Page 29 - DCOM409_CONTEMPORARY_ACCOUNTING

Contemporary Accounting

Notes CIMA Terminology defines current purchasing power accounting as follows:
“Inflation accounting is a method of accounting for inflation in which the values of the non-
monetary items in the historical cost accounts are adjusted using a general price index to show
the change in the general purchasing power of money. The current purchasing power balance
sheet shows the effect of financial capital maintenance”.

The following steps are followed in order to convert the historical cost based financial statements
into the financial statements based on current costs using the current purchasing power method.

Calculation of Conversion Factor and Mid-Point Conversion Factor
Calculation of the Gain or Loss on Monetary Items
Calculation of Cost of Sales and Inventory at Current Prices
Calculation of Profits

Construction of Balance Sheet.
Calculation of Conversion Factor and Mid-Point Conversion Factor:

1. Conversion Factor: As the financial statements prepared on historical cost accounting
basis are to be restated considering the current prices, the value of assets in historical cost
accounts are multiplied by the conversion factor.

!
Caution Conversion factor is calculated as under:
Conversion Factor = Price index at the date of conversion / Price index at the date the item
arose.

Example: Layman Brothers purchased machinery on 1.1.2008 for a sum of `6,60,000. The
retail price index on that date stood at 150. You are required to restate the value of the machinery
according to CPP method on 31st December, 2008 when the price index stood at 200.

Solution:
Conversion Factor = Price index at the date of conversion/Price index at the date of item
arose.

= 200/150 = 4/3
st
Value of machinery on 31 December, 2008 after conversion.
= Existing value × Conversion factor

= 6,60,000 × 4/3
= ` 8,80,000
Mid-point Conversion Factor: For translating the transactions to current prices occurring
throughout the period, conversion factor cannot be used. In such cases, the mid-point
conversion factor is used. Normally the mid-point conversion factor is given. In case the
same is not given, it can be calculated by taking the average of the index that is at the
beginning of the year and at the end of the year. Thus, it is the average index of the period.
Transactions such as purchases, sales and payment of expenses are converted using the
mid-point conversion factor.

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