What is Current Cost Accounting? – Definition
The adoption of Current Cost Accounting Technique in place of Current Purchasing power of Replacement Cost Accounting Technique for price level changes. The crux of the current cost accounting technique is the preparation of financial statements (Balance Sheet and Profit and Loss Account) on the current values of individual items and not on the historical or original cost.
The Inflation Accounting Committee of the U.K. government set up this method in 1975. It has been extensively studied and debated and now it has been finalized by the issue of SSAP 16 (Statement of Standard Accounting Practice).
This system takes into account price changes relevant to the particular firm or industry rather than the economy as a whole. It seeks to arrive at a profit which can be safely distributed as dividend without impairing the operational capability of the firm.
The Current Cost Accounting (CCA) method is based on the concept that a business enterprise is a going concern which is continuously replacing its assets. The method uses current dollars/ rupees and values assets at their acquisition costs and hence no adjustment for inflation is done in the accounts. The financial statements are drawn up here on the assumption that the purchasing power of money is stable over time.
However, since the purchasing power of money differs in different periods of time, these statements do not ultimately measure what they seek to measure. Yet this is the oldest and the most popular method of inflation accounting.
Features of the Current Cost Accounting (CCA) Method
The salient features of this method are:
- Fixed assets are shown not at their depreciated original cost but at their net replacement value.
- Stocks are shown at their net replacement value.
- Depreciation is calculated at the current value of assets.
- Gain/ loss due to the changes in the price level are shown in a separate statement.
- Inventory consumed is valued at the price at the date of consumption.
Under this approach, assets and expenses are shown in the financial statements at the current cost to replace those specific resources. Thus, profit is measured by comparing revenues with the current replacement cost of the assets consumed in the earning process.
Suitability of the Current Cost Accounting (CCA) Method
The current cost accounting method is suitable when the management is committed to the industry and is interested in replacing the present plant by a new one at the end of its useful life.
The current cost accounting (CCA) technique has been preferred to the current purchasing power (CPP) technique of price level accounting as it is a complete system of inflation accounting. The financial statements prepared under this technique provide more realistic information and make a distinction between profits earned from business operations and the gains arising from changes in price levels. As depreciation under CCA is provided on current cost, the method prevents overstatement of profits and keeps the capital intact.
How Current Cost Can Alleviate the need of Cost Flow Method
A current cost accounting system can alleviate the need for a cost flow method and thus solve the problem of having either a realistic income statement or a realistic balance sheet, but not both. In general, current cost is the cost of currently acquiring an item. Under such a system, cost of goods sold is recorded at the current cost of the item at the time of its sale.
Thus, the gross margin figure, which is the difference between sales and the current cost of goods sold, represents income available to the firm to cover operating expenses after maintaining its ability to purchase new inventory. On the balance sheet, ending inventory is recorded at the current cost as of the end of the accounting period. The difference between the current cost of the ending inventory and its historical cost is considered an unrealized holding gain. Thus, figures on the income statement and balance sheet represent realistic amounts.
Current cost accounting is not a generally accepted accounting principle for primary financial statements. However, because of the perceived importance of this data to present and potential investors and creditors, the FASB requires that certain companies disclose selected current cost data on a supplemental basis. In regard to inventories, FASB Statement No. 33 requires firms having inventories and property, plant, and equipment of more than $125 million, or total assets exceeding $1 billion, to disclose income from continuing operations on a current cost basis, and the current cost amounts of inventory and property, plant, and equipment at the end of the year.