International Accounting Chapter 7: Price Changes
11 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to Lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is one potential consequence of not adjusting financial statements for changing prices?

  • Inaccurate asset valuation (correct)
  • Lower tax obligations
  • Decreased financial projections
  • Lower reported income

What is the objective of general price level adjustments in accounting?

  • To preserve the purchasing power of a firm’s original investment (correct)
  • To generate higher net income for reporting purposes
  • To reflect historical acquisition costs
  • To calculate taxes owed more accurately

During periods of specific price changes, what effect can the overstatement of reported income have on a firm?

  • Higher dividends distributed to shareholders (correct)
  • Inaccurate inventory reporting
  • Lower wages for employees
  • Decreased operational budget efficiency

What is a key reason for adjustments made to financial projections during changing prices?

<p>To reflect true economic performance (A)</p> Signup and view all the answers

What does a positive price movement indicate?

<p>Inflation (B)</p> Signup and view all the answers

How is the general price level change characterized?

<p>A movement in the prices of all goods and services on average (C)</p> Signup and view all the answers

Which index measures specific price changes?

<p>Specific Price Index (SPL) (A)</p> Signup and view all the answers

Why can financial statements be misleading during inflationary periods?

<p>Expenses are often recorded based on higher purchasing power due to past asset acquisitions (D)</p> Signup and view all the answers

What is the reciprocal of the General Price Level index indicative of?

<p>The general purchasing power of the monetary unit (A)</p> Signup and view all the answers

What happens to a firm holding monetary assets during inflation?

<p>Experiences a purchasing power loss (A)</p> Signup and view all the answers

What is the objective of adjustments for specific price changes?

<p>To preserve the firm's productive capacity (A)</p> Signup and view all the answers

Flashcards

Changing Prices

A general increase or decrease in the prices of goods and services in an economy.

General Price Level Change

The average movement in prices of all goods and services in an economy.

Inflation

An increase in the general price level of goods and services.

General Price Level Index (GPL)

A cost ratio comparing current basket costs to base period basket costs.

Signup and view all the flashcards

Financial Statement Misleading

In periods of changing prices, revenue and expense values might wrongly reflect economic reality because some values are referenced with different purchasing powers.

Signup and view all the flashcards

Historical Cost Accounting

A method of accounting that records assets at their original purchase price, regardless of current market value.

Signup and view all the flashcards

General Price Level (GPL) Adjustments

Adjusting financial statements to account for inflation by expressing values in terms of constant purchasing power.

Signup and view all the flashcards

Misleading Financial Statements (Inflation)

Financial statements using historical costs can overstate income during periods of rising prices because they don't reflect the real value of assets.

Signup and view all the flashcards

GPL Adjustment Objective

To determine income that maintains the original purchasing power of a company's investment.

Signup and view all the flashcards

Non-sensical performance Index

A misleading performance measure derived by deducting historical costs from current prices.

Signup and view all the flashcards

Price-Level Adjusted Expenses

Expenses adjusted to reflect their current purchasing power at the end of the period.

Signup and view all the flashcards

Monetary Asset

Cash or a claim to a fixed amount of currency in the future, like cash or accounts receivable.

Signup and view all the flashcards

Monetary Liability

Obligations to pay a fixed amount of currency in the future, such as most payables (excluding customer advances).

Signup and view all the flashcards

Purchasing Power Loss (Monetary Loss)

Loss of value of a monetary asset (cash or accounts receivable) due to inflation, as its value hasn't been adjusted.

Signup and view all the flashcards

Price-Level Adjusted Net Income

Net income adjusted for the purchasing power effect of inflation. It reflects the amount available to withdraw while maintaining the company's production capacity.

Signup and view all the flashcards

Inventory Replacement Cost

The current cost of replacing inventory, factoring in price increases.

Signup and view all the flashcards

Specific Price Increase

A particular price increase of an inventory item, not due to general inflation.

Signup and view all the flashcards

General Inflation

A broad increase in prices across many goods and services due to factors like increased demand.

Signup and view all the flashcards

Adjusted Operating Income

Calculated operating income adjusted for changes to inventory value, taking into consideration inflation and replacement costs.

Signup and view all the flashcards

Preserving Productive Capacity

Ensuring a business can maintain its production levels in the face of price increases and inflation, by having enough funds to buy new inventory.

Signup and view all the flashcards

Study Notes

International Accounting, Chapter 7: Financial Reporting and Changing Prices

  • Learning Objectives:
    • Define changing prices
    • Explain how changing prices mislead financial statements
    • Detail various adjustments for changing prices
    • Discuss international variations in adjustments
    • Explain IAS 21's stance on inflation adjustments
    • Describe the restatement-translation controversy
    • Examine the potential for double-counting of foreign inflation

What Does "Changing Prices" Mean and How are Price Changes Measured?

  • General price level change: Refers to average price movements for all goods and services in an economy.

    • Positive movement is inflation
    • Negative movement is deflation
  • Specific price change: Refers to the price movement of a particular asset (e.g., inventory, equipment)

  • General Price Level Index (GPL): Measures general price level changes.

    • Compares the cost of a basket of goods in the current period to the cost in a base period.
    • Reciprocals indicate general purchasing power.
  • Specific Price Index (SPL): Measures specific price changes.

    • Compares the cost of a specific item in the current period to its cost in a base period.

Why are Financial Statements Potentially Misleading During Periods of Changing Prices?

  • Inflation: Revenues are based on the current general purchasing power, while expenses often reflect older lower purchasing power, creating a distorted picture of profitability.
  • Historical purchasing power: Using historical purchasing power when comparing revenues and expenses during times of changing prices results in inaccurate performance indexes.

Types of Adjustments for Changing Prices

  • Objective of historical cost accounting: Maintain a firm's original investment.
  • Example: A firm begins with $1000
  • All inventory is sold at 50% markup ($1500), no price changes
  • Revenues are $1500 (uniformly throughout the year)
  • Expenses are 1000,netincome=1000, net income = 1000,netincome=500

General Price Level Adjustments

  • Objective: Measure income to represent an amount that can be withdrawn, preserving the general purchasing power of the original investment.
  • Example using a GPL that increased from 100 to 121:
    • Revenues: 1500∗(121/110)=1500 * (121/110) = 1500∗(121/110)=1650
    • Expenses: 1000∗(121/100)=1000 *(121/100) = 1000∗(121/100)=1210
    • Adjusted operating income: $440

General Price Level Adjustments (Continued)

  • Monetary items: Cash, receivables, and payables.
  • Nonmonetary items: Inventory, equipment, etc.
  • During inflation, gains/losses based on holding monetary items need accounting.
    • Monetary assets: Loss in purchasing power
    • Monetary liabilities: Gain in purchasing power

General Price Level Adjustments (Continued)

  • Example (continued):
    • Cash from sales 1500,adjustedforinflationto1500, adjusted for inflation to 1500,adjustedforinflationto1,650
    • Real cash balance is 1500,resultinginalossof1500, resulting in a loss of 1500,resultinginalossof150
  • Final adjusted net income: 290(=290 (= 290(=440 - 150),leavethefirmwith150), leave the firm with 150),leavethefirmwith1,210
  • Non-monetary assets/liabilities are adjusted to their purchasing power equivalents

Adjustments for Specific Price Changes

  • Objective: Measure income to maintain the firm's productive capacity
  • Example: Inventory price rises 30%
  • Increased equity 300,endingequity=300, ending equity = 300,endingequity=1,300
  • Restructured inventory & expenses reflect current cost equivalents

Adjustments for Specific Price Changes (Continued)

  • Restated inventory costs to $1,300
  • Inventory & cost of sales = $1,300
  • Adjusted operating income: 200(200 (200(1,500 - $1300)
  • $1300 is the actual amount that can stay in the business, in order to maintain capacity as seen by the increased prices

National Variations - US

  • U.S. SFAS 89: encourages but does not mandate specific disclosures.
  • Income from continuing operations (current costs)
  • Net monetary items (gains/losses)
  • Adjusted changes in inventory, plant, equipment (net of inflation)
  • Aggregate foreign currency adjustments
  • Specific figures for each of 5 years to be reported

National Variations - United Kingdom

  • SSAP 16: offers three reporting options relating to current costs and historical costs:
    • Current cost accounts as the sole accounts, or with supplementary historical cost accounts
    • Historical cost accounts, with supplementary current cost accounts
    • Current cost accounts only with adequate historical cost information
  • Monetary gains/losses, and gearing adjustments required

National Variations - Brazil

  • Permanent assets, equity adjustments, and monetary items that consider general price level changes as well

  • Asset/equity adjustments are offset (power losses/gains)

IAS 21

  • Restatement of primary financial statements in hyperinflationary environments using constant purchasing power (balance sheet date)
  • Include gains/losses on net monetary items, and disclose what methods were used to meet this accounting

Restate/Translate Controversy

  • Issue: Consolidating subsidiary accounts in inflationary environments during restatement/translation
  • Solution: Restate to consolidate for specific price changes, translate to parent currency using the current rate.
  • Use specific price indexes to calculate monetary gains/losses

Double-counting for Inflation

  • Local inflation affects exchange rates impacting translation to parent currency
  • Solution: Back out the translation gain/loss during the inflation adjustment

Other Chapter Exhibits

  • Includes other terms (attributes, monetary assets/liabilities, etc.) and examples for understanding the specific concepts and calculations needed for adjusting financial statements during changing price levels, and specific price adjustments for subsidiaries.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Quiz Team

Related Documents

Description

Explore the complexities of financial reporting in relation to changing prices in International Accounting. This quiz covers definitions, implications on financial statements, and international standards like IAS 21 regarding inflation adjustments. Test your understanding of these critical concepts and the controversies involved.

More Like This

Financial Reporting Quiz
14 questions

Financial Reporting Quiz

WellEstablishedWisdom avatar
WellEstablishedWisdom
Financial Reporting and Analysis Quiz
24 questions
Financial Reporting ACCA
30 questions

Financial Reporting ACCA

LawfulPointillism7491 avatar
LawfulPointillism7491
Use Quizgecko on...
Browser
Browser