Question

Question 7

The profit figure is an objective measure with some subjective estimates. It has been argued that it does not reflect current value. For example in a period of high inflation, Casi Plc decided to use replacement cost accounting. Closing inventory was purchased for £35 per unit. The general price increases during the period meant the purchase price had increased by 30% by the end of the period.

The Finance manager of Casi Plc is interested in how Positive accounting, Normative accounting, Public interest and Capture theories impact on the accounting theory.

Caspi Plc has implemented IAS 36 impairment of assets. All the assets were reviewed for impairment where appropriate and the impairment loss has been included within the financial statements.

Requirement:

1. Explain any two criticisms of the accountant’s measure of profit. (maximum word count 60)

                                                                                 

2. What is the value per unit of closing inventory of Casi Plc at the end of the period?

        iii)        Explain the following in relation to accounting theory.       

• Positive accounting theories
• Normative accounting theories
• Public interest theory
• Capture theory

(maximum word count 160)                     

  

iv) Describe what is meant by ‘impairment’ and briefly explain the procedures that must be followed when performing an impairment review. (maximum word count 220)

Answer 1

i. Criticisms of the accountant’s measure of profit are:

1. Accountant measure Depreciation and amortisation of goodwill are subjective non cash costs that reduce accounting profit, but have no impact on free cash flow and thus no impact on a company’s enterprise value.
2. When investors entrust their money to a company, they expect to receive a minimum return by way of compensation. This minimum return is ignored in traditional accountant's measures of profit

.ii. Value per unit of closing inventory of Casi Plc at the end of the period is £35.

iii.

Positive accounting theory is based on cold, hard statistics. This approach is regularly used within bookkeeping and data collection, positive accounting scrutinises the real world transactions of a company and compares the incomings with the outgoings to identify any discrepancies. This approach allows the accountant to see whether a business is making or losing money. The theory provides accountants with a framework from which to predict how the company will account for transactions going forwards.

Normative accounting theory advises policy makers on what should be done based on a theoretical principle; it starts with a theory and deduces specific policies from this. It works with events in the future. It is most commonly used in a firm’s marketing or business plan and aims to sum up what the future of the company will look like financially while advising on how to plan for future events.

The Public Interest theory assumes that the economic markets have a tendency to operate in favor of individual’s concern while ignoring the importance of the society as a whole. Therefore to direct and monitor the economic markets government’s intervention is required and in terms of accounting accounting bodies are formed and practice are regulated accordingly.

The Capture theory states that an industry can benefit from regulation if it can capture the accounting regulatory agency involved. This can happen if the industry’s political influence and technical knowledge makes the regulatory agency dependent on it. Political appointees from the industry, along with the agency’s need for informal cooperation from the industry, help create a accounting policy in which the agency is captured.

iv. In accounting, impairment describes a permanent reduction in the value of a company's asset, typically a fixed asset or an intangible asset.

When reviewing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company's balance sheet.

At first, Identify the impairment indicators, assessing or reassessing the cash flows, determining the discount rates, testing the reasonableness of the assumptions and benchmarking the assumptions with the market.

Then it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset.

If it exceeds then the difference between the two is written off and the value of the asset declines on the company's balance sheet.

Regulators have many disclosure requirements, the disclosure requirements are extensive which need to be complied with.