Question

Describe how the General Price Level Adjusted (GPLA) model accounts for changes in the general purchasing power of the reporting currency over time.  What are its strengths and weaknesses of this model?

Answer 1

This method of adjustment, applied to a current cost base, underlay FAS33 as modified by FAS82 in the USA. Finally, Edwards and Bell's historical cost base is compared with a recent British proposal for a one-line adjustment to capture the effects of inflation on historical cost profit. The simplicity of the latter proposal lies in the form rather than the substance of the information presented.

Strength Of GPLA--

(1) It enables company to present more realistic view of its profitability because current revenues are matched with current costs.

(2) Depreciation charged on current values of assets in inflation accounting further enables a firm to show accounting profits more nearer to economic profits and replacement of these assets when required.

(3) It enables a company to maintain its real capital by avoiding payment of dividends and taxes out of its capital due to inflated profits in historical accounting.

(4) Balance Sheet reveals a more realistic and true and fair view of the financial position of a concern because the assets are shown at current values and not on distorted values as in historical accounting.

(5) When financial statements are presented, adjusted to the price level changes, it makes possible to compare the profitability of two concerns set up at different times.

Weakness Of GPLA--

Some people are of the opinion that inflation accounting may create more problems than solving them because of the following inherent disadvantages of the price level accounting:

(1) Adjusting accounts to price level changes is a never-ending process. It involves constant changes and alterations in the financial statements.

(2) Price level accounting involves many calculations and makes financial statements so complicated and confusing that it becomes very difficult for man of ordinary prudence to understand, analyze and interpret them.

(3)Depreciation charged on current values of fixed assets is not acceptable under the Income Tax Act, 1961 and hence adjusting it to price level changes does not serve any practical purpose.

(4) During deflation, when the prices are falling, adjustments of accounts to price level changes will mean charging lesser depreciation and overstatement of profits.