Slide AKT 405 Teori Akuntansi 8 Godfrey

GODFREY HODGSON HOLMES TARCA

CHAPTER 8

Proprietary and entity

theory

• _{Proprietary theory is based on the} idea that the owner is the centre of attention

– _{accounting is done with the owners’}

interests in mind

Proprietary theory

• _{Proprietorship = net worth of owners =}

capital

• _{P = A – L}

• _{The objective of accounting is to}

determine the net worth of the owners

• _{Profit is the increase in net worth} – _{includes operating profit}

Proprietary theory

• _{Present accounting is largely based on} this theory

– dividends

– salaries

– equity accounting

– consolidation accounting

• _{Has a financial view of capital}

Proprietary theory

• _{With the advent of the company the}

theory has proved inadequate as a basis for explaining company accounting

– _{developed when businesses were smaller} – a company is separate from its owners

– _{a company is a legal entity in its own right} – shareholders rely on managers for

information

Entity theory

• _{Inadequacies in proprietary theory} led to the entity theory

Entity theory

• _{The company is viewed as a separate}

entity with its own identity

– _{separation of owners and managers}

– _{accounting views the entity as an operating}

unit

– _{accounting principles and procedures not}

formulated in terms of an ownership interest

– _{can also be applied in proprietorships,}

Entity theory

• _{The objective of accounting may be} either stewardship or accountability

– _{entity seen as being in business for itself} – _{interested in its own survival}

– _{sees owners as outsiders}

– _{reports to owners to meet legal}

Entity theory

• _{Focuses on the assets}

• _{Assets are resources controlled by} the entity

• _{Liabilities are obligations of the entity} • _{Profit increases net assets and}

accrues to the entity

• _{The owners only have a residual}

Entity theory

• _{Both proprietary and entity theories} are still influential in practice

– _{entity theory}

• _{conventional accounting theory based on it}

• _{financial reports reflect it}

– _{proprietary theory}

• _{interest charges are an expense}

Liabilities defined

IASB Framework definition of liabilities:

A present obligation of the entity arising from past events, the

settlement of which is expected to

result in an outflow from the entity of resources embodying economic

Present obligation

• _{The actual sacrifices are yet to be made} • _{Obligation is already present}

• _{Planned obligation included if to an}

external party

• _{Legal enforceability}

Past transaction

• _{A past transaction (or event) ensures} that only present liabilities are

recorded and not future ones

• _{What kind of past transaction or} event is acceptable?

Liability recognition

Recognition criteria:

• _{Reliance on the law}

– _{legal enforceability}

• _{Determination of the economic} substance of the event

Liability recognition

Recognition criteria:

• _{Ability to measure the value of the}

liability

– normally the nominal amount

– if period longer than 12-months, based on the present value of expected future cash flows

• _{Use of the conservatism principle}

IASB

Framework

• _{A liability should be recognised if}

– _{it is probable that any future economic}

benefit associated with the items will flow to or from the entity; and

– _{the item has a cost or value that can be}

IASB

Framework

• _{What does probable mean?} • _{What is meant by reliable}

Liability measurement

• _{The Framework provides little guidance about how}

to measure liabilities

• _{A number of different measurement bases may be}

used

• _{Under IFRS, historical cost is the most common} • _{Fair value measurement is more commonly being}

used

– _leases

Employee benefits –

pension (superannuation)

plans

• _{Unfunded commitments}

Provisions and

contingencies

• _{Provisions and contingencies occur where}

there is a blurring between present and future obligations

• _{Liabilities and provisions are recognised}

only when there is a present obligation, it is probable and it can be reliably measured

• _{Contingent liabilities do not meet these}

criteria

What impact will the credit crisis have on the provision for bad debts

Owners’ equity

• _{Framework defines equity as}

– _{the residual interest in the assets of the}

entity after deduction of its liabilities

Owners’ equity

Essential features

• _{Rights of the parties}

Concept of capital

• _{Influenced by legal prescriptions}

– capital maintenance

• _{Financial capital}

– invested money or invested purchasing power

• _{Physical capital}

– the productive capacity of the entity

• _{Capital can be measured on either a}

Classifications within

owners’

equity

• _{The distinction between contributed} and earned capital is useful

– _{retained earnings}

– _{not all transactions fit nicely into}

categories

Challenges for standard

setters

• _{IASB has several projects which will} affect the definition, recognition and measurement of liabilities

– _{debt versus equity distinction} – _{extinguishing debt}

Issues for auditors

• _{The completeness of liabilities recognised}

on the balance sheet and the note

disclosures about contingencies and other obligations are major issues for auditors

– _{evidence, timing, cut off}

– concealment and understatement

– going concern

– overstatement - provisions

Summary

• _{There two competing theories that help explain}

accounting practice - proprietary and entity theories

• _{There are definitions for both liabilities and}

equity

• _{There are recognition criteria for both liabilities}

and equity

• _{There are various measurement practices used}

in relation to liabilities and equity

Key terms and concepts

• Liabilities

• Owners’ equity • Proprietary theory • Entity theory

• Definitions

• Recognition criteria – probable, reliable • Present obligation

• Past transaction

• Measurement and fair value • Provisions and contingencies • Rights of the parties

• Economic substance • Concept of capital