Chapter 11
International Accounting for Price
Changes
Inflation
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Inflation has had a devastating effect on
many countries
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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
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BP uses replacement costs
More companies will likely follow BP’s lead
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Impact of Inflation on the
Corporation
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Accounting Measurement
Alternatives
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General purchasing power accounting
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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
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Constant dollar accounting (U.S.)
General price level accounting (U.S.)
Current purchasing power accounting (U.K.)
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Accounting Measurement
Alternatives
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Current value accounting
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
General Purchasing Power
Accounting
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
General Purchasing Power
Accounting
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Current Value Accounting
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Income is not earned until the company has
maintained its capital in current value terms
Current cost (replacement cost) method
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Should the same asset or one performing a similar function
with new technology be used?
Current exit price method
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Current Value Accounting
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Results in holding gains and losses that are
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Recognized on the income statement
Reflected on the balance sheet as a capital
adjustment account
Current values are determined by
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Suppliers’ lists (inventory)
Construction cost indices (PP&E)
Appraisal values (fixed assets)
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
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!!!
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
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IAS 6 (1977)
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A brief narrowing of options available to deal with
inflation
IAS 15, Information Reflecting the Effects of
Changing Prices
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
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IAS 29 (1989)
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Focuses on hyperinflationary economies
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100% inflation over 3 years
Requires restatements for GPP changes
regardless of previous treatment
IAS 16 (revised in 1998)
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Current value approach is permitted for PP&E
“Fair value” is used
Regular revaluations are required
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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U.K.
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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U.S.
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Australia, Canada, and New Zealand
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Developments are more tentative than in U.S.
Similar to U.S. current cost system
Continental Europe
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Much less enthusiasm for inflation accounting
No professional standards on the subject
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Brazil
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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
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Inflation accounting introduced was the accounting
profession
1972 – GPP financial statements were recommended
Recommendation withdrawn in 1995 due to low inflation
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Current Value Accounting in Holland
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Some firms use current cost method
Some use partial current cost statements or historical cost
statements with supplementary disclosures
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Theodore Limperg – father of replacement value
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Philips
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
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Philips
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
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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.
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
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Controversy remains over
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
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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
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black