Arguments For and Against Inclusion of Capital | Accounting

In this article we will discuss about the arguments for and against inclusion of capital.

Arguments in Favour of Inclusion:

(a) When wages is the reward of labour, interest is the reward of capital.

(b) Interest should either be ignored entirely or else included in respect of all capital employed whether such capital requires the payment of interest or not to avoid distortion of accounts.

(c) The exclusion of interest in Cost Accounts would distort cost of product in industries like seasoning of timber, brewing of wine etc. Where substantial time is waited after the investment of capital, for which interest must be considered for ascertainment of profitabi­lity of the product.

(d) In many management decisions, the cost of capital will be crucial consideration especially when such decisions affect the organization’s long-term prospects. It necessitates the inclusion of capital in Cost Accounts.

(e) The comparison of cost and profitability of different jobs, cost units or organizations, time periods cannot be done without the inclusion of interest on capital.

(f) The importance of time value of money is recognized only when interest is considered as an element of cost.

(g) For long-run survival of the organization it must earn sufficient profits to pay interest on capital provided for its business. Hence, importance of interest in Cost Accounts need not be over emphasized.

(h) Capital investment decisions are taken only after consideration of interest on capital otherwise it would be disastrous.

Arguments Against Inclusion:

(a) The amount of interest paid depends entirely upon the method of capitalization and the financial policy of the organization and its financing pattern.

(b) It is the argument of economists, “wages is the reward of labour, interest is the reward of capital”, and it is not the argument of costing.

(c) If interest is included in manufactured stock it has to be written back for balance sheet purposes.

(d) It is difficult to calculate the cost of capital. Its calculation may lead to various interpretations like interest on term loans, debentures, owner’s capital, working capital facilities etc. and other factors such as risk, period of maturity, bank rate etc.

(e) Interest is merely an anticipation of profit.

(f) It is difficult to apportion cost of capital to different cost centres and absorption of it into product cost.

In view of difficulties mentioned above, interest on capital cannot be included in Cost Accounts, but interest on capital should be given due consideration in all managerial decision making and comparative purposes.