Chapter 11

International Accounting for Price

Changes

Inflation
Inflation

has had a devastating effect on

many countries

Brazil and Russia as high as 2,000%

1970s in the U.K. 25%

Some

companies are using other methods of

accounting to combat the effects of inflation

BP uses replacement costs

More companies will likely follow BPs lead

Impact of Inflation on the

Corporation
Assets

become devalued
Liabilities become less expensive to pay off
Interest rates on loans increase with inflation
Income can be overstated as old costs are
matched with new revenues
Shareholders could demand more dividends
and employees could demand higher wages

Accounting Measurement
Alternatives
General

purchasing power accounting

Includes all systems designed to maintain the

purchasing power of capital or equity
Accounts for changes in the level of prices
Concerned with the value of money
Other names include

Constant dollar accounting (U.S.)

General price level accounting (U.S.)
Current purchasing power accounting (U.K.)

Accounting Measurement
Alternatives

Current value accounting

Includes all systems designed to account for current values

or changes in specific prices
Concerned with the cost of specific assets
Types of accounting include
Current cost accounting
Replacement value accounting
Current exit price accounting

Real value accounting is a combination of current

value and general purchasing power accounting

General Purchasing Power

Accounting
The monetary unit of measure should be
uniform while retaining the basis of
measurement used in the financial statements
(historical cost)
All items except financial assets and liabilities
(cash, receivables, payables) are restated to
reflect common purchasing power
Previous years accounts are also updated to
provide comparability

General Purchasing Power

Accounting

Example
General price level increased by 15% during
the year
A machine purchased on January 1 cost
$10,000
End-of-year purchasing power to buy machine
on Dec. 31
= $10,000 + ($10,000 x 0.15) = $11,500

Current Value Accounting

Income is not earned until the company has

maintained its capital in current value terms
Current cost (replacement cost) method

Should the same asset or one performing a similar function

with new technology be used?

Current exit price method

Values assets at what they could be sold for, less cost to

complete and sell the items
Going-concern concept asset is valued at estimated
sales price on normal completion of production

Current Value Accounting

Results

Recognized on the income statement

Reflected on the balance sheet as a capital
adjustment account

Current

in holding gains and losses that are

values are determined by

Suppliers lists (inventory)

Construction cost indices (PP&E)
Appraisal values (fixed assets)

Current Value Accounting

Example
Sales = $1,000,000
Current COGS = $900,000
Historical COGS = $700,000
Operating gross profit
$100,000 for current cost method
$300,000 for historical cost method, part of which is due to
holding during a period of price increase
Realized holding gain = $900,000 - $700,000 = $200,000

Real Value Accounting

Example
Value of asset
Beginning = $150,000
Current value at year end = $190,000
GPP value at year end = $165,000
Total holding gain
$190,000 - $150,000 = $40,000
Real holding gain
$190,000 - $165,000 = $25,000

***What matters is the net impact of prices directly affecting the

corporation relative to the average level of prices affecting the
GPP of money!!!

International Financial
Reporting Standards
IAS

6 (1977)

A brief narrowing of options available to deal with

inflation

IAS

15, Information Reflecting the Effects of

Changing Prices

Recognized the two major methods (GPP or

current cost), but did not champion one or the
other
Required information on the effects of price
changes if the historical cost method is used

International Financial
Reporting Standards

IAS 15 suggestions for price change info

The amount of the adjustment to or adjusted amount of
depreciation of PP&E
The amount of the adjustment to or the adjusted amount of cost of
sales
The adjustments relating to monetary items, the effect of
borrowing, or equity interests when those adjustments are used in
determining income
The overall effect on income of adjustments and any items
reflecting the effects of changing prices
Current cost of PP&E of inventories
Methods adopted to compute information used in the preceding
items and any indices used
IAS 15 was withdrawn in 2003

International Financial
Reporting Standards
IAS

Focuses on hyperinflationary economies

100% inflation over 3 years

Requires restatements for GPP changes

regardless of previous treatment

IAS

29 (1989)

16 (revised in 1998)

Current value approach is permitted for PP&E

Fair value is used
Regular revaluations are required

Comparative National
Regulation and Practice
U.K.

SSAP 16, requiring current cost accounting, was

issued and withdrawn due to lower inflation
Only a few companies now provide current cost
disclosures
Some companies revalue their PP&E at market
values

Comparative National
Regulation and Practice
U.S.

Accounting Series Release 190 required

disclosure of replacement cost info
SFAS 33 required disclosure on both GPP and a
current cost basis
SFAS 33 made an array of information available

Comparative National
Regulation and Practice
Australia,

Canada, and New Zealand

Developments are more tentative than in U.S.

Similar to U.S. current cost system

Continental

Europe

Much less enthusiasm for inflation accounting

No professional standards on the subject

Comparative National
Regulation and Practice

Brazil

Inflation accounting used as early as the 1950s

Company law in 1976 required indexation approach to
restate historical costs in terms of current purchasing
power
With reduced inflation levels, requirement was withdrawn in
1996

Argentina

Inflation accounting introduced was the accounting

profession
1972 GPP financial statements were recommended
Recommendation withdrawn in 1995 due to low inflation

Comparative National
Regulation and Practice

Current Value Accounting in Holland

Some firms use current cost method

Some use partial current cost statements or historical cost
statements with supplementary disclosures

Comparative National
Regulation and Practice

Theodore Limperg father of replacement value

Focused on the relationship between economics and

accounting
Believed that income is a function of revenue and
replacement value instead of historical costs
Believed that current value info should be used by all
decision makers

Comparative National
Regulation and Practice
Philips

First used current value techniques in 1936

Used current value approach in 1952 for financial
reporting purposes
Departments of the company determined current
values of inventory, equipment, and fixed assets
The effect of current value changes showed in
cost of goods sold and depreciation expense

Comparative National
Regulation and Practice
Philips

Brink (1992) showed that Philips used

replacement value techniques to enhance profits
The company used inventory value reductions
and the gearing adjustment in hyperinflationary
countries
Recorded a loss of 4.24 billion guilders in 1990,
which led to the demise of the replacement value
system in 1992

Problems and Prospects

Inflationary

accounting is likely to remain a

hot topic for the foreseeable future
Some South American countries in
hyperinflation use GPP accounting
Some European companies still make
voluntary current value disclosures
No current cost accounting regulations exist
in the U.K. or the U.S.

Problems and Prospects

Controversy

remains over

The gearing adjustment

Treatment of gains and losses on monetary items
The use of indices with respect to foreign subs
Verification of current costs in industries with rapid
technological change

Problems and Prospects

Future

experimentation with price change

accounting systems is hoped for
The usefulness of exit prices and cash flows
may be better appreciated in the future