Chapter 13 Accounting for Inflation amp; Changing Prices.ppt

Chapter 13: Accounting for Inflation Changing Prices Inflation Price indexes Inflation accounting Income measurement systems SFAS No. 33 Inflation The rise in the average price level for all goods and services produced in an economy Under a historical cost-based system of accounting inflation leads to two basic problems Many historical numbers are not economically relevant Historical numbers are not additive Inflation and Historical Costing Likely predictive value is diminished Comparability among financial statements of different firms is restricted Capital maintenance Income usually overstated relative to amounts that can be distributed to stockholders Many dividends are really liquidating in nature Price Indexes Is a weighted average of the current prices of goods and services Averages are related to prices in a base period Purpose is to determine how much change has occurred Types of price indexes Specific price index General price index Price Indexes Paasche-type indexes Uses current-year quantities Wholesale Price Index Consumer price Index Laspeyres-type indexes Uses base-year quantities Less costly to construct Inflation Accounting General purchasing power adjustment translates historical dollars into dollars having equivalent purchasing power Current valuation, also called current cost, attempts to derive the specific value or worth for a particular point ... Entry values Exit values Entry vs. Exit Values Entry values Value in use is best represented by replacement costs Strong argument in support of use Exit values Are a form of opportunity costs The balance sheet becomes the principal financial statement Purchasing Power Gains Losses Arise as a result of holding net monetary assets or liabilities during a period when the price level changes Monetary assets and liabilities include cash itself and other assets and liabilities that are receivable or payable in a fixed number of dollars Purchasing Power Gains Losses Holding Gains Losses Holding g