Price Level Accounting

The price level has a significant impact on the purchase of goods and services but also on the purchasing power of money. For instance, if P is the amount of money required to buy a specified quantity of goods and services, then one dollar can buy 1/P.

By considering money as a commodity, its demand will have a negative correlation with its value, and a positive correlation with the price level. The price level changes as the consumer basket of goods and services changes during a specified period, month or year. Furthermore, the price level refers to the price of assets traded on the market.

Method of Price Level Accounting

1. Current Purchasing Power Technique

Current Purchasing Power Technique of accounting requires the companies to keep their records and present the financial statements on conventional historical cost basis but it further requires presentation of supplementary statements in items of current purchasing power of currency at the end of the accounting period.

In this method the various items of financial statements, i.e. balance sheet and profit and loss account are adjusted with the help of recognized general price index. The consumer price index or the wholesale price index prepared by the Reserve Bank of India can be taken for conversion of historical costs.

The main objective of this method is to take into consideration the changes in the value of money as a result of changes in the general price levels. It helps in presenting the financial statements in terms of a unit of measurement of constant value when both cost and revenue have been changing due to changes in the price levels.

This technique of price level accounting has been followed by a number of companies in Germany, Australia and U.S.A. But although this method is simple, it may be considered as only a first step towards inflationary accounting.

2. Replacement Cost Accounting Technique

Replacement Cost Accounting (RCA) Technique is an improvement over Current Purchasing Power Technique (CPP). One of the major weaknesses of Current Purchasing Power technique is that it does not take into account the individual price index related to the particular assets of a company.

In the Replacement Cost Accounting technique the index used are those directly relevant to the company’s particular assets and not the general price index. In this sense the replacement cost accounting technique is considered to be a improvement over current purchasing power technique.

But adopting the replacement cost accounting technique will mean using a number of price indices for conversion of financial statements and it may be very difficult to find out the relevant price index to be used in a particular case. Further, the replacement cost accounting technique provides for an element of subjectivity and on this ground it has been criticized by various thinkers.

3. Current Value Accounting Technique

In the Current Value Accounting Technique of price level accounting all assets and liabilities are shown in the balance sheet at their current values.

The value of the net assets at the beginning and at the end of the accounting period is ascertained and the difference in the value in the beginning and the end is termed as profit or loss, as the case may be. In this method also, like replacement cost accounting technique, it is very difficult to determine relevant current values and there is an element of subjectivity in this technique.

4. Current Cost Accounting Technique

The British Government had appointed a committee known as Sandilands Committee under the chairmanship of Mr. Francis C.P. Sandilands to consider and recommend the accounting for price level changes. The committee presented its report in the year 1975 and recommended the adoption of Current Cost Accounting Technique in place of Current Purchasing Power of Replacement Cost Accounting Technique for price level changes.

The crux of the current cost accounting technique is the preparation of financial statements (Balance Sheet and Profit and Loss Account) on the current values of individual items and not on the historical or original cost.