Question

Oundjam Corporation recently sold inventory for $140,000. The goods had originally cost $94,000. Inflation during the period was 5%. The goods could be replaced from their long-time supplier for $115,000. For simplicity, assume that there are not other costs of doing business. 1. Calculate a measure of accounting income, consistent with.

a) Nominal dollar financial capital maintenance.

b) Constant dollar financial capital maintenance.

c) Physical capital maintenance in nominal dollars.

2. Assume in each case in requirement 1 that the company collected revenue in cash and paid out 100% of net income in dividends to owners. Calculate the remaining cash balance. Explain the significance of the remaining cash flow in each case.

3. If the company were planning to replace the inventory, which capital maintenance concept allows it to keep enough money to accomplish this with no further investment or borrowing?

4. Which capital maintenance concept is dominant in Canada? which one(s) is (are acceptable under IFRS?

Answer 1

1) a) Accounting income under nominal dollar financial capital maintenance,

Current value of Inventory- Original Value of Inventory

= $ 140,000-$ 94000

= $ 46000

b) Accounting income under constant dollar financial capital maintenance,

Current value of inventory- Original Value of goods in constant dollars

=$ 140,000- ( $ 94000* 105%)

=$ 140,000- $98,700

=$ 41300

c) Accounting Income under physical capital maintenance in nominal dollars,

Current value of inventory- Replacement value of inventory

=$ 140,000- $ 115,000

=$ 25,000

2)Cash Balance if 100% net income is distributed

a)Under nominal dollar financial capital maintenance approach,

Cash from revenue- net income distributed in cash

=$140000 - $ 46000= $ 94000

it would be unable to buy the same stock again as replacement value has increased to $ 115,000 but the cash balance is only $94,000

b) Under constant dollar financial capital maintenance approach,

Cash from revenue- net income distributed in cash

= $ 140,000- $ 41,300= $ 98,700

Again,it would be unable to buy the same stock again as the purchase price has risen to $ 115,000 but the cash balance is only $ 98,700

c) Under physical capital maintenance in nominal dollars approach,

Cash from revenue - net income distributed in cash

= $ 140,000- $ 25,000 = $ 115,000

Here, the operating capability of the entity is maintained as the goods can be replaced with the closing cash balance which is $115,000

3) If the company were planning to replace the inventory , physical capital maintenance approach allows it to keep enough money ($115,000 ) to accomplish it without any further investment or borrowing.

4) Most entities in Canada use the financial capital maintenance concept, as it is the easiest to apply because it uses actual prices paid for goods, rather than making adjustments.

Under the IFRS, the two basic definitions of capital maintenance are financial capital maintenance and physical capital maintenance.

Both capital maintenance concepts provide useful information.

Investors prefer to use the financial capital maintenance concepts as they are focused on increasing and maximizing the returns they get on their investments.

Staff and management may prefer to use the physical capital maintenance concept as it allows them to assess the entity’s ability to maintain its operating capacity.

This is useful for manufacturing businesses in particular where management may need to ensure the business can keep producing the same volume of goods.