What Is Constant Purchasing Power Accounting?
When youre composing financial statements, its important to consider the changing value of money and adjust for inflation/deflation. Thats why constant purchasing power is such an important concept for accountants and small business owners to master. Learn more with our simple guide, including how to calculate constant purchasing power. Constant purchasing power accounting explained  Constant purchasing power accounting (CPPA) is a method of preparing financial statements wherein adjustments for changes in the value of money are included. Its also referred to as current purchasing power accounting, constant dollar accounting, and general price level accounting. In short, it means that all non-monetary items that are recorded on the historical-cost basis should be adjusted by applying a general price index. In short, its because the historical cost basis of accounting assumes that the value of items on the balance sheet havent changed since they were acquired. Obviously, this isnt the case when inflation/deflation has taken place, and often it means that the real value of a certain asset will differ from the value reported on the balance sheet. The methodology behind constant purchasing power accounting is relatively simple. First off, its important to note that it only applies to non-monetary items that are recorded on the historical cost basis. Monetary items that arent recorded on the historical cost basis dont need to be adjusted for inflation/deflation. Remember, monetary items covers cash and cash equivalents like accounts receivable, while non-monetary items covers fixed assets like property and equipment, as well as other, more intangible assets like patents and so on. Heres a quick overview of how your main financial documents should be treated when using constant purchasing power accounting within the IASB (IFRS) framework:  Income statement  All items should be adjusted. Cash flow statement  All items should be adjusted. Financial statement  Monetary items shouldnt be adjusted, items already adjusted for current market value/fair value shouldnt be adjusted, equity should be adjusted, and all other non-monetary items should be adjusted. Example of constant purchasing power accounting  Lets look at an example to see how constant purchasing power accounting works in the real-world. As youll see, learning how to calculate constant purchasing power isnt particularly difficult, so long as you have access to the appropriate financial documents and a general price index. Imagine Company A has the following expenses for the year ending December 2019:  Sales expenses  $250,000  Interest expenses  $20,000  Rental expenses  $150,000  Administration expenses  $200,000  These expenses are spread evenly throughout the accounting period, apart from rent (paid in advance at the beginning of the period) and interest (accrues at end of period). The price index information reads as follows:  January 1, 2019  100  December 31, 2019  110  2019 average  105  Using constant purchasing power accounting, you can calculate the adjustments you need to make:  Sales expenses = $250,000 x 110/105 = $261,904.76  Interest expenses = $20,000 x 110/110 = $20,000  Rental expenses = $150,000 x 110/100 = $165,000  Administration expenses = $200,000 x 110/105 = $209,523.81  So, there you have it. As you can see, constant purchasing power accounting has raised Company As expenses. This is because the value of money increased throughout the accounting period. Constant purchasing power: GAAP and IFRS  Constant purchasing power accounting is authorized under both GAAP and IFRS. So, if youre using either of these accounting frameworks, you should be able to implement constant purchasing power accounting relatively easily. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.