Constant Purchasing Power accounting

Constant purchasing power accounting means to record and update the accounting items on the basis of daily consumer price index. We know that inflation will increase the prices fastly. It decreases the power money to buy anything. If we have to keep our account upto date, we have to adjust all monetary items. Assets and liabilities should be keep on the basis of fair and market value instead of historical cost. All non monetary item will be same as their past unit of measurement. Its other names are real value accounting, current cost accounting.

For Example :

1. ABC Company  had a closing balance of inventory at 30 June 2012 equal to $10000. This inventory had been purchased in the last three months of the financial year. Assume the general price level index was 140 on 1 July 2011, 144 on 31 December 2011, 150 on 30 June 2012, the average for the year (July 2011-June 2012) was 145 and the average for April 2012 - June 2012 was 147.

For showing updated inventory with CPPA, we will use following formula

Book value of inventory X current month general price index/ average index of three months

= 10000 X 150/ 147 = $ 10204

2. XYZ Ltd purchased a vehicle on 1 July 2011 for $140 000. The vehicle is depreciated on a straight-line basis over a 4-year period, with nil residual value. The following general price level indices are available:

1 July 2011

130

30 June 2012

140

Average for year

135

What is the amount of depreciation shown in the income statement (restated to a constant purchasing power basis) for the year ended 30 June 2012?

$140 000/4yrs = $35 000 depreciation expense

$35 000 x 140/130 = $37 692

3. MNO Ltd recorded administration expenses of $115 000 for the year ended 30 June 2012. Assume that these costs were incurred evenly over the year. If the general price level index was 170 on 1 July 2011 and 190 on 30 June 2012 with an average of the year of 180, what amount would be recorded to administration expenses for the year in accounts restated to a constant purchasing power basis?

$115 000 x 190/180 = $121 389

Importance of Constant Purchasing Power Accounting 


IFRS's IAS 29 applies on CPPA. It is useful to show the correct financial statement in hyper-inflationary economy. 

Entities that prepare financial statements on the historical cost basis of accounting do so without regard either to changes in the general level of prices or to increases in specific prices of recognized assets or liabilities. The exception to this are those assets and liabilities that the entity is required, or chooses, to measure at fair value. For example, property, plant and equipment may be revalued to fair value and biological assets are generally required to be measured at fair value. Some entities, however, present financial statements that are based on a current cost approach that reflects the effects of changes in the specific prices of assets held.

Related : Inflation Accounting