Constant purchasing power accounting is one of the accounting model in which amounts of all non-monetary items that are recorded on historical-cost basis in the financial reports of the entity are restated by applying a general price index prevailing at the end of accounting period.
Constant purchasing power accounting (CPPA) model is also named as:
- current purchasing power accounting
- general price level accounting or general purchasing power accounting
- constant dollar accounting
Definition might seem overwhelming as many concepts are mentioned together so lets divide it in parts and understand each in detail:
- Constant purchasing power accounting is one of the accounting model
- in which amounts of all non-monetary items
- that are recorded on historical-cost basis in the financial reports of the entity are restated
- by applying a general price index prevailing at the end of accounting period.
In simple words it is an alternative to historical cost accounting model in which only those items are restated or adjusted for inflation/deflation using general price index method that are non-monetary AND recorded on historical cost basis.
This means the items that are monetary or not recorded on historical cost basis are not restated or adjusted for inflation or deflation.
Monetary items mean cash, cash equivalents or items that are readily convertible to known amounts of cash.
Not all assets are recorded on historical cost basis for example if entity has selected (or is required to use) fair value measurement for certain class of assets then it is already adjusted for current period ending monetary unit. Therefore, restatement or adjustment is not needed for amounts of such assets in the financial statements.
Under historical cost model, assets are recorded and carried forward at the cost of acquisition and it is assumed that value has not changed since acquisition. This is hardly the case in present day economies that are either inflation inclined or deflation. Because of these factors, the real value of asset on a certain date can be significantly different from the carrying value reported in the financial statements. With such criticism, accounting world has matured and is now constantly moving to more accurate approaches like fair value approach.
Although accounting frameworks understand the flaws of historical cost approach, they have issued detailed guidelines particular to each asset type to overcome its limitations. For example IASB framework still allows three accounting approaches to capital maintenance:
- Physical capital maintenance
- Financial capital maintenance i.e. historical cost accounting.
- Constant purchasing power accounting
Financial capital maintenance or historical cost accounting is still a preferred choice of accounting framework. But recognizing the fact that economies around the world are not ideal for such approach, frameworks like IASB has permitted the use of CPPA.
Following are some of the main guidelines under CPPA model as per IFRSs:
- statement of financial position:
- Monetary items are not adjusted as they are already at the latest value.
- Items that are already adjusted for net realisable value, current market value or fair value will not be adjusted.
- All other non-monetary items are adjusted for general price index including depreciable fixed assets, inventories carried at cost, intangible assets etc.
- Owners’ equity and changes to equity are restated according to general price index.
- income statement:
- All the items are adjusted according to the change in general price index.
- Cash flow statement:
- All the items in cash flow statement are adjusted to be expressed in current value terms by incorporating changes in general price index.
- Corresponding figures are also adjusted for changes price index including any disclosures made.
ABC depreciates its assets using straight-line method over 10 years. By the end of December 2017 entity’s machinery account stood at 150,000. No new machinery is acquired during the year.
Following information is available regarding price indices:
January 1, 2017: 125
December 31, 2017: 135
Depreciation for the year = 150,000 / 10 = 15,000
CPPA Adjusted depreciation: 15,000 x 135/125 = 16,200
Under CPPA method, depreciation of 16,200 will be recorded.
Income statement expenses
Following information is available regarding entity’s expenses for the year ended December 2018:
Administrative expenses 100,000
Selling expenses 120,000
Rental expenses 60,000
Interest expenses 35,000
All costs are spread evenly over the period except rental expenses that are paid in advance at the beginning of the year and interest expenses that accrue at the end of the period i.e. last day of the year.
Price index information is following:
January 1, 2018: 110
December 31, 2018: 125
Average of the year: 120
Following are the adjustments for each expenses:
Administrative expenses = 100,000 x 125/120 = 104,167
Selling expenses = 120,000 x 125/120 = 125,000
Rental expenses = 60,000 x 125/110 = 68,182
Interest expenses = 35,000 x 125/125 = 35,000