Under current purchasing power (CPP) methods, financial claims prepared under historical cost accounting are re-stated by using an approved price index. The following steps should be adopted to prepare financial statements under the CPP method of accounting for price-level changes. CPP method consists of the re-statement of historical statistics at current purchasing power. For this function, historical figures must be multiplied by transformation factors.
For the things taken from the beginning period (e.g resources, liabilities, taken from the working balance sheet), starting conversion factor is used. For the things which take place throughout the year like sales, purchases, operating expenditures etc., average conversion factor can be used. Of the year like taxes For the items which occur by the end, dividend etc. closing conversion is used. CPP method classifies all property and liabilities into two groups i.e. financial items and non-monetary items.
Monetary Items: Monetary items are possessions and liabilities, the levels of that are receivable or payable only at current monetary value. Non-monetary Items: Those goods that cannot be stated in a fixed monetary value are called non-monetary items. Such items denote liabilities and resources that do not symbolize specific financial promises. Non-monetary accounts include land, building, machinery, vehicles, furniture, inventory, equity share capital, irredeemable preference share capital, accumulated depreciation etc. Non-monetary items do not carry a set value like monetary items. Therefore, under the CPP method, all such items are to be restated to represent current general purchasing power. Financial items are payable or receivable in a fixed amount irrespective of changes in the purchasing power of money.
The change in purchasing power of money impacts monetary resources and financial liabilities, Therefore, the keeping of such items results in gain or loss in terms of real purchasing power. Such gain or reduction is termed as general price level gain or loss. During the period of inflation, the holding of monetary assets results in loss and holding of monetary liabilities lead to gain.
Such gain or reduction must be studied into accounts when income statement is ready under CPP solution to arrive at the entire profit or loss. Cost of inventory and sales value vary according to cost flow assumptions i.e. first-in-first-out (FIFO) or last-in-first-out (LIFO). Under FIFO, cost of sales comprises the whole starting stock and current purchases less shutting stock.
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And shutting is completely from current purchase. Under the LIFO method, cost of sales comprises current purchase only. However, if the current purchase is significantly less than cost of sales, a part of starting inventory could become an integral part of cost of sales also. Year And shutting stock comprise buys made in previous. Under current purchasing power method, profit can be determined in two ways.
Under this technique, historical income statement is re-stated in CPP terms. Following transformation factors are accustomed to restate the statistics of historical cost declaration. Sales and operating expenses are converted at the average rate program for the entire year. Cost of sales is converted according to cost flow assumption i.e. FIFO and LIFO.