Companies operating in other countries should give serious thought to adapting a
cash flow statement to supplement the income statement and balance sheet. This is
particularly true if they are operating in inflationary environments, because looking
at profits alone can be deceptive.
20.6 MEASUREMENT APPROACHES TO INFLATION ACCOUNTING. Financial ac-
counting standard setters in different countries have developed two basic approaches
for dealing with inflation in financial statements. There are differences in the way the
two methods are applied and whether they are used in the primary statements or as
supplementary data.
In one method, called “constant dollar,” general price level indices are used to ad-
just historical cost accounting records into monetary units of the same general pur-
chasing power. Inflation effects are eliminated by changing the units of measure from
the historical monetary unit, with different purchasing power at different dates, into
a monetary unit with the same purchasing power. In practice, the GNP (Gross Na-
tional Product) price level deflator developed by governmental economists has been
suggested as the best measure of purchasing power in an economy. It measures the
relative prices of all goods and services in the economy.
In contrast, the other general method, called, variously, “current cost,” “current
value,” or “replacement cost,” attempts to arrive at an economic value for past trans-
actions. Current cost is used by the United States and is described in FAS No. 89.^12
The FASB requires only the restatement of inventories and property, plant, and
equipment. The current cost of inventories is the current cost of purchasing the goods
concerned or the current cost of the resources required to produce the goods. The cur-
rent cost of property, plant, and equipment is the current cost of acquiring the same
service potential of the asset owned. This considers operating cost and physical out-
put capacity.
As applied in the United States, there are several ways to calculate this current
cost.^13 It may be applied to single items or broad categories, as appropriate. The cur-
rent cost may be calculated by:
- Indexation.Either externally generated price indices for the class of goods or
services being measured or internally generated price indices. - Direct pricing.Current invoice prices; vendors’ price lists, quotes, or estimates;
or standard manufacturing costs that reflect current costs.
Current value has been used in the Netherlands, based on the Limperg theory,^14
which says that the underlying assumption of the enterprise is continuity, whereby as-
sets have to be replaced by building, equipment, and inventories that perform a sim-
ilar economic function.
For goods produced and sold, current value is the sum of the values of the factors of
production consumed at the moment of exchange (sale). For capital goods—inventories
and fixed assets—value is, for all practical purposes, measured at the moment of state-
ment (balance sheet) presentation, annually or quarterly, although continuous recording20 • 10 ACCOUNTING FOR THE EFFECTS OF INFLATION(^12) FAS No. 89, FASB, 1986, p. 11.
(^13) FAS No. 89, paragraph 19, FASB, 1986.
(^14) Enthoven, 1982, p. 27.