Accounting for changes in prices
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A. E. ppendix. Accounting for Changes in Prices. Objectives. 1. Understand the difference between current value and general price level adjustments. 2. Explain the three alternatives to historical cost.

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Accounting for changes in prices

A

E

ppendix

Accounting for Changes in Prices


Objectives

Objectives

1.Understand the difference between current value and general price level adjustments.

2. Explain the three alternatives to historical cost.

3. Understand issues related to the measurement of current cost, the adjustment of historical dollars for general price-level changes, and the purchasing power gain or loss on net monetary items.

Continued


Accounting for changes in prices

Objectives

4.Explain the conceptual issues relating to the alternatives to historical cost.

5.Be aware of the disclosure requirements that have existed for alternative disclosures, including the reasons for the elimination of the required disclosures.


Current value

Current Value

Current value adjustments account for changes in the value of individual assets and liabilities…


Accounting for changes in prices

Current Value

…and not for the change in the value of the dollar.


Accounting for changes in prices

Current Value

Current value is a general concept and may be measured in several ways, including—

(1)An exit value, such as net realizable value.

(2)The present value of future cash flows.

(3)An input value, such as current cost.


Accounting for changes in prices

Current Value

We will use current cost as a measure of current value because it is encouraged by FASB Statement No. 89.


Accounting for changes in prices

Four Alternative Concepts

  • Historical cost

  • Historical cost adjusted for changes in the general price level (historical cost ÷ constant purchasing power)

  • Current value (current cost)

  • Current value adjusted for changes in the general price level (current cost ÷ constant purchasing power)


Accounting for changes in prices

Current Cost Financial Statements

Step

1 2 3 4 5

Income Statements

The increase in recognized in the period of sale.

Revenue———$2,000—

Cost of goods sold———(1,250)—

Net income———$ 750—

Unreal. holding gain——$ 250(250)—

Real. holding gain—— — 250—

Net income— —$ 250$ 750

A $250 increase due to current cost increasing.

Continued


Accounting for changes in prices

Current Cost Financial Statements

Step

1 2 3 4 5

Balance Sheets

Cash$3,000$2,000$2,000$4,000$2,750

Inventory— 1,000 1,250 — 1,250

Total Assets$3,000$3,000$3,250$4,000$4,000

Capital$3,000$3,000$3,250$4,000$4,000


Accounting for changes in prices

Historical Cost/Constant PP Financial Statements

Step

1 2 3 4 5

Income Statements

Index increased 10%

Revenue———$2,000—

Cost of goods sold———(1,100)—

Purchasing power

loss——$(200) ——

Net income— —$(200)$ 900—

$2,200 – $2,000

Continued


Accounting for changes in prices

Historical Cost/Constant PP Financial Statements

Step

1 2 3 4 5

Balance Sheets

Cash$3,300$2,200$2,000$4,000$2,750

Inventory— 1,100 1,100 — 1,250

Total Assets$3,300$3,300$3,300$4,000$4,000

Capital$3,300$3,300$3,300$4,000$4,000


Accounting for changes in prices

Current Cost/Constant PP Financial Statements

Step

1 2 3 4 5

Income Statements

The increase in recognized in the period of sale.

Revenue———$2,000—

Cost of goods sold———(1250)—

Operating income———$ 750—

Unreal. Holding gain——$150(150)—

Realized hold. Gain———150—

Purch. power loss—— (200) — —

Net income— —$ (50)$ 750—

$1,250 – $1,100

Continued


Accounting for changes in prices

Current Cost/Constant PP Financial Statements

Step

1 2 3 4 5

Balance Sheets

Cash$3,300$2,200$2,000$4,000$2,750

Inventory— 1,100 1,100 — 1,250

Total Assets$3,300$3,300$3,300$4,000$4,000

Capital$3,300$3,300$3,300$4,000$4,000


Accounting for changes in prices

Measurement of Current Cost

Three alternative methods of measuring the current costs of inventory and property, plant, and equipment are:

Direct pricing.Current invoice prices, vendors’ price lists, other quotations or estimates, or standard manufacturing cost.


Accounting for changes in prices

Measurement of Current Cost

Three alternative methods of measuring the current costs of inventory and property, plant, and equipment are:

Functional or Unit pricing.The estimation of construction (or acquisition) costs per unit and multiplication by the number of units in the asset being measured.


Accounting for changes in prices

Measurement of Current Cost

Three alternative methods of measuring the current costs of inventory and property, plant, and equipment are:

Revision of Historical Acquisition Cost (Indexation).Using (a) externally generated specific price indexes for the class of goods or service being measured, or (b) internally generated indexes of cost changes for the class of goods or services being measured.


Accounting for changes in prices

Adjustment of Historical Dollars

Current Period Price-Level Index

Constant Purchasing Power Dollars

Historical Dollars

x

=

Historical Price-Level Index


Accounting for changes in prices

Adjustment of Historical Dollars

A company purchased land for $24,000 when the price index was 120 and that the index now is 150.


Accounting for changes in prices

Adjustment of Historical Dollars

150

Current Period Price-Level Index

$30,000

$24,000

Constant Purchasing Power Dollars

Historical Dollars

x

=

Historical Price-Level Index

120


Accounting for changes in prices

What is Income?

A common definition is that income for a year is “the amount the corporation can distribute to the owners of the company and be as well off at the end of the year as at the beginning.”


Accounting for changes in prices

What is Income?

This is a useful definition of income, but what is meant by being “as well off”?


Accounting for changes in prices

Capital Maintenance Concepts

Historical Cost

Historical dollars of capital at the beginning of the year.


Accounting for changes in prices

Capital Maintenance Concepts

Historical Cost/Constant Purchasing Power

Purchasing power of the capital at the beginning of the year.


Accounting for changes in prices

Capital Maintenance Concepts

Current Cost

Operating capacity (the ability to provide goods and services) at the beginning of the year, measured in dollars.


Accounting for changes in prices

Capital Maintenance Concepts

Current Cost/Constant Purchasing Power

Operating capacity (the ability to provide goods and services) measured in units of constant purchasing power.


Accounting for changes in prices

Reliability

Current cost financial statements are considered less reliable than historical cost financial statements.


Accounting for changes in prices

Reliability

Financial statements prepared using historical cost are more understandable than those prepared using other concepts.


Accounting for changes in prices

Reliability

Many argue that historical cost financial statements should be continued, with the new data supplied in supplementary form.


Accounting for changes in prices

Exit Value Financial Statements

Step

1 2 3 4 5

Income Statements

$1,800 – $1,000

Purchasing margin—$800——$950

Holding gain———$200—

Net income—$800—$200$950

$2,200 – $2,000

Continued


Accounting for changes in prices

Exit Value Financial Statements

Step

1 2 3 4 5

Income Statements

Cash$3,000$2,000$2,000$4,000$2,750

Inventory— 1,800 1,800 — 2,200

Total Assets$3,000$3,800$3,800$4,000$4,950

Capital$3,000$3,800$3,800$4,000$4,950


Accounting for changes in prices

Disclosures

In 1986FASB Statement No. 89 rescinded the requirements that qualifying companies disclose the effects of changing prices. However, the Statement encourages continued disclosure of information about the effects of changing prices.


Accounting for changes in prices

International Accounting

International accounting standards require that the primary financial statements of a company that reports in the currency of a hyperinflationary economy are prepared in terms of the currency at the balance sheet date.


Accounting for changes in prices

A

E

ppendix

The End


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