price level problem

8/13/2019 Price Level Problem

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TOPIC :

THE PRICE LEVEL PROBLEM(Conclusions)

JUN REY M. MORALES, C.E.

MEM - Construction Management


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The Price Level Problem

ACCOUNTANTSView measures the goods and services that

enter into his calculation of net income essentially at their

acquisition cost, that is, at the prices paid when these goods and

services were originally acquired by the company.

ECONOMISTSView measures cost not in terms of the price

originally paid for goods and services but rather in terms of real

prices, that is, he adjusts acquisition prices to allow for

changes in purchasing power or in the economic significance ofthe specific goods or services.


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The Price Level Problem

- the difference between the accounting concept of

income and the economistsconcept of income.

- this difference arises because the purchasing power ofthe monetary unit of measurement is different at different

times.


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Proposals to deal with this problem:

1. LIFO Method of Inventory- has become a generally accepted accounting principle and

is also allowed for tax purposes.

2. DEPRECIATION on Replacement Cost- is not a generally accepted accounting principle in the

United States.

3. Price Level Adjustments

- involves the preparation of supplementary financialstatements rather than a change in the principles underlying the

regular balance sheet and income statement


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A. LIFO METHOD OF INVENTORY

Last-In, First-Out is a method of measuring inventory cost

Inventory is costed as if the units most recently added to inventory

were the first units sold

Ending inventory is therefore assumed to consist of the oldest unitsand is measured at the cost of these oldest units

In certain industries, LIFO does match economic flow of values

since they claim, the profit margin that actually influences business

pricing decisions is the margin between sales prices and currentcosts, not the margin between sales prices and cost levels that

existed at the time the inventory was purchased.


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A. LIFO METHOD OF INVENTORY

o there is a tendency to limit the amount of reported net income to an

amount which might be made available to shareholders without

impairing the scope and intensity of the operations of a going

concern.

o such restrictions in reported income serve to conserve funds by

reducing income taxes.

o under LIFO, inventory is valued forever in terms of whatever the

price level happened to be at the time LIFO was introduced.

o as time goes on and price levels change, the inventory figure under

LIFO departs further and further from reality, becoming neither a

reflection of actual purchase costs nor of current costs.


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C. PRICE LEVEL ADJUSTMENTS

the process of making such Adjustments is a fairly long and

complicated one, and it requires information as to the approximate

date on which each asset was acquired.

instead of adjusting all items, some accountant advocate that only

depreciation expenses be adjusted.


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Conclusions :

1. Of the techniques discussed, only LIFO is currently inaccordance with generally accepted accounting principles.

2. Depreciation on replacement costs may become accepted

either as in accordance with accounting principles, as a basis ofincome taxation, or both.

2. The overall adjustment of all financial statement items to current

prices is likely to remain as a supplementary report rather than asa substitute for figures based on historical cost.


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References :

ANTHONY, Robert N.Management Accounting (Text and Cases), 1970

www.simplified-accounting.com

price level problem

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