No gearing adjustment arises where a company is wholly financed by shareholders’ capital. Thus, the standard provides for an adjustment in respect of monetary working capital when determining current cost operating profit. This adjustment should represent the amount of additional (or reduced) finance needed for monetary working capital as a result of changes in the input prices of goods and services used and financed by the business.

Social image

This method helps in reflecting a more accurate picture of a company’s financial condition by adjusting for inflation or deflation. The primary objective of price level accounting is to ensure that financial reports reflect real values, which are not distorted by changes in the price level. Artemis Corporation purchased a piece of production equipment five years ago for $100,000. Under general level price accounting, Artemis would adjust the historical cost of the equipment to reflect the current purchasing power, making it easier to compare with other financial data that is more recent. It is necessary for every business concern to present true and fair view of the operating and financial position of the concern.

Accounting & Financial Analysis

“The fertiliser market is a seller’s market,” company owner Dangote raves. “People are begging for us to sell and we are choosy about who we sell to.” For decades, there was no oil processing industry in Nigeria, apart from illegal refineries in the Niger Delta (which are very polluting due to the lack of cracking). The oil refinery in Lekki went into operation in December 2023 and presently produces 650,000 barrels of oil per day, with plans to expand capacity to 14 million barrels per day.

But apart from this, the method needs the presentation of supplementary financial statements of items at the end of the accounting period in the current purchasing power of the money/currency. The traditional method of accounting, historical cost accounting, records transactions at their original purchase prices. As a result, financial statements might not reflect the true economic value of a company’s resources, particularly in inflationary environments. The basic idea behind price level accounting is to adjust the values of assets, liabilities, and price level accounting other financial figures using an index like the Consumer Price Index (CPI). This adjustment allows businesses and investors to understand the true economic value of a company’s financial data, making it easier to compare performance over time and make better financial decisions. In economies with stable price levels, the differences between historical cost accounting and price level accounting may be minimal.

General Price Level Accounting

(b) Similarly, inventories are shown in the Balance Sheet at their value prevailing on the date of the Balance Sheet. These are not shown at cost or market price whichever is lower, as in case of historical accounting. CPP method involves the restatement of historical figures at current purchasing power. Under this method any established and approved general price index is used to convert the values of various items in the Balance Sheet and Profit and Loss Account. This method takes into consideration the changes in the value of items as a result of the general price level, but it does not account for changes in the value of individual items.

The Island also contains many of the city’s largest wholesale marketplaces (such as the popular Idumota and Balogun Markets). It also has the National Museum of Nigeria, the Central Mosque, the Glover Memorial Hall, Christ’s Church Cathedral (CMS), and the Oba’s Palace (Iga Idunganran). It borders the Idumota and Balogun markets and houses major Banking institutions. Captures the increase in asset value due to adjustments for price level changes. By providing more accurate and realistic financial information, PLA enhances transparency and credibility.

• The important principle to be remembered is that current costs must be matched with current revenues.
• However, the requirements they impose on companies operating in the country vary.
• As far as sales are concerned, it needs no adjustment as it is a current revenue.

Depreciation charged on current values of fixed assets is not acceptable under the Income Tax Act, 1961. The traditional method of accounting does not reveal real profits at times of inflation or deflation. Accounting for Changing Price-Level present more realistic view of profitability as under this system current revenues are matched with current costs.

• By accounting for these changes, it provides a more realistic view of a company’s financial position, helping investors and stakeholders make more informed decisions.
• One of the features of current cost accounting is to show inventories in the Balance Sheet on the basis of their value to the business, and not at cost or market price, whichever is lower.
• It also outlines some of the techniques used, including the current purchasing power method, replacement cost accounting method, current value accounting method, and current cost accounting method.
• In Replacement Cost Accounting (RCA) method all of the non-monetary items are reported in the balance sheet at replacement cost.

Realistic view

PLA helps in maintaining the real value of a company’s capital by ensuring that it is not eroded by inflation. This is particularly important for companies looking to sustain operations and growth over the long term. Imagine a company, ABC Inc., bought a piece of machinery for $10,000 in 2015. For example, if a company purchased a building for $100,000 ten years ago, and the inflation rate over this period was 20%, the adjusted cost of the building would be $120,000 under GPLA.

During the period of rising prices, shareholders are benefitted to the extent fixed assets and net working capital are financed while the amount of borrowings to be repaid remains fixed except interest charges. In the same manner, there is a loss to the shareholders in the period of falling prices. To adjust such profit or loss on account of borrowings, ‘gearing adjustment’ is required to be made. This adjustment reduces the total adjustment for cost of sales, depreciation and monetary working capital in the proportion of finance by borrowings to the total financing. Working capital is that part of capital which is required to meet the day to day expenses and for holding current assets for the normal operations of the business.

(c) Monetary and Non-Monetary Accounts (Gain or Loss on Monetary items):

If ABC Inc. were using traditional accounting methods, the machinery would still be recorded on the balance sheet at its historical cost of $10,000 (less any depreciation that might have been charged over the years). In contrast, GPLA adjusts these historical costs to reflect their current value. This adjustment is usually done by applying a general price index to the historical costs.

According to this method the business keeps its accounts on the basis of conventional historical cost system. However, it further requires preparation of supplementary statement at the end of accounting period. This supplementary statement shows all the items of the financial statement in terms of the purchasing power of currency or value of rupee as at the end of the period. Historical accounting is based on assumption that monetary unit remains stable. This assumption does not remain valid in present changing business world. In the reality the value of assets and liabilities of an enterprise is affected by the changes in the purchasing power of money.

As result, they showcase the following disadvantages of price level accounting. The social image of the company that prepares the financial statements adjusted to the price level changes gets improved. The balance sheet also reveals a fair and true view of the financial position of the company since assets are valued at the current position and not in distorted historical values. While repayment rights on borrowing are normally fixed in monetary amount, the proportion of net operating assets so financed increases or decreases in value to the business. Thus, when these assets have been realized, either by sale or use in the business, repayment of borrowing could be made so long as the proceeds are not less than the historical cost of those assets.