Comparison between USA’s FAS 33 and UK’s SSAP 16

FAS 33 (USA) and SSAP 16 (UK) differ in the following respects:

1. General Requirements:

SSAP 16 calls for a complete profit and loss account and complete balance sheet on a current cost basis that may be presented as supplementary information or as the “main accounts with supplementary historical cost accounts” or as “the only accounts accompanied by adequate historical cost information.”

In contrast, FAS 33 does not tamper with the primary financial statements. The FASB has expressly indicated its intention to introduce any major changes in measurement concepts by requiring supplementary disclosures rather than by changing the basic financial statements.

Further, the supplementary information required by FAS 33 is characterised explicitly as experimental. The FASB is committed to monitoring the presentation of that information and conducting research to assess the usefulness of that information as a basis for comprehensive review after a period of not more than five years.

Although enterprises may choose to present complete supplementary financial statements, FASB Statement No. 33 requires only that cost of sales and depreciation be presented in terms of units of general purchasing power and in items of current cost in determining supplemental measures of income or loss from continuing operations and that only inventory and property, plant and equipment be presented separately in terms of current cost.

2. Primary Focus:

SSAP 16 retains the conventional nominal monetary unit as the unit of measure but changes the conventional historical amounts to some form of ‘current values model or to a model that . substitutes measures based on ‘current cost’ or ‘value to the business’ for measures based on historical costs.

SSAP 16 acknowledges the possible need for addressing the unit of measure, particularly in presenting comparative information for different years, but that cannot be said to be part of its primary thrust. Instead, SSAP 16 states explicitly that the current cost accounting set forth “is not a system of accounting for general inflation”.

FAS 33 of USA requires supplementary disclosures and has primary thrust on the following:

(i) It retains the conventional historical cost accounting but changes the unit of measure from nominal monetary units to units of general purchasing power.

(ii) It also changes both the unit of measure and the historical cost accounting model.

FAS 33 requires constant dollar disclosures (current purchasing power disclosures) and current cost disclosures. The constant dollar disclosure changes only the unit of measure: the current cost disclosure involves changes in both the unit of measure and the attribute measured.

FAS 33 recognises the related purchasing power gain or loss on net monetary items and ‘real’ rather than nominal’ changes in current cost of inventories and property, plant and equipment.

Prior period amounts must also be restated in terms of the same current monetary units if information is provided for comparative purposes, for example, in a five-year or ten-year summary. These unique features of measuring in terms of units of general purchasing power are present in the current cost disclosures required by FASB Statement No. 33.

3. Current Cost Operating Profit:

The current cost accounting prescribed in the UK highlights two measures:

(i) Current cost operating profit, and

(ii) Current cost profit attributable to shareholders.

FASB Statement No. 33 highlights three measures:

(i) Current cost income from continuing operations,

(ii) Purchasing power gain or loss on net monetary items, and

(iii) increases or decreases in the current cost amounts of inventory and property, plant, and equipment, net of inflation, or what is frequently referred to as ‘real holding gains and losses.’

The ‘current cost operating profit’ of SSAP 16 and the ‘current cost income from continuing operations’ of FASB Statement No. 33 are similar conceptually except in one significant aspect, the monetary working capital adjustment that is deducted in determining SSAP 16’s current cost operating profit.

The monetary working capital adjustment represents the amount of additional balances of cash and trade accounts receivable, less additional balances of trade accounts payable that are needed for monetary working capital as a result of changes in the prices of goods and services used and financed by the business.

Current cost operating profit (calculated in SSAP 16) is measured by making a series of deductions from revenues (sales). In general, those deductions represent asset that have been consumed (or liabilities that have been incurred) in the ordinary activities of the business.

The monetary working capital adjustment is an exception; it represents not a reduction in assets but an increase in assets. For example, if maintaining operating capability in the face of higher prices requires a larger cash balance, that increase in the amount of cash held is deducted as an expense in arriving at current cost operating profit.

Similar increases in other assets that also may be essential to sustain a given physical volume of sales or services under conditions of increasing prices, however, are not deducted in measuring current cost operating profit; e.g., revaluation of land, plant and machinery, and inventories of raw materials, work-in-progress, and finished goods. The increased investment in inventories necessary to maintain them at their existing physical volume seems especially analogous to the increased net investment in cash balances, trade receivables, and trade payables.

4. Current Cost Profit Attributable to Shareholders:

Measuring SSAP 16’s current cost operating profit involves deductions for:

(i) The excess of current cost over the historical cost of goods sold,

(ii) The excess of current cost depreciation over historical cost depreciation, and

(iii) The additional net monetary working capital necessary to maintain operating capability.

A portion of the additional cost of goods sold, additional depreciation, and additional monetary working capital is then added back to current cost operating profit to arrive at current cost profit attributable to shareholders. The portion added back is referred to as a ‘gearing adjustment’ and is determined by the ratio of net borrowing to net borrowing plus shareholders’ equity.

The ‘gearing adjustment’ represents a measure of the extent to which those realised higher costs—realised in the sense that they have been deducted in determining current cost operating profit—have accrued to the benefit of shareholders because they are financed by borrowing. The gearing adjustments has no counterpart in FAS 33 measure of income from continuing operations.

5. Gearing Adjustment vs. Purchasing Power Gain and Loss:

Some have suggested that a gearing adjustment such as the one called for by SSAP 16 is similar to or serves the same function as the purchasing power gain or loss on net monetary items called for by FAS 33. Mechanically, both may be included in measures of profit and shareholders’ equity, but conceptually they have utterly nothing in common.

The gearing adjustment is based on nominal increases in assets—specifically, nominal increases in monetary working capital and nominal increases in the current cost of inventories and depreciable assets.

It is unrelated to or independent of inflation. For example, even in the complete absence of inflation, a gearing adjustment would be required whenever specific prices of inventories and depreciable assets change; even if there was significant inflation during the period, there would be no gearing adjustment if the specific prices of those assets did not change; and if the specific prices of those assets decline during a period of inflation, the gearing adjustment would be in the opposite direction from a purchasing power gain on net monetary liabilities.

The purchasing power gain or loss, on the other hand, is based on a change in the general purchasing power of the monetary unit in which fixed nominal amounts of receivable are collected, fixed nominal amounts of payables are settled, and fixed nominal amounts of cash are held.

It is unrelated to or independent of changes in the specific prices of particular assets held by the enterprise, such as inventories and depreciable assets.

In the complete absence of inflation there would be a complete absence of purchasing power gain or loss, no matter how much the specific prices of inventories and depreciable assets, or any other assets, might change. On the contrary, inflation produces a purchasing power gain on net monetary liabilities even if the specific prices of inventories and depreciable assets do not change or decline.

Furthermore, regardless of the rate of inflation and changes in specific prices, a gearing adjustment is not applicable if an enterprise is in a net monetary asset position rather than a net borrowing position.

On the other hand, during periods of inflation purchasing power losses are incurred by enterprises in net monetary asset positions, as well as purchasing power gains by those in net monetary liabilities positions. Indeed, the FASB itself reports a purchasing power loss in its financial statements because it is in a net monetary asset position.

6. Holding Gains and Losses:

Under SSAP 16, nominal increases in current cost amounts of inventories and property, plant and equipment and monetary working capital adjustments are reflected initially in a ‘current cost reserve’, that reserve is a component of shareholders equity.

A distinction is maintained within the current cost reserve between those amounts that have been realised in the sense that they have been included as adjustments in measuring current cost operating profits and those amounts that remain un-realised in the sense that they have not yet been included as such adjustments.

Because monetary working capital adjustments are included in their entirety in measuring current cost operating profit, they are reflected immediately in the current cost reserve but increases in the current cost amounts of inventories and property, plant and equipment are reflected initially in the un-realised to the realised current cost reserve.

The gearing adjustment then transfers from the realised current cost reserve. As costs of sales adjustments and depreciation adjustments are included in determining current cost operating profit, equivalent amounts are transferred from the un-realised to the realised current cost reserve.

The gearing adjustment then transfers from the realised current cost reserve to the current period’s profit attributable to shareholders that portion of the cost of sales adjustments, depreciation adjustments, and monetary working capital adjustment deemed to be financed by borrowing. The remainder of those adjustments are never included in current cost profit attributable to shareholders but do enhance common equity by residing permanently in the realised current cost reserve.

In contrast, FAS 33 highlights a separate measure of the periodic increases or decreases in the current cost amounts of inventory and property, plant and equipment, net of inflation—that is, a separate measure of the ‘real holding gains’ during the current period.

No distinction is required to be made between real holding gains that have been ‘realised’ by consuming assets in operations during the period and real holding gains that remain ‘un-realised’ in the sense that they relate to assets still on hand at the end of the period.

Recognised holding gains enhance shareholders’ equity in exactly the same way whether they are ‘realised’ or “un-realised’ and regardless of the financial structure of the enterprise.

The effect is to report real holding gains and losses as a separate item in the period in which changes in the specific prices of those assets occur and to report current cost income from continuing operations strictly on the basis of current revenue and current costs.

7. Capital Maintenance Concept:

SSAP 16 is based on physical capital maintenance and FAS 33 implies financial capital maintenance concept. Physical capital maintenance concept views capital as a physical capital in terms of the capacity to produce goods or services. By contrast, financial capital maintenance concept is concerned with the original capital invested in the firm; the excess of the cash over the original capital invested is treated as income that can be consumed or distributed.

Thus, financial capital maintenance concept aims to keep the original financial capital intact. In physical capital maintenance concept the objective is to maintain the firm’s ability to replace its physical productive assets.

The main difference between the two capital concepts is that holding gains are regarded as income of the given period under financial capital maintenance concept, whereas under the physical capital maintenance concept, holding gains are treated as ‘capital maintenance adjustments’ and shown in the equity capital section of the balance sheet.