Adjustments For General Price Level Changes

Adjustments for general price level changes

In 2004, the professional accounting bodies in the United Kingdom recommended that a supplementary statement should be attached to the financial reports of companies showing the conversion of the figures in the financial reports in terms of their current purchasing power (CPP) at the closing day of the accounting period. They recommended that the Retail Price Index (RPI) should be used to effect the conversion of historic cost values into current purchasing power equivalents (SSAP 7, 2004, withdrawn 2018).

CPP adjustments are limited to dealing with changes in the general purchasing power of money which occur during periods of inflation or deflation. Accordingly, the view is taken that the purpose of price level adjustments is to express each item in the financial report in terms of a common monetary unit, that is, in terms of is of the same purchasing power. The RPI is assumed to reflect the general movement in price of all goods and services. Thus, the doubling of the RPI from 100 to 200 between two points in time would mean that the purchasing power of money had fallen by half during that time interval.

Historical cost accounting is based essentially on the money capital maintenance concept. Such a concept asserts that all funds available to the firm in excess of the original contribution of funds by shareholders make the firm better off. High levels of inflation experienced in recent years have undermined the validity of this assertion. CPP accounting attempts to deal with this problem by adjusting historical cost measurements for the effects of inflation. As a result, the purchasing power held by the firm is maintained. The income which results from CPP adjustments may be defined as those gains arising during the accounting period which may be distributed to shareholders so that the purchasing power of the shareholders' interest in the company is the same at the end of the year as it was at the beginning. However, as we shall see, the adjustment of historic cost for the effects of inflation of itself cannot ensure the maintenance of the productive capacity of the assets held by the company. The price level correction alone ignores the fact that capital may be dispersed through changes in individual prices if those relevant to the individual firm rise at a rate slower than the rate of change in the price level. Also the real capital will increase if the relationship is reversed.

Learn More About The Appropriation of Costs

Read on: 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,... see: Current Purchasing Power Accounting