Objectives Of Accounting For Price Level Changes
Historical cost accounting financial statements are prepared on the assumption that monetary unit is stable. But in reality, monetary unit is never stable and most of the countries have been facing high rates of inflation. Therefore, financial statements prepared under historical cost accounting do not reflect current economic realities. They fail to give realistic and correct picture of the state if affairs of a concern. To overcome the limitation of historical cost accounting, there is a need to consider the effects of changes in value of money as a result of changes of price of goods and services. Following are the objectives of accounting for price level changes.
* To show the true result of the operations i.e. real profit or loss.
* To show the true financial position in current values.
* To show the realistic value of fixed assets in financial statement.
* To provide sufficient depreciation to generate funds for the replacement of fixed assets.
* To indicate the real capital employed.
* To make distinction between holding gain or loss and operating gain or loss.
* To make accounting records reliable for the various users.
Methods Of Accounting For Price Level Changes
There are many methods of adjustments for the effects of changes in prices. The generally accepted methods of accounting for price level changes are as under:
1. Current purchasing power method or general purchasing power method(CPP or GPP)
2. Current cost accounting method(CCA method)
3. A hybrid method i.e mixture of CPP and CCA method.
Note: These methods are described separately in other posts.
Historical cost accounting financial statements are prepared on the assumption that monetary unit is stable. But in reality, monetary unit is never stable and most of the countries have been facing high rates of inflation. Therefore, financial statements prepared under historical cost accounting do not reflect current economic realities. They fail to give realistic and correct picture of the state if affairs of a concern. To overcome the limitation of historical cost accounting, there is a need to consider the effects of changes in value of money as a result of changes of price of goods and services. Following are the objectives of accounting for price level changes.
* To show the true result of the operations i.e. real profit or loss.
* To show the true financial position in current values.
* To show the realistic value of fixed assets in financial statement.
* To provide sufficient depreciation to generate funds for the replacement of fixed assets.
* To indicate the real capital employed.
* To make distinction between holding gain or loss and operating gain or loss.
* To make accounting records reliable for the various users.
Methods Of Accounting For Price Level Changes
There are many methods of adjustments for the effects of changes in prices. The generally accepted methods of accounting for price level changes are as under:
1. Current purchasing power method or general purchasing power method(CPP or GPP)
2. Current cost accounting method(CCA method)
3. A hybrid method i.e mixture of CPP and CCA method.
Note: These methods are described separately in other posts.
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