Current Purchasing Power Accounting

Current Purchasing Power Accounting

Accounting measurements are based on a monetary standard which hitherto has been assumed to be stable. However, experience of recent history has proved this assumption to be unrealistic with the result that the measurement of corporate income during periods of changing price levels has become a controversial issue.

Price changes may be seen as having general and specific effects. General price changes reflect increases or decreases in the value of the monetary unit. In this case, all individual prices are assumed to change in the same direction, so that the value of a currency in relation to goods and services is different through time. For example, if £15 can only buy today what £10 would have bought on an earlier date, we may say that the price level has increased, the purchasing power of money has fallen and the economy is in a period of inflation.

By contrast, specific price changes occur for several reasons. Changes in consumer tastes, technological improvements, speculation by buyers are all reasons found at the root of specific price changes. Thus, increased demand for houses in the face of a limited supply will force up the price of houses, even if the general price level is constant. It is common, however, for people to hedge against inflation by investing in property and this factor may also influence property prices. Hence, we may say that whilst specific price changes may occur independently of changes in the general price level, changes in the price level may induce disproportionate changes in the price level of specific goods.

Adjusting for the effects of price changes may take the following forms:

(a) general adjustments,

(b) specific adjustments based on current costs.

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Read on: Economic Concepts of Income and Value Summary

Conventional accounting concepts of income and value possess a limited usefulness for decision making, because of the limitations inherent in the conventions of historical cost and realization which govern the measurement of accounting income. Under conditions of inflation, conservative asset values on the balance sheet contrast with over-optimistic income measurement in the income statement. Changes in value are not reported as they occur. Changing money values also undermine the stability of the unit of measurement in accounting.

Under conditions of certainty, economic income provides an ideal... see: Economic Concepts of Income and Value Summary