Accounting Adjustment Form

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					Chapter 13:
Accounting for Inflation & Changing Prices
    Price indexes
    Inflation accounting
    Income measurement
    SFAS No. 33
   The rise in the average price level for all
   goods and services produced in an economy
   Under a historical cost-based system of
   accounting inflation leads to two basic
     Many historical numbers are not economically
     Historical numbers are not additive
Inflation and Historical Costing
   Likely predictive value is diminished
   Comparability among financial statements
   of different firms is restricted
   Capital maintenance
     Income usually overstated relative to amounts
     that can be distributed to stockholders
     Many dividends are really liquidating in nature
Price Indexes
   Is a weighted average of the current prices
   of goods and services
     Averages are related to prices in a base period
     Purpose is to determine how much change has
   Types of price indexes
     Specific price index
     General price index
Price Indexes
   Paasche-type indexes
     Uses current-year
     Wholesale Price Index
     Consumer price Index
     Uses base-year
     Less costly to construct
Inflation Accounting
   General purchasing power adjustment
   translates historical dollars into dollars
   having equivalent purchasing power
   Current valuation, also called current cost,
   attempts to derive the specific value or
   worth for a particular point ...
     Entry values
     Exit values
Entry vs. Exit Values
   Entry values
     Value in use is best represented by replacement
     Strong argument in support of use
   Exit values
     Are a form of opportunity costs
     The balance sheet becomes the principal
     financial statement
Purchasing Power Gains & Losses
   Arise as a result of holding net monetary
   assets or liabilities during a period when the
   price level changes
   Monetary assets and liabilities include
   cash itself and other assets and liabilities
   that are receivable or payable in a fixed
   number of dollars
Purchasing Power Gains & Losses

     State of the
                        Inflation   Deflation

   Net Monetary        Purchasing   Purchasing
   Asset Position      Power Loss   Power Gain

   Net Monetary        Purchasing   Purchasing
  Liability Position   Power Gain   Power Loss
Holding Gains & Losses
   Holding gains and losses on real (nonmonetary)
   assets can be divided into two parts
     monetary holding gains and losses, which arise purely
     because of the change in the general price level during
     the period; and
     real holding gains and losses, which are the difference
     between general price-level-adjusted amounts and
     current values.
   Are capital adjustments only; they are not a
   component of income
The Gearing Adjustment
   Somewhat related to the holding gain
   Was used in Great Britain as part of that
   country’s inflation accounting mechanism
   Results in gains to equity capital during
   inflation because debt capital does not have
   any claim on holding gains
   proved to be an extremely confusing
Income Measurement Systems
   Current Value Approaches
     Distributable Income (DI)
     Realized Income (RI)
     Earning Power Income (EPI)
   Methods differ in terms of disposition of
   real holding gains and the resulting type of
   capital maintenance measure
SFAS No. 33
   FASB decided to keep nominal historical costs as
   the basis of primary financial statements
   Specified that the effects of changing prices
   should be presented as supplementary information
   in annual reports
   FASB realized that a consensus could not be
   obtained on which method of accounting should
   be adopted
SFAS No. 33
   Not all enterprises had to comply with
   SFAS No. 33
   For constant dollar reporting, the SFAS
   required disclosure of
     Information on income from continuing
     operations for the current fiscal year on a
     historical cost/constant dollar basis . . .
     The purchasing power gain or loss on net
     monetary items for the current fiscal year. .
SFAS No. 33’s Failure
   There was a dramatic
   decline of inflation
   during the early 1980s
   problems were present
   Questions of
   understandability and
   usefulness for
   predictive purposes
SFAS No. 82 issued in 1984
   Eliminated the constant dollar income
   disclosures that had previously been
   required by SFAS No. 33
   SFAS No. 33
     information confused users
     may have caused “information overload”
     because of the presence of similar current cost
     income disclosures
SFAS No. 89
   Two parts of SFAS No. 33 remained in
   effect; were “encouraged” but not required
     current cost income measurement, purchasing
     power gain or loss, and
     holding gain information
   FASB beat a hasty retreat from the problem
   of accounting for changing prices
Chapter 13:
Accounting for Inflation & Changing Prices
    Price indexes
    Inflation accounting
    Income measurement
    SFAS No. 33

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