Current Purchasing Power (CPP) Method
The introduction of current purchasing power (CPP) method is one of the greatest
revolutions in the field of accounting. Under current purchasing power (CPP)
method, any established and approved general price index is used to convert the
values of various items in the balance sheet and profit and loss account. It involves
the restatement of some or all of the items in the historical financial statement for
changes in the general price level. For this purpose, approved price index is used
to convert the various items of historical financial statement. This method helps to
present financial statement in terms of units of equal purchasing power.
Under this method, financial statements are prepared on the basis of historical
cost and a supplementary statement is prepared showing historical items in terms
of current value on the basis of general price index. Retail price index or wholesale
price index is taken as an appropriate index for the conversion of historical cost
items to show the changes in value of money. This method takes into consideration
the changes in the value of items as a result of general price level, but it does not
account for changes in the value of individual items.
Characteristics Of CPP Method
1. A supplementary statement is prepared and annexed to historical financial
statement. The supplementary statement includes re-statement of income
statement and re-stated balance sheet.
2. Any statement prepared under CPP method is based on the historical statement.
3. Consumer price index or wholesale price index is used as conversion factor for
re-stated of historical items.
4. All the items in financial statement are classified into monetary and non-
monetary items. Non-monetary items are adjusted, there is no need of any
adjustment for the monetary items.
5. Net gain or loss account of monetary items is to be accounted in the profit and
loss account.
CPP will aid in comparisons year over year.
Questions arise because the RPI was used whether it bears any relationship to the
company’s own cost. ( imported raw materials have little connection to the RPI)
CPP attempts to maintain the Purchasing Power of the shareholders’ capital.
CURRENT COST ACCOUNTING
Definition
The financial accounting term current cost accounting refers to an approach that values assets at
their fair market value rather than historical cost. In practice, current costs can be determined in a
number of ways, including applying a specific price index to the book value of the asset.
The objective of the current cost accounting method is to report the financial assets and liabilities of
a company at their fair market value rather than historical cost. For example, the book value of the
vehicles owned by a company may be $15,000,000; however, the fair market value of the vehicles
might be closer to $8,000,000.
Specific Price indices are used instead of the RPI
FAIR VALUE ACCOUNTING COVERED UNDER IFRS13
Definition of fair value accounting
An alternative approach to measurement that seeks to capture changes in asset and liability values
over time. The International Accounting Standards Board (IASB) defines fair value as "... an amount
at which an asset could be exchanged between knowledgeable and willing parties in an arms length
transaction".
Under the fair value measurement approach, assets and liabilities are re-measured periodically to
reflect changes in their value, with the resulting change impacting either net income or other
comprehensive income for the period. The result is a balance sheet that better reflects the current
value of assets and liabilities. The cost is greater volatility in periodic reported performance caused
by changes in fair value.
The notion of fair value accounting is intuitive when applied to quoted investments such as equities,
bonds, commodities, etc. that are carried in an entity’s balance sheet at their market value. This form
of fair value accounting is often termed mark-to-market accounting. However, while market prices
are one aspect of fair value measurement, the term is increasingly being used to describe
measurement by other means. For example, accountants often arrive at an estimate of fair value for
non-quoted investments based on a model (e.g., a share option valued by applying a specialist
option valuation model) or specialist opinion. Such applications of fair value measurement are
referred to as mark-to-model accounting.
The IASB has followed US standard-setters in dealing with the problem of fair values that do not
result from market prices. Specifically, IFRS 13 Fair Value Measurement applies the following
valuation hierarchy:
Level 1: fair values are derived from quoted market prices for identical assets or liabilities from an
active market for which an entity has immediate access
Level 2: where there are market prices available for similar (as opposed to identical) assets or
liabilities
Level 3: if values for levels 1 or 2 are not available, fair value is estimated using valuation
techniques
Fair value accounting is most frequently applied to financial assets and liabilities because market
prices or reliable estimates thereof are most likely to exist for such elements. Proponents argue that
fair value accounting for assets or liabilities better reflects current market conditions and hence
provides timely information. Opponents, on the other hand, argue that fair values can be irrelevant
and potentially misleading for a variety of reasons. For example, some claim that fair value is not
relevant for items that are held for a long period (i.e., to maturity) as investors are not interested in
interim value changes. Others argue that fair values can be distorted by market inefficiencies,
investor irrationality or liquidity problems and that estimated values derived from models may lack
reliability.
LEVEL 1 IS THE MOST PREFFERED AND DECLINING TO LEVEL 3
EFFECT ON REVENUE
If a company recorded revenue as follows:
2015 $1 000 000
2016 $1 150 000
2017 $1 200 000
And the average indices were:
2015 100
2016 117
2017 125
Then when adjusted for inflation
2015 1 000 000 X 125/100 = $ 1 250 000
2016 1 150 000 x 125/117 =$ 1 228 632
2017 1 200 000 x 125/125 =$1 200 000
DEPRECIATION
To charge the cost of an asset against the revenue over the term of its useful life…in
order to reduce the profits available to owners and so make replacement of the asset at
the end of its useful life possible.
If an asset cost $ 40 000, useful life 4 years, straight line depreciation then each year
depreciation charge would be $ 10 000. But the asset to replace after the 4 years may
cost $46 000 which means there should have been an additional depreciation charge of
$46 000/4 = $ 11, 500 vs $10,000 under historical cost..additional depreciation charge
should be $1 500
In times of inflation the reduction in profits is not enough to replace the asset.
Holding gains…where stock was bought when prices were low and sold when prices
increased as a result of inflation;
Massy has in stock flour that they paid $5 per bag and are currently selling for $10.
Desired profit-$5. Once Flour Mills announced the increase in price to $6 per bag,
Massy increased all bags of flour to $12.
So on stock held before the price increase, the new profit will be $12-$5=$7 through no
efficiencies introduced but simply changes in prices in the economy. Holding Gain $2.
Holding gains increase reported profits through no extra effort on the part of the
company.
