Definition
Current-Cost Accounting (CCA) is a financial reporting method that prioritizes maintaining the operating capacity of a business. Unlike traditional accounting methods, which use historical costs, CCA values assets at their deprival value, which is the loss a business would incur if it were dispossessed of the asset. This deprival value could be the asset’s replacement cost, net realizable value, or economic value.
This approach helps segregate holding gains from operating profits, preventing the accidental distribution of capital maintenance gains to shareholders. The necessary adjustments include the cost of sales adjustments, depreciation adjustments, monetary working capital adjustments, and gearing adjustments.
Examples
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Replacement Cost Adjustment: Suppose a business owns a piece of machinery purchased for $50,000. Over time, the replacement cost of this machine has risen to $70,000 due to inflation. CCA would adjust the asset’s value on the balance sheet to reflect the current replacement cost.
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Holding Gains and Operating Profits: A company that experiences an increase in the value of its stock inventory due to inflation will separate this increase (holding gain) from the operating profits. This ensures shareholders’ dividends are only paid out of genuine operating profit.
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Depreciation Adjustment: Instead of depreciating an asset based on its historical cost, CCA adjusts depreciation charges according to the asset’s current cost, ensuring maintenance of operating capacity in real terms.
Frequently Asked Questions (FAQs)
Q1: Why was Current-Cost Accounting widely adopted in the UK during the 1970s and 1980s?
A1: Due to high inflation during this period, historical-cost accounting inadequately reflected the current economic realities. CCA was introduced to adjust for inflation and provide more accurate business valuations.
Q2: Why did Current-Cost Accounting fall out of favor?
A2: As inflation rates dropped, the need for frequent adjustments diminished. Additionally, businesses and stakeholders found CCA complex and cumbersome compared to historical-cost accounting.
Q3: What is the deprival value in Current-Cost Accounting?
A3: Deprival value is the economic value an enterprise would lose if it was deprived of using an asset. It could be determined by its replacement cost, net realizable value, or economic value in use.
Q4: What are holding gains?
A4: Holding gains are increases in the value of an asset held over a period, often due to inflation or market factors. In CCA, these gains are separated from operating profits to avoid misleading profitability metrics.
Q5: Is Current-Cost Accounting commonly used today?
A5: CCA is largely abandoned and rarely used today, primarily replaced by other methods such as the historical-cost method and contemporary approaches like fair value accounting.
Related Terms
- Historical-Cost Accounting: An accounting method where assets and liabilities are recorded at their original cost.
- Replacement Cost: The cost to replace an existing asset with a similar new one.
- Net Realizable Value (NRV): The estimated selling price of an asset minus any costs associated with its sale.
- Economic Value: The value of an asset based on its ability to generate future income.
- Holding Gain: An increase in the value of an asset from the time it was acquired to the present time.
- Current Purchasing Power Accounting: An accounting method that adjusts historical costs to current purchasing power.
- Real Terms Accounting: Adjusting financial statements to remove the effects of inflation.
Online Resources
Suggested Books for Further Studies
- “Financial Accounting Theory” by William R. Scott
- “Advanced Accounting” by Debra C. Jeter and Paul K. Chaney
- “Elements of Accounting: An Introduction” by Anthony D. Peck, Robert Fuller
Accounting Basics: “Current-Cost Accounting” Fundamentals Quiz
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