Choi/Meek, 6/e
6
Deducting expenses based on historical purchasing power from revenues that expressed in currency of current purchasing power yields a nonsensical index of performance.
Learning Objectives
What do we mean by the term, changing prices?
Why are financial statements misleading during periods of changing prices?
What are the various ways of adjusting financial statements for changing prices?
General price level change: refers to a movement in the prices of all goods and services in an economy on average.
Positive price movement is termed inflation. A negative price movement is called deflation.
Expenses, such as depreciation and amortization, may be based on currency of higher general purchasing power because their related assets were typically acquired in the past when GPLs were lower.
The reciprocal of the GPL is a measure of the general purchasing power of the monetary unit.
Choi/Meek, 6/e
4
Specific price change: refers to the movement in the price of a specific asset; e.g., a change in the price of inventory, plant, or equipment.
What is the restate-translate controversy all about?
Is it possible to double-count for the effects of foreign inflation?
Choi/Meek, 6/e
2
What Does “Changing Prices” Mean and How are Price Changes Measured?
Higher taxes
Higher dividends
Higher wages
Choi/Meek, 6/e
8
From a managerial perspective, accounting numbers unadjusted for changing prices distort: Financial projections Budget comparisons Performance data
Specific price changes are measured by a specific price index (SPL).
SPL is a cost ratio that compares the cost of a specific item with its cost in a prior or base period.
Choi/Meek, 6/e
7
Why are Financial Statements Potentially Misleading During Periods of Changing Prices? (contin)
Байду номын сангаас
During a period of specific price changes, assets recorded at their original acquisition costs seldom reflect the assets’ current (higher) value resulting in an overstatement in reported income. This, in turn, may lead to:
Choi/Meek, 6/e
1
Do adjustments for changing prices vary internationally?
What does IAS 21 have to say about inflation adjustments in hyperinflationary countries?
Choi/Meek, 6/e
3
General price level changes are measured by use of a general price level index (GPL).
GPL is a cost ratio that compares the cost of a basket of goods in the current period with the cost of that same basket in a prior or base period.
Choi/Meek, 6/e
5
Why are Financial Statement Potentially Misleading During Periods of Changing Prices?
During periods of inflation, revenues are based on the general purchasing power of the current period.