Doctorate of Business Administration Income And Asset Value Measurement Systems By: Associate Professor Dr. GholamReza Zandi zandi@segi.edu.my

Statement Of Financial Position As Prime Financial Statement In countries financed mainly by bank loans: Main focus is on the ability to repay loans Statement of financial position is important. In countries financed mainly by shareholders: Main focus is on to investor protection Investor decision-making Income statement and profit is important. Emphasis changing to Shareholders’ of FP.

Statement Of Financial Position As Prime Financial Statement Post-2000 effect of corporate scandals Liquidity problems Off balance sheet liabilities. Emphasis now changing back to: Statement of financial position as prime statement Income seen as a residual arising from changes in opening statement of financial position; closing statement of financial position.

Role And Objective Of Income Measurement Main objectives are to provide a means of: Control in the micro sense by assessing stewardship performance in maximising income; comparing actual performance with predicted performance. Control in the macro sense by government bodies regulating price charged by public utilities.

Income Measurement Objectives Means of prediction Dividend policy Retention policy A basis for assessing tax Subject to the disallowance of certain expenses, e.g. entertainment. Uniform provision, e.g. capital allowances to replace the depreciation charge.

Income Measurement Objectives Investor Decision-making Investors need to predict future cash flows. Necessary for estimating dividend and retention policy. Important for estimating future dividend income and capital growth. The income statement is the surrogate for future cash flows.

Accountant’s View of Income Accounting income is an ex post measure; relating to transactions that have already occurred; based on historical cost; a link between the opening and closing statements of financial position. It explains the change between opening and closing statements of financial position.

Accountant’s View of Income Accounting income is also Still affected by subjective judgements including estimating non-current asset expected life and residual value; inventory obsolescence; trade receivable provisions. Income = net assets at end – net assets at beginning + dividends paid.

Accountant’s View of Capital Accounting capital consists of: The unconsumed portion of non-monetary assets such as non-current assets and inventory, plus The monetary assets such as accounts receivable and cash, less The monetary liabilities such as accounts payable.

Accountant’s View of Value Accounting value is the value of unconsumed costs of assets; not market realisable value; market value now being used for marketable securities.

Economist’s View of Income, Capital And Value Fisher’s view: Capital is the present value of future cash flows. Capital is measured at the beginning and end of the period. Income is the maximum consumption enjoyed by the individual without reducing the individual’s capital stock as measured in present value terms.

Economist’s View of Income, Capital And Value

Illustrate Opening Capital Calculation @ 8%

Illustration Of Income Calculation For Year 1  PV1=115,403 PV0 = 115,403 = 106,853 1.08 Income Y1= 115,403-106,853=8,550

Illustration Of Predicting Income Calculation For Year 2

Illustration Of Predicting Income Calculation For Year 2 Y2= 124,636 – 115,403= 9,233

Critical Comment on The Economist’s Measure Choice of discount factor is subjective Opportunity cost, current cost of capital, borrowing rate. Investors have differing risk and time preferences.   Capital and hence income includes unrealised cash flows So, not used for assessing tax. So, not used as a base for declaring dividends.

Critical Comment On The Economist’s Measure Future cash flows may not materialise Investment plans may change.   Individual assets are not reported in a balance sheet Capital and income are a result of using a bunch of assets as a group.

Critical Comment On The Accountant’s Measure Heterogeneous mix of values in the balance sheet. Capital gains not normally recognised until realised but accrue in previous periods. Unallocated costs are carried forward under the going concern assumption. Accounting income and economic income are reconciled in the long term.

Income, Capital And Changing Price Levels Economic and accounting income assume capital maintenance before income can arise HOWEVER Differing definitions of capital.

Differing Definitions Of Capital Money capital initially put in by the owners The aim of traditional, transaction-based accountancy. Potential consumption capital The aim of the economist. Operating capacity capital to maintain productive capacity The aim of the current cost accounting system.

The End End of Chapter 1.