The Committee considered CCA as a comprehensive technique of accounting for inflation. The CCA method matches current revenues with the current cost of the resources which are consumed in earning them. The Current Cost Accounting (CCA) method is also termed as Specific Price Level approach. Under historical cost accounting, it remains on the books at $100,000 (minus accumulated depreciation). However, if current replacement cost is $130,000, CCA would show this higher value, providing stakeholders with more relevant information about the company’s actual asset base.
The British Government had appointed a committee known as Sandilands Committee under the chairmanship of Mr. Francis C.P. Sandilands to consider and recommend the accounting for price level changes. The examples of such items are cash, debtors, bills receivables, outstanding incomes, etc., as assets and creditors, bills payable, loans etc., as liabilities. Such items whose amounts are fixed and do not require reassessment are also known as money value items. Inflation accounting does involve a bunch of calculations and makes the financial statements complicated. Therefore, it becomes difficult for the common man to understand, analyse and then interpret. However, few people consider that the price level accounting may create problems instead of solving them.
Monetary items need no conversion since they are already stated in current rupees at the end of the period to which the accounts relate. Under this method any established and approved general price index is used to convert the values of various items in the Balance Sheet and Profit and Loss Account. This method takes into consideration the changes in the value of items as a result of the general price level, but it does not account for changes in the value of individual items. Based on adoption of proper conversion method Price level accounting depends heavily on the selection of proper conversion method. Accounting for changing price level changes makes possible the comparative study of the enterprises set up at different periods. In addition to the balance sheet and profit and loss account, an appropriation account and a statement of changes is prepared.
- Under historical cost accounting, it remains on the books at $100,000 (minus accumulated depreciation).
- Hence, it may not be possible to charge depreciation on replacement cost basis.
- In 1986 the FASB issued its Statement No. 89 which no longer required the reporting of the information.
Current cost operating profit is the profit as per historical cost accounting before charging interest and taxation but after charging adjustments of cost of sales, depreciation and monetary working capital. As depreciation under CCA is provided on current cost, the method prevents overstatement of profits and keeps the capital intact. The effect of holding monetary items in terms of gains and losses having an impact on the finance of the business is also highlighted. In the Current Value Accounting Technique of price level accounting all assets and liabilities are shown in the balance sheet at their current values. Hence, to rectify this, it is necessary that fixed assets are valued at replacement cost values and depreciated on such replacement cost values.
But adopting replacement cost method is also not free from difficulties. Monetary accounts are those assets and liabilities which are not subject to reassessment of their recorded values owing to change of purchasing power of money. The amounts of such items are fixed, by contract or otherwise in term of rupees, regardless of change in the general price level.
- The Current Purchasing Power (CPP) method, also known as general price level accounting, addresses inflation by converting historical costs into current purchasing power units.
- The depreciation adjustment allows for the impact of price changes when determining the charge against revenue for the part of fixed assets consumed in the period.
- As for sales are concerned, it is current revenue and out of the costs, all operating expenses are current costs.
- The current cost accounting method is an alternative to the current purchasing power method.
Moreover, it becomes difficult to determine with a relevant price index. A plant was purchased on 1st Jan. 2000 for Rs. 2, 00,000 and is depreciated at 10% p.a. Show how the plant account would appear in the Balance Sheet as at 31st Dec. 2004. (b) Cost of sales is converted as per cost flow assumption (FIFO or LIFO) as explained in the preceding pages. Personal preferences In Price Level Accounting the adjusted measures are based on assumptions and these assumptions are dependent on personal preferences. Compute the backlog depreciation from the information given in illustration 14.
Furthermore, this method gets criticized by thinkers due to the element of subjectivity in it. The main goal of this method is that it takes into consideration the changes resulting in the value of money due to the change in the general price levels. It presents the financial statements in terms of constant value ( a unit of measurement) when both revenue and costs changes due to the change in price levels. Depreciation is charged on the current value of assets in price level accounting. As a result, this enables the company to show their accounting profit closer to economic profits.
Accounting for Price Level Changes Accounting
Governments also benefit from the use of price level accounting methods when assessing the impact of the current economy on the purchasing power of both individual consumers and corporate entities. This method is based on the normal accounting concept that profit is the change in equity during an accounting period. Under this method, the openings as well as closing balance sheets are converted into CPP terms by using appropriate index numbers. The difference in the balance sheet is taken as reserves after converting the equity capital also. The main objective of this method is to take into consideration the changes in the value of money as a result of changes in the general price levels.
Current Cost accounting
The part of the MWCA related to trade creditors reflects this reduction. (ii) Net Realisable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. (b) Similarly, inventories are shown in the Balance Sheet at their value prevailing on the date of the Balance Sheet. These are not shown at cost or market price whichever is lower, as in case of historical accounting.
Depreciation
The closing inventory in LIFO is out of the purchases made in the previous year. Replacement Cost Accounting Technique is referred to as an improved version of CPP( current purchasing power technique). The major drawback of CPP is that it does not consider the price index individually related to the assets of the company.
These are called the Depreciation Adjustment, Cost of Sales Adjustment and Monetary Working Capital Adjustments. In Replacement Cost Accounting (RCA) method all of the non-monetary items are reported in the balance sheet at replacement cost. Different countries have varying requirements for price level accounting. Some nations mandate supplementary disclosures showing the effects of inflation, while others allow companies to choose their preferred method. International Financial Reporting Standards (IFRS) provide guidance on hyperinflationary economies but don’t require routine price level adjustments in stable economic environments.
Disadvantages of inflation accounting
This process of adjustment of cost of sales and inventory has been explained in the following illustration. There are several transactions which take place throughout the year such as purchases, sales, expenses, etc. For conversion of such items, average index of the year can be taken as the one index for all such items. If such an average is not available, the index of the mid-year is taken for this purpose. And, if the index of the mid year is also not available, then the average of index at the beginning and at the end of the period may be taken.
It is referred to as the excess of current assets over current liabilities. The changes in the price levels disturb the working capital position of a concern. The depreciation is charged on the current values of the fixed assets and not on original costs. Three main adjustments to trading account, calculated on the accounting for price level changes historical cost basis before interest, are required to arrive at current cost operating profit.
Exploring current cost accounting
Current Cost Accounting (CCA) takes a different approach by valuing assets at their current replacement cost rather than adjusting historical costs. This method recognizes that different assets experience varying rates of price change, providing a more precise reflection of current economic realities. Price level accounting is a type of financial accounting strategy that seeks to allow for the impact of changes in the value of a currency as the economy goes through a period of inflation or recession.
In this method the various items of financial statements, i.e. balance sheet and profit and loss account are adjusted with the help of recognized general price index. The consumer price index or the wholesale price index prepared by the Reserve Bank of India can be taken for conversion of historical costs. In this method of price level accounting, all the liabilities and assets are represented in the balance sheet at the current values. The difference in the net assets calculated at the beginning and end of the accounting period is ascertained which is known as the profit or loss. Current purchasing power method or CPP method is used for purpose of adjusting financial statement during inflationary period.