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Chapter 10 by Google Laba (Income)
Chapter 10
Laba (Income)
Completing the book
Accounting Theory: Engineering Financial Reporting
by Suwardjono (BPFE, 2005)
Rp
Rp
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Chapter 10 by Google Laba (Income)
Learning objectives
Achieving participant capabilities and competencies to:
• Define profit structurally and semantically.
• State the objectives of income reporting.
• Identify the weaknesses of conventional accounting profits.
• Distinguish between accounting profit and economic profit.
• Mention and explain various interpretations of profit at the
semantic, syntactic and pragmatic levels.
• Mention and explain the types of capital and their
measurements.
• Explain the meaning of profit based on the concept of retention
capital.
• Explain the entity theory and its implications for the understanding
of profit (profit for whom).
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Terminology Problems
• IAI matches income with earnings which includes revenue and
profit.
• Income in foreign textbooks is generally defined as
profit.
• This book uses the term profit to refer to income in foreign
textbooks as defined by the FASB.
• Profit is also used as a synonym for earnings.
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Purpose of Profit Reporting
• Efficiency measure •
Entity and management performance measure •
Basis for determining taxes •
Means of allocating economic resources
• Determination of public service
rates • Optimization of debt-receivable
contracts • Compensation
basis • Motivators
• Basis for dividend distribution
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Theory of Profit Reporting
• One profit figure for multiple purposes.
• Different goals, different profits.
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Accounting Profit (Conventional)
Profit is defined as the difference between revenue and costs
measured and presented on the basis of generally accepted
accounting principles (GAAP).
Disadvantages:
• It has no semantic meaning but only structural
• Shareholder focused
• PABU provides the opportunity for differences between entities
• Based on historical costs
• Only partial information input for investors
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Profit Theory Level
Unlike other elements, profit is discussed at several
semiotic levels because accrual profit is seen as useful
for predicting future cash flows .
Discussion Level:
• Semantics
• Syntactic
• Pragmatic
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Chapter 10 by Google Laba (Income)
The Concept of Profit in Semantic Level
Discusses how profit is interpreted or expected to function
and what meaning should be attached to profit.
1. Performance meter
2. Confirm investor expectations
3. Estimator laba economic
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Accounting versus Economic Profit
Distinguishing Aspects Accounting Profit Laba Economic
Point of view Engineer, compiler Shareholders
standards and statements
Basis of measurement Historical cost Opportunity cost, market
value, liquidation value
Makna “economical” Long-term economic Short-term economic
viability feasibility
Meaning of depreciation Cost allocation Decrease in economic value
Unit of measurement Rupiah nominal Purchasing power
Measurement targets Monetary/nominal profit Royal Laba
The concept of a peddler Continuity, accrual Liquidation, cash value
Asset function Remaining service potential Reserves/value reserves
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Meaning of Profit
1. Increase in wealth/ capital.
2. Increase in a period.
3. Can be enjoyed, distributed, or withdrawn
by entities that control or have claims to
prosperity/capital as long as the
original (initial) prosperity remains intact.
Characteristic 3 is based on the capital
maintenance concept .
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Laba vs. Capital
• Profit means flow .
• Capital means stock .
• In the context of time periods, the two are
related (see Figure 5.6).
• Analogy with a water tank (reservoir).
The term capital is absorbed into capital to distinguish it
from capital which has been used as an equivalent
of the word equity. Capital is more generic than capital.
Capital is capital from the perspective of shareholders .
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General, formal and semantic definitions:
Additional economic capacity is characterized by
an increase in capital in a period originating
from productive activities in the broad sense
that can be consumed or withdrawn by the
controlling entity/capital owner without
reducing the initial economic capacity of the
capital (beginning of the period).
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Capital in the Context of Accounting Profit
Capital for the party who
owns/controls the claim (marked
Obligation with a debt certificate, for example a
bond).
Asset
Equity
Capital for the party that
owns/controls the claim
Capital for business entities or (marked with share
management that control these certificates)
economic resources (physical or
financial) to be managed effectively
productive
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Capital Maintenance Concept
An important concept in the semantic meaning of profit.
Characteristics:
1. Return on investment # return on investment.
2. Operating transactions # capital transactions (with owner).
3. Limit distribution to owners in order to maintain initial
capital.
4. Demand the amount of rupiah for capital adjustment in
order to maintain capital.
5. Application of the asset-liability approach in valuation.
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Visualization of Capital Retention Concept
Mark
Profit based on the concept
of capital preservation.
Capital adjustment.
Capital to be maintained
Capital that must be with capital adjustments.
maintained without
capital adjustments.
Initial capital Final capital
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The Concept of Profit in Syntactic Level
Discusses how profits are measured, recognized, and
presented.
1. Transaction approach
2. Activity approach
3. Capital maintenance approach
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Theoretical Problems at Syntactic Level
1. The transaction and activity approach is equivalent
to the concept of realization and collection in
revenue.
2. The transaction and activity approach adheres to
revenue-cost approach in measuring and valuing
elements (see Chapter 5, pp. 221-222).
3. The capital maintenance approach adheres to
asset-liability approach in measuring and
valuing elements.
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Chapter 10 by Google Laba (Income)
Capital Measurement and Valuation
With the concept of capital maintenance, profit is the difference
between capital measurements at two different points in time.
Measurement takes into account:
1. Type of capital (financial versus physical)
2. Measurement scale (nominal versus purchasing power)
3. Measurement attributes (historical versus current cost)
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Profit Measurement
with the Concept of Capital Retention
1. Capitalization of expected cash
flows 2. Market
valuation 3. Current cash
equivalents 4. Historical input
prices 5. Current input prices
6. Preservation of purchasing power
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The Concept of Profit in Pragmatics
Discusses how profits are interpreted and used in
practice and whether they are truly useful.
1. Cash flow predictor
2. Efficient contracting facilities
3. Management control tools
4. Information content of earnings in efficient
market theory
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Accrual Earnings as a Predictor of Cash Flow
Business entity
Accounting profit (accrual)
Predictor
Various earnings
forecasting models Future cash flows
Predictor
Cash flow
Investor
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Value Relevance
Do accounting numbers (earnings, book value, and
cash flow) explain changes in the company's value (as
indicated by the stock price)?
At least accounting information becomes an estimator of
the company's value.
There is at least an association between accounting
information and firm value variables.
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Value Relevance
Accounting numbers do not correlate perfectly with
stock prices because:
• Accounting uses historical costs.
• Stock prices reflect not only accounting
information (earnings, book value).
• Changes in earnings do not always reflect
fundamental economic changes.
• Different investor expectations and sophistication.
• Market behavior is often unpredictable.
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Relationship between Profit and Stock Price
Estimator Stock price
Profit or loss
changes
per share
per share
Book value per Estimator Price
share per share
at one time at one time
Change Change
Estimator
book value stock price
per share per share
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Efficient Contracting
Agency theory is a theory built on the basis of agency
relationships.
The inclusion of accounting figures (profit figures) in the
contract encourages the contracting parties (especially agents)
to achieve the objectives of the contract so that the
contract becomes efficient.
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Manager Behavior Control
Profit can be used to motivate the behavior of
division managers towards achieving overall
company goals.
(Relevant) profit is used as the basis for compensation
so that managers maximize their interests.
Goal congruence is achieved when a manager's
efforts to maximize himself also maximize the
interests of the company as a whole.
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Efficient Market Hypothesis
The efficient market hypothesis is only meaningful when linked
to a set of information provided or available in a financial
reporting system.
The capital market is said to be efficient with respect
to information if the stock price fully reflects the information.
Or, if security prices reflect promptly and fully all the information
available in a financial reporting system.
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Forms of Market Efficiency
Information is available in a
Shape
reporting system
Weak Past prices and volumes of securities
Semi-strong All publicly available information
Strong All information including information
private or in
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The Importance of the Efficient Market Hypothesis
Private information cannot always be conveyed
explicitly through financial statements. Earnings
carry with them private information that
management wants to convey . Earnings contain inside in
The efficient market hypothesis is a means of empirically
testing the information content of earnings.
1. Event testing
2. Association testing (profit relevance value)
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Empirical Testing Variables
• R = return (return) • RA =
return abnormal (abnormal return)
• LK = surprise profit (unexpected earnings)
• RAK = cumulative abnormal return (cumulative
abnormal return)
• Rm = return pasar (market return)
• R = return mean/rerata (mean return)
The term return is absorbed into fixed return as
modern is absorbed into modern. Mean is absorbed into mean.
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Empirical Testing Variables
LK = LA - LH
• LK = surprise profit (unexpected earnings)
• LA = laundry actual (actual earnings)
• LH = laba harapan (expected earnings)
All variables are measured on the event date.
Expected earnings are obtained through earnings
expectation models which usually use earnings
forecasting models .
See Figure 10.8
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Empirical Testing Variables
Measuring RA
• Mean-adjusted returns: RAj,t Rj,t Rj
ÿ
ÿ
• Market-adjusted returns: RAj,t Rj,t Rmt
ÿ
ÿ
Measuring the RAK
t 2
• Cumulative market return: LOAD,( 1,IT
2)
ÿ
ÿ Raj t
,
1tt
ÿ
See Figure 10.9 for a visualization of the concept.
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The Concept of Empirical Testing
Association
• Generally using regression models.
• LK is regressed against R, RA or RAK in the window period for the
sample firms.
• The coefficient R, RA or RAK indicates the association.
• If the coefficient is statistically significant, it means there is
an association. This means that the accounting variable
explains the variation in the market variable (market price).
• It can be concluded that accounting numbers have value
relevance.
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The Concept of Empirical Testing
Profit information content
• Generally with event studies; using t-test
Principle
If the mean RAK or RA of the sample companies in
the window period is statistically different from zero,
it means that there is a market reaction to the
event (e.g. earnings announcement).
Reactions can be positive or negative.
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Chapter 10 by Google Laba (Income)
Profit and Entity Theory
Discusses various entity concepts other than business
entities and their implications for the understanding
and presentation of profit (profit for whom).
1. Joint effort (Figure 10.10)
2. Business (Figure 10.12)
3. Investors (Figure 10.14)
4. Owner (Figure 10.16)
5. Residual owner
6. Operator
7. Funds (Figure 10.17)
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Implications of Entity Theory
Entity theory determines:
1. Form of accounting equation
2. Profit determining components (whether an item is
an expense or profit sharing)
3. Who is the recipient of the profit?
See Figure 10.18 for a summary of the discussion.
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Definition of Fund (NCGAS No. 1)
A fund is defined as a fiscal and accounting entity with a
self balancing set of accounts recording cash and
other financial resources, together with all related
liabilities and residual equities or balances, and
changes therein, which are segregated for the purpose
of carrying on specific activities or attaining certain
objectives in accordance with special regulations,
restrictions, or limitations.
Error: Remove the parentheses added by the author in the quote on page 504. Remove
the explanation in footnote 40 starting from “Parentheses …” to “ … meaning.”
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Two Definitions of Funds
1. Cash, liquid assets, or financial resources
2. Accounting entity with specific accounting
equation:
Assets = Restrictions on the use of assets
Liquid assets = Fund balance
Entity theory deals with the second notion.
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Fiscal entities:
An entity that functions to receive and spend liquid resources in
one period.
Accounting entity:
The entity that accounts for government assets and liabilities in
the form of a fund accounting equation.
To be called a fund, an entity must be fiscal in nature
and have its own accounting equation. If it is not
fiscal in nature, the entity is called: Accounts group .
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Budget Fund Operations
Funding entity:
project, program, activity, or
government unit
Cash/receivables
Source of income/
receipt
Fund balance increases
Liquid assets = Fund balance
Cash/debt Expense/
expenditure object
Fund balance decreased
Unity of funds
perspective
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Fund Accounting Equation
Budget Fund Operations
Initial balance
Awal period: AL = SD
Statement of Changes in Fund Balance
During the period: AL* = SD + P - B
Income and Expenditure Statement
Last period: AL* = SD*
Final balance
See an example of this fund operation in Appendix 2.
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Ambitious? … It's okay.
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