Meaning :
The general tendency in changes of
prices of goods and services over a time is called price level. The rise
in general price level is called inflation . during the period of inflation
,purchasing power of money declines. The fall in general price level is
deflation . During the period of deflation , pur
chase power of money increase.
Price level change means increase or decrease in purchasing power of money over
a period of time. The accounting which
considers price level change is called “accounting for price level changes.”
Limitations of historical cost accounting
No consideration of price level changes
Unrealistic fixed assets value
Insufficient provision for depreciation
Unrealistic profit
Consequence of over stated profit
Current purchasing power (cpp )method
Cpp method was evolved by the institute of the
chartered accountants in England and wales in may 1974. It is the preparation
of a supplementary statement based on current purchasing power, using the
retail price index as an index of general price change. It involves the re
statement of some or all of the items in the historical financial statement for
the changes in general price level. Under this method ,financial statements are
prepared on the basis of historical cost. This methods take to consideration
the changes in the value of items as a
result of general price level, but it does not account for changes in the value
of individual items.
Current cost
accounting (cca) method
Current costing method is an alternative of cpp method. Cca approach
recognizes the changes inn the price of individual caused by the changes in
general price level. This method includes the process of preparing and
interpreting financial statement in a such way
that relevant changes in the price is considered significantly. Under
this method, each financial statement is required to be restated in terms of
the current value of such items to provide current information.
Gearing adjustment
Due to the price change accounting statement such a balance sheet , p/l
account do not truly reflect the value of assets and liabilities of a firm. Total
capital of a company may comprise shareholder’s equity and borrowing. gearing
is the ratio of average borrowed capital and average shareholders equity.
Gearing adjustment measures the trend of change in price level of total
adjustment.
Gearing adjustment =gearing ratio*Total current cost adjustment
Where,
Gearing ratio = NB
NB + SHE
Total current cost adjustment =cosa+mwca+ depreciation adjustment
NB=
average net borrowing
She=
average share holders equity
Cosa=
cost of sales adjustment
Mwca=
monetary working capital adjustmet
