Financial reporting and changing prices--A review of the issues

The problem of accounting for changing prices, which has been discussed in the academic literature for over 50 years, has affected a wider population in the last decade as regulatory bodies in both the UK and US have developed standards requiring companies to report the effects of changing prices in their accounts. The issues raised illustrate the difficulty of defining and measuring income. Some affected by these developments argue that any price level adjustments are too subjective and wish to adhere to traditional historical cost accounting. Others who accept the case for reform cannot agree on whether allowance should be made for general price changes, specific price changes or both. Agreement cannot be reached either on the benchmark for measuring profit--whether it should be a financial or a physical one--or on the appropriate basis of valuation for the assets of a company. These issues are examined in the light of assumed user needs, showing the effects of some alternatives on profit. The requirements of the UK and US standards, and of a new proposed UK standard, are outlined to illustrate the opinions of the standard setters on these issues; these standards, though similar in parts, differ in a number of respects, particularly over what types of price change should be reflected in accounting information--and how--and what definition of income should be used.