Overview
Current Purchasing Power (CPP) Accounting, also known as Constant Purchasing Power Accounting, is a form of accounting that measures profit by adjusting for changes in the general price level. This method ensures that the shareholders’ capital maintains the same monetary purchasing power over time, despite inflation or deflation. An accepted price index is used to make the necessary adjustments in the financial statements.
Key Features
- Inflation Adjustment: CPP accounting uses a general price index to adjust the financial statements for inflation, maintaining the purchasing power of capital.
- Focus on Shareholders’ Capital: The method prioritizes maintaining the purchasing power of shareholders’ capital but does not necessarily consider loan creditors’ capital.
- International Standards: The approach is in alignment with International Accounting Standard 29, which deals with financial reporting in hyperinflationary economies.
Historical Context
In the UK, CPP accounting was addressed by the provisional Statement of Standard Accounting Practice (SSAP) 7, issued in May 1974 and withdrawn in October 1978. The method was later endorsed internationally by IAS 29, using the term Capital Maintenance in Units of Constant Purchasing Power (CMUCPP).
Examples
Example 1: Adjusted Financial Statement
Consider a company’s equity of $100,000 at the beginning of the year, with an inflation rate of 10%. By the end of the year, to maintain the purchasing power of the shareholders’ capital:
\[ \text{Adjusted Equity} = \text{$100,000} \times (1 + 10%) = $110,000\]
Example 2: Maintaining Purchasing Power
If a company earns a profit of $50,000 during a year with a 10% inflation rate, the adjusted profit would be:
\[ \text{Adjusted Profit} = \text{$50,000} \times (1 + 10%) = $55,000\]
This ensures the company’s reported profit reflects the true economic value under adjusted price levels.
Frequently Asked Questions
What is the primary objective of CPP accounting?
The primary objective is to maintain the purchasing power of shareholders’ capital, ensuring that financial statements accurately reflect the real value of investments after adjusting for inflation or deflation.
How is an appropriate general price index chosen?
An appropriate general price index, such as the Consumer Price Index (CPI) or Producer Price Index (PPI), should fairly represent the general price level changes in the economy.
Why doesn’t CPP accounting address the purchasing power of creditors’ capital?
CPP accounting prioritizes shareholders’ capital, as the method is designed to preserve the true value of shareholders’ equity. The interest and principal repayments generally already protect creditors against the impacts of inflation.
How does IAS 29 relate to CPP accounting?
IAS 29 provides guidelines for financial reporting in hyperinflationary economies. It endorses the use of capital maintenance in units of constant purchasing power, which is effectively the same as CPP accounting.
Related Terms
- Capital Maintenance in Units of Constant Purchasing Power (CMUCPP): Adjusting capital to maintain its purchasing power during inflation or deflation periods, as advocated by IAS 29.
- Hyperinflation: Extremely high and typically accelerating inflation, which drastically erodes the purchasing power of currency.
- International Accounting Standard 29 (IAS 29): Guidelines provided by the International Accounting Standards Board for financial reporting in hyperinflationary economies.
- Gross National Product (GNP): The total market value of all finished goods and services produced by a country’s residents.
Online Resources
- International Accounting Standards Board (IASB)
- Investopedia
- Financial Accounting Standards Board (FASB)
- CPA Canada
Suggested Books for Further Studies
- “International Financial Reporting Standards (IFRS) Guidebook: 2021 Edition” by Steven M. Bragg
- “Financial Accounting: An Introduction” by Pauline Weetman
- “Understanding Business Valuation: A Practical Guide to Valuing Small to Medium-Sized Businesses” by Gary R. Trugman
- “The Interpretation of Financial Statements” by Benjamin Graham and Spencer B. Meredith
Accounting Basics: “Current Purchasing Power Accounting” Fundamentals Quiz
Thank you for exploring this critical accounting concept and testing your understanding with our quiz. Continue advancing your financial knowledge and mastery!
