Profit measurement under different systems of accounting

28/07/2021 1 By indiafreenotes

Under Current Purchasing Power Method, the profit can be determined in two ways:

(i) Net Change Method:

This method is based on the normal accounting principle that profit is the change in equity during an accounting period.

In order to determine this change the following steps are taken:

(a) Opening Balance Sheet prepared under historical cost accounting method is converted into CPP terms as at the end of the year. This is done by application of proper conversion factors to both monetary as well as non-monetary items. Equity share capital is also converted. The difference in the balance sheet is taken as reserves. Alternatively, the equity share capital may not be converted and the difference in balance sheet be taken as equity.

(b) Closing Balance Sheet prepared under historical cost accounting is also converted. The difference between the two sides of the balance sheet is put as reserves after converting the equity capital. Alternatively, the equity capital may not be restated in CPP terms and the balance be taken as equity.

(c) Profit is equivalent to net change in reserves (where equity capital has also been converted) or net change in equity (where equity capital has not been restated).

(ii) Conversion or Restatement of Income Statement Method:

In case of this method, the income statement prepared on historical cost basis is restated in CPP terms, generally on the basis:

(a) Sales and operating expenses are converted at the average rate applicable for the year.

(b) Cost of sales is converted as per cost flow assumption (FIFO or LIFO) as explained in the preceding pages.

(c) Fixed assets are converted on the basis of the indices prevailing on the dates they were purchased. The same applies to depreciation.

(d) Taxes and dividends paid are converted on the basis of indices that were prevalent on the dates they were paid.

(e) Gain or loss on account of monetary items should be calculated and stated separately in Restated Income Statement to arrive at the overall figure of profit or loss.