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Homework answers / question archive / 1)For over 20 years the accounting profession in many countries has attempted to formulate a method of preparing financial statements that takes account of the effects of price increases (inflation)
1)For over 20 years the accounting profession in many countries has attempted to formulate a method of preparing financial statements that takes account of the effects of price increases (inflation). It seems that no proposed method of reflecting the effects of changing prices has gained international acceptance. The decision of the IASB, and the accounting standard setters in many countries, is that no form of accounting for price changes should be made compulsory, but entities are encouraged to present such information. There have been two main methods put forward by various accounting standard bodies for reporting the effects of price changes. One method is based on the movements in general price inflation and is referred to as a General (or Current) Purchasing Power Approach, the other method is based on specific price changes of goods and assets and is generally referred to as a Current Cost Approach. Some bodies have also suggested an approach which combines features of each method. Required: (a) Explain the limitations of (pure) historic cost accounts when used as a basis for assessing the performance of an entity. You should give an example of how each of three different user groups may be misled by such information. (b) Describe the advantages and criticisms of General Purchasing Power and Current Cost Accounting.
2)Tutorial IMA 82 Question 1 Coco ine manufactures chocolate syrup in three departments: Cooking, Mixing, and Botting. Coco uses the weighted average method. All manufacturing inputs are applied uniformly. The following are cost and production data for the cooking department for April (Note: Assume that units are measured in gallons:) Production: Units in process, April 1, 60% complete Units completed and transferred out Units in process, April 30, 30% complete 35,000 60,000 20,000 $95.650.00 $320.650.00 Costs: WIP, April 1 Costs added during Apri I Required 1 Prepare a production report for the cooking department. Round cost per equivalent unit value to the nearest cent and use rounded value in intermediate calculations 2 Prepare the journal entries for A Transfering the Cooking Department cost to Mixing Department B. Transferring the Mixing Department to Bottling Department (assume that the cost transferred out is $465,980) C. Transferring the Bottling Department to finished goods inventory (assume that the cost transferred out is $654.000)
1)(a) Historical cost is the original cost of assets as recorded in an entitys accounting records.Its principle states that a business must record and account the assets and liabilities at their purchase or acquisition price. One must record the assets on the balancesheet for the amount paid for the asset.This helps in knowing the original value of assets or liabilities in the financial statements as it requires no adjustments.
Limitations of historical cost of accounting:
Failure to disclose the current worth of the enterprise, the accounts presented on the basis of historical concept doesnot show many effects which are due to the inflation gap. In th economic environment the prices are constantly rising and in times of inflation the value of money falls and the monetary unit doesnt have a constant value and will be flexible when price rises.
It doesnot match the current revenues with current cost of operations.
Example 1: Replacement of inventory
A company purchased a inventory for Rs.100000 and sold at the end of the year for Rs.120000.The inventory was sold and the comapny had other expenses of rs.10000. When the company decides to buy a new one in replace of the inventory sold but he will need to have Rs.120000 and the cash resource he has amounts to rs.110000 only after other expense.Hence the company is not able to maintain its operating activities unless he has to borrow funds.
Example 2: Replacement of Fixed assets
A company purchases a machine of Rs 200000 which expects to last for three years and no scrap value, with a depreciation of Rs.10000 every year. Gain after three years if a machine needs to be purchased replacing the old one, it is unable to purchase without sufficient cash.
(b)
Advantages of General Purchasing power and Current cost accounting
| General Purchasing power | Current cost accounting |
| Purchasing power is the value of currency expresssed in terms of the amount of goods and services that one unit can buy | Current cost accounting is the valuation method where assets and goods used in production are valued at their actual or estimated current market price at the time of production. |
| In this case if inflation decreases purchase of the amount of goods and services are possible | It helps in providing reliable amount of goods and services and also helps in lowest cost with highest effieciency |
Criticism
| General Purchasing power | Current cost accounting |
|
It is harder to measure the market based rates. Fluctuating exchange rates affects the purchasing power |
It violates the tradition revenue recognition principle by recognizing the increases in the value of assets both current and non current before they are sold |
2)
| Cost of Production Report-Cooking Department | ||
| Unit Information | ||
| Units charged to production: | ||
| Inventory in process, April 1 | 35000 | |
| Units started | 45000 | |
| Total units to be accounted for | 80000 | |
| Units to be assigned costs: | ||
| Whole Units | Equivalent Units of Production | |
| Units Completed and transferred | 60000 | 60000 |
| Inventory in process, April 30 | 20000 | 6000 |
| Total units to be assigned costs | 80000 | 66000 |
| Cost Information | ||
| Cost per equivalent unit: | ||
| Costs | ||
| Cost of Beginning WIP | $ 95,650 | |
| Costs added | $ 320,650 | |
| Total costs | $ 416,300 | |
| Total equivalent units | 66000 | |
| Cost per equivalent unit | $ 6.31 | |
| Costs assigned to production: | ||
| Inventory in process, April 1 | $ 95,650 | |
| Costs incurred in April | $ 320,650 | |
| Total costs to be accounted for | $ 416,300 | |
| Costs allocated to completed and partially completed units: | ||
| Units Completed and transferred | $ 378,600 | |
| Inventory in process, April 30 | $ 37,860 | |
| Total costs assigned | $ 416,460 |
Difference of $160 is due to rounding off, alternatively inventory in process as on April 30 can be written as $37,700
2.
| Account Titles | Debit | Credit |
| Work in Process - Mixing | $ 378,600 | |
| Work in Process - Cooking | $ 378,600 | |
| Work in Process - Bottling | $ 465,980 | |
| Work in Process - Mixing | $ 465,980 | |
| Finished Goods Inventory | $ 654,000 | |
| Work in Process - Bottling | $ 654,000 |
