by Institute of Chartered Accountants in England and Wales recommended that changes in the price level should be reflected in the financial statements through the current purchasing power method (CPP). For measuring changes in the price level and incorporating the changes in the financial statements we use index numbers, which may be considered to be a barometer meant for the purpose.
Under this method any established and approved general price index is used to convert the values of various items in the Balance Sheet and Profit and Loss Account. This method takes into consideration the changes in the value of items as a result of the general price level, but it does not account for changes in the value of individual items.
For example, a particular machine may have become cheaper over the last few years, whereas the general price level may have risen; the value of the machine will also be raised in accordance with general price index. Thus general price level adjustment restates financial data by bringing past rupee amounts in line to current rupee purchasing power by general index multiplier.
Mechanisms Under the CPP Method:
- Conversion technique
- Mid- period conversion
- Non- monetary and monetary accounts
- Adjustment of cost of inventory and sales
- LIFO method
- FIFO method
- Ascertainment of profits
- Net change method
- Conversion of income method
The preparation of the financial statements according to CPP method, needs understanding of the following steps:
(i) Conversion technique
CPP method involves the restatement of historical figures at current purchasing power.
(ii) Mid-Period Conversion:
In case of transactions occurring throughout a period, it will be advisable to convert them according to the average index of the period. Such transactions generally include revenue items such as sales and purchases of goods, payment of expenses etc. In case the information regarding average index is not available, it may be calculated by taking the average of the index numbers at the beginning and at the end of the period.
(iii) Monetary and Non-Monetary Items:
Monetary items are those assets and liabilities the amount of which are fixed by contract or otherwise, and expressed in units of money, regardless of changes in general price level. These cover cash, bank, bills receivable, bills payable, debtors, creditors, outstanding expenses, pre-paid expenses etc., represent specific monetary claim which is receivable or payable in specified number of rupees regardless of price level changes.
(iv) Cost of Sales and Inventories:
Cost of sales and inventory value vary according to cost flow assumptions, i.e., FIFO or LIFO. Under FIFO method cost of sales comprise the entire opening stock and current purchases less closing stock. And closing stock is entirely from current purchases.
Under LIFO method cost of sale comprise current purchases only. However, if the current purchases are less than cost of sales, a part of the opening inventory may also become a part of cost of sales. And closing stock comprises purchases made in the previous year.
The following indices are used Under CPP method for restating the historical figures:
(i) For current purchases: Average index of the year.
(ii) For opening stock: Index at the beginning of the year.
(iii) For purchases of the previous year: Average indices for the year.
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