1. Accountants have considerable discretion in how they measure and report on an entity. While accounting standards provide guidance, accountants can define boundaries and classifications. 2. The entity theory views the firm as the primary unit of accountability rather than the proprietor. It emphasizes stewardship to equity holders through financial reporting. Retained earnings appear on the equity side of the accounting equation to represent the firm's investment in itself. 3. The fund theory views financial statements as reports of restrictions on assets, with liabilities and equity representing claims on assets. It sees the statement of financial position as an inventory of assets and restrictions rather than a performance report.

1. Adoptinganaccountingperspective
Questions
1.Do accountants really constructtheirown reality with respectto whatis
measuredandreportedbyanentity?Inasense,hasn’ttheaccountingprofession
codifiedacceptanceofthisinbroadlydefiningreportingentitiesinAASB 1025?
Discuss.
TheanswertothisquestionwithrespecttoAASB 1025isfoundbelowatquestion14.
Accountantshaveconsiderablediscretioninclassifying,measuringandreportingthe
economicactivitiesofanentity.Theycandefinetheboundariesofanoperatingentity
and,ashighlightedinseveralcasesinthischapter,canatanytimedividethefirm into
anynumberofoperatingentitiesinaccordancewiththeirpreferences.Althoughthere
are legislated accounting standards and disclosure requirements, there is
considerable discretion as to the nature and extentofboth measurementand
disclosureofaccountinginformation.Atthebasiclevel,accountingisafunctionof
humanactivity,anextension(function)ofourexistence—sowedefineit.
2.Withrespecttotheproprietarytheory:
(a)Whatistheobjectiveofthefirm?
(b)Howimportantistheconceptof‘stewardship’?
(c)Whatistherelationshipbetweenassets/liabilitiesandtheowner?
(d)Howwouldyoudefinerevenues,expenses,profit?
(e)Whatarethreeeffectsoncurrentpractice?
(f)Whatarethetheory’slimitations?
(a)Thefirm essentiallyistheproprietor.Thefirm issimplytheproprietor’sinstrument
toachievehisorherpurpose,whichistoincreasehisorherwealth.Income
representstheincreaseinthewealthoftheproprietorinagivenperiod.
(b)Stewardshipisrelativelyunimportant,becauseaccountabilitytooutsidepartiesis
notcritical.Theproprietoris,ineffect,thefirm,andthereforeisinaprivileged
positiontoknowwhatishappening.Liabilitiesareusuallyshortterm,andtherefore
thereisnoneedtogiveacontinualaccountingtocreditors.
(c)Theassetsare‘owned’bytheowner,andtheliabilitiesare‘owed’bytheowner.
Thisshowsthatthereisnoseparationbetweenthefirm andtheowner.Inthe
accountingequation,Pstandsforthenetworthoftheowner.
A–L=P
(d)Revenueistheincreaseinproprietorship;expenseisthedecreaseinproprietorship;
andprofitistheneteffectofproprietorship,excludingadditionalinvestmentsand
withdrawalsbytheowner.Revenueandexpenseaccountsaretrulysubsidiary
accountsofP.Theyhavethesamealgebraiccharacteristicas‘networth’—
increasesinnetwortharecreditsanddecreasesinnetwortharedebits.The

2. proprietarytheoryfocusesonPinviewingincome.Revenuesandexpensesare
causedbythedecisionsandactionsoftheproprietor.Theprofitofthefirm
belongstotheproprietorandthatiswhyPisaffectedintheaccountingequation.
(e)Thefollowingareexamplesoftheeffectoftheproprietarytheoryonaccounting
practice:
 Dividendspaidareadistributionofearnings,notanexpense;andinterest
chargesareanexpense.
 Inasoleproprietorshiporpartnership,salariestoownerswhoworkinthefirm
arenotconsideredanexpenseofthebusiness.Thereasonisthatthefirm and
theownerarenotseparateentities;theyarethesame.
 Theequitymethodforlong-terminvestmentsfocusesontheproprietaryinterest
oftheinvestorcompanyintheinvestedcompany.
 Theparentcompanytheoryforconsolidatingfinancialstatementsviewsthe
parentas‘owning’thesubsidiary.Minorityinterestisconsideredan‘outside’
claim,andlogicallyshouldthereforebealiabilityontheconsolidatedstatement
offinancialposition.
 Thepoolingofinterestsmethodforbusinesscombinationsemphasisesthe
uniting(pooling)oftheowners’interestsofthetwocombiningcompanies.
 Commontermsusedrevealtheproprietaryinterestsofownersare:bookvalue
pershare,earningspershareandincometoshareholders.
 Theuseoftheconsumerpriceindexforgeneralpriceleveladjustmentsshows
thatthe‘consumerdesires’ofownersareconsidered.
 Thefinancialcapitalviewispertinenttoowners.
(f)Theproprietarytheorydoesnotaccordwiththerealitiesofthelargecorporation.
Thelawrecognisesthecorporationasaseparateentity,distinctfrom theowners.
Thecorporation—nottheshareholders—owns(controls)theassets,andisliable
forthedebts.Forthelargecorporation,withdrawalsofcashorotherassetsby
shareholderscannotbemadewithoutrunningafoulofthelaw.Thisshowsthatthe
ownershiprightsofshareholdersarelimited.Accountabilitytoshareholdersis
significant;otherwise,shareholders have no knowledge ofthe status and
operationsofthebusiness.Theassumptionsoftheproprietarytheoryarenot
relevanttotheshareholdersoflargefirms.
3.Withrespecttotheentitytheory:
(a)Whatarethereasonsforconcentratingontheentityasaunitofaccountability
ratherthantheproprietor?
(b)Whatistheobjectiveofaccounting?
(c)Howimportantistheconceptof‘networth’?
(d)WhatisthereasonformodifyingtheaccountingequationtoAssets=Equities?
(e)Onwhatsideoftheequationin(d)wouldretainedprofitsappear?
(f)Whyisthereastressonprofitdetermination?
(g)How do theconceptsofrevenues,expensesand profitsdifferfrom the
proprietarytheory?Whataboutinterestcharges,dividendsandincometax?

3. (h)Whatarethreeeffectsoncurrentpractice?
(a)Emphasisisontheentity,becauseinthe20thcenturytheseparationofowners
from managementinthecorporateform ofbusinessiscommon.Shareholdersof
largecorporationshavelittlepowertomakedecisionsforthecompany.The
corporation,theentity,hasalifeofitsown.Itisthereforemorerealistictoviewthe
entityastheunitofaccountability—thatis,toseetheaccountingprocessfromthe
pointofviewoftheentity.Itistheentity(throughitsmanagement)thathasthe
powertomakedecisionsthataffectthefinancialstatusandoperationsofthe
business.
(b)Stewardshiporaccountabilitytoequityholdersisofprimarysignificance.Theentity
needstogiveanaccountingtothosewhohavesuppliedfunds(shareholdersand
creditors).Therearetwoviewsoftheentitytheory,butbothstressaccountabilityto
equityholders. The conventional view emphasises stewardship because
equityholdersareseenas‘associates’inbusiness.Thenewerview focuseson
stewardshipbecauseoflegal,contractualrequirements,andalsotomaintaingood
relationswithequityholdersintheeventthecompanymayneedmorefunds.
(c)Thenetworthoftheownerisnotameaningfulconcept,becausetheownerisnot
recognisedassuchbutasanequityholder,aprovideroffunds.So-calledowners
arenotseenashavingthepowertomakedecisionsforthefirm.Thenetassets
belongtotheentity.However,networthcanbeameaningfulconcept.Anargument
canbemadethattheentityneedstoknowtheworthofitsnetassetsforitsown
purposes.
(d)Thereasonisthattheentityisthefocusofattention,andthereforecreditorsand
ownersareseensimplyasthosewhosuppliedthefundstotheentity.Their
financialinterestinthecompanyis‘equities’—claimsontheassets.Thus,theyare
seenasequityholders.Theirrelationshipwiththecompanyisacontractualone.
(e)PatonandLittletonarguethattheshareholdershaveacontractualresidualclaim
ontheassets,anditisforthisreasonthatincomeisplacedintheretained
earningsaccount.Shareholdersgettheleftoversafterthecreditorshavebeenpaid,
intheeventofliquidationofthecompany.Thenewerviewoftheentitytheorysees
retainedearningsasthefirm’sequityorinvestmentinitself.
(f)Profitisstressedfortworeasons:
 Profitiswhatequityholdersareinterestedin,becauseitrepresentstheresults
oftheirinvestmentinthecompany
 Thefirmisinbusinesstomakeaprofit—profitisessentialtothefirm’ssurvival.
(g)Revenueistheinflow ofassets(increaseintotalassets)duetotheevents
undertakenbythefirm withregardtoitsoutput.Undertheproprietarytheory,
revenueistheincreaseinproprietorship.Expenseisthedecreaseinassetsor

4. increaseofliabilitiesduetotheconsumptionofassetsandservicesbythefirm to
generatecurrentrevenue.Underproprietarytheory,expenseisthedecreasein
proprietorship.
Forboth theentityand proprietarytheories,profitisthedifferencebetween
revenuesandexpenses.Theentitytheory,however,emphasisestheleftsideofthe
accountingequation(assets),whereastheproprietarytheoryconcentratesonthe
rightside(proprietorship).Theentitytheoryfocusesonwhattheentitydoes,its
performance; whereas the proprietary theory focuses on the effect on
proprietorship.
Forthetraditionalentitytheory,interestcharges,dividendsandincometaxes
shouldbedistributionsofearnings.Thetheoryconsiderstheseaspaymentstothe
equityholdersfortheuseoftheirfunds.Ofcourse,thegovernmentdoesnot
providefundsastheothers,butprovidesintangibleservices(funds?)suchas
protectionfromforeignpowers.Thenewerversionoftheentitytheoryseesinterest
charges,dividendsandincometaxesaspaymentsto‘outsiders’,andthereforethey
areexpenses.
(h)Althoughconventionalaccountingtheorysubscribestotheentitytheory,thetheory
has had little effecton actualpractice.The reason is thatthe theory was
formulatedinthe20thcentury,andmanycurrentpracticesweredevisedsincethe
timeoftheItalian city–statesand arebased on theproprietarytheory.The
followingshowtheeffectoftheentitytheoryonpractice:
 Thephysicalcapitalviewisinconsonancewiththeentitytheory.
 Salariestocorporateemployeeswhoarealsoshareholdersareexpenses,
becausethecompanyisaseparate,distinctentityfromtheholders.
 Inconsolidatingfinancialstatements,anentitytheoreticalapproachcanbe
taken.Insteadofconcentratingontheproprietaryinterestoftheparent(parent
companytheory),theentitytheoryseestheconsolidationfromthepointofview
oftheconsolidatedentity.
 Theuseofprofitandcostcentresforinternalpurposesisbasedontheentity
theory.Thecentreisseenasanindividualentity.
4.Withrespecttothefundtheory:
(a)Whatare‘restrictionsonassets’?
(b)Howisthestatementoffinancialpositionviewed?
(c)Howmeaningfulisthestatementoffinancialperformance?
(a)Restrictionsonassetsareliabilitiesandowners’equity.Usuallyliabilitiesand
owners’equityareseenasclaimsontheassets,butVatterarguesthatclaimsdo
notariseagainstassets,butagainstpeople.Thefundattemptstobeimpersonal.
Liabilitiesrepresentfuturepayments;thereforethesignificanceofliabilitiesisthe
restrictiontheyplaceontheassets,theearmarkingofacertainportionforfuture
payment.Theowners’equityrepresentsafinal,residualrestrictionontheassets.
(b)Thestatementoffinancialpositionisseenasan‘inventorystatement’ofassets

5. andtherestrictionsonthem.
(c)Thestatementoffinancialperformanceisnotconsideredmeaningful.Thereare
toomanyproblemsindeterminingincome.Thegeneral-purposestatementof
financialperformanceislimitedinitsusefulness,becausedifferenttypesofusers
needdifferentkindsofinformation.Informationshouldbereportedinsuchaway
thatusers,iftheywished,cancalculatetheirownincomefigure.Butthefocus
shouldbeontheflowoffundsratherthanincome.
5.Withrespecttothecommandertheory:
(a)Whoisthe‘commander’?
(b)Whatistheroleof‘ownership’?
(c)How are the statementoffinancialposition and statementoffinancial
performanceviewed?
(a)Acommanderisanypersonwhohascommandorcontroloverresources.The
generalmanagerofacompanywouldbethetopcommander,andtheotherofficers
wouldbehisorherstaff,whointurnmaybecommandersoverasmallersetof
resources.Aholderisacommanderoverhisorherownresources.Thepointofthe
commandertheoryiseconomiccontroloverresources,andsuchcontrolisinthe
hands ofpeople;thus,the theory focuses on people — people who are
commanders.
(b)Ownershipisnotmeaningfulinthistheory.Rather,itiscontrolovereconomic
resources.Theemphasisshouldbeontheeconomicfunctionofpeopleratherthan
theirlegalrelationshiptothefirm.
(c)Thefinancialstatementsarereportsfrom thecommanderofthecompanyto
commandersofthefundsthatwereprovidedtothecompany.Thestatementof
financialperformanceisanexplanationoftheresultsofactivitiesinagivenperiod
initiatedbythecommanderandstaff.Theresultsarefrom thecommander’spoint
ofview.Heorsheisexplainingwhattypesofexpenditurewereincurredandwhat
the resultis.The statementoffinancialposition is truly a statementof
accountabilityofthecommanderofthecompany.Itshowsthesourcesfromwhich
thecommanderhasreceivedresourcesandtheapplicationsoftheseresources.
Thestatementoffinancialpositionisastatementofstewardshipratherthanof
ownership;itisastatementofaccountability.
6.(a)Cantherebean‘investortheory’,giventhebroadrangeofinvestorobjectives?
(b)Doinvestorshaveuniforminformationneedsthatfitwithinasingletheory?
Investorswantinformation so thattheycan predictthefuturecash receiptsto
themselvesduetotheirrelationshipwiththecompany.Futurecashreceiptsdepend
on:
 thecompany’sabilitytodisbursecash

6.  thewillingnessofthecompanytopayinvestors
 thelegalpriorityoftheinvestor’sclaim.
Financialstatementscanprovideinformationespeciallyonthefirstandsecond
factors.
7.Withrespecttotheenterprisetheory:
(a)Whatisprofit?
(b)Whatrelevance do you see in the ‘value added’statementoffinancial
performance?
(c)Howrealisticaretheimplicationsofthetheory?
(d)Explaintherelationship,ifany,betweenenterprisetheoryandtriplebottom-
lineaccounting.
(a)Profitisvalue-addedincome.Thefigureshowsthecompany’scontributionto
society—thatis,thewealthcreatedbythecompanyinagivenperiod.Anotherway
oflookingatthisistosayvalue-addedincomemeasuresthedistributiontothe
participantsintheentity— employees,holders,creditorsandgovernment.Ofthe
totalsalesoftheoutputofthecompany,theamountisdividedasfollows:wages
andsalariestoemployees,dividendstoholders,interesttocreditors,incometaxes
togovernment,andtheresidualtothecompanyitselfforfutureexpansionor
replacementofassets.
(b)Thisisanopinionquestion.IntheUnitedKingdom,itisestimatedthatatleast20%
ofthelistedcorporationsnowpublishavalue-addedstatementassupplementary
data.Somebelievethatthevalue-addedincomeisbecomingmoreimportant
becauseitreflectsasocialchange— holdershavebecomelesspowerfuland
organisedlabourandgovernmentmorepowerful.Manypeopleinsocietywantto
knowwhatthecontributionofacompanyistotheeconomicwellbeingofsociety,
andhowthe‘pie’(thecontribution)isdividedforacompany.Whatisa‘fair’division
isamatterofopinion,andultimatelydependsonthevaluesofthepeopleofthe
givensociety.
(c)Thetheoryimpliesthattheparticipantsaretocooperateintheirendeavourto
createprofit.Managementisto serveasmediator.Theparticipantsneed to
cooperateifthefirm istosurvive.Theideaofthecooperativeeffortofholders,
creditors,employeesandgovernmentdoesnotappeartoberealisticatpresentin
Australia.History,traditionandvaluesaresuchthatcooperationdoesnotappear
likelyintheforeseeablefuture.However,economicstresscouldchangepeople’s
attitudes.ItisinterestingtonotethattheJapanesemodeloftheenterprisedoes
takeseriouslytheneedforemployeestohaveaparticipatoryroleindecision
makinginthecompany;andtherepresentativesofgovernmentdoappeartofeel
obligatedtohelpcompanieswithbasicresearchandtaxrelief,andtocreatean
environmentthatis‘pro’business.

7. (d)Enterprise theory and triple bottom-line accounting are very similarin the
underlying view thata corporation hassocialresponsibilitiesthatshould be
reported.Enterprisetheoryhasbeenmorefocusedonquantifyingtheseimpacts,
whereastriplebottom-lineaccountinghasopenedoutreportingtobothquantitative
andqualitativeinformation.
8.Basedoninformationfrom theconventionalstatementoffinancialperformance
ofInbergLtdforthecurrentyear,prepareavalue-addedstatement.
Salesrevenue $5000Incometax $800
Materialsused 1200Electricityexpense 300
Salariesandwagesexpenses 900Interestexpense 200
Depreciationexpense 400Dividendspaid 300
Althoughnotaskedfor,aconventionalstatementoffinancialperformanceisalso
preparedforpurposesofcomparison.
STATEMENTOFFINANCIALPERFORMANCE
(conventional)
Sales $5000
Less:
Materialsused $1200
Electricity 300
Salariesandwages 900
Depreciationexpense 400
Interestexpense 2003000
Profitbeforetax $2000
Incometax 800
Netprofit $1200
Lessdividends 300
Retainedprofits $900
VALUE-ADDEDSTATEMENT
Sales $5000
Less:materials,depreciationandservicesused
($1200+$400+$300) 1900
Valueadded $3100
Distributionofvalueadded:

8. Toemployees $900
Toprovidersofcapital
Dividends $300
Interest 200500
Togovernment 800
Toenterpriseforexpansion
Retainedprofits 900
$3100
9.(a)Triplebottom-linereportsseektodetailtheactivitiesofanentityastheyrelate
tosociety,theeconomyandenvironment.Istheannualreportofanentityan
appropriatevehicleforsuchabroadbaseofinformation?
(b)Listthetypeofinformationthatyouconsiderwouldberelevanttothetriple
bottom-lineapproach.Whatwouldbethe‘bottomline’insuchastatement?
(a)Annualreportsinitiallybeganaslegaldocuments,whichreportedfinancialposition
andperformanceandfulfilledlegislativerequirementssuchasnamesofkeyoffice
holdersanddirectors.Inmorerecenttimestheannualreporthasbeenseenasa
keydevicenotonlytosummarisepastperformance,butalsotosignalthefuture
activitiesandminimisepoliticalcosts,andperhapsinfluenceperceptionsoffirm
value.With quarterlyreporting and therequirementto reportimmediatelyon
significantfactorsthatcanaffectafirm’svalue(understockexchangelisting
requirements),informationconcerningfinancialperformanceismoreimmediate
andreadilyavailable.Thismeansthattheannualreportisincreasinglyusedasa
signalling device to keylobbygroups.Is itappropriate forthis purpose?It
representsaformalcommunicationfrom thefirm andthereforecarriesabasic
authority.Itprovidesaclearchannelofcommunicationandallowsfirmsaplatform
inwhichtolegitimisecommunicationspertainingtotheiractivities,bothactualand
proposed.However,itshould be considered whetherlobby groups and key
stakeholdersaccepttheinformationprovidedingoodfaith.Theinstructormight
liketotakesomeexamplesofannualreportstoclassandaskstudentstoconsider
whethertheyareeffectivecommunicationdevicesorsimplypoliticalstatements.
(b)Getstudentstoclassifytheinformationaccordingtocategoriessuchassocial,
employee,environmental,economicandcommunity-based.Intermsofanactual
‘bottom-line’,thisdoesnotexistbecauseitisnotaboutderivingasingleoutcome,
suchasprofit,butaboutidentifyingthepositiveandnegativeimpactsofthe
entity’sactivitiesonabroadrangeofstakeholders.
10.Acompanydeclaresa10% dividend.Discussthenatureofthedividendtothe
recipientsfromthepointofviewofthefollowingtheories:
(a)proprietarytheory (d)fundtheory
(b)entitytheory (e)investortheory
(c)commandertheory (f)enterprisetheory.
(a)Undertheproprietarytheory,thefirm isconsideredaninstrumentoftheholdersto
achievetheirobjectiveofincreasingtheirwealth.Holders’equitybelongstothe

9. holders,andthereforeadividend,whichissimplyaredistributionfrom retained
earningstocapital,isjustanother‘pieceofpaper’torepresentthesamedollar
amountofownershipinterest.Thedividendisnotincometotheholders;theyare
notreceivinganythingbeyondwhattheyhadbeforeinthecompany.
(b)Undertheentitytheory(eithertraditionalor‘newer’view),sincethecorporationisa
separate‘person’fromtheholders,thedividendwouldbeconsideredincometothe
recipients.Theincomeofthecompanydoesnotbelongtotheholdersbuttothe
company.Therefore,sincethedividendcomesoutofretainedincome,theholders
arereceivingsomethingtheydidnothavebefore.Theissuanceofdividendsisone
entitytransferringsomethingofvaluetootherentities(shareholders).
(c)Thecommanderisastewardwhohasbeenentrustedwiththefundsofthe
companyandgiventherighttooperatethecompany.Theissuanceofadividendis
duetohisorherinfluenceanddecision.Butwhohasgiventhecommander
authority?
Thecommanderactsonbehalfoftheentity,nottheshareholders.Thus,thetheory
assumes thatthe commanderreceives authority from the entity.Because
shareholdersdonothaveeconomiccontrolovertheresourcesofthecompany,the
theoryimpliesthattheydonothavemuchpowerinthecompany.Thetheoryalso
impliesthatthecompanyontheonehandandtheholdersontheother,aredistinct,
separateentities.Ifso,thendividendsareincometotheshareholders,because
theyarereceivingsomethingthattheyhadnocontroloverbefore.
(d)Thefundtheoryseesthefirm asanimpersonalfund.Owners’equityisthe
restrictionontheassets.Inthissense,shareholdersdonothaveanyclaimsonthe
assets;theiramountinthecompanyisviewedasasum thatthecompanymay
havetopayinthefuture.Adividenddoesnotchangethesum thatis‘owing’tothe
shareholders;itsimplyshiftsanamountfrom oneholder’saccounttoanother.It
wouldseem thatunderthefundtheory,dividendsarejustmore‘piecesofpaper’to
representthesameamountofrestrictionontheassets.Thus,dividendsarenot
incometotherecipients.
(e)Theinvestortheoryisanextensionoftheentitytheory,exceptthataccountability
toshareholdersisemphasised.The‘separation’ofthefirm from holdersistaken
forgranted.Similartotheentitytheory,dividendswouldbeconsideredincometo
shareholders,becausetheyarereceivingsomethingtheydidnot‘own’before.
(f)Theenterprisetheoryseesshareholdersasonegroupofparticipantstohelp
generate income from the enterprise.In particularthey provide funds,and
dividendsarethecompensationtoshareholdersfortheircontribution.Dividends
constitutetheirshareofthetotalvalue-addedincome.Sincedividendsreduce
retained earnings(regarded asadistribution ofincometo theenterprisefor
expansionpurposesthatbenefitallparticipants),theywouldbeconsidereda
distributiontoshareholders.Thus,dividendsareincometotherecipients.

10. 11.Thepointofviewadvocateddependsontheparticularuser:theowner,manager,
investorandprovideroffunds.Whichperspectiveshouldtakepreference?
Thisisanopinionquestion.Conventionaltheoryoptsfortheentitytheory.TheFASB
andtheAARF appeartoacceptthisview,butwiththeinclusionoftheentity’s
responsibilityforreportinginformationtousers,mainlyshareholdersandcreditors,
whichistheinvestortheory’semphasis.
12.Ifanentitytheoryviewpointistaken,whichofthefollowingdoyoubelieveis
appropriateindeterminingprofit:
(a)financialcapitalorphysicalcapital?
(b)historicalcostorcurrentcost?
(c)nominaldollarsorconstantdollars?
(a)Financialorphysicalcapital
Whatiscapitalintheentitytheory?Theright-handsideoftheaccountingequation
isequities.Thiscanbedividedbetweenspecificequities(liabilities)andresidual
equity(shareholders’equity).Thetraditionalviewoftheentitytheoryemphasises
accountabilitytoequityholdersforthefundsprovidedbythem.Thisrelatestothe
investmentoftheequityholders,andthereforeafinancialcapitalviewisimplied.
Thenewerinterpretationoftheentitytheorywoulddefinitelytakeaphysicalcapital
approach,becausetheentityisseenasconcernedaboutitself.Thus,theentity
wouldnaturallybeconcernedaboutitsoperatingcapability.Infact,theaccounting
equation,Assets=Equities,fitswellwiththephysicalcapitalviewbecauseowners’
equityisnotrecogniseddirectly.Thefocusisonassets,andthephysicalcapital
viewisconcernedaboutassets,oftheentity’sproductiveandoperatingcapability.
(b)Historicalcostorcurrentcosts
Underthetraditionalentitytheory,anyofthealternativeswouldfitin.However,it
hasbeenarguedthatsinceequityholdersaremainlyconcernedabouttheamount
oftheirinvestment,thenhistoricalcostisthelogicalchoice.Thisisso,becausethe
useofthefundsprovidedbytheequityholdersisinvestedinassets,andfornon-
monetaryassetstheamountoftheinvestmentisthepurchaseprice— the
historicalcost.Thisistheargumentinconventionalaccounting.Butwhether
equityholdersareonlyinterestedintheoriginalamountoftheirinvestmentis
debatable.Manybelievetheyarealsointerestedinchangesinvalue.
Underthenewerentitytheory,followingalongthephysicalcapitalalternative,then
currentcostisthelogicalchoice.Forphysicalcapital,thequestionattheendofthe
periodis:How muchdoestheentityneedinordertomaintainitsoperating
capability?.Theamountneededattheendoftheperiodistheamounttopurchase
theassets,whichiscurrentcost.
(c)Nominalorconstantdollars
Underboth views ofthe entity theory,neitheris favoured.Constantdollar
accountingattemptstocorrectamathematicalproblem,ofdollarsofdifferent
purchasingpowerbeingaddedtogether.Mathematically,numbersmustbeofthe

11. samedomain(samequalityorunitofmeasurement)tobeadditive.Ifsucha
correctionisdesired,thenageneralpriceindexthatispertinenttotheentity’s
circumstancesshouldbeselected.
13.Whatis deprivalvalue accounting? On whatbasis are non-currentassets
measured?Whywouldusersoffinancialreportsconsiderdeprivalvaluesuseful?
Underthedeprivalvalueconcept,assetsarevaluedatanamountthatrepresentsthe
lossthatmightbeexpectedtobeincurredbyanentityifthatentityweredeprivedof
theservicepotentialorfutureeconomicbenefitsofthoseassetsatthereportingdate.
Thusthevaluetotheentityinmostcaseswillbemeasuredbythereplacementcostof
theservicesorbenefitscurrentlyembodiedintheasset,giventhatdeprivalvaluewill
normallyrepresentthecostavoidedasaresultofcontrollingtheassetandthatthe
replacementcostrepresentstheamountofcashnecessarytoobtainanequivalentor
identicalasset.Inthecasewhereitisexpectedthattheassetwillnotbereplaced,the
assetshouldbevaluedatthenetpresentvalueofthecashflowsexpectedfrom
continueduseandsubsequentdisposaloftheasset.
Deprivalvalueallowsusersoffinancialreportstoconsiderthe‘real’valueofassetsin
use,andhowtherelativeimportanceoftheseassetschangesovertime.
14.Whatisthereportingentityconcept?Whatimpactdoesthereportingentity
concepthave on Australian financialreporting? Explain in the contextof
AASB 1025.
AASB 1025.27definesareportingentityas:
…anentity(includinganeconomicentity)inrespectofwhichitisreasonabletoexpectthe
existenceofusersdependentongeneralpurposefinancialreportsforinformationwhichwill
beusefultothem formakingandevaluatingdecisionsabouttheallocationofscarce
resources,andincludesbutisnotlimitedtothefollowing:
(a) alistedcorporation;
(b) aborrowingcorporation;and
(c) acompanywhichisnotasubsidiaryofaholdingcompanyincorporatedinAustraliaand
which isasubsidiaryofaforeign companywherethatforeign companyhasits
securitieslistedforquotationonastockmarketorthosesecuritiesaretradedona
stockmarket.
Intermsoftheabovedefinition,thekeyfactorindeterminingwhetherareporting
entityexistsornotiswhetherornotthereareusersdependentongeneral-purpose
financialreportsofaparticularentityasabasisformakingandevaluatingdecisions
abouttheallocationofscarceresources.
TheapplicationofAASB 1025meansthatasignificantnumberofentitiesareno
longerrequiredtodisclosefullGAAPstatements.However,intermsofpublished
financialreports,publiclylistedcompanieswillcontinuetoreportunderfullGAAP,so

12. verylittle,ifanything,willchangeforinvestorstradinginsharesinlistedcompanies.
StatementofAccountingConceptSAC1,‘DefinitionoftheReportingEntity’,suggests
severalindicatorsthatmaybeusedindeterminingwhetherareportingentityexists.
Thesefactorsinclude:
 separationofmanagementfromeconomicinterests(paragraph20)
 economicorpoliticalimportance/influence(paragraph21)
 financialcharacteristics(paragraph22).
FurtherguidanceisprovidedinAustralianProfessionalStatementAPS 1,‘Conformity
withAccountingStandardsandUIGConsensusViews’.Accordingtoparagraph16of
APS 1,thefollowingtypesofentitieswillalwaysexhibitthecharacteristicsofreporting
entities:
 companieswhosesecuritiesarepubliclylisted
 listedtrustsandothertrustswhichraisefundsfromthepublic
 government-controlledbusinessundertakings
 federal,stateandterritorialgovernments
 localgovernments.
Conversely,accordingtoparagraph18ofAPS1,thefollowingtypesofentitieswill
oftennotexhibitthecharacteristicsofreportingentitiesand,therefore,wouldgenerally
notberequiredtopreparegeneral-purposefinancialreports:
 exemptproprietarycompanies
 familytrusts
 partnerships
 soletraders
 whollyownedsubsidiariesofAustralianreportingentities.
Theaboveareexamplesonly,andtheclassificationofaparticularentitywilldepend
onthecircumstancessurroundingthatentity.Theclassificationcouldalsochange
overtime.
Whendecidingwhetherareportingentityexists,itisimportanttoconsiderwhether
anyfinancialreportusersareabletocommandthepreparationoffinancialreportsas
andwhenrequestedbythem,ratherthanrelyingonthegeneral-purposefinancial
reportsofanentity.
AASB 1025alsorequirestheapplicationofallexistingAASBaccountingstandardsto
non-reportingentitiesthatpurporttopreparegeneral-purposefinancialreports.A
general-purposefinancialreportisdefinedinAASB 1025.27asafinancialreport
intendedtomeettheinformationneedscommontouserswhoareunabletocommand
thepreparationofreportstailoredsoastospecificallysatisfyalloftheirinformation

13. needs.
Adiagramoutliningthedecisioncriteriaisfoundonp.126.
15.WhyhavegovernmententitiesinAustraliamovedtoaccrualaccounting?What
perspectiveshouldgovernmentdepartmentsandagenciesadopt?
Untiltherecentadoptionoftheaccrualsystemofaccountingbygovernmentagencies,
thecashflow modelwasadoptedandrevolvedaroundanannualbudgetoffunds
available.Thiswasbecauseoftheannualallocationoffundsforbothongoingand
capitalexpenditures.Theshifttoaccrualaccountingwassupportedbytheaccounting
profession,becauseasingleframeworkofaccountingfororganisationscouldbe
adoptedinAustralia.Possiblereasonsforitsintroduction,include:
 tointroduceacorporatemodelofevaluationoftheperformanceofagenciesand
departments
 toallow abaseforvaluationofassetstosupporttheprivatisationofcertain
governmentactivitiesandassetsheld
 toprovideacommonplatformforaccountingeducation
 asapoliticaldevicetobringforwardexpendituresoffutureperiods,largelythrough
capitalisationmethods,inordertosignalcommitmentsbygovernmentsinadefined
politicalcycle.