Advanced Financial Accounting Mcom

Semester 1

ACCOUNTING FOR PRICE LEVEL CHANGES

 CONCEPT
 METHODS
 ADVANTAGES

Accounting for Price Level Changes

The general tendency in changes of prices of goods and services over a time is called price level.
The rise is general price level is called inflation. During the period of inflation, purchasing power
of money declines. The fall in the general price level is called deflation. During the period of
deflation, purchasing power of money increases.

Price level changes mean increase or decrease in the purchasing power of money over a period of
time. The accounting which considered price level changes is called accounting for price level
changes.

Accounting for price level changes is a system of maintaining accounts in which all items in
financial statements are recorded at current value. This system of accounting ascertains profit or
loss and present financial position of the business on the basis of current prices. Accounting for
price level changes is also known as Inflation Accounting because most of the countries of the
world is experiencing inflation since Second World War.

According to American Institute of Certified Public Accountants (AICPA), “Inflation accounting

is a system of accounting which purports to records, as a built in mechanism, all economic events
in terms of currents cost.”

Methods of inflation accounting

The following are the generally accepted methods of accounting for price level changes:-

• Current Purchasing Power Method (CPP)

In this method historical amounts are adjusted for changes in the general price level. Under this
method any established and approved general price index is used to convert the values of various
items in the Balance Sheet and Statement of Profit and Loss. 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.

This method is known by different names such as General Purchasing Power Method (GPP) or
Current Rupee Accounting.

For this purpose, historical figures must be multiplied by conversion factors and the formula for
the calculation of conversion factor is:

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Advanced Financial Accounting Mcom
Semester 1

Conversion Factor = Price Index at the date of revaluation

Price Index at the date of existing figures

Example:

Suppose the cost of machinery in 2010 is Rs. 100,000 and general price index was 200 and
current price index is 400. We calculate

100,000*400/200 = Rs 200,000
So, the value of the machine today is Rs 200,000.

• Replacement Cost Accounting Method

In this techniques the index used are those directly relevant to the company‘s particular asset and
not the general price index.

• Current Value Accounting Method

In this technique all the Assets and Liabilities are shown in the Balance Sheet at their current
values. The value of the Assets at the beginning and at the end of the accounting period is
ascertained and the difference in the value in the beginning and the end is termed as profit or
loss.

• Current Cost Accounting Method (CCA)

The Current Cost Accounting (CCA) Method is an alternative to the Current Purchasing Power
(CPP) Method. This method has been suggested by the Sandilands Committee of U.K. in the
year 1975.

Under this method, assets are valued at current cost. Current cost is the cost at which the assets
can be replaced as on a date. While the current purchasing power method is known as the general
price level approach, the current cost accounting method is known as the Specific Price Level
Approach or Replacement Cost Accounting.

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Advanced Financial Accounting Mcom
Semester 1

Features of CCA System:

The following are the important features of the CCA Method:

1. The fixed assets are shown in the balance sheet at their current values and not at the historical
cost.
2. Inventories are shown at market values rather than market or cost price whichever less as in
the historical system.
3. Revaluation surplus is transferred to current cost accounting reserve but not distributed as
dividend to shareholders.
4. Depreciation of fixed assets is to be calculated at replacement value.
5. Two types of profit i.e. profit from operations and profit from revaluation is calculated.

Important adjustment required under CCA techniques

1. Current cost of sales adjustment (COSA)

• Under this CCA techniques cost of sales are calculated on the basis of cost of replacing the
goods at the time they are sold.
• In this current cost must be matched with current revenues.
• But in case of inventories certain adjustment will have to made known as cost of sales
adjustment.

2. Depreciation adjustment

• Under this method assets are shown in the balance sheet at the current replacement cost after
allowing for depreciation.
• Formula is:

Opening Current Value of the Asset + Closing Value of the Asset * 2

Life of the Asset

Objectives of Inflation Accounting

• To show the true results of the operations i.e. real profit or loss.
• To show the true financial position in current value.
• To show the realistic value of fixed assets in financial statement.
• To provide sufficient depreciation to generate funds for the replacement of fixed assets.
• To indicate the real capital employed.
• To make distinction between holding gain or loss and operating gain or loss.
• To make accounting records reliable for the various users.

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Advanced Financial Accounting Mcom
Semester 1

Advantages of Inflation Accounting

•Changes in the value of money recognized.

• Logical application of matching principle concept
• Reported profits--- a realistic picture.
• Fixed assets shown at economic value.
• Ensures funds for replacement of assets
• Valuation of business at current prices

Submitted By,
Lucky Upadhhyay
Amity College of Commerce & Finance
M.Com (Semester : 1)

Date :

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