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Inflation accounting using different methods of costing

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J&J Enterprises is formed on December 31, 2000. At that point it has one asset costing $2,487. The asset has a three-year life with no salvage value and is expected to generate cash flows of $1,000 on December 31, in the years 2001, 2002, and 2003. Actual results are the same as planned. Depreciation is the firm's only expense. All income is to be distributed as dividends on the three dates mentioned. Other information includes:

The price index stands at 100 on December 31, 2000. It goes up to 104 and 108 on January 1, 2002 and 2003 respectively.

Net realizable value of the asset on December 31 in the years 2001, 2002, and 2003 is $1,500, $600, and $0, respectively.

The firm's asset IRR is 10%

Your Task is to Produce:

Income statements for the years 2001, 2002, and 2003 under:

Historical costing

General price-level adjustment

Exit valuation

Replacement cost

Discounted cash flows

Based on the information you have now created briefly address the following questions:

How does the information you produced meet the theoretical notion of "usefulness?" (1 to 2 paragraphs)

Is the construct of utility a scientific or cultural notion? (1 to 2 Paragraphs)

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Solution Summary

A comprehensive problem on inflation accounting, which covers different methods for costing such as Historical costing, General price-level adjustment, Exit valuation and Replacement cost. The income statement is generated under various costing options to see the impact of each of these methods on the net income of the firm. The problem also discussed in detail the theoretical notion of usefulness.

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The theoretical notion of "usefulness" is the ability of the accounting information to provide useful information to take correct internal decisions. Since, accounting for the affects of changes in price level is still unresolved. The accounting information is produced based of historical cost information as price changes are dynamic and rapid and cannot be tackled on daily basis. Further there may be different prices available for the same assets or valuation and pricing on a regular basis is not economical. Therefore, accountants should concentrate on the development of methods of bringing revaluations and their subsequent effects on the accounting statements to provide a better clarity of the financial reports in the presence of inflation.

In the above question, we have worked ...

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