Current Cost Accounting (CCA) - Objective and Evaluation

Current Cost Accounting (CCA): Objective and Evaluation http://www.accountingnotes.net/current-cost-accounting/current-cost-ac...
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In this article we will discuss

about Current Cost Accounting
(CCA):- 1. Definition of Current
Cost Accounting (CCA) 2.
Objectives of CCA 3. Evaluation.
Current cost accounting uses

“value to the business” as the
measurement basis. Value to the
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business is defined as:
(a) Net current replacement cost or, if a

permanent diminution to below net
current replacement cost has been
recognised;
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(b) Recoverable amount. Recoverable

amount is the greater of net realisable
value of an asset and, where applicable,
the amount recoverable from its further
use.
The ‘value to the business’ concept

is illustrated in the following
figure:
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Where an asset will normally be

replaced it is shown at the net current
replacement cost, and charged on this
basis in the profit and loss account.
However, where it is not to be replaced
or where replacement cost is higher
than both net realisable value and
present value, the higher of net
realisable value and present value is
usually used as the measurement basis.
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The replacement cost of a specific asset

is normally derived from the current
acquisition cost of a similar asset, new
or used, or of an equivalent productive
capacity or service potential. Net
realisable value usually represents the
net current selling price of the asset.
Present value represents a current
estimate of future net receipts
attributable to the asset, appropriately
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discounted.
Current Cost Accounting (CCA) aims to

maintain capital of a business
enterprise in terms of its operating
capability. Operating capability is
denoted by the net operating assets of
the enterprise in terms of share-holders
funds. As an equation,
Net Operating assets = Total tangible

assets + Net monetary working capital
(current assets – current liabilities)
A change in the input prices of goods

and services used and financed by the
business will affect the amount of funds
required to maintain the operating
capability of the business enterprise.
Therefore, maintaining the operating
capability is the objective which is
attempted to be achieved under CCA
while preparing profit and loss account
and balance sheet. CCA is based on UK
accounting standard, SSAP 16 Current
Cost Accounting, issued in 1980.
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CCA aims to prepare the

following:
(A) Current Cost Profit and Loss

Account (to determine Current Cost
Operating profit).
(B) Current Cost Balance Sheet.
(A) Current Cost Profit and Loss

Account:
In CCA, the profit and loss account is

prepared to determine the current cost
operating profit (CCOP). CCOP is
determined after allowing for the
impact of price changes, on the funds
needed to continue the existing business
and maintain its operating capability
whether financed by share capital or
borrowing. CCOP is calculated before
interest on net borrowings and taxation.
5 of 36 3/10/2019 11:33 AM
CCOP is determined after making

the following three adjustments to
historical cost profit before
interest and taxes:
(1) Depreciation Adjustment.
(2) Cost of Sales Adjustment (COSA).
(3) Monetary Working Capital

Adjustment (MWCA).
After determining CCOP, interest and

taxes are considered in current cost
profit and loss account to finally
ascertain net income under CCA. Net
income under CCA can be defined as the
surplus amount which can be
distributed to proprietor or
shareholders after keeping the
operating capability of an enterprise
intact.
(1) Depreciation Adjustment:
This reflects the difference between

depreciation calculated on the current
cost of fixed assets and depreciation
charged in computing the historical cost
income. The accounting policy adopted
for the purposes of calculating the
historical cost profit should be followed
when calculating the depreciation on
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the current cost of fixed assets.
The current cost depreciation charge

may be calculated by revising the
depreciation charge in accordance with
change in the appropriate index level
between the year of purchase of the
asset and current year. This is
illustrated by the following example.
A plant was purchased on January 1,

2005 for Rs. 1,20,000 when the price
index was 100. The life of the plant was
estimated to be 10 years having no scrap
value. On December 31, 2009 the
relevant price index was 150. The
following calculations will be made to
arrive at depreciation adjustment figure
on December 31, 2009.
When fixed assets are revalued every

year, there will also be a shortfall of
depreciation representing the effect of
price rise during the current year on the
accumulated depreciation till date. This
shortfall is called backlog depreciation
which is the amount needed to cover
total depreciation provision based on
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current cost at the year end.
This backlog depreciation arising out of

increase in current costs could be
charged either to the general reserves or
against the related revaluation surplus
on fixed assets. The former will ensure
that the enterprise maintains its
operating capital at the time of
replacement of fixed assets. The latter
procedure has been recommended in
the UK Standard (SSAP 16).
(2) Cost of the Sales Adjustment

(COSA):
The cost of the sales adjustment refers

to the difference between current cost of
inventories at the date of sale and
amount charged as the cost of goods
sold in computing the historical cost
profit. Theoretically, current cost of
sales should be determined on an item
by item basis. In a real world situation,
however, it would be impracticable to
do so and therefore, groups of similar
items may be used.
The following example illustrates

cost of sales adjustment. The
following data relate to a
company:
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(3) Monetary Working Capital

Adjustment (MWCA):
The MWCA reflects the amount of

additional (or reduced) finance needed
for monetary working capital as a result
of changes in the input prices of goods
and services used and financed by the
business.
Monetary working capital (usually

represented by the difference between
trade debtors and trade creditors) is an
integral part of the net operating asset
of the business. In times of rising prices,
a business needs more funds to finance
monetary working capital. The
adjustment reflects this additional need
for funds.
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MWCA is calculated if debtors are more

than the creditors. If creditors are more
than the debtors, this is a minus net
working capital. The minus excess
(creditors-debtors) is not regarded as
funding working capital and excluded.
It is included in net borrowing for the
purpose of calculating gearing ratio and
gearing adjustment.
The MWCA is made in the calculation of

current cost operating profit and takes
the form of a charge or credit to profit
and loss account with the corresponding
credit or charge to the current cost
reserve. SSAP 16 of UK requires that
MWCA should include items used in
day-to-day operating activities of the
business.
It includes trade debtors (including

trade bills receivables, prepayments)
and trade creditors (including trade
bills payable, accruals, expense
creditors). MWCA should not include
creditors or debtors relating to fixed
assets bought or sold or under
construction.
Calculating MWCA:
(i) Determine the items to be included
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in MWCA.
(ii) Determine separately the relevant

indices to be used in adjusting debtors
and creditors:
(a) The index for debtors should reflect

changes in the current cost of goods and
services sold attributable to change in
input prices over the period the debt is
outstanding. Indices of selling prices
may be used where these provide a fair
approximation of cost changes in
amount and time.
(b) The index for creditors should

reflect similar changes in the cost of
items which have been financed by
those creditors over the period the
credit is outstanding.
(c) Where the percentage changes in the

indices to be used on debtors and
creditors are similar, a single index can
be used and the adjustment can be
determined in one calculation.
(iii) Apply relevant index or indices to

debtors and creditors to determine
MWCA. In principle, in calculating the
adjustment on debtors the profit
element in debtors should be excluded.
However, the total amount of debtors
11 of 36 3/10/2019 11:33 AM
can be used where this gives a fair

approximation.
(iv) An averaging method, compatible

with the method used for COSA, may be
used to calculate the adjustment.
The following example illustrates

the calculation of monetary
working capital adjustment:
Net Monetary Working Capital in terms

of current cost (Jan. 1) 20,000 X
110/100 = Rs. 22,000
(Dec. 31) 30,000 x 1107120 = Rs.

27,500
Change due to volume = Rs. 27,500 –

Rs. 22,000 = Rs. 5,500
Total change = Rs. 30,000 – Rs. 20,000

= Rs. 10,000
Monetary working capital adjustment =

Rs. 10,000 – Rs. 5,500 = Rs. 4,500
The following journal entry is

made to record monetary working
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capital adjustment:
Profit and Loss A/c Dr. 4,500
To Current Cost Reserve A/c. 4,500
(Monetary Working Capital

Adjustment)
110 becomes the average price index.
Gearing Adjustment:
The current cost operating profit

(CCOP) determined after making the
above three adjustments is the true
amount of profit from operations
(ordinary activities of an enterprise)
which can help the enterprise to
continue to maintain its operating
capability. However, the net operating
assets which are used to indicate
operating capability of a firm are likely
to be financed partly by borrowings.
Therefore, the effect of the borrowings

is considered while determining profit
which can be distributed to
shareholders. This effect is measured
through calculating gearing ratio and
subsequently the amount of gearing
adjustment. No gearing adjustment
arises, where a company is wholly
13 of 36 3/10/2019 11:33 AM
financed by shareholder’s capital.
A company that has a large proportion

of fixed interest and fixed dividend
bearing capital to ordinary capital is
said to be highly geared. While
repayment obligations in respect of
borrowings are normally fixed in
monetary amount, the proportion of net
operating assets so financed by
borrowings increases or decreases in
value to the business.
Thus, when these assets have been

realised either by sale or use in the
business, repayment of borrowing could
be made so long as the proceeds are not
less than the historical costs of those
assets. It is, therefore, suggested that
the current cost profit attributable to
shareholders should be determined by
taking into account the method of
financing the net operating assets.
The current cost profit attributable to

shareholders reflects surplus for the
period after making allowance for the
impact of price changes on funds
needed to maintain the shareholder’s
proportions of the net operating assets.
Thus, gearing adjustment is made
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where a proportion of the assets of

business is financed by borrowing. Net
borrowing is defined as the amount by
which liabilities exceed assets.
Liabilities and assets for the purpose of
gearing adjustment are defined as
follows:
Liabilities are the aggregate of all

liabilities and provisions (including
convertible debentures and deferred tax
but excluding dividends) other than
those included within monetary
working capital. Assets are the
aggregate of all current assets other
than those that are subject to a cost of
sales adjustment and those that are
included within monetary working
capital.
The gearing adjustment itself results

from the application of the gearing ratio
to the net adjustment made in
converting the historical cost income to
current cost income. The gearing ratio is
found in the relationship between net
borrowings and average net operating
assets. Average net operating assets is
obtained from the opening and closing
net operating assets divided by two.
The gearing ratio formula is:
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Net borrowings = All liabilities and

provisions including convertible
debentures and deferred tax but
excluding dividends and items included
in MWCA
minus
All current assets other than items

included in MWCA and COSA.
If the total of current assets (bank

balance) is more than the current
liabilities, no gearing adjustment is
calculated.
Sometimes, gearing ratio is

calculated using average equity
capital, as follows:
Current Cost Reserve:
Current cost accounting suggests the

creation of a reserve account, known as
current cost reserve account.
The current cost reserve includes:
(i) Current cost adjustments, i.e.,
16 of 36 3/10/2019 11:33 AM
depreciation backlog adjustment, cost of

sales adjustment and monetary working
capital adjustment,
(ii) Gearing adjustment,
(iii) Un-realised revaluations surpluses

on fixed assets, closing stock and
investment.
The gearing adjustment amount is

credited to profit and loss account and
debited to Current Cost Reserve
Account.
Example:
Assume a company has a capital

mix of 40 per cent debt and 60 per
cent equity. The following
amounts of adjustments have
been found using CCA method:
In the above case debt constitutes 40

per cent of the total capital. Therefore,
the amount of gearing adjustment will
be Rs. 22,000 (Rs. 55,000 x 40%). It
means only Rs. 33,000 which
represents shareholders’ share will be
charged to Profit and Loss account. The
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Current Cost Reserve Account will be

credited with the amount of Rs. 33,000
on account of three adjustments.
Alternatively, more preferably, Rs.

55,000 is charged to Profit and Loss
account. Since the amount of gearing
adjustment is credited to Profit and
Loss account, the net effect is that only
Rs. 33,000 stands charged to Profit and
Loss account. Also, gearing adjustment
is debited to Current Cost Reserve
account.
(B) Preparation of Current Cost

Balance Sheet:
Under current cost accounting, current

cost balance sheet is prepared.
Balance sheet items are treated in

the following manner:
(1) Fixed Assets:
The fixed assets should be shown in the

balance sheet at their value to the
business. The value of the business of an
asset is the amount which the business
would lose if it were deprived of that
asset.
Determining the value to the business,
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i.e., generally the current cost of fixed

assets, involves great difficulty, because
usually the assets now in use were
acquired long ago than is typically the
case with inventory, and the assets in
use, if replaced currently, would be
replaced by different assets.
Thus, if a used asset of like age and

condition to the asset in use can be
priced, that will set the current cost. If a
new asset has to be used as the basis for
pricing the old asset, adjustments have
to be made for the differences in life
expectancy, productive capacity, quality
of service, and operating costs between
the new and the old asset.
The concepts of gross and net current

replacement cost are important in this
context. The gross current replacement
cost of an existing asset is the cost that
would have to be incurred at the date of
the valuation to obtain and install a
substantial identical asset in new
conditions. For example if a plant
purchased on January 1, 2007 for Rs.
80,000 can be purchased on December
31, 2009, for Rs. 1,00,000, its gross
current replacement cost on December
31, 2009, will be Rs. 1,00,000.
19 of 36 3/10/2019 11:33 AM
The net current replacement cost of an

existing asset refers to that part of the
gross current replacement cost which
represents its unexpired service
potential. For example, suppose the
plant in the above example is estimated
to have an economic life of five years.
Since it has been used for three years,
its net current replacement cost would
be Rs. 40,000 (assuming that the
equipment will have a zero scrap value
at the end of its economic life).
In circumstances, where the asset in use

would not be replaced, if for any reason
it were taken out of service, its value to
the business is not its current cost but a
lower recoverable amount.
This recoverable amount is its value if

sold or its value if used, whichever is
higher. Its value if sold is its realisable
value, net of selling costs. Its value in
use is the net present value of future
cash flows (including the ultimate
proceeds of disposal) expected to be
derived from the use of the asset by the
enterprise.
(2) Land and Buildings:
The land and buildings occupied by the
20 of 36 3/10/2019 11:33 AM
owner himself, should be shown in the

balance sheet at their value to the
business which will normally be the
open market value for their existing
uses, plus estimated acquisition costs.
However, in cases where an open

market valuation of the land and
buildings as a whole cannot be made,
the net replacement cost of the
buildings and the open market value of
land for its existing use plus the
estimated acquisition costs should be
taken as their value to the business. The
valuation should be made by
professionally qualified valuers at
periodic intervals.
(3) Inventories:
In the balance sheet, inventories should

normally be shown at the lower of the
current replacement cost as on the date
of balance sheet and the net realisable
value.
Revaluation Surplus Transferred

to Current Cost Reserve Account:
Increase in the value of fixed assets like

plant and machinery, land and building,
closing stock, investment is credited to
current cost reserve account The
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increase in value of fixed asset is arrived

at by deducting the net historical cost of
the asset from its net current cost at the
end of the year, both sums being
calculated before taking depreciation
into account.
To take an example, assume a plant was

purchased for Rs. 1,20,000 having a
useful life of ten years. Its replacement
cost now is Rs. 1,80,000.
In the fifth year, the amount to be

transferred to current cost reserve
account will be Rs. 36,000,
calculated as follows:
The profit and loss account,

balance sheet and current cost
reserve account under current
cost accounting will appear as
follows:
Current Cost Accounting (CCA)

Profit and Loss Account:
Notes:
1. Alternatively, gearing adjustment
22 of 36 3/10/2019 11:33 AM
amount could be deducted from the

total of current cost operating
adjustments (dep. adjustment, COSA
and MWCA). The result will be the same
if gearing adjustment is deducted from
current cost adjustments, or if not
deducted from current cost operating
adjustment and subsequently added to
current cost profit.
2. Gearing adjustment is calculated only

when a firm is financed partly by
borrowing. No gearing adjustment
arises when a company is wholly
financed by shareholders’ capital. To
find out the net borrowings, cash
balance is deducted from total
borrowings. Or if cash balance is more
than the borrowings, there will be no
gearing adjustment.
The above profit and loss account

(prepared in a statement format)
can be shown in a T format, as
below:
23 of 36 3/10/2019 11:33 AM
Illustrative Problem 2:
A company buys and sells goods.

During the three months ending
March 31, 2009, the company
enter into the following
transactions:
Current Purchasing Power

Accounting with Illustrative
Problem 2
Illustrative Problem 3:
The following are the profit and

loss account for the year ending
December 31, 2008 and balance
sheets as at December 31, 2008
and December 31, 2009 prepared
on historical cost basis:
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The following additional

information has been provided:
(i) The general purchasing power

price-level indices for 2008 and
2009 were as follows:
(ii) Fixed assets were acquired when the

purchasing power index was 100.
(iii) All transactions, sales and

purchases occurred evenly throughout
the year.
(iv) Stock at January 1, 2009 was

acquired evenly during the last three
months of 2008.
(v) Stock at December 31, 2009 was

acquired evenly during the last three
months of 2009.
25 of 36 3/10/2019 11:33 AM
(vi) Depreciation of plant and

machinery is at the rate of 14% on cost.
(vii) The specific price indices

relating to plant and machinery
were as follows:
(viii) The specific price index was 100

when the plant and machinery was
purchased.
(ix) The specific price indices for

stock were as follows:
(x) The specific price indices used for

stock are to be used in computing the
monetary working capital adjustment.
(xi) The freehold premises were valued

on an existing use basis, the value being
Rs. 45,000 at December 31, 2008 and
Rs. 75,000 at December 31, 2009.
(xii) The aggregate monetary working

capital adjustment to December 31,
2008 was Rs. 2,130 and the aggregate
cost of sales adjustment was Rs. 6,907.
26 of 36 3/10/2019 11:33 AM
The accumulated depreciation

adjustment to December 31, 2008 is to
be charged equally between the profit
and loss account and the current cost
reserve.
(xiii) The debenture interest was paid

on December 31, 2009.
Solution
27 of 36 3/10/2019 11:33 AM
28 of 36 3/10/2019 11:33 AM
The adoption of current cost or lower

recoverable amount in place of
historical cost as the attribute to be used
for measuring assets and if relevant,
liabilities also, would greatly increase
the relevance of information conveyed
in financial reports, and it would
increase its utility and representational
faithfulness.
It is important that the value of an item

to the business must be capable of being
determined reliably; if this cannot be
done, a surrogate for it must be found
satisfactorily.
The basic objective of current cost

accounts is to provide more useful
information than that available from
historical cost accounts for the guidance
of management of the business, the
shareholders and others on such
matters as the financial viability of the
business, return on investment; pricing
policy, cost control and distribution
decisions; and gearing.
The current cost accounting possesses

the merit of closely approximating the
29 of 36 3/10/2019 11:33 AM
impact of specific price changes on the

business enterprise because it makes
use of specific indices. The CCA
measures an individual company’s
experience of inflation by reference to
that company’s specific pattern of
expenditure.
As such, the method seeks to maintain

the operating capability of the
enterprise during inflation. The same
tools of analysis as those applied to
historical cost accounts are generally
appropriate.
The ratios derived from current cost

accounts for such items as gearing, asset
cover, dividend cover and return on
capital employed will often differ
substantially from those revealed in
historical cost accounts but should be
more realistic indicators when assessing
an entity or making comparisons
between entities.
SSAP 16 points the limitations of

CCA as follows:
“As with historical cost accounts, CCA

(based on value to tile business concept)
is not a substitute for forecasting when
such matters as a change in the size or
30 of 36 3/10/2019 11:33 AM
nature of the business are

consideration. It assists cash flow
forecasts, but does not replace them. It
does not measure the effect of changes
in the general value of money or
translate the figures into currency of
purchasing power at a specific date.
Because of this it is not a system of
accounting for general inflation.
Further, it does not show changes in the
value of the business as a whole or the
market value of the equity.”
An important weakness of this model is

that is seems to possess an element of
subjectivity inherent in periodic
revaluations, specially where specific
price indices are not generated by an
authoritative agency.
Furthermore, perhaps the largest

problem is the aggregation problem.
The value to the firm principle has its
theoretic roots in the valuation of the
individual assets, not the firm as a
whole, but accounts, whether balance
sheets or profit and loss accounts, are
aimed at the assessment of the
performance of the business as a whole.
Other important problems include the

precise definition of replacement cost
31 of 36 3/10/2019 11:33 AM
under conditions of economic and

technological change: replacement cost
is fundamental to the value to the firm
method.
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In this article we will discuss

Current cost accounting uses

business is defined as:

(a) Net current replacement cost or, if a

(b) Recoverable amount. Recoverable

The ‘value to the business’ concept

Where an asset will normally be

The replacement cost of a specific asset

Current Cost Accounting (CCA) aims to

Net Operating assets = Total tangible

A change in the input prices of goods

CCA aims to prepare the

(A) Current Cost Profit and Loss

(B) Current Cost Balance Sheet.

(A) Current Cost Profit and Loss

In CCA, the profit and loss account is

CCOP is determined after making

(1) Depreciation Adjustment.

(2) Cost of Sales Adjustment (COSA).

(3) Monetary Working Capital

After determining CCOP, interest and

(1) Depreciation Adjustment:

This reflects the difference between

the current cost of fixed assets.

The current cost depreciation charge

A plant was purchased on January 1,

When fixed assets are revalued every

current cost at the year end.

This backlog depreciation arising out of

(2) Cost of the Sales Adjustment

The cost of the sales adjustment refers

The following example illustrates

(3) Monetary Working Capital

The MWCA reflects the amount of

Monetary working capital (usually

MWCA is calculated if debtors are more

The MWCA is made in the calculation of

It includes trade debtors (including

(i) Determine the items to be included

(ii) Determine separately the relevant

(a) The index for debtors should reflect

(b) The index for creditors should

(c) Where the percentage changes in the

(iii) Apply relevant index or indices to

can be used where this gives a fair

(iv) An averaging method, compatible

The following example illustrates

Net Monetary Working Capital in terms

(Dec. 31) 30,000 x 1107120 = Rs.

Change due to volume = Rs. 27,500 –

Total change = Rs. 30,000 – Rs. 20,000

Monetary working capital adjustment =

The following journal entry is

Profit and Loss A/c Dr. 4,500

To Current Cost Reserve A/c. 4,500

(Monetary Working Capital

110 becomes the average price index.

The current cost operating profit

Therefore, the effect of the borrowings

financed by shareholder’s capital.

A company that has a large proportion