1. International Accounting for Price Changes
Chapter 11
International Accounting for Price Changes

2. 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
Footnote needed for second point on BP?
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black

3. Impact of Inflation on the Corporation
Assets become devalued
Liabilities become less expensive to pay off
Interest rates on loans increase with inflation
Income can be overstated as old costs are matched with new revenues
Shareholders could demand more dividends and employees could demand higher wages
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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
Do I need a citation on the first bullet?
International Accounting & Multinational Enterprises – Chapter 11 – Radebaugh, Gray, Black