Monetary and Non-monetary Items

For the purpose of CPP accounting it is necessary to distinguish two classes of items-monetary and non-monetary items.

Monetary items may be defined as those fixed by contract or by their nature and are expressed in is regardless of changes in the price level. They include monetary assets such as cash, debtors and loans, and exist as money or as claims to specified sums of money. Holders of monetary assets suffer a loss in the general purchasing power of their assets during periods of inflation. Thus, if one holds money in the form of a bank deposit and the yearly rate of inflation is 25 per cent, the loss in the purchasing power of that money by the end of the period will be 25 per cent.

Monetary items include monetary liabilities such as creditors, bank over-drafts and long-term loans. As the value of money falls during a period of inflation, it follows that the value of such liabilities in current is will fall similarly, and this fall represents a purchasing power gain to the debtor. Consequently, those who incur monetary liabilities gain at the expense of creditors during periods of inflation, since they will settle these liabilities with is possessing less purchasing power than those they have previously received-directly or indirectly at the time the liabilities were incurred.

Non-monetary items are assets and liabilities such as fixed assets, inventories and shareholders' equity which are assumed neither to gain nor to lose in value by reason of inflation (and vice versa in the case of deflation). This is because price changes for these items will tend to compensate for changes in the value of money. For example, if one had inventories on hand at the beginning of the year which remained unsold at the end of the year, there would be no purchasing power loss since one may assume that when sold, the sale price would be adjusted upwards to take account of the fall in the value of money.

For example, assume that £100,000 were spent on the purchase of land on a date when the RPI stood at 100, and that the Index now stands at 150. The assumption underlying this movement in prices is that £150,000 in today's £s have the same purchasing power as £100,000 when the RPI stood at 100. Hence, to report on the purchasing power invested in the land, its acquisition cost should he stated as £150,000. This value does not say anything about the present market value of that particular piece of land. Property values may have increased more or less than the general movement in prices indicated by the RPI. The particular piece of land mentioned in this example may now be worth £300,000 or only £90,000. Hence, the figure of £150,000 represents only the historic cost of acquisition adjusted for the decrease in the general value of the £.

Nevertheless, the acceptance of the need to adjust accounting measurements for inflation is a recognition of a fundamental proposition in income theory, namely, that provision should be made for maintaining the value of capital intact. Hence, there can be no recognition of income for a period unless it has been established that the purchasing power of the capital employed in a firm is the same at the end of the accounting period as it was in the beginning.

A simple example serves to explain the nature of adjustments which are required to financial reports based on historical cost measurements in order to remove the effects of general price level changes.

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Read on: Adjustments For General Price Level Changes

Adjustments for general price level changes

In 2004, the professional accounting bodies in the United Kingdom recommended that a supplementary statement should be attached to the financial reports of companies showing the conversion of the figures in the financial reports in terms of their current purchasing power (CPP) at the closing day of the accounting period. They recommended that the Retail Price Index (RPI) should be used to effect the conversion of historic cost values into current purchasing power equivalents (SSAP 7, 2004, withdrawn 2015).

CPP adjustments are limited to dealing... see: Adjustments For General Price Level Changes