Current Purchasing Power Method (C.P.P.)

Definition

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.

This is a mixed method in which financial statements are prepared on a historical basis these statements, in the end, are converted on the current purchasing power of the currency. The items of profit and loss and Balance sheet are adjusted with the price index. The basic ideas of the method are to incorporate changes in the value of money as a result of changes in general price index.

Explanation

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.

Techniques to understand Current Purchasing Power Method

The following techniques are applied to understand C.P.P method:

(a) Conversion Technique
(b) Mid-Period conversion
(c) Monetary and Non-monetary accounts.

(a) Conversion technique.

In this method, historical figures are changed at current purchasing power. Here items of profit and loss and balance-sheet are adjusted with the help of general price index number.

Conversion Factor

= Current Price Index Number /  Previous Price Index at the date of existing figure

Example

A building was purchased in 2018 for$1,60,000. The
general price index was 250. Convert the figures in current dollar in 2019 when index was 500.

Solution:

= Current Price Index / Previous year Index at the date of existing figure

= 500 / 250 = 2 times

Converted Value = Historical cost x Conversion factor

= $1,60,000 x 2 = $3,20,000

(b) Mid-Period Conversion

There are Several transactions which take place throughout the year such as purchases, sales, expenses etc. For conversion of such items, average index of the year can be taken as the one index for all such items. When such index is not available. the index of mid-year can be taken.

(c) Monetary and Non-monetary Accounts

For the conversion of historical costs in terms of CPP of currency. Monetary accounts are those Accounts of assets and liabilities which are not subject to reassessment of their recorded values owing to change of purchasing power of money.

Example

Jan 2018 Dec. 2018
Current Assets 25,000 37,000
Current liabilities 30,000 40,000
Retail price index No. 200 300
Average for the year 240

Calculate net monetary value.

Solution

 

Monetary liabilities = (30,000 x 300) / 200 = 45,000
Increase in liabilities = (10,000 x 300) / 240 = 12,500
57,500
End balance of current liabilities 40,000
Gain a holding monetary liabilities 17,500
Monetary Assets = 25,000 x 300 / 200 = 37,000
Increase in assets 12,000 x 300 / 240 = 15,000
52,500
Balance of end 37,000
15,500
Net gain 17,500 – 15,500 = 2,000

Suitability of the Current Purchasing Power Method

The method may be used when the aim is the maintenance of the purchasing power in general.

  1. To assist decision-makers in evaluating trends, when data for a series are expressed in units of constant purchasing power.
  2. The shareholders can keep the purchasing power of their investment intact.

Problems in Implementation of Current Purchasing Power Method

  1. The critical problem in Inflation Accounting is training accountants and others in the preparation and interpretation of information, adjusted for the effects of inflation.
  2. Price indices to be used for the revaluation of assets.
  3. 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.
  4. 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.
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