Definition
The financial accounting term constant dollar accounting refers to the conversion and reporting of historical financial information in current dollars. The constant dollar accounting method requires the conversion of certain historical assets and liabilities to current dollars using a generally accepted measure of inflation such as the Consumer Price Index.
Calculation
Constant Dollar Value = Historical Cost x (CPI in Current Year / Historical CPI)
Where
Historical CPI = the Consumer Price Index at the time of the original journal entry.
Explanation
Recording and reporting transactions at historical costs is one of the long-standing principles of the accounting profession. However, this approach is not without its critics, especially when an economy experiences double-digit inflation. A number of alternative approaches to the reporting of financial statements have been proposed, including constant dollar accounting.
Also known as general price-level and constant purchasing power, constant dollar accounting uses a general index of prices in an attempt to reflect the purchasing power of a corporation's capital. This allows both the company's management team as well as investor-analysts to understand the company's actual cost to replace certain assets.
The constant dollar accounting method converts the historical values of nonmonetary assets and liabilities into current dollars. The conversion process will typically involve a well-known measure of inflation such as the Consumer Price Index (CPI) published by the Bureau of Labor Statistics. Critics of the constant dollar accounting approach argue reliance on a general measure of inflation does not accurately reflect the price change of all assets. Liquid assets and liabilities such as cash and accounts receivable are not indexed for inflation.
Related Terms
The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements. The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.
Moneyzine EditorJanuary 19th, 2024- The financial accounting term nonmonetary item refers to those assets and liabilities whose price in terms of dollars may change over time. Examples of nonmonetary assets include inventory, raw materials, property, plant and equipment. Examples of nonmonetary liabilities include warranties payable and deferred income tax credits.Moneyzine EditorSeptember 20th, 2023
The financial accounting term monetary items refers to those assets and liabilities whose value is measured and stated in cash. Examples of monetary assets include cash, accounts receivable, notes receivable, and investments. Examples of monetary liabilities include accounts payable, notes payable, sales taxes payable, and various accrued expenses.Moneyzine EditorFebruary 8th, 2024
The financial accounting term current cost accounting refers to an approach that values assets at their fair market value rather than historical cost. In practice, current costs can be determined in a number of ways, including applying a specific price index to the book value of the asset.Moneyzine EditorJanuary 12th, 2024
