Current Cost Accounting: Definition
The current cost accounting (CCA) technique is adopted in place of the current purchasing power (CPP) of replacement cost accounting technique for price level changes.
The crux of the CCA technique is the preparation of financial statements (balance sheet and profit and loss account) on the current values of individual items and not on the historical or original cost.
Current Cost Accounting: Explanation
In 1975, the UK government’s Inflation Accounting Committee (IAC) designed the CCA technique. Since then, it has been extensively studied and debated, and now it has been finalized by the issue of SSAP 16 (Statement of Standard Accounting Practice).
The CCA system considers price changes that are relevant to a specific firm or industry rather than the whole economy. It seeks to arrive at a profit figure that can be distributed safely in the form of a dividend without impairing the firm’s operational capability.
The CCA method is based on the concept that a business enterprise is an ongoing operation in which the continuous replacement of assets is needed.
In CCA, dollars (or another currency) are used, and assets are valued at their acquisition cost. Hence, no adjustment is made for inflation. Financial statements are drawn up on the assumption that the purchasing power of money is stable over time.
However, since the purchasing power of money differs over different periods of time, these statements do not ultimately measure what they seek to measure. However, CCA is the oldest and the most popular method of inflation accounting.
Features of the Current Cost Accounting Method
The salient features of the CCA method are:
- Fixed assets are shown not at their depreciated original cost but at their net replacement value
- Stocks are shown at their net replacement value
- Depreciation is calculated at the current value of assets
- Gains/losses due to the changes in the price level are shown in a separate statement
- Inventory consumed is valued at the price at the date of consumption
Under the CCA method, assets and expenses are shown in financial statements at the current cost to replace those specific resources. Thus, profit is measured by comparing revenues with the current replacement cost of the assets consumed in the earning process.
Suitability of Current Cost Accounting
The CCA method is suitable when managers within an organization are committed to the industry, and also when they are interested in replacing the present plant with a new one at the end of its useful life.
CCA is generally preferred over the current purchasing power (CPP) technique of price level accounting. This is because it is a complete system of inflation accounting.
Financial statements prepared under the CCA method provide more realistic information and make a distinction between profits earned from business operations and gains arising from changes in price levels.
As depreciation under CCA is provided on the basis of current cost, the method prevents the overstatement of profits and keeps capital intact.
How Current Cost Can Alleviate the Need for the Cost Flow Method
CCA systems can alleviate the need for a cost flow method and, in this way, solve the problem of having either a realistic income statement or a realistic balance sheet, but not both.
In general, current cost is the cost of currently acquiring an item. Under such a system, the cost of goods sold is recorded at the current cost of the item at the time of its sale.
Thus, the gross margin figure, which is the difference between sales and the current cost of goods sold, represents income available to the firm to cover operating expenses after maintaining its ability to purchase new inventory.
On the balance sheet, the ending inventory is recorded at the current cost as of the end of the accounting period. The difference between the current cost of the ending inventory and its historical cost is considered an unrealized holding gain.
Thus, figures on the income statement and balance sheet represent realistic amounts.
CCA is not a generally accepted accounting principle for primary financial statements.
However, due to the perceived importance of these data for current and future investors and creditors, the FASB requires that certain companies disclose selected current cost data on a supplemental basis.
Regarding inventories, FASB Statement No. 33 requires firms with inventories and property, plant, and equipment of more than $125 million, or total assets exceeding $1 billion, to disclose income from continuing operations on a current cost basis.
Also, the current costs of inventory and property, plant, and equipment at the end of the year must also be disclosed.