Current purchasing power method (CPP)01/09/2022 0 By indiafreenotes
The current purchasing power (CPP) method is also known as general price-level accounting. CPP adjusts historical cost based on changes in the general level of prices, as measured by the general price level index. Changes in the general level of prices represent changes in the general purchasing power of the monetary unit.
CPP is a mixed method in which financial statements are prepared on a historical basis. These statements, in the end, are converted based on the current purchasing power of the currency. Profit and loss items and balance sheet items are adjusted with the price index.
The basic idea of the CPP method is to apply changes in the value of money in response to changes in general price index.
Inflation reduces an individual’s purchasing power to purchase goods and services, while deflation increases an individual’s purchasing power to purchase goods and services.
Historical financial statements show transactions at various points in time and, as such, they also show replacement purchasing powers at various points in time.
CPP accounting transforms diverse historical measures into a single measure: namely, that of current purchasing power, which represents purchasing power at the same point in time.
Thus, CPP accounting makes all accounting numbers comparable in terms of general purchasing power. This is achieved by removing the mixed purchasing power element from historical financial statements.
CPP differs from current cost accounting (CCA) in that, under CPP, the current values of various assets are not worked out; instead, financial statements are stated in terms of dollars of uniform value.
Hence, the CPP method considers changes in price levels that are denoted by the general price index. Thus, all amounts are expressed in units of equal purchasing power.
Since the CPP method reflects the effects of changes in the general price level, it is also known as general price-level accounting.
Characteristics of CPP Method
- A supplementary statement is prepared and annexed to historical financial statement. The supplementary statement includes re-statement of income statement and re-stated balance sheet.
- Any statement prepared under CPP method is based on the historical statement.
- Consumer price index or wholesale price index is used as conversion factor for re-stated of historical items.
- All the items in financial statement are classified into monetary and non-monetary items. Non-monetary items are adjusted, there is no need of any adjustment for the monetary items.
- Net gain or loss account of monetary items is to be accounted in the profit and loss account.
(1) Calculation of Conversion Factor
CPP method involves the restatement of historical figures at current purchasing power. For this purpose, historical figures must be multiplied by conversion factors. The formula for the calculation of the conversion factor is:
- Conversion factor = Price Index at the date of Conversion/Price Index at the date of item aros
- Conversion factor at the beginning = Price Index at the end/Price Index at the beginning
- Conversion factor at an average = Price Index at the end/Average Price Index
- Conversion factor at the end = Price Index at the end/Price Index at the en
- Average Price Index = Price Index at beginning + Price Index at the end/2
- CPP Value = Historical value X Conversion factor
(2) Distinction between Monetary and Non-monetary Accounts
CPP method classifies all assets and liabilities into two groups’ i.e. monetary items and non-monetary items.
Monetary Items: Monetary items are assets and liabilities, the amounts of which are receivable or payable only at a current monetary value. Monetary assets include cash, bank, bills receivables, debtors, prepaid expenses, account receivables, investment in bond or debentures, accrued income, etc. Monetary liabilities include creditors, accounts payable, bills payable, outstanding expenses, notes payable, dividend payable, tax payable, bonds or debentures, loan, advance income, preference share capital, etc.
Non-monetary Items: Those items which cannot be stated in fixed monetary value are called non-monetary items. Such items denote assets and liabilities that do not represent specific monetary claims. Non-monetary accounts include land, building, machinery, vehicles, furniture, inventory, equity share capital, irredeemable preference share capital, accumulated depreciation, etc.
(3) Gain or Loss on Monetary items
Monetary items are receivable or payable in a fixed amounts irrespective of changes in the purchasing power of money. The change in purchasing power of money has an effect on monetary assets and monetary liabilities, Therefore, the holding of such items results in gain or loss in terms of real purchasing power. Such gain or loss is termed as general price level gain or loss.
(4) Valuation of Cost of Sales and Inventories
Cost of sales and inventory value vary according to cost flow assumptions i.e. first-in-first-out (FIFO) or last-in-first-out (LIFO). Under FIFO, the cost of sales comprises the entire opening stock and current purchases less closing stock. And closing is entirely from the current purchase. Under the LIFO method, the cost of sales comprises the current purchase only.
(5) Restated Balance Sheet
The historical balance sheet is prepared as per the historical income statement, so it can not represent the revised or changed value of assets and liabilities. Under the price level change, the historical balance sheet should be revised to reflect the true picture of the financial position of any organization. Inside the historical balance sheet, both monetary and non-monetary items are listed.