Key Takeaways:
- Understand the distinction between Current Purchasing Power (CPP) and Current Cost Accounting (CCA).
- Learn how inflation affects financial statements and which method uses the general price index for adjustments.
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During periods of inflation, historical cost accounting falls short because it ignores the changing value of money. That's where Inflation Accounting emerges, offering tools to adjust financial statements so they reflect current economic realities.
Current Purchasing Power (CPP) Method
a. Concept of CPP
The CPP method adjusts historical financial data to account for changes in the general purchasing power of money. It relies on a general price index like the Consumer Price Index (CPI)—to restate figures so they're expressed in current purchasing power terms. This method doesn't revalue assets individually; instead, it adjusts the entire set of accounts using a uniform index.
b. Formula for CPP Adjustments
The standard formula for adjusting an item under CPP is:
Adjusted Value = Historical Value × (Current Price Index / Historical Price Index)
Here, the historical value is the amount originally recorded, the current price index reflects today's purchasing power, and the historical price index represents the purchasing power at the time of the original transaction.
c. Example
Suppose a company purchased machinery for Rs. 1,00,000 in 2020, when the general price index was 120. If the index in 2025 is 180, the adjusted value becomes:
Adjusted Value = Rs. 1,00,000 × (180 / 120) = Rs. 1,50,000
This stepwise calculation shows how CPP translates historical cost into current purchasing power, enabling more meaningful analysis during inflationary periods.
Current Cost Accounting (CCA) Method
Revaluation of Assets and Adjustment Accounts
CCA focuses on updating the value of individual assets and liabilities to their current replacement cost, rather than applying a uniform index across all accounts. Each asset is revalued at its present cost—what it would cost to acquire it today. This method involves creating 'adjustment accounts' to record the difference between historical and current cost, impacting depreciation calculations and the overall profit figure.
For example, if the replacement cost of machinery is now Rs. 1,40,000 (versus the original Rs. 1,00,000), the asset is revalued, and depreciation is recalculated on the new amount. CCA therefore provides a more asset-specific reflection of inflation's impact, but demands detailed revaluation processes.
Comparison: CPP vs CCA
| Aspect | CPP (Current Purchasing Power) | CCA (Current Cost Accounting) |
|---|---|---|
| Principle | Adjusts all accounts using general price index | Revalues assets/liabilities at current replacement cost |
| Basis | General price level changes | Specific asset value changes |
| Complexity | Relatively simple, uniform adjustments | Requires detailed asset-by-asset revaluation |
| Depreciation Calculation | On adjusted historical cost | On current replacement cost |
| Preferred Use | When broad inflation adjustment is needed | When real asset values must be reflected |
| Exam Point | Uses general price index for adjustment | Does not use general price index, relies on current asset values |
CPP Adjustments – Example
- Historical cost of inventory: Rs. 50,000 (Index at purchase: 100).
- Current price index: 150.
- Apply formula: Rs. 50,000 × (150 / 100) = Rs. 75,000.
This adjustment means the inventory, when restated for inflation, should be reflected as Rs. 75,000—not Rs. 50,000—on the financial statements.
Which method adjusts accounts using the general price index? The answer is clearly CPP. CCA does not use the general price index instead, it recalculates values based on the current cost of each item.
If a company wants to evaluate the overall purchasing power loss due to inflation, which method offers a direct solution? CPP, because it uses the general price index, allowing for broad, systematic adjustment. But if management wants to know how much it would cost to replace each asset today, CCA steps in with a more granular approach.
Just focus on how each method is applied, the rationale for choosing one over the other, and the impact these adjustments have on reported profits and asset values. The distinction between CPP and CCA is frequently tested, so practice applying the formulas and interpreting results. And remember, clarity of approach often wins marks, so always state your method and show your workings.