Essay: Current Purchasing Power Accounting

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  • Subject area(s): Accounting essays
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  • Published on: January 23, 2019
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Question 1
Three alternatives to Historical Cost Accounting (HCA) are:

1. Current Purchasing Power Accounting (CPPA)

2. Current Cost Accounting (CCA)

3. Continuously Contemporary Accounting (exit price accounting) (CoCoA)

Descriptions CPPA CCA CoCoA

Definition CPPA adjusts to the changes in general price level over the period of time such as during inflation, purchasing power reduces and during deflation purchasing power increases. CPPA restates historical costs in the form of current purchasing power, which makes is comparable and additive. CCA uses value to business or deprival values for the measurement where business value means the current replacement cost and the recoverable amount (greater of net realisable value and economic value). CCA helps to maintain the capital of a firm in its operating capability.

CoCoA is a normative approach which focuses on measuring exit prices of firm’s assets and liabilities. Central objective is to provide information about the firm’s ability to adapt the changing circumstances. Even the profits are connected to the current exit prices.

Assumptions • A general price index is used for CPPA.

• CPP Factor is used to adjust income statement and financial position.

• Monetary and non-monetary item plays important role in CPPA.

• Specific index of prices used to reflect current value of asset and liabilities.

• Fixed assets and their depreciation are recorded at replacement value.

• Revaluation surplus are not distributed to shareholders but reserved as CCA reserve. • All the transactions in the firm are done at present.

• The monetary value of assets, liabilities and equity at balance date based on current exit price.

• Depreciation expenses is not reflected in CoCoA as the valuation of assets is recorded on their current cash equivalents.

Advantages • It retains all the characteristics of historical cost accounting except for the change in unit of measurement, so it possesses the qualities of objectivity and comparability.

• CPA measures income properly as a result of the matching of dollars of different size (purchasing power) on the income statement.

• CPPA presents to users, in general, the impact of general inflation on profit and provides more realistic return on investment.

• CCA provides more useful information that guides management and shareholders.

• CCA helps to main the operating capabilities of the firm during inflation.

• CCA determines the reliability of the value of an item in the firm as the ratios derived from CCA are more realistic than HCA. • It helps in decision making so called as “decision usefulness approach”.

• Entity unable to adapt changes in circumstances are likely to fail because purchasing power is current and continuously changing.

Examples Adam purchased a machine at a cost of $10,000 when the price index was at 80. He anticipated that the machine could be sold later at a profit. Three years later (price index at 130), he was offered $25,000.

Adjusted cost of machine = $10,000 x 130/80 = $ 16,250

Total gain = $ 25,000 – $ 10,000 = $15,000

Real gain = $ 25,000 – $ 16,250 = $ 8,750

Purchasing power gain = $ 15,000 – $ 8,750 = $ 6,250

Suppose A Ltd asset for 2016 was $40,000 with no liabilities so the equity will also be $40,000. During 2016, it sells its asset for $55,000. Under HCA the profit will be $ (55,000 – 40,000) = $15,000 and closing equity will be $55,000 that matches asset in form of cash. If $15,000 is distributed as dividend, equity would remain same. In CCA, profit would differ because of the factor of inflation. The replacement cost of the asset would be $45,000(suppose), then the profit would be $10,000. This is because $45,000 is required to retain the asset in the firm. Central goal of CCA is the maintenance of the firm’s physical capital. Suppose A ltd had equity of $10,000 and it acquired computer at a cost of $2,000 which had market price at $4,000 at the end of 30 June 2017. Prices rose by 10% throughout the period.

As per CoCoA, the net profit will be:

Sales $4,000

Cost of Sales ($2,000)

Trading income $2,000

Capital maintenance adjustment

($10,000 * 10%) ($1,000)

Net Profit $1,000

The viable alternatives to HCA are all of the above-mentioned alternatives but the best one is CoCoA method because it evaluates the net profit on the basis of current market sales price and adjusts it against the net increase or decrease in the price throughout the period. CPPA and CCA ignores the fact that the prices can move in any direction and variable rate, they only provide partial treatments in price levels and index despites they are better off HCA.

Question 2 – 4 marks (750 words)

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