Hyperinflation, Constant Purchasing Power & Current Cost Accounting

Overview

• Historical-cost information can be misleading during periods of high inflation because figures are expressed in pesos of different purchasing power.

• Two principal alternatives seek to remedy this:

• Constant Purchasing Power (CPP) accounting – also called price-level, purchasing-power, or constant-peso accounting.

• Current Cost Accounting (CCA) – also called current-value or replacement-cost accounting.

• International guidance comes mainly from PAS 29 – Financial Reporting in Hyper-inflationary Economies.

Constant Purchasing Power (CPP) Accounting & PAS 29

• Objective: Restate all amounts so they are expressed in $\text{end-of-period pesos}$ (i.e. pesos of the same purchasing power).

• Applies whether the original books were kept on historical-cost or current-cost bases.

• PAS 29 para 8: Restated statements replace conventional statements; unaudited, unrestated schedules are not permitted.

• Restatement uses a general price index (GPI). The adjustment factor is

$CPP\ \text{factor}=\frac{\text{Index at reporting date}}{\text{Index at date of initial recognition}}$

• Other names: constant-peso, purchasing-power, price-level accounting.

When is an economy hyper-inflationary?

• No absolute rule, but PAS 29 lists indicators:

• Population prefers non-monetary assets or a stable foreign currency.

• Prices, wages, and credit terms quoted or indexed in a foreign currency.

• Credit sales & purchases incorporate expected inflation even for short periods.

• Interest rates, salaries, and prices are formally linked to a price index.

• Cumulative three-year inflation $\approx$ or > $100\%$.

Key Terminology – Monetary vs Non-Monetary Items

• Monetary item = a right/obligation fixed or determinable in units of currency (e.g., cash, A/R, A/P, pensions, bonds payable, cash dividends declared).

• Non-monetary item = no such fixed peso claim; value fluctuates with prices (e.g., inventory, PPE, intangibles, prepaid rent).

• Equity is neither monetary nor non-monetary – it is the residual interest.

• Textbook classification exercise highlighted 47 common items and how to classify each.

CPP Restatement Procedures

1. Select general price index covering the life of every item.

2. Classify SFP items into monetary & non-monetary.

3. Monetary items – not restated (already in current pesos).

4. Non-monetary items – restate from date of acquisition (or last revaluation) to reporting date using the CPP factor.

   • Exceptions: Items already at current value (NRV, fair value) are not restated again.

5. Statement of profit or loss items – restate from date of recognition; practical shortcut: use average index for evenly incurred items.

6. Compute purchasing-power gain or loss on net monetary position and present in profit or loss.

7. Test restated non-monetary amounts for recoverability (impairment, NRV, etc.).

8. Eliminate any prior revaluation surplus.

9. Retained earnings becomes the balancing figure in the restated SFP.

10. Comparative figures: restate prior-year monetary items to the current year-end index.

Formula – Purchasing-Power Gain/Loss (Net Monetary Position)

Restated opening net monetary assets plus/minus indexed movements reconcile to closing restated amount; the difference vs. nominal closing net monetary assets equals the gain/loss:

$\begin{aligned}<br>\text{Loss (gain)} &amp;= [\text{Restated NMA}<em>{\text{end}}]\; -\; [\text{Nominal NMA}</em>{\text{end}}]<br>\&amp; = \Big(\frac{\text{GPI}<em>{\text{end}}}{\text{GPI}</em>{\text{beg}}}\times \text{NMA}<em>{\text{beg}}\Big) +\sum \text{Inflows}\, -\sum \text{Outflows}\, -\; \text{Nominal NMA}</em>{\text{end}}<br>\end{aligned}$

Behaviour:

• Inflation $\Rightarrow$ net monetary assets suffer a loss; net monetary liabilities enjoy a gain.

• Deflation produces the opposite.

Advantages & Disadvantages of CPP

Advantages

• Simple, objective – relies on published CPI.

• Adjusts for the unit-of-measure problem – true inflation accounting.

• Focuses on shareholders’ real purchasing power.

Disadvantages

• Ignores specific-price (relative-price) changes; only general inflation captured.

• Produces unfamiliar numbers; users must learn a new scale.

• Assets/liabilities not shown at their value to the business; physical capital not maintained.

• A single CPI may be inappropriate for diverse assets/sectors.

Current Cost Accounting (CCA)

• Measures assets & cost of sales at their current replacement cost (value to the business or deprival value).

• Monetary assets & liabilities not re-measured.

• Key concept – holding gain/loss:

• \text{Current cost} > \text{Historical cost}\;\Rightarrow holding gain

• \text{Current cost} < \text{Historical cost}\;\Rightarrow holding loss

• Classification:

• Unrealized – asset still held.

• Realized – asset sold or consumed.

• Variants exist, but common principles:

• Inventory & PPE appear at deprival/current cost in SFP.

• SOPL charges are based on current values (replacement-cost depreciation & cost of sales).

Deprival Value Logic

• For a productive asset the entity would be ‘deprived’ either by having to pay replacement cost or by losing the recoverable amount. Therefore:

$\text{Deprival value}=\min\big(\text{replacement cost},\;\max(\text{value in use},\text{net realizable value})\big)$

Preparing CCA Financial Statements

Statement of Comprehensive Income

• Sales – not restated (already at current prices when transacted).

• Cost of sales – units sold $\times$ average current cost at sale date.

• Operating expenses – usually already at current costs.

• Depreciation – based on average current cost of PPE for the year.

• Income tax computed on historical-cost income but disclosed alongside.

• Realized holding gain/loss disclosed (current cost – historical cost of assets sold/used).

Statement of Financial Position

• Cash & receivables, payables – unchanged.

• Inventory – current replacement cost at year-end.

• PPE – land at current cost; depreciable PPE at current cost less current-cost accumulated depreciation.

• Equity accounts: share capital & premium at nominal pesos; retained earnings derived from CCA SOPL.

$\begin{aligned}<br>\text{Retained earnings}<em>{\text{end}} &amp;= \text{Retained earnings}</em>{\text{beg}} &amp;+ \text{CCA net income} - \text{dividends}<br>\end{aligned}$

Advantages & Disadvantages of CCA

Advantages

• Relevance – reflects the resources the entity must sacrifice to replace assets; aids decision-making.

• Maintains physical operating capability (capital maintenance in real terms).

• Shows value to the business; users gain insight into current condition & performance.

Disadvantages

• More subjective – replacement cost and deprival value need estimation.

• Complexity; lack of preparer & user familiarity.

• Only non-monetary assets adjusted; monetary items still suffer purchasing-power effects.

Worked Examples & Examination-Type Questions (Highlights)

• Retained-earnings balancing figure approach illustrated (property bought in 20$\times$18, index movement 150$\to$300 produced PPE restated to $1{,}800{,}000$ etc.).

• Illustration of inventory restatement: Jan-1 inventory $1{,}650{,}000$ (index 120) restated to $4{,}200{,}000$ at year-end index 280.

• Purchasing-power loss example: Opening net monetary assets $2{,}000{,}000$; index 125$\to$300 $\Rightarrow$ loss $2{,}800{,}000$.

• Current-cost depreciation: Equipment historical $5\text{ M}$, replacement $7.5\text{ M}$, SL 5 yrs $\Rightarrow$ CCA depreciation $\frac{7.5}{5}=1.5\text{ M}$.

• Holding gains on land: Current cost rises from $5\text{ M}$ to $5.5\text{ M}$ in 20$\times$20 $\Rightarrow$ unrealized gain $0.5\text{ M}$; sale in 20$\times$21 at $6.5\text{ M}$ vs current cost $5.9\text{ M}$ $\Rightarrow$ realized holding gain $0.6\text{ M}$; total gain on sale vs historical cost $1.5\text{ M}$.

• CCA inventory example: Ending inventory 15k units $\times$ $\text{P}72 = 1{,}080{,}000$; Unrealized gain $1{,}080{,}000-945{,}000 = 135{,}000$; CCA COGS uses average cost $\approx \frac{72+58}{2}$.

Conceptual Connections & Real-World Relevance

• CPP aligns with financial capital maintenance (shareholder purchasing power preserved).

• CCA aligns with physical capital maintenance (operating capability preserved).

• IASB Framework acknowledges that in many jurisdictions general-purpose financial statements are still prepared on historical cost but may include supplementary current-value information.

• High-inflation contexts (e.g., Venezuela, Zimbabwe, Argentina) require PAS 29 compliance – vital for comparability and to prevent over-stated profits leading to illusory dividends.

• Analysts must understand CPP and CCA to interpret local GAAP numbers and reconcile to IFRS-compliant results.

• Ethical aspect: Distributing profits measured in eroded pesos may in fact return capital to shareholders, undermining long-term solvency.

Quick Reference – Formulas & Indices

• CPP restatement: $\text{Restated amount}=\text{Historical amount}\times\frac{\text{GPI}<em>{\text{end}}}{\text{GPI}</em>{\text{origin}}}$

• CPP purchasing-power gain/loss – see detailed equation above.

• CCA depreciation (straight-line): $\text{Depreciation}=\frac{\text{Avg current cost}}{\text{Useful life}}$

• CCA cost of sales: $\text{Units sold}\times\text{Avg current cost during period}$

• Holding gain/loss: $\text{Current cost} - \text{Historical cost (carrying amount)}$ (sign indicates gain vs loss).

Study Tips

• Memorise CPP vs CCA differences – scope (all items vs only non-monetary), basis of index vs replacement cost, treatment of gains.

• Practise classifying balance-sheet items quickly; exam MCQs often test this.

• Redraw a ‘T-account’ for net monetary assets to identify purchasing-power gains/losses.

• For long computations, set out a clear table: Item | Historical $ | GPI orig | GPI end | Restated $.

• In hyper-inflation questions, watch dates carefully – asset acquired mid-year means use that date’s index, not Jan-1.

• When both CPP and CCA appear, remember: CPP deals with the money unit; CCA with the specific asset’s value.

Final Cheat-Sheet

• Hyper-inflation benchmark: 3-yr cumulative $\approx$ $100\%$.

• CPP factor = end index $\div$ origin index.

• Monetary items – no restatement; produce purchasing-power gain/loss.

• Non-monetary items – restate unless already at current value.

• CCA relies on deprival (replacement) values, not price indices.

• Holding gain “realized” only on sale/consumption of asset.

• CPP maintains financial capital; CCA maintains physical capital.