Understanding Alternative Accounting Rules
Definition
Alternative accounting rules are special regulatory provisions under the Companies Act that allow companies to value certain assets differently from the traditional historical-cost convention. These rules enable the valuation of intangible assets (excluding goodwill), tangible fixed assets, fixed-asset investments, and current-asset investments at either their current cost or market value, depending on specific criteria. Accounts prepared using these modified rules are described as being under the “modified historical-cost convention.”
Practical Application
- Intangible Assets: Intangible assets, other than goodwill, may be valued at their current cost. Current cost reflects the cost to replace an asset at present prices.
- Tangible Fixed Assets: These can be included at market value, determined during the latest valuation, or at current cost if revalued.
- Fixed-Asset Investments: These investments may be valued at their market value during the latest valuation or at another appropriate basis determined by the directors.
- Current-Asset Investments and Stock: These are included at current cost unless net realizable value is lower, in which case the net realizable value must be deducted.
- Permanent Diminution in Value: Any permanent drop in the value of assets must be accounted for (provided for in books).
Examples
- Intangible Assets: A company holds a patent (not goodwill) valued initially at $50,000. If the current replacement cost rises to $60,000, the company can record the patent at $60,000 under alternative accounting rules.
- Tangible Fixed Assets: A company’s office building last valued at $1.5 million might be revalued at $2 million due to market appreciation. Using alternative accounting rules, the building is recorded at the higher $2 million market value.
- Fixed-Asset Investments: A company’s investment in another firm’s stocks initially bought for $100,000 may be valued at the current market value of $120,000 during the last valuation date.
- Current-Asset Investments: A company holding stock initially calculated at $30,000 current cost might see market depreciation at $25,000 net realizable value. Using alternative rules, the stock is valued at $25,000.
Frequently Asked Questions
1. What is the historical-cost convention?
The historical-cost convention records assets at their original purchase cost. Alternative accounting rules allow adjustments to reflect current or market values.
2. What are intangible assets?
These are non-physical assets with value, such as patents or trademarks, excluding goodwill.
3. What is goodwill?
Goodwill includes the value derived from a company’s reputation, brand, customer base, and other intangibles but is specifically not included in alternative rules valuations.
4. What is net realizable value?
It’s the estimated selling price of an asset in the ordinary course of business, minus any costs to complete and sell it.
5. What happens when there’s a permanent diminution in value?
Any permanent decrease in asset value must be recorded, ensuring that the balance sheet reflects current asset worth accurately.
Related Terms
- Historical-Cost Convention: An accounting method that records asset values at their original purchase costs.
- Current Cost: The cost to replace an asset at the present market value.
- Market Value: The price an asset would fetch in the marketplace.
- Net Realizable Value: Estimated selling price after deducting costs to sell.
- Permanent Diminution in Value: Long-term and non-reversible decrease in asset value.
- Revaluation Model: An accounting method where assets are adjusted to their fair value.
Online References
- IFRS and IFRS for SMEs - Official Standards
- Financial Reporting Council
- UK GAAP – Accountancy Learning website
Suggested Books for Further Study
- “IFRS: A Quick Reference Guide” by Robert Kirk
- “UK GAAP 2019: Generally Accepted Accounting Practice under UK and Irish GAAP” by Ernst & Young LLP
- “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
Accounting Basics: “Alternative Accounting Rules” Fundamentals Quiz
### What is the main purpose of alternative accounting rules?
- [ ] To increase company profits artificially.
- [x] To allow for more accurate asset valuation.
- [ ] To speed up the accounting process.
- [ ] To reduce the cost of preparing financial statements.
> **Explanation:** The main purpose of alternative accounting rules is to allow companies to reflect more accurate asset valuations through current or market values instead of historical costs.
### Are intangible assets valued at current cost under alternative accounting rules?
- [ ] All intangible assets except patents.
- [ ] Only goodwill.
- [x] All intangible assets except goodwill.
- [ ] None of the intangible assets.
> **Explanation:** Under alternative accounting rules, all intangible assets except goodwill may be valued at current cost.
### What is the correct valuation approach for tangible fixed assets under alternative accounting rules?
- [x] Market value at last valuation date or current cost.
- [ ] Historical cost.
- [ ] Estimated future value.
- [ ] Insured value.
> **Explanation:** Tangible fixed assets can be valued at market value as determined at their last valuation date or current cost under alternative accounting rules.
### If net realizable value is lower than current cost, which should be used for current-asset investments?
- [ ] Current cost.
- [x] Net realizable value.
- [ ] Historical cost.
- [ ] Market cost.
> **Explanation:** If net realizable value is lower than current cost, the net realizable value must be used in the valuation of current-asset investments.
### How should a company account for a permanent diminution in value under alternative accounting rules?
- [x] It must be provided for.
- [ ] It can be ignored.
- [ ] It should be recorded as a gain.
- [ ] It is noted but not recorded.
> **Explanation:** Any permanent diminution in value must be provided for, ensuring the financial statements reflect accurate values.
### What principle underlines the alternative accounting rules?
- [ ] Accrual principle.
- [ ] Matching principle.
- [x] Modified historical-cost convention.
- [ ] Consistency principle.
> **Explanation:** The alternative accounting rules are described as using the modified historical-cost convention, allowing assets to be valued at current or market costs.
### Which asset category explicitly does not qualify for alternative accounting rules?
- [ ] Tangible assets.
- [x] Goodwill.
- [ ] Fixed-asset investments.
- [ ] Current-asset investments.
> **Explanation:** Goodwill does not qualify for revaluation under alternative accounting rules.
### Where are alternative accounting rules primarily governed?
- [ ] GAAP.
- [x] Companies Act.
- [ ] Universal Accounting Standards.
- [ ] SEC regulations.
> **Explanation:** Alternative accounting rules are primarily governed by the Companies Act.
### What is the main difference between historical-cost and current-cost conventions?
- [ ] Historical-cost is easier to calculate.
- [x] Historical-cost uses original cost, while current cost uses replacement cost.
- [ ] Current-cost is always higher.
- [ ] There is no significant difference.
> **Explanation:** Historical-cost convention records assets at their original purchase costs, whereas current cost reflects the costs to replace assets at present prices.
### How often should a company revalue its fixed assets under alternative accounting rules?
- [x] At the last valuation date.
- [ ] Annually.
- [ ] Quarterly.
- [ ] Bi-annually.
> **Explanation:** Revaluations are done based on the last valuation date to reflect accurate market values.
Thank you for exploring the concept of alternative accounting rules! Continue enhancing your financial knowledge for more informed decision-making.
