Price Level Accounting

BALJIT SINGH MAAN PGDBM

 

PRICE LEVEL ACCOUNTING (INFLATION ACCOUNTING) Price Level Accounting is a technique of accounting by which the transactions are recorded at current values and the impact of changes in the prices on the accounting transactions is neutralized or at least such impact is pointed out along with transactions recorded on historical cost concept. Price Level Accounting is also known as ‘Inflation Accounting for the reason that prices are usually changing on the higher  side.

Reasons for te E!er"en#e of Pr$#e Le%e& A##o'nt$n" A##o'nt$n" are as fo&&os      

Inaccurate presentation of financial statements during the changes in the price levels. !nrealistic" imaginary and inflated book profits in times of rise in prices due to overvaluation of stock in trade and writing off depreciation on fi#ed assets at a lower rate. Payments of dividends and ta#es" much more than warranted by the real profits" out of the equity capital resulting in the erosion of capital. $ifficulties $ifficulties in replacement of fi#ed assets during inflation. Inadequacy of working capital arising out of increasing Price Levels. Losses arising as a result of holding monetary current assets such as cash and receivables and gains accruing from holding current liabilities as sundry creditors. METHODS OR TECHNIUES OF PRICE LEVEL ACCOUNTING ACCOUNTING * INFLATION INFLATION ACCOUNTING o o o o

CURRENT PURCHASING PO+ER TECHNIUE (CPP) REPLACEMENT COST ACCOUNTING TECHNIUE (RCA) CURRENT VALUE ACCOUNTING TECHNIUE (CVA) CURRENT COST ACCOUNTING TECHNIUE (CCA)

%. CURRENT PURCHASING POWER TECHNIQUE (CPP):&PP' of accounting requires the companies to keep their records and present the financial statements on conventional historical cost basis but it further requires presentation of supplementary statements statements in items of current current purchasing power of currency currency at the end of the accounting accounting period. In this method the various items of financial statements" i.e. balance sheet and profit and loss account are ad(usted with the help of recognised general price inde#. 'he consumer price inde# or the wholesale price inde# prepared by the )eserve *ank of India can be taken for conversion of historical costs. 'he main ob(ective of this method is to take into consideration the changes in the value of money as a result of changes in the general price levels. It helps in presenting the financial statements in terms of a unit of measurement of constant value when both cost and revenue have been changing due to changes in the price levels. 'his technique of Price Level Accounting has been followed by a number of  companies in +ermany" Australia and !.,.A. but although this method is simple. It may be considered as only a first step towards Inflationary Accounting. 'he ma(or weaknesses of this techniques are as follows-

Ma,or +ea-nesses ea-nesses of t$s te#n$.'e   

It is possible that there may be an increase in the general price inde#" but there may not be any increase /rather there might be a decrease0 in the value of a particular asset of a certain company. 'he technique seems to be more of theoretical nature than of any practical utility. In a country like India" even the price indices may not be correct and it may further cause inaccurate  presentation of the financial statements.

1/REPLACEMENT COST ACCOUNTING TECHNIUE (RCA)01 )eplacement &ost Accounting /)&A0 'echnique is an improvement over  &urrent Purchasing Power 'echnique /&PP0. 2ne of the 3a(or weakness of &urrent Purchasing Power 'echnique is that it does not take into account the individual price inde# related to the particular assets of a company. In the )eplacement &ost Accounting 'echnique the inde# used are those directly relevant to the companys particular  assets and not the general inde#. *ut adopting the )eplacement &ost Accounting 'echnique will mean using a number of price indices for conversion of financial statements and it may be very difficult to find out the relevant  price inde# to be used in a particular case.

4. CURRENT VALUE ACCOUNTING TECHNIUE (CVA)01 In the &urrent 5alue Accounting 'echnique of Price Level Accounting all assets and liabilities are shown in the balance sheet at their current values. 'he value of the net assets at the  beginning and the end is termed as profit or loss" as the case may be. In this method also" like )eplacement &ost Accounting 'echnique" it is very difficult to determine relevant current values and there is an element of  sub(ectivity in this technique.

6. CURRENT COST ACCOUNTING TECHNIUE (CCA)01 'he *ritish +overnment had appointed a committee known as ,andilands &ommittee under the chairmanship of 3r. 7rancis &.P. ,andilands to consider and recommend the accounting for  Price Level &hanges. 'he committee presented its report in the year %89: and recommended the adoption of  &urrent &ost Accounting 'echnique in place of &urrent Purchasing Power of )eplacement &ost Accounting 'echnique for Price Level &hanges. 'he cru# of the current &ost Accounting 'echnique is the preparation of  financial statements /*alance ,heet and Profit and Loss Account 0 on the current values of individual items and not on the historical or original cost.

ESSENTIAL CHARACTERISTICS OF CURRENT COST ACCOUNTING TECHNIUE      

'he fi#ed assets are shown in the balance sheet at their current values and not on historical costs. 'he depreciation is charged on the current values of the fi#ed assets and not on original costs. Inventories or ,tock are valued in the balance sheet at their current replacement costs on the date of the  balance sheet and not cost or market price whichever is lower. 'he cost of goods sold is calculated on the basis of their replacement cost to the business and not on their  original cost. 'he surpluses arising out of revaluation are transferred to )evaluation )eserve Account and are not available for distribution as dividend to the shareholders. In addition to the balance sheet and profit and loss account" an appropriation account and a statement of  changes are prepared.

DIFFICULTIES IN THE OPERATION OF CURRENT COST ACCOUNTING TECHNIUE o o o

It is very difficult to determine the ‘value to the business of a real asset. 'here is an element of sub(ectivity in this technique. It does not hold good during the periods of depression.

ADVANTAGES OF PRICE LEVEL ACCOUNTING        

It enables company to present more realistic view of its profitability because current revenues are matched with current costs. It enables a company to maintain its real capital by avoiding payment of dividends and ta#es out of its capital due to inflated profits in historical accounting. *alance ,heet reveals a more realistic and true and fair view of the financial position of a concern because the assets are shown at current values and not on distorted values as in historical accounting. ;hen financial statements are presented" ad(usted to the price level changes" it makes possible to compare the profitability of two concerns set up at different times. Investors" employees and the public at large are not misled by inflated book profits because inflation accounting shows more realistic profits. Inflation accounting helps in avoiding further competition from prospective entrepreneurs. 'he financial statement prepared by a company ad(usted to the price level changes also improves its social image. Inflation accounting also affects the investment market as it helps to establish a realistic price for the shares of a company.

DISADVANTAGES OF PRICE LEVEL ACCOUNTING o o o

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Ad(usting accounts to price level changes is a neverending process. It involves constant changes and alterations in the financial statements. Price level accounting involves many calculations and makes financial statements so complicated and confusing that it become very difficult for man of ordinary prudence to understand" analyse and interpret them. 'he concept of price level accounting appears to have more theoretical importance than practical because ad(usting the accounts to the changes in the price levels may lead to window dressing of accounts due to element of sub(ectivity in it. People may ad(ust the accounts according to the values most suited to them" thereby" making the financial statements more inaccurate. $epreciation charged on current values of fi#ed assets is not acceptable under the Income 'a# Act" %8<%. $uring deflation" when the prices are falling" ad(ustments of accounts to price level changes will mean charging lesser depreciation and overstatement of profits.