is required. The cost to be incurred at the moment of sale to replace the product sold is
the product’s current value.^15The Dutch system is very close to the U.S. system, but by replacement they mean
replacement by an asset that can perform a certain task. The replacing asset does not
have to be technically identical to its predecessor, and the concept of reproduction
cost of existing assets does not fit into the current value theory, nor does replacement
cost of existing capacity, because it presupposes an ideal situation. According to En-
thoven,^16 the current value method “closely resembles the U.S. concept of `replace-
ment cost of existing assets.’ The current value of assets does not imply replacement
by an asset with an identical capacity and identical specifications.”
Companies with debt, whose repayment is fixed in amount, benefit from borrow-
ing and investing in goods whose value increases with specific price inflation or, in
the case of constant purchasing power indexation, from being factored upward with
general price levels. In the United States, a gain or loss on the net monetary position
is calculated based on the difference between monetary assets and monetary liabili-
ties. A net monetary liability position will show a profit from inflation. Both the
Netherlands and the United Kingdom calculate a “gearing” adjustment. Gearingis
the U.K. term for leverage.
To understand the U.K. gearing adjustment, one needs to be familiar with the
Statement of Standard Accounting Practices (SSAP) No. 16 definition of monetary
working capital. This is the aggregate of trade accounts and notes receivable, pre-
payments, and inventories not subject to the cost-of-sales adjustment, less trade ac-
counts and notes payable and accruals. The monetary working capital adjustment is
computed based on a change in a relevant index applied to each element of the mon-
etary working capital. Thus, the index for receivables should reflect the current cost
of items included in the applicable cost of goods and services sold, and the index for
payables should reflect the cost of items financed by the payables.
The gearing adjustment is determined by multiplying the aggregate of three ad-
justments—an adjustment to depreciation, to cost of sales, and to the monetary work-
ing capital—by the ratio of net borrowings to net operating assets. Net borrowings
are the excess of all liabilities and provisions fixed in monetary terms, other than
those in monetary working capital and those that are in substance equity capital, over
the aggregate of all current assets, other than those subject to a cost-of-sales adjust-
ment and those included in monetary working capital. Net operating assets are the
fixed assets, inventory (stock), and monetary working capital presented in an histor-
ical cost balance sheet.
In summary, there are two general ways recommended to handle the problem of
inflation. One uses general price levels; the other uses specific price levels. Both have
to take account of the effect of inflation gains or losses on monetary assets and lia-
bilities. The current or replacement cost method attempts to put an economic value
on the transaction. The general price level method adjusts the unit of measure. From
a practical standpoint, the current price level method has an advantage in that it is
more objective and can be audited objectively. The current or replacement cost
method is more subjective, and its advocates would say it is more relevant.
20.6 MEASUREMENT APPROACHES TO INFLATION ACCOUNTING 20 • 11(^15) Enthoven, 1982, p. 28.
(^16) Enthoven, 1982, p. 29.