During a specific time period, there is a change in price rates of various goods and services. This change is known as price level changes and it happens over a certain time period. If there is an increase in price level, it is known as inflation, while a decrease in level is known as deflation level.
In case of inflation, purchasing power of money declines while the contrary happens in case of deflation. Hence, certain important points need to be noted in this regard.
Price Level Accounting: The way to approach it
There are technically 4 approaches to this context:
- Current Cost Accounting (CCA)
- Current Purchasing Power Accounting (CPPA)
- Periodic reassessment of fixed assets as well as adopting the LIFO method of inventory
- Specific and General Price Level Accounting (SGPLA)
Current Cost Accounting
While using this method, it is only monetary changes that are understood and taken into consideration. When it comes to general items, no such changes in account are understood and therefore to a certain extent, it is completely negated. In this system, a general price index is taken into consideration where value of a specific good may increase as per that.
To take this prospect into consideration, a committee headed by Francis Sandilands was framed known as Inflation Accounting Committee (UK). As per this committee, which published its report in 1975, it was recommended that to deal with concept of Inflation Accounting, the process of current cost accounting should be adopted.
In this case, it is the current value of goods and services that are taken into consideration rather than the historic values. It is on basis of these current values that balance sheet are framed along with profit and loss margin. These items are adjusted as per changes in the purchasing power that is in market currently.
While dealing with this, there are 3 aspects that have to be kept in mind, rather it is 3 prospects that it is divided into:
- Realized holding gain: This is associated with extra replacement cost that is placed over the non-monetary asset that has its date of sale over from historical cost.
- Unrealized holding gain: This is the excess over the replacement cost that a non-monetary asset has shown on the date of closing over the historical asset.
- Current operating profit: This is associated with current operating profit that has to be computed and certain adjustments have to be made in terms of cost accounting methods.
Current Purchasing Power Accounting (CPPA)
In this case, the given general price index is used for converting values of items in a financial statement over a certain period. Changes in price is considered but not in value.
Conversion Factor
Formula = Index you are converting to /Index you are converting from
Conversion Factor = Price index at the date of revaluation/ Price index at the date of existing figure
There is also, Mid Period Conversion/Difference between monetary and non-monetary options/Cost of sales/knowing the profit amount
Periodic reassessment of fixed assets as well as adopting the LIFO method of inventory
If periodic revaluation is done by making use of the LIFO method, it will help in showing the rate of change and increasing prices.