accounting
Standards, DPS 1.1 Current Cost
Accounting, was issued by the
professional bodies in 1977 and
accompanied by DPS 1.2 Explanatory
Statement: The Basis of Current Cost
Accounting
In 1980, the ED 15 Current Cost
Accounting omnibus exposure draft was
issued, and suggested an expansion to
the Provisional Accounting Standard

SAP 1 Current Cost Accounting

(contd)
This provisional standard was issued
as SAP 1 in November 1983
A nationwide survey by Jones and
Love indicates that the number of
companies adopting SAP 1 in
Australia has significantly increased
since the mid-1980s

Conclusion
Of the models compared, general pricelevel-adjusted, net-realisable-value
accounting is the only model to meet each
of the four criteria set forth
SAP 1 does not adopt this model
Australia has opted for a predominantly
replacement-cost-based model
Preferences for exit-value and presentvalue-based models have, however,
manifested in recent accounting regulations