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Approaches to the price level Accounting

Generally there are four important approaches to the price level accounting :

(A) Current Purchasing Power Accounting [CPPA]

(B) Current Cost Accounting [CCA]

(C) Specific and General Price Level Accounting [SGPLA]

(D) Periodic revaluation of fixed assets along with the adoption of the LIFO method of inventory

(A) Current Purchasing Power Accounting (CPPA)

 

According to this method any approved general price index is used to convert the values of items in the financial statement at a particular period of time. This method considers the changes in the value of item as a result of the general price level but it does not consider the changes in the value of an individual item.

 

Steps in Current Purchasing Power Account :

(i) Conversion Factor

Formula =  Index you are converting to /Index you are converting from

or

 

Conversion Factor = Price index at the date of revaluation/ Price index at the date of existing  figure

 

(ii) Mid Period Conversion

(iii) Distinction between monetary accounts and non monetary accounts

(iv) Determine gain or loss on monetary items

(v) Cost of sales and inventories

(vi) Ascertainment of profit

(a) Conversion income method

(b) Net change method

 

(B) Current Cost Accounting (CCA)

 

Current purchasing power method considers only changes in the money value, but it does not take into account the changes in the value of individual item. Under this method, the value of particular item may be increased on the basis of general price index. But the actual value of that item might have decreased. In order to overcome this limitation, the UK Government formed an Inflation Accounting Committee headed by Franis Sandilands. This committee published its report in 1975, to recommend the adoption of current cost accounting for dealing with the problem of Inflation Accounting.

 

In this method, historic values of items are not taken into account. Rather current values of individual items are taken on the basis of preparing profit and loss account and balance sheet. These items are not adjusted as a result of change in the general price level as they are adjusted in the current purchasing power method.

Under current cost accounting approach of inflation accounting, accounting profit is divided into three divisions.

(i) Current operating profit.

(ii) Realised holding gain.

(iii) Unrealised holding gain.

 

(i) Unrealised Holding Gain

Unrealised Holding Gain is the excess of the replacement cost of a non-monetary asset sold on the closing date over its historical cost.

 

(ii) Realised Holding Gain

Realised Holding Gain is the excess of the replacement cost of a non-monetary asset sold on the date of its sale over its historical cost.

 

(iii) Current Operating Profit

For the computation of current operating profit, the following adjustments are to be made in the current cost accounting method.

 

(a)    Depreciation adjustment

(b)   Cost of sales adjustment

(c)    Monetary working capital adjustment

(d)   Gearing adjustment.

(a)    Depreciation Adjustment. The current year depreciation change under current cost   accounting method is obtained by apportioning the average net replacement cost  over the  expected remaining useful life of the fixed assets at the beginning of the period.

(b)   Cost of Sales Adjustment (COSA)

 

Formula :

 

COSA = (C- O) Ia (C/I –O /IO)

Where,             0 = Historical cost of opening stock

C = Historical cost of closing stock

I a = Average index number of the period

10 = Index number appropriate to opening stock

I c = Index number appropriate to closing stock.

(c) Monetary Working Capital Adjustment (MWCA)

 

MWCA = C –O  -I a  (C/Ic-.O/IO) .

0 = Opening monetary working capital

C = Closing monetary working capital

I a = Average index number for the period.

10 = Index number appropriate to opening MWC

I c = Index number appropriate to closing MWC.

(d) Gearing Adjustment

Gearing adjustment =L / L+S

L = Average net borrowing

S = Average shareholders funds

A = Total of current cost adjustments

(C) Specific and General Price Level Accounting (SGPLA)

 

This approach of accounting has not been popular because it has not been proposed so far by any institutional body as other approaches have been recommended by institutional bodies.

 

(D) Periodic Evaluation of fixed assets along with Adoption of LIFO method of Inventory

 

LIFO method of inventory valuation got the world wide general acceptance and is made use of during inflation. The advantage of this method are of the view that periodic revaluation of fixed assets along with the adoption of LIFO method can reasonably reduce the effect of increasing prices.