The accountant and the economics certainly have different ideas about capital and income.

ABOUT CAPITAL

• The Accountant view

Says capital is the difference between NBV of tangible assets and liabilities.

• The Economist view

Says capital is the present value of future earnings derived from an asset or enterprise as a whole.
Two different problem are raised by this latter definition

• how long should we go into the future
• what discount rate shall we choose

ALTERNATIVE PERCEPTION OF THE NATURE OF CAPITAL

• Entity Concept of Capital:- The entity concept perceives the firm as an entity distinct from those who have contributed capital. The objective of accounting here is to account for the interest of the enterprise and not the shareholders. The shareholders. The share holder is perceived as an investor rather than owner.
• Proprietary Concept:- This concept views capital as the wealth sub sensed by the shareholders. The firm is perceived as being owned by a collection of shareholders and the objective of accounting is to account for their interest in the firm.

STOCK AND FLOW CONCEPTS
Capital, being measured at a period in time is a stock item or concept. It has no time dimension. Profit/income on the other hand is measured over a period of time and so has time dimension. Hence it is a flow concept.

ACCOUNTING IN THE PERIOD OF RISING PRICE – INFLATION ACCOUNTING

• The traditional /conventional method for presenting accounting statement is the use of historical cost accounting. This system uses values which have been derived from actual events. However, several other methods have being suggested in accounting literature which takes account of the impact of inflation and these are
• Current Purchasing Power – Both revenue and cost are measured at year end purchasing power of money. i.e. inflation index.
• Current cost/ Replacement cost method:- Revenue are measured at the current price, where cost are measured at replacement cost.
• Net Realisable value:- In this method, both the revenues and cost are measured at selling price. NB: Historical cost accounting system is at present the only legally recognized bases for income taxation.

• Need for adjusting historical accounting statement for the importance of inflation.
• Historical Cost Accounting will cause profit to be overstated, this is because sales revenue which is stated at current prices is being compared with cost of sales which has being incurred over past time periods.
• Historical Cost Accounting will also cause capital employed shown by the balance sheet to be understated, so the use of the ratio of it. Profit to capital employed as measure of managerial efficiency is impaired.
• As HCA overstates profit, if a company pays out a high proportion of its income/profit in dividends, them there is a danger that a dividend could be paid out of capital, if the dividend exceeds the amount of the real profit made.
• When profits are overstated, this gives a false picture to the investors and employees alike e.g. investors are encouraged to expect high dividends, and employee’s high wage demand.

Accounting theorists who support the adjustment process argue that if the accounting statements are computed in terms of current, rather than historic cost , they become more realistic.

CASE AGAINST ADJUSTING ACCOUNTING STATEMENT FOR THE EFFECT OF INFLATION
The fear is that such adjustments could have a depressing effect on profits and that if investors could see the real return their funds are earning.

ITEMS NEEDING ADJUSTMENT

• Fixed Assets and Depreciation
• Cost of sales.
• Monetary items, e.g. debtors, creditors, cash, and
• Capital.

DEFFERED TAXATION
A Deferred Taxation is defined as tax attributable to “timing difference” it is an assortment of accumulated tax liabilities which will have to be discharged at various times in the future accounting periods.
It is also defined as an additional tax charged equivalent to temporary tax savings resulting from timely differences.

Timing Difference: are differences which arise as a result of income being taxed or an expense being allowed for tax purposes in a period other than in which they are included in the final account e.g.

• Interest receivable accrued in financial accounts not taxed until actually received
• Capital allowance allowed for taxation purposes being at different rates to the depreciation change in the final accounts.

NB: - The total of these revenue or expenditure included in accounting income and taxable income will alternately be the same, but the periods of inclusion will differ.

CLASSIFICATION OF TIMING DIFFERENCE
These are

• Originating timing difference – which accrue when accounting income is greater than taxable income in any given year.
• Reversing timing difference – which accrue in subsequent year which taxable income is greater than accounting income.

NB – timing difference originate in one period, but reverse in one or more furure periods.

CLASSIFICATION OF ORIGINATING TIMING DIFFERENCE

• The Short Term
• The Long Term

The short term originating timing difference:- refers to difference which  are expected to reverse completely in the next accounting period, e.g. interest receivable accrued in the financial accounting, but taxed when actually received.

The long term originating timing differences which are expected to reverse over a period exceeding one year e.g. accelerated capital allowances claimed in excess of depreciation change.

JUSTIFICATION FOR DIFFERENCE IN TIMING

• On the ground of prudence.
• On the ground of accrual principle

METHODS OF ACCOUNTING FOR DIFFERENCE IN TIMING

The Deferral method

• FIFO method
• Average method

The Liability method

Prepared By Alh. Y. O. Olajide
Managing Partner
Olajide And Associates
www.olajideassociates.com