126536944 Price Level Accounting

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    PRICE do not remain constant, Price keeps on changing due to 1)   Economic Factors 2)   Social factors 3)   Political factors Change in price levels cause two types of economic conditions:-    INFLATION    DEFLATION INFLATION:-rise in prices OR Decrease in the value of money DEFLATION: - Fall in prices OR Increase in the value of money These changes in the price levels lead to inaccurate presentation of financial statements VARIOUS TRANSACTIONS INCLUDE Current assets acquired and current liability incurred at different points of time in the accounting period. Various Expenses incurred and incomes earned at different points of time Fixed assets maintained on historical or cost basis. REASONS FOR THE EMERGENCE OF PRICE LEVEL ACCOUNTING Inaccurate presentation of financial statements due the changes in price level. Inflated book profits. (Depreciation on fixed assets srcinal cost) Payment of extra dividend due to charging less depreciation. Difficulties in replacement of fixed asset during inflation.    METHODS/TECHNIQUES OF PRICE LEVEL ACCOUNTING CUURENT PURCASING POWER TECHNIQUE (CPP ) CPP technique of accounting requires the companies to keep their financial statements on historical cost basis but it further requires  presentation of statements in terms of current purchasing power of currency. The financial statements are adjusted with the help of recognized General Price Index. MECHANISM OF PREPARING FINANCIAL STATEMENT UNDER CPP METHOD A) Conversion Technique In this method various items of financial statements are adjusted with the help of GENERAL PRICE INDEX. Conversion factor= Current price index Previous price index Converted figure= Historical figure X Conversion factor EXAMPLE:- A building was purchased in 2000 at a price of Rs 80,000.The general price index at that time was 150, convert the figure in current rupees on 31-12-2010 when the index stood at 300. B) Mid  –   period conversions:- For conversion of such items average index of the year can be taken. C) Monetary and Non-monetary accounts:- Monetary Non-monetary - Cash -L & B -Debtors -Plant & Machinery -B/R - Stock. Adjustment of Cost of sales and inventory: - ã LIFO FIFO    A) For current purchases- the average index of the year B) For opening stock-the index at the beginning of the year C) For purchases of previous year:-the average index of the relevant year. HISTROCIAL ACCOUNTING Is the situation in which accountants record revenue, expenditure and asset acquisition and disposal at historical cost: that is, The actual amounts of money, or money's worth or the fair value of the consideration given to acquire them at the time of their acquisition, received or paid to complete the transaction. Limitations of Historical Cost Accounting include:    Control    Consumption    Taxation    Valuation Control    Historical cost accounts, in general, simply show the acquisition cost or the depreciated historical cost of a company’s assets and not their current value, let alone the value of the company as a whole. So historical cost accounting do not  provide an absolute measure of success of the company. The historical cost accounts are most unhelpful when it comes to the comparison of performance  because the inflation which means general increase in price or fall in value of money affect different companies in very different way and the problem is not  just inflation but includes the treatment of changes in relative price Consumption    Empirical evidence suggests that companies' dividends are related to the level of the reported profit.    The concept of capital maintenance  based on historical cost accounting principles has proved to be a dangerous benchmark when used to assess the amount which a company can pay out by way of dividend or through taxation. Taxation    The company tax charge is based on its accounting profit, the higher the amount that will be paid in tax.    The historical cost accounting does not constitute a suitable basis for the computation of the taxation obligations of  business.       The use of historical cost accounting as the basis for taxation means that in period of rising prices the proportion of the increase in company wealth which is taken by taxation may be very much larger than that which is implied by the nominal rate of taxation. The rapid and extreme inflation of the mid-1970 made government and others very much aware of the inadequacy of historical cost accounting for the purpose of taxation    Valuation   The knowledge of historical cost of a company asset will not be of much help in assessing the value of a company or its shares in a business; hence, it is better using current value principle to valuate the company. Alternatives to Historical Cost Accounting    Replacement costs.    Current cost accounting.    Exit price method. CRITICISMS OF THE HISTORICAL COSTS METHOD Historical cost method, over a period of time has been subject to many criticisms, especially as it considers the acquisition cost of an asset and does not recognise the current market value. Historical costs is only interested in cost allocations and not in the value of an asset. While it tells the user the acquisition cost of an asset and its depreciation in the following years, it ignores the  possibility that the current market value of that asset may be higher or lower than it suggests. Another main criticism of historical accounting method is its obvious flaws in times of inflation. The validity of historic accounting rests on the assumption that the currency in which transactions are recorded remains stable, i.e. its purchasing power remains the same over a period of time. Another main point with regards to inflation is rise in prices for an asset. An asset purchased at a point in time may be expensive in future. The traditional accounting principles record all assets at an srcinal cost and continue to use these historic figures throughout the asset's life, while economists make a more intelligible assumption that money has a time-value attached to it. The economist's approach is broadly embraced in the corporate finance model whose objective is centred on value creation for the shareholders. In addition effects of inflation may not be the same for all the companies in the market and historical cost accounts become almost unhelpful when comparing corporate performance.   Alternatives to historical cost accounting Over the years accounting bodies have introduced a number of alternative accounting methods to historical cost accounting. Opportunity costs are commonly used in economics and do not have much relevance here, however accounting bodies and academic commentators have forwarded new methods of accounting using the current asset value, as opposed to the conventional acquisition cost.
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