Matakuliah
Tahun
: F0142/Akuntansi Internasional
: 2006
Session 07
Financial Reporting and
Changing Prices
1
Inflation
• Inflation has had a devastating effect
on many countries
– Brazil and Russia – as high as 2,000%
– 1970s in the U.K. – 25%
• Some companies are using other
methods of accounting to combat the
effects of inflation
– BP uses replacement costs
– More companies will likely follow BP’s lead
2
Impact of Inflation on the
Corporation
• Assets become devalued
• Liabilities become less expensive to pay off
• Interest rates on loans increase with
inflation
• Income can be overstated as old costs are
matched with new revenues
• Shareholders could demand more
dividends and employees could demand
higher wages
3
Accounting Measurement
Alternatives
• General purchasing power accounting
– Includes all systems designed to maintain the
purchasing power of capital or equity
– Accounts for changes in the level of prices
– Concerned with the value of money
– Other names include
• Constant dollar accounting (U.S.)
• General price level accounting (U.S.)
• Current purchasing power accounting (U.K.)
4
Accounting Measurement
Alternatives
• Current value accounting
– Includes all systems designed to account for current
values or changes in specific prices
– Concerned with the cost of specific assets
– Types of accounting include
• Current cost accounting
• Replacement value accounting
• Current exit price accounting
• Real value accounting is a combination of
current value and general purchasing power
accounting
5
General Purchasing Power
Accounting
• The monetary unit of measure should be
uniform while retaining the basis of
measurement used in the financial
statements (historical cost)
• All items except financial assets and
liabilities (cash, receivables, payables) are
restated to reflect common purchasing
power
• Previous year’s accounts are also updated
to provide comparability
6
General Purchasing Power
Accounting
• Example
– General price level increased by 15%
during the year
– A machine purchased on January 1 cost
$10,000
– End-of-year purchasing power to buy
machine on Dec. 31
= $10,000 + ($10,000 x 0.15) = $11,500
7
Current Value Accounting
• Income is not earned until the company has
maintained its capital in current value terms
• Current cost (replacement cost) method
– Should the same asset or one performing a similar
function with new technology be used?
• Current exit price method
– Values assets at what they could be sold for, less cost
to complete and sell the items
– Going-concern concept – asset is valued at estimated
sales price on normal completion of production
8
Current Value Accounting
• Results in holding gains and losses that
are
– Recognized on the income statement
– Reflected on the balance sheet as a capital
adjustment account
• Current values are determined by
– Suppliers’ lists (inventory)
– Construction cost indices (PP&E)
– Appraisal values (fixed assets)
9
Current Value Accounting
Example
Sales = $1,000,000
Current COGS = $900,000
Historical COGS = $700,000
Operating gross profit
$100,000 for current cost method
$300,000 for historical cost method, part of which is
due to holding during a period of price increase
Realized holding gain = $900,000 - $700,000 =
$200,000
10
Real Value Accounting
Example
Value of asset
Beginning = $150,000
Current value at year end = $190,000
GPP value at year end = $165,000
Total holding gain
$190,000 - $150,000 = $40,000
Real holding gain
$190,000 - $165,000 = $25,000
***What matters is the net impact of prices directly affecting
the corporation relative to the average level of prices
affecting the GPP of money!!!
11
International Financial
Reporting Standards
• IAS 6 (1977)
– A brief narrowing of options available to deal
with inflation
• IAS 15, Information Reflecting the Effects
of Changing Prices
– Recognized the two major methods (GPP or
current cost), but did not champion one or the
other
– Required information on the effects of price
changes if the historical cost method is used
12
International Financial
Reporting Standards
• IAS 15 suggestions for price change info
– The amount of the adjustment to or adjusted amount of
depreciation of PP&E
– The amount of the adjustment to or the adjusted amount of
cost of sales
– The adjustments relating to monetary items, the effect of
borrowing, or equity interests when those adjustments are
used in determining income
– The overall effect on income of adjustments and any items
reflecting the effects of changing prices
– Current cost of PP&E of inventories
– Methods adopted to compute information used in the
preceding items and any indices used
• IAS 15 was withdrawn in 2003
13
International Financial
Reporting Standards
• IAS 29 (1989)
– Focuses on hyperinflationary economies
• 100% inflation over 3 years
– Requires restatements for GPP changes
regardless of previous treatment
• IAS 16 (revised in 1998)
– Current value approach is permitted for
PP&E
– “Fair value” is used
– Regular revaluations are required
14
Comparative National
Regulation and Practice
• U.K.
– SSAP 16, requiring current cost accounting,
was issued and withdrawn due to lower
inflation
– Only a few companies now provide current
cost disclosures
– Some companies revalue their PP&E at
market values
15
Comparative National
Regulation and Practice
• U.S.
– Accounting Series Release 190 required
disclosure of replacement cost info
– SFAS 33 required disclosure on both GPP and
a current cost basis
– SFAS 33 made an array of information
available
16
Comparative National
Regulation and Practice
• Australia, Canada, and New Zealand
– Developments are more tentative than in U.S.
– Similar to U.S. current cost system
• Continental Europe
– Much less enthusiasm for inflation accounting
– No professional standards on the subject
17
Comparative National
Regulation and Practice
• Brazil
– Inflation accounting used as early as the 1950s
– Company law in 1976 required indexation
approach to restate historical costs in terms of
current purchasing power
– With reduced inflation levels, requirement was
withdrawn in 1996
• Argentina
– Inflation accounting introduced was the
accounting profession
– 1972 – GPP financial statements were
recommended
– Recommendation withdrawn in 1995 due to low
inflation
18
Comparative National
Regulation and Practice
• Current Value Accounting in Holland
– Some firms use current cost method
– Some use partial current cost statements or historical
cost statements with supplementary disclosures
19
Comparative National
Regulation and Practice
• Theodore Limperg – father of replacement value
– Focused on the relationship between economics
and accounting
– Believed that income is a function of revenue and
replacement value instead of historical costs
– Believed that current value info should be used by
all decision makers
20
Comparative National
Regulation and Practice
• Philips
– First used current value techniques in 1936
– Used current value approach in 1952 for
financial reporting purposes
– Departments of the company determined
current values of inventory, equipment, and
fixed assets
– The effect of current value changes showed in
cost of goods sold and depreciation expense
21
Comparative National
Regulation and Practice
• Philips
– Brink (1992) showed that Philips used
replacement value techniques to enhance
profits
– The company used inventory value reductions
and the gearing adjustment in
hyperinflationary countries
– Recorded a loss of 4.24 billion guilders in
1990, which led to the demise of the
replacement value system in 1992
22
Problems and Prospects
• Inflationary accounting is likely to remain a
hot topic for the foreseeable future
• Some South American countries in
hyperinflation use GPP accounting
• Some European companies still make
voluntary current value disclosures
• No current cost accounting regulations
exist in the U.K. or the U.S.
23
Problems and Prospects
• Controversy remains over
– The gearing adjustment
– Treatment of gains and losses on monetary
items
– The use of indices with respect to foreign subs
– Verification of current costs in industries with
rapid technological change
24
Problems and Prospects
• Future experimentation with price change
accounting systems is hoped for
• The usefulness of exit prices and cash
flows may be better appreciated in the
future
25