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Module No. 3: TIME VALUE OF MONEY

Introduction: -
The main goal of accounting is to prepare financial statements. These
statements should give a true and fair view of the business's operating results
and financial position. Financial statements are prepared using monetary units.
These statements work well if the value of these monetary units stays the same.
This is only possible when prices are stable. However, prices have not remained
stable over time. Inflation has become more common, especially after 1931.
Current financial statements do not show the current economic situation. In the
historical accounting system, accounts are prepared without considering price
level changes. Assets are shown at their purchase value, minus any depreciation.
Sales are recorded at market prices, while inventory is recorded at cost price.
Therefore, neither the profit and loss account nor the balance sheet accurately
reflects the business's position.
Price Level Accounting: -
Price level accounting is a technique used to restate financial statements. This
restatement reflects changes in the general price level. Such be inflation or
deflation. In general, price level accounting is more concerned with inflationary
tendencies.
Limitations of Conventional Financial Statements (Historical accounting):
1. Historical accounting fails to disclose current worth of the Enterprise: -
The Conventional financial statements are recording only the historical facts.
They don't give us the true current worth of the enterprise.
2. Non-comparable items: -
The financial statements contain items which are not comparable because they
belong to different time periods with different inflation values. For eg: If a
company constructed a building for a sum of $500,000 in the year 2000, and
again it constructed a similar building in 2018 at the cost of $1,000,000, the
total cost of the building will be shown in the balance sheet at the end of 2018
as follows.
for eg: An asset purchased for a sum of ₹50000 in 2000 would be valued in
2010 according to cpp method, at the amount which would be needed to buy the
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same asset, as per change in the general price index in 2010 as compared to
2000. Assuming that general price index was 150 in 2000 and 300 in 2010, the
asset would be valued at;
Buildings (2000) ₹ 2,00,000
Buildings (2010) ₹ 1,50,000
3. Problem at the time of replacement: According to the conventional
method, depⁿ is charged on historical cost of the assets. It creates problem at the
time of replacement of that asset.
e.g. If a machinery was purchased for ₹1,00,000 and its life was expected to be
10 years, then the annual depⁿ will be ₹10,000. But after 10 years the same asset
can be purchased at a new price of ₹ 1,50,000, the firm may have to face
serious problems due to lack of funds.
4. Mixes holding gains and operating gains:
In Conventional accounting, gains on account of holding the inventories may be
mixed up with operating gains.
For Example: A business purchased 100 units of a product at ₹6/unit in 2010. It
could sell only 50 of such units in that year. In 2011 it purchased another 100
units at ₹8/unit and sells all 150 units at ₹10/unit.
In such a case, the profit in 2011 as per historical accounting will be as follows:
Sales (150 x 10) = 1500
(-) Cost of sales
(50 units x 6) + (100 x 8)
(300 + 800) = 1100
Profit = 400
As a matter of fact, out of the total profit of ₹400, a sum of ₹100 (50x2) is only
on account of holding the inventory. Thus, in this case ₹100 is a holding gain.
Profit and the remaining ₹300 is the operating Profit. In general, it can be said
that under inflationary Condition, the reported Copies. are over stated. and
assets are. Understated. When accounts are prepared according to historical
accounting, over reporting of profits gives rise to a no. of problems like heavy
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taxation, higher dividend etc, resulting ultimately in heavy financial drain of the
company.
Methods of Accounting For changing prices:
I Current purchasing power method (CPP) General purchasing power method
(GPP).
II Current Cost accounting method (CCA)
[Link] method (mixture of CPP & CCA).
I current purchasing power method (CPP): The method of CPP was evolved
by The Institute of Chartered Accountants of England & Wales. by the use of
provisional statement of standard accounting practice. No.7 (SSAP-7) entitled
"Accounts for changes in purchasing power of the money" in 1974.
According to this method all items in the financial Statement are to be restated
for changes in the general price level. for this purpose, any approved price index
is used to convert the Various items of the profit and loss account and the
balance sheet.
It should be noted that under the cpp method, only the changes in general
purchasing power of money is taken into account. It doesn't consider the
changes in the value of individual asset. In other words, a particular asset might
have become cheaper over the years, whereas the general price index has
increased. In such a case the value of that asset will be increased as per this
method. In
preparation of financial statements according to cpp. method.
Step 1: Conversion factor
Conversion factor = price index at the date of Conversion / price index at the
date of item arose
The retail price index is considered to be appropriate price index under cpp
method.
Step 2: Mid period Conversion.
Some revenue transactions like sales, purchases, payment of Expenses etc.
occur throughout the year. In such cases, it will be advisable to convert them
according to the Average index of the Average period.
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Step 3: Monetary and non-monetary items:

a. Monetary items Are those whose amounts are fixed by Contracts in terms of
money, without taking into account changes in General price level.
Eg:- Cash, debtors, Creditors, loan, Capital etc:-Holders of monetary assets used
general purchasing power during the time of inflation.
For examples: If the Co. had sundry debtors worth ₹1,00,000/- as on 1/1/2012,
it will be collected after 2 or 3 months with that fixed amount ( ₹1,00,000). It
shows that because of inflation the value of money comes down after 2 or 3
months thereby causing the Co. a loss.
If we take Example of monetary liability, For e.g. A person lends to the Co. a
sum of ₹1,00,000/- on 1-1-2010 payable on 31/12/2010. If the price index on 1-
1-2010 was 100 while it is 150 on 31/12/2010. On account of increase in price
level if the creditor is to be compensated for loss in purchasing power, he should
be paid a sum of ₹1,50,000 (1,00,000 x 150/100) however he will be paid as per
Contract a sum of ₹1,00,000 only. Here the Co is gaining ₹50000/- while the
lender is losing a sum of ₹50000/-.
b. Non-monetary items: These are the items that can't be stated in fixed
monetary amt they include tangible items such as building, machinery,
inventories etc.
For eg: A building costing ₹1,00,000 in 2000 may be sold for ₹35,00,000 today
even though it was used and it has become old fashion.
Investments in bonds or debentures are monetary items because they have fixed
claims. Similarly, Pref. Shar holders are also monetary items because they have
a right to get only the fixed. amt of their Share Capital. However, the equity
Share capital in a non-monetary item because the Equity Shareholders have the
right to claim the entire Surplus fund.
Step 4: Gain & Loss on Monetary Items
Changes in the purchasing power of money affects both monetary and non-
monetary items. In case of monetary items, the firm receives or pays fixed amt.
but it will gain or lose in terms of real purchasing power. Such gain or loss is
called "General Price Level Gain or Loss". Such gain or loss under CPP method
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should be shown as a separate item in restated income statement to arrive at the

overall profit or loss.
Problem No.1:
Compute the net monetary result of x [Link] as on 31/12/2010.
Particulars 1-1-2010 31-12-10
Cash 5000 10000
Book debt 20000 25000
Grs 15000 20000
Loan 20000 20000

Retail price index number:

0n 01.01.2010 – 200
31.12.2010 – 300
Avg index for the year 240.
Solution: -
Cash of conversion factor
Conversion factor = price index at the date of conversion
Price index at the date the item arose
c.f. for the items as on 1-1-2010
= 300 = 3
200 2
c.f for the items happening during the year
= 300 = 5
240 4
c.f for the end of year = 1.
Statement showing the net monetary result on account of price level changes.
Particular RS RS
1. Monetary liabilities 52500
as on 1-1-2010
should have gone
upto
[15000+20000]
35000x3
2

2. Increase in monetary
liability during 2010
[40000-35000]
5000x5/4 6250

Monetary liability as 58750

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on 31/12/2010 should
have stood at
(-) monetary liability
as on 31/12/2010
40000
actual stood at
18750
Gain on holding
monetary liability
3. Monetary assets as on
01-01-2010
[5000+20000] should
have gone up to
25000x3/2 37500
4. Increase in monetary
assets during
2010[35000-25000]
Which should have
gone up by
10000x5/4 12500

50000
Monetary assets as on
31/12/2010 should 35000
have stood at
Monetary asset as on
31/12/2010
15000
Loss on holding
monetary

Net gain on monetary 3750

items

2. Ascertain the net monetary result at the end of 2010 from the under mention that
Particular 1-1-2010 31-12-2010
Bank 2000 3000
a/c’s receivable 10000 12000
a/c’s payable 15000 10000
2010’s start index – 100
2010 end index – 200
2010 avg index – 160

Solution
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Calculation of conversion factor

c.f as on 1-1-2010 = 200 = 2 = 2
100 1
C.f as on 31-12-2010 = 200 = 1
200
c.f as during the year = 200 = 5
160 4
==

Statement showing the net monetary result on a/c of price level changes.
Particular
1. Monetary liability as on 1-1-2010
should have gone upto
15000 x 2 30000
(-) increase/decrease in monetary
liability during 2010[15000-10000]
6250
5000x5/4

2. Monetary liability as 31/12/2010 23750

should stood at
(-) Monetary liability as on actual
10000 13750
stood at
Gain on holding monetary liability

3. Monetary assets as on 1-1-2010

should have gone upto
[2000+10000]12000x2 24000
(+) Increase in Monetary assets
during 2010 [15000-12000]
3750
3000x5/4

Monetary amet as on 31/12/2010 27750

should stood at
12750
(-) Monetary amets as on 31/12/2010
15000
actually stood at

Loss on holding Monetary assets

Net gain on Monetary items 1000

Step 5: Cost of Sales and Inventories.

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These values depend on which method of pricing the materials issued has been
adopted by the firm, i.e., FIFO or LIFO method. While restating the figures
under CPP method, we should keep in mind the method of pricing the issues
because they affect both the Cost of Sales and Closing Inventory. The following
explanation will prove the statement:
FIFO method;
a) Cost of Sales: It comprises the entire opening stock and current purchases
less closing stock.
b) Closing Inventory: It comprises entirely current purchases. However, in rare
cases, if the total sales are less than the opening stock, a part of the op-stock
may also become a part of the cl-stock.
LIFO method:
a) Cost of Sales: It comprises current purchases only. However, if the current
purchases are less than the Cost of Sale, a part of the op-stock may also become
a part of the Cost of Sales.
b) Closing Inventory: It comprises purchases made in the previous year of
year's.
The following indices are used under CPP method for restating the historical
figure:
(i) For current purchases; avg index of the year
(ii) For op-stock; index at the beginning of the year
(iii). For the purchases of the previous year; avg index of the previous year....
[Link] the following details ascertain:
1. Cost of sales
2. Closing inventory as per CPP method when the firm is following (FIFO)Method.
Historical Cost Price Index
[Link] on 1-1-2010 4000 80
Purchases during 2010 20000 125
[Link] (out of purchases
made in last total) 3000 120
index number on 31-12- - 140
2010
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Solution

Statement showing the cost of sales and closing inventory under CPP Method following
FIFO
Particular Historical Conversion Converted
cost Factor Amt
Opening Stock 4000 140 = 7 4000 x 7/4
80 4 7000
(+) Purchases 20000 140 = 28
125 25 22400
24000 29400
(-) Closing Inventory 3000 140 = 7
120 6 3500
Cost of sales 21000 25900
Cost of sales = 25900
[Link] = 3500
4. From the following data calculate:
a. Cost of sales
b. [Link] under CPP method presuming that the firm is following LIFO Method for
inventory valuation method.
Particular
Inventory as on 1-1-2000 Rs. 8000
Purchase during 2000 Rs. 48000
Inventory as on 31-12-2000 Rs. 12000
Price index as on 1-1-2000 Rs.100
Price index as on 31-12-2000 Rs. 140
Avg price index for 2000 Rs. 125

Solution
Statement showing the cost of sales and cl. inventory under CPP Method following LIFO
Method.
Particulars Historical Cost C.F Converted Amt
Opening Stock 8000 140 = 7 11200
100 5
(+) Purchases 48000 140 = 28 53760
125 25
56000 64960
(-) [Link] 12000
8000 Rs. Stock is
out of [Link] 8000x7
5
= 11200
The remaining Rs. 4000 x 28
4000 is out of 25 15680
current purchases = 4480
Cost of Sales 44000 49280
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Cost of sales = 49280

Closing inventory = 15680
Step 6: Determination of profit under cpp method:
There are two methods to Calculate profit under cpp method:
I Net change method
II Conversion | Restatement of income statement method.
I. Net Change Method:
It is similar to Statement of affairs method followed under single entry system.
The following step are involved under this method to Calculate profit.
(i) opening Balance sheet prepared under historical cost accounting method is
converted by applying proper conversion factor. E.g. share Capital is also
converted. The difference in the Balance sheet is taken as Reserve.
Alternatively, E.g. Share Capital may not be Converted and in that case, the
difference in the b/s is taken as Equity.
(ii) Closing balance sheet prepared under historical cost accounting is also
converted the difference b/w two sides of the Balance sheet is taken as Reserve.
just like the above, e.g. Share Capital may not be converted and the difference
in the B/s is taken as Equity.
(iii) profit is equal to the difference b/w the reserves (when Eg Capital in
converted if E.g. share capital is not converted, profit is equal to Net change in
equities.
II Conversion/Restatement of income statement method.
(i) Sales and operating Expenses are converted at avg rat applicable for the year.
(ii) Cost of sales is converted according to the method of pricing the issue
(FIFO & LIFO)
(iii) Fixed assets are converted on the basis of indices that are prevalent on the
date their convert purchase. The same rule applies to depreciation .
(iv) Tax's and dividend rate paid converted on the basis of indices that were
prevalent on the date they were paid.
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(v) Gain of loss on sale of monetary items should be calculated & stated
separately restated income statement to arrive at the overall figure of profit &
loss.

[Link] balance sheet of as on 1-1-2010 and the income statement for the year ending 31-
12-2010 are set out below.

Balance Sheet as on 1-1-2010

Liabilities Amt Assets Amt
Share Capital 10000 New Machine 15000
10% Debentures 6000 Stock 2400
GS 3600 Drs 1200
Cash 1000
19600 19600
Income Statement for the year ending 31-12-2010
Particular Rs. Rs.
Sales 10,000
(-) Cost of goods sold : 5000
Opening Stock (FIFO) 2400
Purchases (Net) 4600
7000
(-) [Link] (FIFO) 2000
Gross profit on sales 5000
operating expenses. 800
Dep 1500
Int on debentures paid on
31-12-2010 600 2900
Retail canning 2100

Drs and credit balances remain constant throughout the year: General price indices as
given below :
on 1-1-2010 = 200
Avg index for the year = 240
On 31-12-2010 = 300
Your required to prepare the final a/c for the year 2010 after adjusting the price level
change under CPP Method.

Solution:
Calculation of C.F
C.F. for the item as on 1-1-2010 = price index at the date of conversion
Price index at the date of arose.
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C.F. as on 1-1-2010 = 300 = 3

200 2
c.f for the item as on
during the year = 300 = 5
240 4
C.F as on 31-12-2010= 300 = 1
300

Restated income statement (as per CPP Method)

Particular Historical Cost C.F Converted Amt
Sales 10000 10000 x 5/4 12500
Opening Stock 2400 2400 x 3/2 3600
(+) Purchases 4600 4600 x 5/4 5750
(-) [Link] 7000 9350
2000 2000 x 5/4 2500
Cost of Sales 5000 6850
Gross Profit (Sales- 5000 5650
Cost of sale)
(-) Operating 800 800 x 5/4 1000
Expenses
Depn 1500 3/2 2250
Int on debenture 600 1 600
Income Before Price 2100 1800
Level gain or loss :
(+) General price
level gain or loss - 2550
Retained Earnings 2100 4350
Statement showing the monetary gain or loss

Particulars Historical Cost C.F Converted Amt

Net Monetary
liability as on 1-1-
2010 7400 3/2 11100
(+) purchases 4600 5/4 5750
Operating exp 800 5/4 1000
Int on debenture 600 1 600
13400 18450
(-) Sales 10000 5/4 12500
Net Monetary
Liability as on 31-
12-2010 3400 5950
(-) Net Monetary
liability on 31-12-
2010 on Historical
cost basis 3400
Resultant Monetary
Gain 2550
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Calculation of Net Monetary liability as on 1-1-2010

Total Monetary liability as on 1-1-2010

(Debenture + Ers) 9600
(-) Monetary Assets as on 1-1-2010 (Drs +
Cash) 2200
7400

Balance Sheet as on 31-12-2010

Liabilities H.c.a c.f CPP Assets H.c.a c.f CPP

Rs.
Share New Machine
Capital 1000 3/2 15000 (-)depn 15000 13500 3/2 20250
10%
Debenture 6000 1 6000 1500
Creditors 3600 1 3600 [Link] 2000 5/4 2500
Retained
Earnings 2100 4350 Debtor’s 1200 1 1200
Cash 5000 1 5000
21700 28950 21700 28950

Working Note :
1. For all monetary items ie monetary assets & monetary liabilities at the closing B/S
should be converted at end year interest (c.f. 1)

6. Following is the comparative B/S of ABC Ltd as on 31-12-2000 & 2001.

Liabilities 2000 2001 Assets 2000 2001

Current Cash & Receivable 200000 260000

Liabilities 80000 90000

Long Term Inventories (FIFO) 150000 130000

liabilities 100000 116000 Land 40000 40000

Equity Share
Equipment 210000 270000

Capital(rs.10) 140000 140000 Less: accumulated - (24000)

depn

Share 280000 280000

premium
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Reserve &
surplus - 50000

600000 676000 600000 676000

Income Statement of the Co. for the year ending 31-12-2001.

Particulars Rs. Rs.

Net Sales 800000
(-) Cost of goods sold : 520000
Opening inventories (FIFO) 150000
Purchases (Net) 500000
650000
(-) Closing inventory (FIFO) 130000
Gross Profit 280000
(-) Operating Expenses (Excluding depn) 96000
Depn 24000 120000
Profit before tax 160000
(-)Income Tax 70000
Profit after tax 90000
(-) Dividend paid 40000
Retained Earnings 50000

Equipment costing Rs. 60000 was acquired on 1-7-2001, when the general price index was
157.5. The amount of deprecition has been calculated as follows :
10% on Rs. 210000 - Rs. 21000
5% on Rs. 60000
(rate being 10% p.a) - Rs. 3000
Total depn - Rs. 24000
=======
Sales, purchases, operating Expenses took place evenly throughout the year.
Inventories are priced according FIFO method. goods in closing inventories
where acquired evenly throughout the year. the dividend of 40000 was declared
and paid at the end of 2001. Income tax accrued throughout the year.
your required recent above the statement taking into account the price level
adjustment under cpp method.
The general price indices are as follows: at the end of the year 2000
(beginning of the year 2001) -> 150
Average for the year 2001 -> 157.5
at the end of the year 2001 -> 163.8.
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solution:
Calculation of conversion factor
Conversion factor for the appearing at the begging = price index at the date of conversion
Price index at the date the item arose.

1-1-2001 = 163.8
150 = 1.092

Conversion factor for the items appearing throughout the year = 163.8
157.5 = 1.04

Co n.f for the item appearing at the end of the year = 163.8
163.8 = 1
Restated income statement under CPP Method
Particular Historical Cost C.F CPP
Sales 800000 1.04 832000
(-) Cost of Sales ;-
Opening inventory 150000 1.092 163800
(+)purchase 500000 1.04 520000
650000 688800
(-) Cl. Inventory 130000 1.04 135200
Cost of sale 520000 548600
Gross Profit 280000 283400
(-) Operating
Expenses (Excluding
depn) 96000 1.04 99840
Deprn 24000 21000 x 1.092
= 22932
3000 x 1.04
3120 26052
Income for price
level gain 160000 157508
General price level
gain/loss - 4800
Income before price
level gain/loss 160000 152708
(-) Income Tax 70000 1.04 72800
Income after tax 90000 79908
(-) Dividend paid 40000 1 40000
Retained Earnings 50000 39908
Statement showing the monetary gain or loss
Particular Historical Cost C.F Converted Amt
Net Monitary Assest
as onn 1-1-01.
(Total Monetary
asset – Total
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Monetarial) 20000 1.092 21840

(200000-180000)
(+) Sales 800000 1.04 832000
820000 853840
(-) Purchase 500000 1.04 520000
Operating Ex 96000` 1.04 99840
Income Tax 70000 1.04 72800
Dividend Paid 40000 1 40000
Equipment 60000 1.04 62400
purchased
Net monetary assets 54000 58800
as on 31/12/2001
(-) net monetary
assets as per
historical cost
account 54000
Monetary loss 4800
Current Cost Accounting method (CCA)
Criticism of the CPP method:
The CPP method Contained in SSAP-7 didn't find favour with a large number of
accountants for the following reasons:
(i) CPP method is based on index numbers, which are Statistical averages.
Therefore, they can't be applied with cent percent accuracy.
(ii) The Selection of a suitable price index is difficult because there are various
price indices.
(iii) This method deals with a change in general price level and not with
changes in prices of individual firms.
Meaning of current Cost Accounting methods:
In due of the general complaint that CPP method is not adequate for reporting
price level change the UK Govt adopted. CCA method after many revisions.
Since 1975
The CCA method requires each item of financial Statement to be restated in
terms of the current value. of the item. In other words, under CCA method,
assets are stated at the value to of the business. It is also called an "deprival
value" method.
Adjustment / provision:
(a) Net current replacement value:
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It refers to the fund required to buy a new asset of the same [Link] than that
recognizes the fact that the true replacement of the asset would not be a new
asset, but an asset which has the same remaining useful life as an existing asset.
It is also known as current entry price/value.
(b) Net Realizable Value:
This is the value which is represented by the Net Cash proceeds, if the existing
assets is sold now. It is known as current exit price/value.
(c) Economic Value:
It is the net present value (NPV) of the cash inflows of holding and using an
asset. In other words, it refers to present value of the Net income that will be
earned for using the existing assets, during the rest of its life. However, the
income will be discounted at a proper rate to arrive at the present value of the
future cash inflows.
To sum up, replacement cost is a significant method under CCA method.

Preparation of Income Statement

In order to prepare Income Statement under CCA method the following
adjustments will have to, modify the profit as per HRA basis:
I Cost of Sales Adjustment [COSA]
II Depreciation Adjustment
III Monetary Working Capital Adjustment [MWCA]
IV Gearing Adjustment
I Cost of Sales Adjustment [COSA]
The following 3 steps are involved in calculating COSA:
Step I: Calculating the increase or decrease in the closing stock over the
opening stock as per HCA basis: This represents the total change [C-O].
Step II: Convert both Closing stock and opening Stock to current Cost by using
the appropriate Index. This will give us increase in the closing stock over the
opening stock & CCA Basis.
Step III: From the total change ascertained in Step I, deduct the volume change
ascertained in Step II. The resulting difference is called COSA.
COSA
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The following three steps are involved in calculating COSA (Change in

Operating Stock Adjustment):
Step 1
C−OC−O
Step 2
Ia(CIc−OIo)Ia(IcC−IoO)
Where:
 C = Closing stock on historical basis
 O = Opening stock on historical basis
 I_a = Average Index number for the period
 I_c = Index number for closing stock
 I_o = Index number for opening stock
Step 3:

Problem 1:
From the data given below calculate COSA
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Particulars Historical Cost Price Index

Opening stock on 1/01/2000 40,000 180

Purchases during 2000 1,20,000 198 (Average)

Total available for Sales 1,60,000

Less: Closing stock on 31/12 50,000 220

Cost of Sales 1,10,000

Calculation Steps:
1. 50,000−40,000=10,000
2. Calculate stock in index:
 50,000220=227.272
 40,000180=222.22
 227.27−222.22=5.05
3. Multiply by average index:
 198×5.05=999.9
4. Subtract this from initial stock change:
 10,000−999.9=9,000.1
COSA=9,000.1
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Problem 2
From the following information, calculate COSA.
Particulars

Particulars Historical Cost Price Index

Opening Stock as on 1/01/2010 10,000 200

Purchase of material 18,000

Closing Stock as on 31/12 14,100 225

Price Index as on 31/12 = 240

You may presume that materials are consumed uniformly throughout the year.
Generally, a month after the date of purchase, the rise in the prices is also
throughout the year.
Solution
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Ⅱ Depreciation Adjustment
(a) On which value to calculate dep’n:
Under CCA method dep,n is calculated on replacement cost. But the problem is
replacement cost changes day by day. The usual custom is that the avg
replacement cost is taken for calculating dep’n under CCA method.
If Index Numbers are used to obtain replacement cost, then average Index of the
year should be used to obtain the value for calculating dep’n.
(b) Dep’n adjustment:
Dep’n adjustment = CCA dep’n - HCA dep’nn

(a) Back-log depⁿ:

Back log is the depⁿ difference in the depⁿ to be provided on account of
revaluation & what is already provided in the accounts in respect of earlier
years. Back-log depⁿ arise every time an assets is revalued. Such revaluation
makes an provision in adequate amt and hence the need for providing back log
depⁿ.In case assets is revalued, we should.
C) Monetary working capital adjustment (mwc)

This adjustment reflects the amt of additional finance needed for monetary w. Capital as a
result of changes in the input prices of goods and services used by the business.
There are difficulties in practice in identifying the monetary assets and liabilities reasonable
accuracy and objectivity however can be achieved by including only trade debtors and
creditors with in monetary working capital.

D) Gearing Adjustment
Gearing adjustment is a different type of adjustment compared to the Cartier 3 adjustments.
This adjustment is necessary because a part of a net operating assets are financed by
borrowing which are to be repaid in the same monetary amount, irrespective of changes in
price, for the purpose of gearing adjustment the form "Shareholders fund" refers to all funds,
belonging to the Shareholders as per CCA.
22

When the business is financed not only by the Shareholders but also by borrowings from
long term lenders. The burden of CE adjustments should be shared by both the Shareholders
as well as long term lenders -

where B = Net borrowing S = Equity fund

Net borrowing inflows/loans debentures, overdraft, hire purchase creditors, other leasing,
obligation and provision for taxation. Cash is deducted from net opening assets as well as
borrowings. Shareholders' fund includes ordinary Share Capital, preference Share Capital,
Reserves including general reserve, proposed dividends and minority interest
Problem no 1:
From the following current cost balance sheet calculate gearing adjustment and gearing
proportion.
MWCA RS.15000
COSA RS 30000
DEPRECIATUIN ADJUSTMENT RS 45000

Balance Sheet of Preema Limited (as on 31/12/2010 and 31/12/2011)

Assets

Particulars 31/12/2010 31/12/2011

Fixed Assets 3,10,000 3,50,000
Stock 1,50,000 2,00,000
Debtors 2,00,000 1,50,000
Cash Balance 80,000 1,20,000
Total 7,50,000 8,20,000

Liabilities

Particulars 31/12/2010 31/12/2011

Share Capital 1,50,000 1,50,000
Reserve 2,00,000 2,50,000
Capital Reserve 50,000 1,00,000
23

Particulars 31/12/2010 31/12/2011

12% Debenture 2,00,000 2,00,000
HIRE Purchase Creditors 20,000 30,000
Provision for Tax 50,000 70,000
Trade Creditors 80,000 20,000
Total 7,50,000 8,20,000
24

PROBLEM NO 2
25

The company facts and figures extracted from the balance sheet of Arun ltd as on
31/12/2024

Particular Amount
Bank and cash 4,50,000
Current liabilities
Creditors (Hire purchase) 170000
Taxation 210000
Proposed dividend 250000
BOD 190000
Share holders fund 354000
Net assets employed 268000
Debentures 540000
Deferred taxation 320000
Calculate current cost gearing ratio and proportion
Solution
Calculation of net borrowings

particular Amount
Debentures 540000
BOD 190000
Creditors 170000
Taxation 210000
Deferred taxation 320000
Less
Bank and cash 450000

NET BORROWINGS 980000

CALCULATION OF EQUITY SHARE AMOUNT

PROPESED DIVIDEND 250000
SHAREHOLDERS FUND 2680000

2930000
26

MCQ

1. The main goal of accounting is to:

a) Maximize profit
b) Prepare financial statements
c) Maintain ledgers only
d) Calculate taxes
Answer: b) Prepare financial statements

2. Historical accounting records assets at:

a) Market value
b) Current cost
c) Purchase value minus depreciation
d) Net realizable value
Answer: c) Purchase value minus depreciation

3. Price level accounting is mainly concerned with:

a) Deflation
b) Inflationary tendencies
c) Depreciation of assets
d) Holding period gains
Answer: b) Inflationary tendencies

4. A key limitation of conventional financial statements is:

a) Easy comparability
b) Disclosure of current worth
c) Non-comparability due to inflation
27

d) Consistency in values
Answer: c) Non-comparability due to inflation

5. The CPP method was evolved by:

a) FASB
b) Institute of Chartered Accountants of England & Wales
c) Institute of Chartered Accountants of India
d) Government of USA
Answer: b) Institute of Chartered Accountants of England & Wales

6. The conversion factor in CPP method is calculated as:

a) (Price index at beginning / Price index at conversion)
b) (Price index at conversion / Price index at date item arose)
c) (Current value / Historical value)
d) (Market value / Book value)
Answer: b) (Price index at conversion / Price index at date item arose)

7. Which of the following is a monetary item?

a) Building
b) Machinery
c) Cash
d) Inventory
Answer: c) Cash

8. Which of the following is a non-monetary item?

a) Creditors
b) Loans
c) Debtors
d) Equity share capital
Answer: d) Equity share capital

9. Holding gain arises due to:

a) Selling fixed assets
b) Change in general price level
c) Increase in value of inventory held
d) Decrease in liabilities
Answer: c) Increase in value of inventory held

10. In CPP method, revenue transactions occurring throughout the year are converted at:
a) Opening index
b) Closing index
c) Average index
d) Historical value
Answer: c) Average index

11. FIFO method of inventory valuation means:

a) First In, First Out
b) Final In, First Out
28

c) Free Interest Free Out

d) Fixed Input, Fixed Output
Answer: a) First In, First Out

12. Under LIFO method, cost of sales is calculated using:

a) Opening stock first
b) Current purchases first
c) Historical prices
d) Market prices
Answer: b) Current purchases first

13. General Price Level Gain or Loss arises in:

a) Monetary items
b) Non-monetary items
c) Only inventories
d) Only fixed assets
Answer: a) Monetary items

14. Which is NOT a limitation of CPP method?

a) Based on statistical averages
b) Deals with general price level, not individual prices
c) Requires complex revaluation daily
d) Selection of index is difficult
Answer: c) Requires complex revaluation daily

15. Current Cost Accounting (CCA) method is also called:

a) Exit value method
b) Entry value or deprival value method
c) CPP method
d) Historical method
Answer: b) Entry value or deprival value method

16. Net Current Replacement Value refers to:

a) Present market selling price
b) Cash realizable on sale of asset
c) Cost to buy a similar asset at current price
d) Book value of asset
Answer: c) Cost to buy a similar asset at current price

17. Net Realizable Value is also known as:

a) Current exit price
b) Entry price
c) Replacement value
d) Book value
Answer: a) Current exit price

18. Economic Value of an asset is measured by:

a) Historical cost
29

b) Market price
c) Present value of future cash inflows
d) Net realizable value
Answer: c) Present value of future cash inflows

19. Depreciation under CCA is calculated on:

a) Historical cost
b) Replacement cost
c) Net realizable value
d) Market value
Answer: b) Replacement cost

20. Backlog depreciation arises due to:

a) Wrong calculation
b) Revaluation of assets
c) Inflation
d) Deflation
Answer: b) Revaluation of assets

21. COSA stands for:

a) Cost of Sales Adjustment
b) Current Operating Stock Adjustment
c) Cash Outflow Statement Adjustment
d) Cost of Standard Assets
Answer: a) Cost of Sales Adjustment

22. Gearing adjustment is related to:

a) Equity capital
b) Debtors management
c) Borrowed funds vs equity funds
d) Inventory valuation
Answer: c) Borrowed funds vs equity funds

23. Monetary Working Capital Adjustment (MWCA) under CCA is:

a) Adjustment for depreciation
b) Adjustment for inflation in working capital
c) Adjustment in reserves
d) Adjustment in dividends
Answer: b) Adjustment for inflation in working capital

24. Hybrid method of accounting for changing prices is a mixture of:

a) FIFO and LIFO
b) CPP and CCA
c) Historical and market value
d) Net realizable and replacement cost
Answer: b) CPP and CCA
30

25. A major criticism of conventional accounting in inflation is:

a) Understatement of profits
b) Overstatement of assets
c) Overstatement of profits, understatement of assets
d) Accurate reporting
Answer: c) Overstatement of profits, understatement of assets

8 MARKS QUESTIONS

[Link] the limitations of conventional (historical) financial statements in the context of

inflation.

[Link] is the Current Purchasing Power (CPP) method? Explain the steps involved in
preparing financial statements under this method.

[Link] the Current Cost Accounting (CCA) method and explain the various adjustments
required in preparing income statements under this method.

[Link] balance sheet of as on 1-1-2010 and the income statement for the year ending 31-12-
2010 are set out below.

Balance Sheet as on 1-1-2010

Liabilities Amt Assets Amt
Share Capital 10000 New Machine 15000
10% Debentures 6000 Stock 2400
GS 3600 Drs 1200
Cash 1000
19600 19600
Income Statement for the year ending 31-12-2010
Particular Rs. Rs.
Sales 10,000
(-) Cost of goods sold : 5000
Opening Stock (FIFO) 2400
Purchases (Net) 4600
7000
(-) [Link] (FIFO) 2000
Gross profit on sales 5000
operating expenses. 800
Dep 1500
Int on debentures paid on
31-12-2010 600 2900
Retail canning 2100
31

Drs and credit balances remain constant throughout the year: General price indices as
given below :
on 1-1-2010 = 200
Avg index for the year = 240
On 31-12-2010 = 300
Your required to prepare the final a/c for the year 2010 after adjusting the price level
change under CPP Method.

Solution:
Calculation of C.F
C.F. for the item as on 1-1-2010 = price index at the date of conversion
Price index at the date of arose.
C.F. as on 1-1-2010 = 300 = 3
200 2
c.f for the item as on
during the year = 300 = 5
240 4
C.F as on 31-12-2010= 300 = 1
300

Restated income statement (as per CPP Method)

Particular Historical Cost C.F Converted Amt
Sales 10000 10000 x 5/4 12500
Opening Stock 2400 2400 x 3/2 3600
(+) Purchases 4600 4600 x 5/4 5750
(-) [Link] 7000 9350
2000 2000 x 5/4 2500
Cost of Sales 5000 6850
Gross Profit (Sales- 5000 5650
Cost of sale)
(-) Operating 800 800 x 5/4 1000
Expenses
Depn 1500 3/2 2250
Int on debenture 600 1 600
Income Before Price 2100 1800
Level gain or loss :
(+) General price
level gain or loss - 2550
Retained Earnings 2100 4350
Statement showing the monetary gain or loss

Particulars Historical Cost C.F Converted Amt

32

Net Monetary
liability as on 1-1-
2010 7400 3/2 11100
(+) purchases 4600 5/4 5750
Operating exp 800 5/4 1000
Int on debenture 600 1 600
13400 18450
(-) Sales 10000 5/4 12500
Net Monetary
Liability as on 31-
12-2010 3400 5950
(-) Net Monetary
liability on 31-12-
2010 on Historical
cost basis 3400
Resultant Monetary
Gain 2550
Calculation of Net Monetary liability as on 1-1-2010

Total Monetary liability as on 1-1-2010

(Debenture + Ers) 9600
(-) Monetary Assets as on 1-1-2010 (Drs +
Cash) 2200
7400

[Link] the net monetary result of x [Link] as on 31/12/2010.

Particulars 1-1-2010 31-12-10
Cash 5000 10000
Book debt 20000 25000
Grs 15000 20000
Loan 20000 20000

Retail price index number:

0n 01.01.2010 – 200
31.12.2010 – 300
Avg index for the year 240.
Solution: -
Cash of conversion factor
Conversion factor = price index at the date of conversion
Price index at the date the item arose
c.f. for the items as on 1-1-2010
= 300 = 3
200 2
c.f for the items happening during the year
= 300 = 5
33

240 4
c.f for the end of year = 1.
Statement showing the net monetary result on account of price level changes.
Particular RS RS
5. Monetary liabilities 52500
as on 1-1-2010
should have gone
upto
[15000+20000]
35000x3
2

6. Increase in monetary
liability during 2010
[40000-35000]
5000x5/4 6250

Monetary liability as 58750

on 31/12/2010 should
have stood at
(-) monetary liability
as on 31/12/2010 40000
actual stood at
18750
Gain on holding
monetary liability
7. Monetary assets as on
01-01-2010
[5000+20000] should
have gone up to
25000x3/2 37500
8. Increase in monetary
assets during
2010[35000-25000]
Which should have
gone up by
10000x5/4 12500

50000
Monetary assets as on
31/12/2010 should 35000
have stood at
34

Monetary asset as on
31/12/2010

15000
Loss on holding
monetary

Net gain on monetary 3750

items

6.

. Ascertain the net monetary result at the end of 2010 from the under mention that
Particular 1-1-2010 31-12-2010
Bank 2000 3000
a/c’s receivable 10000 12000
a/c’s payable 15000 10000
2010’s start index – 100
2010 end index – 200
2010 avg index – 160

Solution
Calculation of conversion factor
c.f as on 1-1-2010 = 200 = 2 = 2
100 1
C.f as on 31-12-2010 = 200 = 1
200
c.f as during the year = 200 = 5
160 4
==

Statement showing the net monetary result on a/c of price level changes.
Particular
1. Monetary liability as on 1-1-2010
should have gone upto
15000 x 2 30000
(-) increase/decrease in monetary
liability during 2010[15000-10000]
6250
5000x5/4

2. Monetary liability as 31/12/2010 23750

should stood at
(-) Monetary liability as on actual
10000 13750
stood at
Gain on holding monetary liability
35

3. Monetary assets as on 1-1-2010

should have gone upto
[2000+10000]12000x2 24000
(+) Increase in Monetary assets
during 2010 [15000-12000]
3750
3000x5/4

Monetary amet as on 31/12/2010 27750

should stood at
12750
(-) Monetary amets as on 31/12/2010
15000
actually stood at

Loss on holding Monetary assets

Net gain on Monetary items 1000

7. From the following details ascertain:

4. Cost of sales
5. Closing inventory as per CPP method when the firm is following (FIFO)Method.
Historical Cost Price Index
[Link] on 1-1-2010 4000 80
Purchases during 2010 20000 125
[Link] (out of purchases
made in last total) 3000 120
index number on 31-12- - 140
2010

Solution

Statement showing the cost of sales and closing inventory under CPP Method following
FIFO
Particular Historical Conversion Converted
cost Factor Amt
Opening Stock 4000 140 = 7 4000 x 7/4
80 4 7000
(+) Purchases 20000 140 = 28
125 25 22400
24000 29400
(-) Closing Inventory 3000 140 = 7
120 6 3500
Cost of sales 21000 25900
Cost of sales = 25900
[Link] = 3500
36

8. . From the following data calculate:

c. Cost of sales
d. [Link] under CPP method presuming that the firm is following LIFO Method for
inventory valuation method.
Particular
Inventory as on 1-1-2000 Rs. 8000
Purchase during 2000 Rs. 48000
Inventory as on 31-12-2000 Rs. 12000
Price index as on 1-1-2000 Rs.100
Price index as on 31-12-2000 Rs. 140
Avg price index for 2000 Rs. 125

Solution
Statement showing the cost of sales and cl. inventory under CPP Method following LIFO
Method.
Particulars Historical Cost C.F Converted Amt
Opening Stock 8000 140 = 7 11200
100 5
(+) Purchases 48000 140 = 28 53760
125 25
56000 64960
(-) [Link] 12000
8000 Rs. Stock is
out of [Link] 8000x7
5
= 11200
The remaining Rs. 4000 x 28
4000 is out of 25 15680
current purchases = 4480
Cost of Sales 44000 49280

Cost of sales = 49280

Closing inventory = 15680
9. Following is the comparative B/S of ABC Ltd as on 31-12-2000 & 2001.

Liabilities 2000 2001 Assets 2000 2001

Current Cash & Receivable 200000 260000

Liabilities 80000 90000

Long Term Inventories (FIFO) 150000 130000

liabilities 100000 116000 Land 40000 40000

Equity Share
37

Equipment 210000 270000

Capital(rs.10) 140000 140000 Less: accumulated - (24000)

depn

Share 280000 280000

premium

Reserve &
surplus - 50000

600000 676000 600000 676000

Income Statement of the Co. for the year ending 31-12-2001.

Particulars Rs. Rs.

Net Sales 800000
(-) Cost of goods sold : 520000
Opening inventories (FIFO) 150000
Purchases (Net) 500000
650000
(-) Closing inventory (FIFO) 130000
Gross Profit 280000
(-) Operating Expenses (Excluding depn) 96000
Depn 24000 120000
Profit before tax 160000
(-)Income Tax 70000
Profit after tax 90000
(-) Dividend paid 40000
Retained Earnings 50000

Equipment costing Rs. 60000 was acquired on 1-7-2001, when the general price index was
157.5. The amount of deprecition has been calculated as follows :
10% on Rs. 210000 - Rs. 21000
5% on Rs. 60000
(rate being 10% p.a) - Rs. 3000
Total depn - Rs. 24000
=======
Sales, purchases, operating Expenses took place evenly throughout the year.
Inventories are priced according FIFO method. goods in closing inventories
where acquired evenly throughout the year. the dividend of 40000 was declared
and paid at the end of 2001. Income tax accrued throughout the year.
38

your required recent above the statement taking into account the price level
adjustment under cpp method.
The general price indices are as follows: at the end of the year 2000
(beginning of the year 2001) -> 150
Average for the year 2001 -> 157.5
at the end of the year 2001 -> 163.8.

solution:
Calculation of conversion factor
Conversion factor for the appearing at the begging = price index at the date of conversion
Price index at the date the item arose.

1-1-2001 = 163.8
150 = 1.092

Conversion factor for the items appearing throughout the year = 163.8
157.5 = 1.04

Co n.f for the item appearing at the end of the year = 163.8
163.8 = 1
Restated income statement under CPP Method
Particular Historical Cost C.F CPP
Sales 800000 1.04 832000
(-) Cost of Sales ;-
Opening inventory 150000 1.092 163800
(+)purchase 500000 1.04 520000
650000 688800
(-) Cl. Inventory 130000 1.04 135200
Cost of sale 520000 548600
Gross Profit 280000 283400
(-) Operating
Expenses (Excluding
depn) 96000 1.04 99840
Deprn 24000 21000 x 1.092
= 22932
3000 x 1.04
3120 26052
Income for price
level gain 160000 157508
General price level
gain/loss - 4800
Income before price
level gain/loss 160000 152708
(-) Income Tax 70000 1.04 72800
39

Income after tax 90000 79908

(-) Dividend paid 40000 1 40000
Retained Earnings 50000 39908
Statement showing the monetary gain or loss
Particular Historical Cost C.F Converted Amt
Net Monitary Assest
as onn 1-1-01.
(Total Monetary
asset – Total
Monetarial) 20000 1.092 21840
(200000-180000)
(+) Sales 800000 1.04 832000
820000 853840
(-) Purchase 500000 1.04 520000
Operating Ex 96000` 1.04 99840
Income Tax 70000 1.04 72800
Dividend Paid 40000 1 40000
Equipment 60000 1.04 62400
purchased
Net monetary assets 54000 58800
as on 31/12/2001
(-) net monetary
assets as per
historical cost
account 54000
Monetary loss 4800

10. From the following information, calculate COSA.

Particulars

Particulars Historical Cost Price Index

Opening Stock as on 1/01/2010 10,000 200

Purchase of material 18,000

Closing Stock as on 31/12 14,100 225

Price Index as on 31/12 = 240

40

You may presume that materials are consumed uniformly throughout the year.
Generally, a month after the date of purchase, the rise in the prices is also
throughout the year.