General Price Level Accounting
General Price Level Accounting (GPLA) is a system of accounting in which financial statements are adjusted according to changes in the purchasing power of the currency. This method of accounting, also known as inflation accounting, aims to provide more accurate financial information by considering the impact of inflation on financial statements.
In traditional accounting, financial statements are prepared based on historical costs, meaning the price paid for an item when it was originally bought or produced, regardless of changes in its price due to inflation or deflation over time.
In contrast, GPLA adjusts these historical costs to reflect their current value. This adjustment is usually done by applying a general price index to the historical costs.
For example, if a company purchased a building for $100,000 ten years ago, and the inflation rate over this period was 20%, the adjusted cost of the building would be $120,000 under GPLA.
Using GPLA can provide a more accurate picture of a company’s financial status in an inflationary or deflationary environment. However, it can also make financial statements more complex and harder to understand for those who aren’t familiar with this method. It’s worth noting that GPLA is not widely used in practice, primarily due to these complexities and the fact that many accounting standards, such as the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), still rely on the historical cost principle.
Example of a General Price Level Accounting
Imagine a company, ABC Inc., bought a piece of machinery for $10,000 in 2015. In 2023, the company wants to prepare its financial statements.
If ABC Inc. were using traditional accounting methods, the machinery would still be recorded on the balance sheet at its historical cost of $10,000 (less any depreciation that might have been charged over the years).
Now, let’s say the rate of inflation over these eight years has been 3% per year. If ABC Inc. was using GPLA, the original cost of the machinery would be adjusted to reflect this inflation.
So, the adjustment would be:
$10,000 * (1 + 0.03) ^ 8 = $12,689.58
The machinery would be recorded in the 2023 financial statements at $12,689.58 (again, less any depreciation over the years).
By doing this, ABC Inc.’s balance sheet reflects a more realistic replacement cost for the machinery, taking into account the purchasing power of the dollar in 2023 as opposed to 2015. This can provide a more accurate picture of the company’s current financial position in real terms.
It’s important to note that while this example makes it seem straightforward, in practice, GPLA can be quite complex, as different items may need to be adjusted using different indexes and at different rates. Furthermore, GPLA is not commonly used under most established accounting frameworks like GAAP or IFRS.