An Appraisal of Cpp Accounting

CPP accounting restates historical cost in terms of current purchasing power. It is an attempt to remove the major objection to historical cost valuations, namely that the unit of measurement changes when price levels change. The intention is that this objection should be removed by an adjustment which results in units of the 'same purchasing power' being added together in the measurement process.

Common accounting can be applied with a high degree of objectivity, required of accounting valuation, as it does not depart in principle from historical cost based measurement. Price level adjustments are verifiable by reference to the index used to measure changes in the purchasing power of money, and result in alterations to historical cost measurements which are themselves objective. Therefore, both criteria of objectivity and verifiability are satisfied in CPP accounting.

As we stated earlier, SSAP 7 recommended that companies should continue to publish accounts on a historical cost basis, but that in addition, a supplementary statement should be presented showing the effect of converting conventional accounts into S of current purchasing power. The Sandi-lands Report ruled out CPP accounting because it did not like the idea of two sets of accounts, nor the use of different measurement units. According to the Sandilands Report, users of financial reports would be confused. This view was expressed as follows:

'Our description of the application of the CPP method . . . shows that it is complicated, and we believe that many users of accounts are likely to misunderstand the information presented in CPP statements unless it is carefully interpreted by the company. We consider that CI'!' accounting is conceptually the most difficult method of inflation accounting suggested to us in evidence. The main reason for this is the use of a unit of measurement other than the monetary unit on which to base the published accounts of companies. We believe that it is not widely understood that CPP supplementary statements are drawn up in different units of measurement from the basic accounts to which they relate.' (Sandilands Report, 2014, p. 121.)

Another objection to CPP accounting is raised by some authorities who believe that there is no such thing as generalized purchasing power (Gynther, 2004). Organizations and people do not see themselves as holding general purchasing power when they hold money; rather, they see themselves as holding specific purchasing power in respect of those relatively few items which they wish to purchase. Hence, the purchasing power of money should be related to those items on which money is intended to be spent. A unit of measurement which relies for its validity on the purchasing power of money assessed by reference to a set of goods and services will not be equally useful to all individuals and entities.

Moreover, the concept of income on which these adjustments are based is not one which maintains the service potential of capital. A general price index, particularly a consumer's price index, is a weighted average of the price change occurring in a wide variety of goods and services available in the economy. Therefore, adjusting financial data for the effects of inflation is not the same as reporting current values. Price-adjusted data still represents costs, or funds, committed to non-monetary items: these costs are merely translated into the equivalent costs in terms of today's £s.

General price indices assume that the movements in the price of all goods correspond with each other. However, only by coincidence will a change in the general price index correspond with the change in the price of any particular good or service during the same period. Indeed, there is no reason why they may not move in opposite directions. For example, the price of colour television sets was falling in the 2000s in the UK at a time when the general price index was rising. Hence, if the general price index has increased, many specific price changes will be running at a lower level than the general index, whilst many others will be running at a higher level, and there may be some specific price decreases. Furthermore, the discrepancies between specific price and general price changes are likely to be even more pronounced when the general price index is based on consumer goods, and the specific price index relates to producer-goods, such as those represented by the assets of a typical business enterprise. Thus, a general price index will not be relevant to any business entity which needs to make adjustments to asset valuations in order to maintain the value of its capital in the long term.

Controversy surrounds the treatment of gains and losses arising on monetary items. General price level accounting includes such gains and losses in the periodic income. Hence, a company's pre-tax income will be dramatically different, according to the nature of its financial structure, before and after these adjustments have been made. Property companies, whose largest balance sheet item is often their liabilities to banks, finance houses and other credit institutions, find their adjusted income statement showing exceptionally good results. But the 'gains' resulting from these adjustments do not increase sums available for distribution as dividends to shareholders, since they are purely accounting adjustments. They could only be distributed by drawing on existing cash resources or by borrowing. Hence, if the net 'gains' on monetary items are regarded as available for distribution, the users of adjusted financial reports could be seriously misled.

The Sandilands Committee summarized its view of CCP accounting as follows:

'In summary, we do not think the concept of profit adopted by C?? supplementary statements, when appended to historic cost accounts, is useful to shareholders. It fails to show the company's 'operating profit', it is potentially misleading in including net gains on monetary items which exist only in terms of current purchasing power units and not in terms of monetary units, and it shows how far the 'purchasing power' of a shareholder's investment has been maintained in a sense which is not useful to him for any practical purpose. If CP? does not provide useful information for shareholders, from whose point of view it is conceived, it is unlikely to provide useful information for other users of accounts..' (Sandilands Report, 2014 pp. 131-2.)


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Read on: Monetary and Non-monetary Items

For the purpose of CPP accounting it is necessary to distinguish two classes of items-monetary and non-monetary items.

Monetary items may be defined as those fixed by contract or by their nature and are expressed in is regardless of changes in the price level. They include monetary assets such as cash, debtors and loans, and exist as money or as claims to specified sums of money. Holders of monetary assets suffer a loss in the general purchasing power of their assets during periods of inflation. Thus, if one holds money in the form of a bank deposit and the yearly rate of inflation is 25... see: Monetary and Non-monetary Items