METHODS OF PRICE

LEVEL
ACCOUNTING

Methods

Though an effective and acceptable method of

inflation accounting is still not developed but
there are techniques with the help of which
enterprises
are
restating
their
financial
statements. The commonly accepted methods
of accounting for price level changes are:
1. Current Purchasing Power (CPP) Method
2. Current cost accounting method (CCA)
Method
3. Hybrid method

CPP method:

In this method figure stated in the financial statements are

converted into figures at current purchasing price.
Conversion factor = Price index at the time of conversion
Price index at the date of transaction

The figures in the financial statements are classified into

monetary and non monetary items. Monetary items are those
items whose amounts are fixed by contract. The changes in
price levels do not have any effect on such items e.g. cash,
debtors, creditors, loans, outstanding expenses etc. Monetary
items need not be converted since they are already stated at
current price levels. If a debtor is created on 1.1.2005 for
Rs.1000 and he repays Rs.1000 on 31.12.2005 price index being
100 and 150 respectively. The debtor should have paid
1000* 150 = 1500
100

Thus there is a loss of Rs.500 due to inflation.

Such gain/loss in case of monetary items are
determined and shown separately in the
income statement to arrive at the total profit or
loss.

Non monetary items are those items which are

held by the company as assets or liabilities like
buildings, inventories etc... Such items are to be
restated at the current price level. Equity share
capital is treated as non-monetary item.

The difference in Balance Sheet is treated as

reserve.

Hence under CPP method:

1. Monetary items are not restated but Gain/loss on
monetary items is determined
2. Non monetary items are restated at current price
levels
3. Gain/loss on monetary items is adjusted in Profit /loss
A/c
4. Any difference in Balance Sheet is shown as
reserves.

Criticisms against CPP

1. The selection of price index is not easy. There are
different price indices
2. The price level selected is general price level and
not for the individual items.

CURRENT COST ACCOUNTING METHOD

As per this method, each item of the financial

statements is restated at its current value. Assets are
shown at the current costs. The profits are computed on
the basis of what the cost would have been at the date
of sale rather than the actual cost.

e.g. If a product costing Rs.8 is valued at Rs.10/- on the

date of sale and the sale price is Rs.12 , then profit will be
taken as Rs. 12- Rs.10 = Rs.2 and not Rs.12 Rs 8 = Rs.4.

Under this method adequate provision is made for the

operating assets of the business viz fixed assets, stock,
net monetary working capital (Debtors Creditors).
These are shown at current cost which may be higher or
lower than the historical cost. The difference is charged
to Current Cost Accounting Reserve / Monetary Working
Capital Adjustment.

CCA method is preferred by accountants since it

measures the real profit or loss for the accounting
year. This technique can be built in into the
accounting system and financial statements can
be regularly prepared on CCA basis.

Criticisms:
1. Depreciation under CCA method is provided on the
current value of the assets. They may not be
adequate to provide for the replacement of all
types of assets.
2. There is subjectivity in adopting the current value of
the assets depending upon the discretion and
personal judgments of the managers.
3. This method does not take into account the
change in value of borrowed funds

CCA method is preferred by accountants since it

measures the real profit or loss for the accounting
year. This technique can be built in into the
accounting system and financial statements can
be regularly prepared on CCA basis.

Criticisms:
1. Depreciation under CCA method is provided on the
current value of the assets. They may not be
adequate to provide for the replacement of all
types of assets.
2. There is subjectivity in adopting the current value of
the assets depending upon the discretion and
personal judgments of the managers.
3. This method does not take into account the
change in value of borrowed funds

HISTROCIAL
ACCOUNTING

Is the situation in which accountants record revenue, expenditure

and asset acquisition and disposal at historical cost: that is,

The actual amounts of money, or money's worth or the fair value of

the consideration given to acquire them at the time of their
acquisition, received or paid to complete the transaction.

Limitations of Historical Cost

Accounting

Control

Consumption

Taxation

Valuation

CONTROL

Historical cost accounts, in general, simply show the acquisition cost

or the depreciated historical cost of a companys assets and not
their current value, let alone the value of the company as a whole.
So historical cost accounting do not provide an absolute measure
of success of the company.

The historical cost accounts are most unhelpful when it comes to the
comparison of performance because the inflation which means
general increase in price or fall in value of money affect different
companies in very different way and the problem is not just inflation
but includes the treatment of changes in relative price

Consumption

Empirical evidence suggests that companies' dividends are related

to the level of the reported profit.

The concept of capital maintenance based on historical cost

accounting principles has proved to be a dangerous benchmark
when used to assess the amount which a company can pay out by
way of dividend or through taxation.

Taxation

The company tax charge is based on its accounting profit, the

higher the amount that will be paid in tax.

The historical cost accounting does not constitute a suitable basis

for the computation of the taxation obligations of business.

The use of historical cost accounting as the basis for taxation means
that in period of rising prices the proportion of the increase in
company wealth which is taken by taxation may be very much
larger than that which is implied by the nominal rate of taxation.

The rapid and extreme inflation of the mid-1970 made government

and others very much aware of the inadequacy of historical cost
accounting for the purpose of taxation

Valuation

The knowledge of historical cost of a company asset will not be of

much help in assessing the value of a company or its shares in a
business; hence, it is better using current value principle to valuate
the company.

ADVANTAGES OF HISTROCAIL
ACCOUNTING

The main advantage of using historical cost on the balance

sheet for property, plant and equipment is that historical cost can
be verified. Generally, the cost at the time of purchase is
documented with contracts, invoices, payments, transfer taxes, and
so on.
The historical cost of plant and equipment (not land) is also used to
determine the amount of depreciation expense reported on the
income statement. The accumulated amount of depreciation is also
reported as a deduction from the assets' historical costs reported on
the balance sheet. (In the case of impairment, some assets might
be reported at less than the amounts based on historical cost.)

THANK YOU

BY DEEPA FERNANDES AND KULADEEPA KR