Chapter 11

Chapter 11International Accounting for Price ChangesInternational Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackInflationInflation has had a devastating effect on many countriesBrazil 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 inflationBP uses replacement costs More companies will likely follow BPs lead

2Footnote needed for second point on BP?International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackAssets become devaluedLiabilities become less expensive to pay offInterest rates on loans increase with inflationIncome can be overstated as old costs are matched with new revenuesShareholders could demand more dividends and employees could demand higher wages

Impact of Inflation on the CorporationInternational Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackAccounting Measurement AlternativesGeneral purchasing power accountingIncludes all systems designed to maintain the purchasing power of capital or equityAccounts for changes in the level of pricesConcerned with the value of moneyOther 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, BlackAccounting Measurement AlternativesCurrent value accountingIncludes all systems designed to account for current values or changes in specific pricesConcerned with the cost of specific assetsTypes of accounting include Current cost accountingReplacement 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, BlackGeneral Purchasing Power AccountingThe 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 powerPrevious years accounts are also updated to provide comparability

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackGeneral Purchasing Power AccountingExample General price level increased by 15% during the yearA machine purchased on January 1 cost $10,000End-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, BlackCurrent Value AccountingIncome is not earned until the company has maintained its capital in current value termsCurrent cost (replacement cost) methodShould the same asset or one performing a similar function with new technology be used?Current exit price methodValues assets at what they could be sold for, less cost to complete and sell the itemsGoing-concern concept asset is valued at estimated sales price on normal completion of productionInternational Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackCurrent Value AccountingResults in holding gains and losses that areRecognized on the income statementReflected on the balance sheet as a capital adjustment accountCurrent values are determined bySuppliers lists (inventory)Construction cost indices (PP&E)Appraisal values (fixed assets)

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackCurrent Value AccountingExample

Sales = $1,000,000Current COGS = $900,000Historical 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 increaseRealized holding gain = $900,000 - $700,000 = $200,000International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackReal Value AccountingExample

Value of asset Beginning = $150,000Current value at year end = $190,000GPP value at year end = $165,000

Total holding gain $190,000 - $150,000 = $40,000Real 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, BlackInternational Financial Reporting StandardsIAS 6 (1977)A brief narrowing of options available to deal with inflationIAS 15, Information Reflecting the Effects of Changing PricesRecognized the two major methods (GPP or current cost), but did not champion one or the otherRequired information on the effects of price changes if the historical cost method is usedInternational Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackInternational Financial Reporting StandardsIAS 15 suggestions for price change infoThe amount of the adjustment to or adjusted amount of depreciation of PP&EThe amount of the adjustment to or the adjusted amount of cost of salesThe 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 inventoriesMethods adopted to compute information used in the preceding items and any indices usedIAS 15 was withdrawn in 2003International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackInternational Financial Reporting StandardsIAS 29 (1989)Focuses on hyperinflationary economies100% inflation over 3 yearsRequires restatements for GPP changes regardless of previous treatmentIAS 16 (revised in 1998)Current value approach is permitted for PP&EFair value is usedRegular revaluations are required

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeU.K.SSAP 16, requiring current cost accounting, was issued and withdrawn due to lower inflationOnly a few companies now provide current cost disclosuresSome companies revalue their PP&E at market values

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeU.S.Accounting Series Release 190 required disclosure of replacement cost infoSFAS 33 required disclosure on both GPP and a current cost basisSFAS 33 made an array of information available

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeAustralia, Canada, and New ZealandDevelopments are more tentative than in U.S.Similar to U.S. current cost systemContinental EuropeMuch less enthusiasm for inflation accountingNo professional standards on the subjectInternational Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeBrazilInflation accounting used as early as the 1950sCompany law in 1976 required indexation approach to restate historical costs in terms of current purchasing power With reduced inflation levels, requirement was withdrawn in 1996ArgentinaInflation accounting introduced was the accounting profession1972 GPP financial statements were recommendedRecommendation withdrawn in 1995 due to low inflation

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeCurrent Value Accounting in HollandSome firms use current cost methodSome use partial current cost statements or historical cost statements with supplementary disclosures

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticeTheodore Limperg father of replacement value Focused on the relationship between economics and accountingBelieved that income is a function of revenue and replacement value instead of historical costsBelieved that current value info should be used by all decision makers

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticePhilipsFirst used current value techniques in 1936Used current value approach in 1952 for financial reporting purposesDepartments of the company determined current values of inventory, equipment, and fixed assetsThe effect of current value changes showed in cost of goods sold and depreciation expense

International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackComparative National Regulation and PracticePhilipsBrink (1992) showed that Philips used replacement value techniques to enhance profitsThe company used inventory value reductions and the gearing adjustment in hyperinflationary countriesRecorded a loss of 4.24 billion guilders in 1990, which led to the demise of the replacement value system in 1992International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackProblems and ProspectsInflationary accounting is likely to remain a hot topic for the foreseeable futureSome South American countries in hyperinflation use GPP accountingSome European companies still make voluntary current value disclosuresNo current cost accounting regulations exist in the U.K. or the U.S.International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackProblems and ProspectsControversy remains over The gearing adjustmentTreatment of gains and losses on monetary itemsThe use of indices with respect to foreign subsVerification of current costs in industries with rapid technological change

24International Accounting & Multinational Enterprises Chapter 11 Radebaugh, Gray, BlackProblems and ProspectsFuture experimentation with price change accounting systems is hoped forThe usefulness of exit prices and cash flows may be better appreciated in the future

25Do I need a citation on the first bullet?