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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 original 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
Adjustment of Cost of sales and inventory: - LIFO
FIFO

-B/R

- Stock.

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 companys
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 original 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.

Replacement costs could be used as a possible alternative to historical cost method. In crude terms replacement costs may be
defined as the estimated amount that would have to be paid in order to replace the asset as the date of valuation. An advantage of
replacement cost is that it focuses on the services the asset will provide rather than the precise physical asset.
However, there is an immediate flaw noted in its definition, where the costs have to be estimated. Estimation has to be carried out
after reviewing the asset, the market and if an identical asset is still being traded in the market. While there are problems in simply
achieving a precise replacement cost, this method also does not provide the various choices and features that historical cost
accounting has to offer.
More accounting systems such as current cost accounting, exit price method, etc. are possible alternatives to historical cost
accounting but these are also subject to manipulation to set a norm for measuring corporate performance. How is historical
accounting better than alternatives?
Quite clearly the several limitations and flaws of the traditional historical costs method have been highlighted and picked upon
from time to time. Still historical costs are the standard form of accounting due to its unique features and conventions that make it
better than most available alternatives.
One of the main resources why historic accounting even though flawed forms the basis of our traditional accounting model is
because accountants are reluctant to price the assets at current market value. Over the years number of cases relating to accounting
malpractice and creative accounting have been exposed that have made accounting bodies reluctant from using current values
which directly affect the share prices.
Accountants have to guard the integrity of their data against internal modifications. The use of current cost or exit price opens the
door to manipulation of these numbers. The alternative measures for measuring and reporting assets provide management with
considerable discretion and opportunities to influence the value of assets reported. Critics admit that the possibility of manipulation
exits, but the profession can formulate rules on how current values are to be ascertained. Under historical cost accounting there is
no room for manipulation and the data is supported by evidence such as invoices, receipts, etc. Any other basis for recording
transactions would be subjective, i.e. the amount in which the transaction will be recorded would be dependant on individual point
of view and is bound to differ with different people.
The historical cost system provides managers with a significant range of alternatives in recognising, reporting and measuring
economic information. One of the advantages of using historical costs it helps the managers to forecast future operational costs
based on past data. The basic function of historical accounting is to tell a user "the cost of a thing". Without knowing the original
costs future projections are almost hampered.
Historical costs play an important role here providing this necessary information. Historical cost is based on recording actual
transactions. Not only is there a record of actual transactions, but also the figures are reliable.

For current cost or exit price accounting, changes in prices are recorded but these are not based on actual transactions.
Financial statements based on historical cost have been found to be useful. Empirical evidence indicates that people find the
conventional statements useful. No other method of accounting can provide exact information at a glance on the change in trends in
the company's working like the historical costs method.

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