Current Purchasing Power Method (C.P.P.) is also known as General Price-Level Accounting. This method is recommended by the Accounting Policy Board and also the Financial Accounting Standards Board (FASB) of USA. This method adjusts historical cost for changes in the general level of prices as measured by the general price-level index. Changes in the general level of prices represent changes in the general purchasing power of the monetary unit.
Thus Inflation, in general, reduces the general purchasing power to purchase goods and services while deflation increases the general purchasing power to purchase goods and services. Historical financial statements consist of transactions at various times and hence replacement purchasing powers at various points in time.
CPPA transforms the various historical measures into current purchasing power which represents
purchasing power at the same point in time. Thus CPPA makes all accounting numbers comparable in terms of general purchasing power by removing the mixed purchasing power element from historical financial statements.
This method differs from Current Cost Accounting (CCA) in that, under this approach, the current values of various assets are not worked out but the financial statements are stated in terms of rupees of uniform value, Hence, this method takes into account changes in price levels which are denoted by the general price index.
Thus, all amounts are expressed in units of equal purchasing power. Since this method shows the effects of
changes in the general price level, this method is also called General Price Level Accounting.
The CPP method makes a distinction between monetary items and non-monetary items, Monetary items are those assets and liabilities that represent a claim to receive, or an obligation to pay, a fixed amount of foreign currency. Examples of monetary items include cash, accounts payable, accounts receivable, long-term debt.
Monetary items are translated at the current rate while non-monetary items (such as fixed assets, stock, plant and buildings) are translated at historical rates. During a period of rising prices, holding monetary assets results in a loss of purchasing power. Likewise, creditors tend to gain during a period of rising prices as debts are now repaid in dollars of less purchasing power than those originally borrowed.
Non-monetary items such as stocks, plants and buildings, increase in value during inflation. The lower of cost and net realizable value can be taken and then adjusted further.
The index used here could be the cost of living index or the consumers’ expenditure deflates or the general index of retail prices.
Suitability of the Current Purchasing Power Method
The method may be used when the aim is the maintenance of the purchasing power in general.
- To assist decision-makers in evaluating trends, when data for a series are expressed in units of constant purchasing power.
- The shareholders can keep the purchasing power of their investment intact.
Problems in Implementation of Current Purchasing Power Method
- The critical problem in Inflation Accounting is training accountants and others in the preparation and interpretation of information, adjusted for the effects of inflation.
- Price indices to be used for the revaluation of assets.
- Corporate profits are watched closely by business managers, government officials and investors. Management may sometimes have a vested interest in maintaining the present level of profits and not make any adjustment to this profit. This may be due to the management wanting to maintain the present rate of taxation, rate of return on equity Capital and so on.
- Finally, labor unions also may not agree to the adjustment of the financial statement for the effects of inflation, if they fear that as a result of the adjustment, profits and hence bonus will fall.