Steps Of Current Purchasing Power (CPP) Method

Under current purchasing power ( CPP) method, financial statements prepared under historical cost accounting are re-stated by using an approved price index. The following steps should be followed to prepare financial statements under CPP method of accounting for price level changes.

1. Calculation Of Conversion Factor
CPP method involves the re-statement of historical figures at current purchasing power. For this purpose, historical figures must be multiplied by conversion factors. The formula for the calculation of conversion factor is:
Conversion factor = Price Index at the date of Conversion/Price Index at the date of item arose

Conversion factor at the beginning = Price Index at the end/Price Index at the beginning

Conversion factor at an average = Price Index at the end/Average Price Index

Conversion factor at the end = Price Index at the end/Price Index at the end

Average Price Index= Price Index at beginning + Price Index at the end/2

CPP Value = Historical value X Conversion factor

Notes:
* For the items taken from the beginning period (e.g assets, liabilities, taken from the operating balance sheet), beginning conversion factor is used.
* For the items which occur throughout the year like sales, purchases, operating expenses etc., average conversion factor is used.
* For the items which occur at the end of the year like tax, dividend etc. ending conversion is used.

2. Distinction Between Monetary And Non-monetary Accounts
CPP method classifies all assets and liabilities into two groups i.e. monetary items and non-monetary items.
Monetary Items: Monetary items are assets and liabilities, the amounts of which are receivable or payable only at current monetary value. Monetary assets include cash, bank, bills receivables, debtors, prepaid expenses, account receivables, investment in bond or debentures, accrued income etc. Monetary liabilities include creditors, account payable, bills payable, outstanding expenses, notes payable, dividend payable, tax payable, bonds or debentures, loan, advance income, preference share capital etc.
Non-monetary Items: Those items which cannot be stated in ficed monetary value are called non-monetary items. Such items denote assets and liabilities that do not represent specific monetary claims. 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 fixed value like monetary items. Therefore, under CPP method, all such items are to be restated to represent current general purchasing power.

3. Gain Or Loss On Monetary items
Monetary items are receivable or payable in fixed amount irrespective of changes in purchasing power of money. The change in purchasing power of money has an effect on monetary assets and monetary liabilities, Therefore, the holding of such items results gain or loss in terms of real purchasing power. Such gain or loss is termed as general price level gain or loss. During the period of inflation, holding of monetary assets results in loss and holding of monetary liabilities result in gain. Such gain or loss must be taken into accounts when income statement is prepared under CPP method to arrive at the overall profit or loss.

4. Valuation Of Cost Of Sales And Inventories
Cost of sales and inventory 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 entire opening stock and current purchases less closing stock. And closing is entirely from current purchase. Under LIFO method, cost of sales comprises current purchase only. However, if the current purchase are less than cost of sales, a part of opening inventory may also become a part of cost of sales. And closing stock comprises purchases made in previous year.

5. Ascertainment Of Profit
Under current purchasing power method, profit can be determined in two ways. They are:

i. Re-statement Of Income Method
Under this method, historical income statement is re-stated in CPP terms. Following conversion factors are used to restate the figures of historical cost statement.
* Sales and operating expenses are converted at the average rate application for the year.
* Cost of sales is converted as per cost flow assumption i.e. FIFO and LIFO.
* Depreciation is converted on the basis of indices prevailing on the dates when assets were purchased.
* Taxes and dividend paid are converted on the indices that were prevalent on the dates when they are paid.
* Gain or loss on monetary items should be shown as separate item to arrive at the overall profit or loss.

ii. Net Change Method
This method is based on the normal accounting principle that profit is change in equity during an accounting period. In order to determine profit, following steps are taken.
* Opening balance sheet prepared on historical cost accounting method is converted in CPP forms at the end of the year.Monetary and non-monetary items are re-stated by using proper conversion factors. Equity share capital is also converted. The difference in the balance sheet is taken as reserve. Alternatively, the equity share capital may not be converted and the difference in balance sheet be taken as equity.
* Closing balance sheet prepared under historical costing is also converted. Only non-monetary items are re-stated. The difference in balance sheet is taken as reserve after converting equity capital. Alternatively, the equity capital may not be restated in CPP terms and balance be taken as equity.
* Profit is equivalent to net change in reserve where equity capital has also been converted or net change in equity where equity capital has not been re-stated.

6. Restated Balance Sheet
The historical balance sheet is prepared as per the historical income statement, so it can not represent the revised or changed value of assets and liabilities. Under the price level change, the historical balance sheet should be revised to reflect the true picture of financial position of any organization. Inside the historical balance sheet, both monetary and non-monetary items are listed. So, the monetary and non monetary items should be separated first of all. It is not necessary to change the monetary item into CPP value because such items are already utilized while calculating the holding gain or loss. Only the non monetary items are to be adjusted to the CPP value by multiplying appropriate conversion factors.