Purpose of Current Purchasing Power Accounting
Current purchasing power accounting (CPPA) aims to ensure the accurate reflection of financial statements by adjusting for changes in the general price level. This ensures that the shareholders’ capital maintains its purchasing power.
Key Facts
- Purpose: The purpose of current purchasing power accounting is to ensure that financial statements accurately reflect the purchasing power of the shareholders’ capital by adjusting for changes in the general price level.
- Adjustments: Non-monetary items recorded on the historical-cost basis are adjusted using a general price index to account for changes in the value of money. Monetary items, such as cash and cash equivalents, are not adjusted.
- Financial Statements: When using current purchasing power accounting, adjustments are made to various financial statements:
- Income Statement: All items on the income statement should be adjusted for changes in the general price level.
- Cash Flow Statement: All items on the cash flow statement should be adjusted for changes in the general price level.
- Balance Sheet: Monetary items should not be adjusted, items already adjusted for current market value/fair value should not be adjusted further, equity should be adjusted, and all other non-monetary items should be adjusted for changes in the general price level.
- Monetary and Non-monetary Items: Current purchasing power accounting distinguishes between monetary items and non-monetary items. Monetary items represent a fixed amount of currency and are adjusted at the current rate, while non-monetary items, such as fixed assets, are adjusted at historical rates.
Adjustments in Current Purchasing Power Accounting
Non-monetary items recorded on the historical-cost basis are adjusted using a general price index to account for changes in the value of money. Monetary items, such as cash and cash equivalents, are not adjusted.
Financial Statement Adjustments
When using CPPA, adjustments are made to various financial statements:
- Income StatementAll items on the income statement should be adjusted for changes in the general price level.
- Cash Flow StatementAll items on the cash flow statement should be adjusted for changes in the general price level.
- Balance SheetMonetary items should not be adjusted, items already adjusted for current market value/fair value should not be adjusted further, equity should be adjusted, and all other non-monetary items should be adjusted for changes in the general price level.
Distinction Between Monetary and Non-monetary Items
CPPA distinguishes between monetary items and non-monetary items. Monetary items represent a fixed amount of currency and are adjusted at the current rate, while non-monetary items, such as fixed assets, are adjusted at historical rates.
Conclusion
Current purchasing power accounting is a method that adjusts financial statements for changes in the general price level to ensure the accurate reflection of the purchasing power of shareholders’ capital. It involves adjusting non-monetary items using a general price index, distinguishing between monetary and non-monetary items, and making adjustments to various financial statements.
Sources
- Oxford Reference: https://www.oxfordreference.com/display/10.1093/oi/authority.20110803095653993
- GoCardless: https://gocardless.com/en-us/guides/posts/what-is-constant-purchasing-power-accounting/
- Finance Strategists: https://www.financestrategists.com/accounting/cost-accounting/inflation-accounting/current-purchasing-power-method-c-p-p/
FAQs
What is the purpose of current purchasing power accounting?
CPPA aims to ensure that financial statements accurately reflect the purchasing power of shareholders’ capital by adjusting for changes in the general price level.
What adjustments are made in CPPA?
Non-monetary items recorded on the historical-cost basis are adjusted using a general price index to account for changes in the value of money. Monetary items, such as cash and cash equivalents, are not adjusted.
How are financial statements affected by CPPA?
When using CPPA, adjustments are made to various financial statements:
- Income Statement: All items on the income statement should be adjusted for changes in the general price level.
- Cash Flow Statement: All items on the cash flow statement should be adjusted for changes in the general price level.
- Balance Sheet: Monetary items should not be adjusted, items already adjusted for current market value/fair value should not be adjusted further, equity should be adjusted, and all other non-monetary items should be adjusted for changes in the general price level.
How does CPPA distinguish between monetary and non-monetary items?
CPPA distinguishes between monetary items and non-monetary items. Monetary items represent a fixed amount of currency and are adjusted at the current rate, while non-monetary items, such as fixed assets, are adjusted at historical rates.
What are some advantages of using CPPA?
Advantages of CPPA include:
- Tracking trends over time by expressing data in units of constant purchasing power.
- Maintaining the purchasing power of investments by adjusting for inflation.
- Evaluating corporate profits more accurately by considering changes in the general price level.
What are some challenges associated with implementing CPPA?
Challenges associated with CPPA include:
- Training personnel to prepare and interpret information adjusted for inflation.
- Selecting an appropriate price index for revaluing assets.
- Potential resistance from managers and labor unions due to perceived impacts on profits and bonuses.
When is CPPA particularly useful?
CPPA is particularly useful when the aim is to maintain purchasing power in general, such as:
- Evaluating trends over time, especially when data is expressed in units of constant purchasing power.
- Assisting shareholders in keeping the purchasing power of their investment intact.
What are some alternative methods to CPPA?
Alternative methods to CPPA include:
- Historical Cost Accounting: Records transactions at various points in time, showing replacement purchasing powers at those times.
- Current Cost Accounting: Determines the current values of various assets, rather than stating financial statements in terms of dollars of uniform value.