Changing price levels - financial reporting

what are the 3 capital maintenance concepts?

• nominal financial capital

• real financial capital

• operating capital

what do capital maintenance concepts do?

Capital maintenance concepts seek to measure profit by ensuring that the resulting period end capital is at least as much as the opening

what is nominal financial capital?

• is the nominal monetary units of invested capital

• underpins HC accounting

• use HC as measurement unit

• ignores inflation and change to purchasing power

what is real financial capital maintenance?

• concerned with general purchasing power of shareholder interest

• use general retail price index to measure GPP

• uses constant purchasing power accounting

• use inflation adjusted historical cost as measurement unit

what is physical capital maintenance?

• concerned with maintaining the operating capacity of an entity

• uses specific price index to represent operating capacity

• uses current cost accounting

• use replacement cost as measurement unit

what gets restated?

• non monetary items

• share capital

• retained earnings = balancing figure

how do you restate non-monetary items?

HC x RPI @ YE/ RPI @ origin date

what gets included in a statement of P&L when it is restated?

gains/losses on net monetary position

what are the strengths of Current purchasing power accounting?

• CPP is objective as it is transaction based and hence easily verifiable

• its measurement unit RPI

• takes shareholder purchasing power into consideration and hence prevents dividend payments out of real capital

• recognises that inflation induces loss of holding monetary assets and accounts of such items before profit

what are the advantages of RPI being the measurement unit of CPP?

• RPI is well understood by the majority of the public

• RPI facilitates time-series comparisons of accounts since they are of the same measurement basis

what are the disadvantages of Current purchasing power accounting?

• since it is based on HCA, some of the defects associated with HCA are still applicable to CPP

• the general rate of inflation may not coincide with the inflation rate of specific assets so doesn’t reflect current value of asset

• CPP maintains the purchasing power of the shareholders, however it does not necessarily maintain the operating capacity of the business in physical terms