Chapter 11

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					                Chapter 11
International Accounting for Price
                        Changes
Inflation
   Inflation has had a devastating effect on
    many countries
       Brazil and Russia – as high as 2,000%
       1970s in the U.K. – 25%
   Some companies are using other methods of
    accounting to combat the effects of inflation
       BP uses replacement costs
       More companies will likely follow BP’s lead


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Accounting Measurement
Alternatives
   General purchasing power accounting
       Includes all systems designed to maintain the
        purchasing power of capital or equity
       Accounts for changes in the level of prices
       Concerned with the value of money
       Other names include
           Constant dollar accounting (U.S.)
           General price level accounting (U.S.)
           Current purchasing power accounting (U.K.)


            International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Accounting Measurement
Alternatives
   Current value accounting
       Includes all systems designed to account for current values
        or changes in specific prices
       Concerned with the cost of specific assets
       Types of accounting include
         Current cost accounting

         Replacement value accounting

         Current exit price accounting

   Real value accounting is a combination of current
    value and general purchasing power accounting


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
General Purchasing Power
Accounting
   The monetary unit of measure should be
    uniform while retaining the basis of
    measurement used in the financial statements
    (historical cost)
   All items except financial assets and liabilities
    (cash, receivables, payables) are restated to
    reflect common purchasing power
   Previous year’s accounts are also updated to
    provide comparability

       International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
General Purchasing Power
Accounting
   Example
     General price level increased by 15% during
      the year
     A machine purchased on January 1 cost
      $10,000
     End-of-year purchasing power to buy machine
      on Dec. 31
      = $10,000 + ($10,000 x 0.15) = $11,500



       International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Current Value Accounting
   Income is not earned until the company has
    maintained its capital in current value terms
   Current cost (replacement cost) method
       Should the same asset or one performing a similar function
        with new technology be used?
   Current exit price method
       Values assets at what they could be sold for, less cost to
        complete and sell the items
       Going-concern concept – asset is valued at estimated
        sales price on normal completion of production


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Current Value Accounting
   Results in holding gains and losses that are
       Recognized on the income statement
       Reflected on the balance sheet as a capital
        adjustment account
   Current values are determined by
       Suppliers’ lists (inventory)
       Construction cost indices (PP&E)
       Appraisal values (fixed assets)


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Current Value Accounting
Example

 Sales = $1,000,000
 Current COGS = $900,000
 Historical COGS = $700,000

 Operating gross profit
   $100,000 for current cost method
   $300,000 for historical cost method, part of which is due to
   holding during a period of price increase

 Realized holding gain = $900,000 - $700,000 = $200,000


     International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Real Value Accounting
Example

  Value of asset
       Beginning = $150,000
       Current value at year end = $190,000
       GPP value at year end = $165,000

  Total holding gain
        $190,000 - $150,000 = $40,000

  Real holding gain
        $190,000 - $165,000 = $25,000

***What matters is the net impact of prices directly affecting the
   corporation relative to the average level of prices affecting the
   GPP of money!!!


        International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
   IAS 6 (1977)
       A brief narrowing of options available to deal with
        inflation
   IAS 15, Information Reflecting the Effects of
    Changing Prices
       Recognized the two major methods (GPP or
        current cost), but did not champion one or the
        other
       Required information on the effects of price
        changes if the historical cost method is used


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
   IAS 15 suggestions for price change info
     The amount of the adjustment to or adjusted amount of
       depreciation of PP&E
     The amount of the adjustment to or the adjusted amount of cost
       of sales
     The adjustments relating to monetary items, the effect of
       borrowing, or equity interests when those adjustments are used
       in determining income
     The overall effect on income of adjustments and any items
       reflecting the effects of changing prices
     Current cost of PP&E of inventories
     Methods adopted to compute information used in the preceding
       items and any indices used
   IAS 15 was withdrawn in 2003

         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
International Financial
Reporting Standards
   IAS 29 (1989)
       Focuses on hyperinflationary economies
           100% inflation over 3 years
       Requires restatements for GPP changes
        regardless of previous treatment
   IAS 16 (revised in 1998)
       Current value approach is permitted for PP&E
       “Fair value” is used
       Regular revaluations are required

            International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   U.K.
       SSAP 16, requiring current cost accounting, was
        issued and withdrawn due to lower inflation
       Only a few companies now provide current cost
        disclosures
       Some companies revalue their PP&E at market
        values




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   U.S.
       Accounting Series Release 190 required
        disclosure of replacement cost info
       SFAS 33 required disclosure on both GPP and a
        current cost basis
       SFAS 33 made an array of information available




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Australia, Canada, and New Zealand
       Developments are more tentative than in U.S.
       Similar to U.S. current cost system
   Continental Europe
       Much less enthusiasm for inflation accounting
       No professional standards on the subject




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Brazil
       Inflation accounting used as early as the 1950s
       Company law in 1976 required indexation approach to
        restate historical costs in terms of current purchasing
        power
       With reduced inflation levels, requirement was withdrawn in
        1996
   Argentina
       Inflation accounting introduced was the accounting
        profession
       1972 – GPP financial statements were recommended
       Recommendation withdrawn in 1995 due to low inflation

         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Current Value Accounting in Holland
       Some firms use current cost method
       Some use partial current cost statements or historical cost
        statements with supplementary disclosures




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Theodore Limperg – father of replacement value
       Focused on the relationship between economics and
        accounting
       Believed that income is a function of revenue and
        replacement value instead of historical costs
       Believed that current value info should be used by all
        decision makers




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Philips
       First used current value techniques in 1936
       Used current value approach in 1952 for financial
        reporting purposes
       Departments of the company determined current
        values of inventory, equipment, and fixed assets
       The effect of current value changes showed in
        cost of goods sold and depreciation expense



         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Comparative National
Regulation and Practice
   Philips
       Brink (1992) showed that Philips used
        replacement value techniques to enhance profits
       The company used inventory value reductions
        and the gearing adjustment in hyperinflationary
        countries
       Recorded a loss of 4.24 billion guilders in 1990,
        which led to the demise of the replacement value
        system in 1992


         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
   Inflationary accounting is likely to remain a
    hot topic for the foreseeable future
   Some South American countries in
    hyperinflation use GPP accounting
   Some European companies still make
    voluntary current value disclosures
   No current cost accounting regulations exist
    in the U.K. or the U.S.

       International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
   Controversy remains over
       The gearing adjustment
       Treatment of gains and losses on monetary items
       The use of indices with respect to foreign subs
       Verification of current costs in industries with rapid
        technological change




         International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black
Problems and Prospects
   Future experimentation with price change
    accounting systems is hoped for
   The usefulness of exit prices and cash flows
    may be better appreciated in the future




       International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black

				
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