CHAPTER 39

Financial Reporting and Changing Prices

Questions

Q39-1. A general price-level change is an increase or decrease in the overall level of

prices of goods and services throughout the economy. It is measured by using
a general price-level index such as the Gross National Product Implicit Price
Deflator or the Consumer Price Index for all Urban Consumers.

A specific price change is an increase or decrease in the price of a specific

good or service in the economy. It may be measured through the application
of direct pricing or indexing methods.

Q39-2. A general price-level index is constructed by the government and is designed

to indicate how much the overall level of prices in the economy has changed
over time. The index is calculated based on changes that occur over time in
the prices of a predetermined market basket of goods and services. A base
period is selected and assigned an index number of 100. All other periods in
the index are then assigned index numbers that relate to the base. The GNP
Deflator and the CPI-U are examples of general price-level indexes in the
United States.

Q39-3. A monetary item is either cash, assets that represent a fixed number of pesos
to be received, or obligations that represent a fixed number of pesos to be
paid. A nonmonetary item is any financial-statement item that is not monetary
in nature. Cash, accounts receivable, accounts payable, and interest payable
are examples of monetary items. Examples of nonmonetary items include
inventory, plant assets, obligations under product warranties, and ordinary
shares.

Q39-4. The following methods may be used to determine an assets current cost:
1. Direct pricing. This method requires the use of current market prices (as
indicated by current invoice prices, vendors price lists, current standard
manufacturing costs, or appraisals).
2. Indexing. This method requires the use of an appropriate specific price
index to restate the assets historical cost.

Q39-5. Refer to page 1864.

Q39-6. Refer to pages 1864 to 1865.

39-2 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Q39-7. Refer to pages 1865 to 1866.

Q39-8. Refer to page 1868.

Q39-9. Current cost accounting, one form of current value accounting, is a system in
which the attribute measured in financial statements is current cost, and the
measuring unit is the nominal peso. In a system of current cost accounting, an
asset is measured at the amount a company would currently have to spend to
acquire the same asset in its existing condition. Current costs, as opposed to
historical costs, are used to measure the elements of financial statements, and
holdings gains and losses are reported as the specific prices of a companys
assets and liabilities change.

Q39-10. Holding gains and losses in a system of current cost accounting are items that
occur as a result of changes in the current cost of an asset while it is simply
held over time. In a current cost system, holding gains and losses are reported
in the period in which the current cost of an asset changes, even though the
asset might not have been sold during that period.

Exercises

E39-1. 1. 200 / 80 6. 200 / 200 11. 200 / 195

2. 200 / 195 7. 200 / 195 12. 200 / 195
3. 200 / 64 8. 200 / 200 13. 200 / 194
4. 200 / 200 9. 200 / 112 14. 200 / 195
5. 200 / 192 10. 200 / 167 15. 200 / 200

E39-2. (a) Unrealized holding gain for 2013 is P20,000.

P120,000 P100,000 = P20,000
(b) Unrealized holding gain, adjusted for inflation, for 2013 is P10,000.
P120,000 (P100,000 x 1.10) = P10,000
1.10 = 121 / 110
(c) In part (a) we are saying that Lana Company is better off by P20,000 as a
result of holding the land throughout 2013 (despite the fact that the
company did not sell the land). In part (b) we are saying that Lana
Company is better off by only P10,000 as a result of holding the land.
The specific price of the land rose by 20% during 2013, but the general
price level rose by 10%. Thus, only half of the P20,000 holding gain can
properly be viewed as a real holding gain. The other half is a fictional
holding gain due to inflation.
 Financial Reporting and Changing Prices 39-3

E39-3. 1. Historical cost accounting:

2013: No gain or loss (because no sale occurred).
2014: P20,000 gain (P60,000 P40,000 = P20,000).
2. Current cost accounting:
2013: P5,000 gain (P45,000 P40,000 = P5,000).
2014: P15,000 gain (P60,000 P45,000 = P15,000).

E39-4. Love Company

Current Cost Statement of Profit or Loss and Other Comprehensive Income
For 2013

Sales P28,000
Cost of goods sold 22,500
Current operating income 5,500
Realized holding gain (P22,500 P15,000) 7,500
Conventional income 13,000
Unrealized holding gain (P7,500 P5,000) 2,500
Net income P15,500

Problems

P39-1. Requirement (a)

Fuego Company
Combined Statement of Income and Retained Earnings
Historical Cost / Nominal Peso Basis
For 2013

Sales P300,000
Cost of goods sold:
Beginning inventory P 30,000
Purchases 150,000
Goods available 180,000
Ending inventory 20,000 160,000
Gross margin on sales 140,000
Operating expenses P 40,000
Depreciation expense 10,000 50,000
Income before taxes 90,000
Income tax expense 36,000
Net income 54,000
39-4 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Retained earnings, Jan. 1 -0-

Less: Dividends 14,000
Retained earnings, Dec. 31 P 40,000

Requirement (b)
Fuego Company
Statement of Financial Position
Historical Cost / Nominal Peso Basis
December 31, 2013

Assets
Cash* P 25,000
Accounts receivable** 75,000
Inventory 20,000
Land 50,000
Equipment P 80,000
Less: Accumulated depreciation (10,000) 70,000
Total assets P240,000

Liabilities and Shareholders Equity

Accounts payable*** P 30,000

Ordinary shares 170,000
Retained earnings (see solution part a) 40,000
Total shareholders equity 210,000
Total liabilities and shareholders equity P240,000
_____________
* P10,000 + P225,000 P120,000 P40,000 P36,000 P14,000 = P25,000
** P300,000 x 25% = P75,000
*** P150,000 x 20% = P30,000

Requirement (c)

Fuego Company
Combined Statement of Income and Retained Earnings
Current Cost / Nominal Peso Basis
For 2013

Sales P300,000
Cost of goods sold 190,000
Gross margin on sales 110,000
 Financial Reporting and Changing Prices 39-5
Operating expense P40,000
Depreciation expense* 11,000 51,000
Income before taxes 59,000
Income tax expense 36,000
Current operating income 23,000
Realized holding gain** 31,000
Conventional income 54,000
Unrealized holding gain*** 33,000
Net income 87,000
Retained earnings, Jan. 1 -0-
Less: Dividends 14,000
Retained earnings, Dec. 31 P 73,000
_____________
* (P80,000 + P96,000) 2 = P88,000; P88,000 8 = P11,000
** Realized holding gain for 2013:
Inventory sold (P190,000 P160,000) P30,000
Equipment used (P11,000 P10,000) 1,000
Total P31,000
***Unrealized holding gain for 2013:
Inventory on hand (P24,000 P20,000) P 4,000
Land on hand net (P65,000 P50,000) 15,000
Equipment on hand net (P84,000 P70,000) 14,000
Total on Dec. 31 P33,000
Less: Unrealized holding gain, Jan. 1 -0-
Amount to recognize in 2013: P33,000

Requirement (d)
Fuego Company
Statement of Financial Position
Current Cost / Nominal Peso Basis
December 31, 2013

Assets
Cash P 25,000
Accounts receivable 75,000
Inventory 24,000
Land 65,000
Equipment P 96,000
Less: Accumulated depreciation (12,000) 84,000
Total assets P273,000

Liabilities and Shareholders Equity

Accounts payable P 30,000

39-6 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Ordinary shares 170,000

Retained earnings (see solution part c) 73,000
Total shareholders equity 243,000
Total liabilities and shareholders equity P273,000

Requirement (e)

The major conceptual differences are (1) in the current cost/nominal peso
statements, the elements are measured at current costs, not historical costs,
and (2) in the current cost/nominal peso statements, the holding gain (realized
and unrealized) is separately measured and reported.
P39-2. Requirement (a)
Fuego Company
Schedule Showing Computation of Purchasing Power Loss
For 2013

Nominal Conversion Constant

Peso Basis Factor* Peso Basis
Net monetary items, Jan. 1 P10,000** 1.1025 P11,025
Add: Sources of net monetary
items:
Sales 300,000 1.05 315,000
Deduct: Uses of net
monetary items:
Purchases (150,000) 1.05 (157,500)
Operating expenses (40,000) 1.05 (42,000)
Income tax expense (36,000) 1.05 (37,800)
Dividends (14,000) 1.00 (14,000)
Net monetary items, Dec. 31,
actually on hand P70,000***
Net monetary items, Dec. 31,
that should be on hand if
no purchasing power
gain or loss exists P74,725
Purchasing power loss
(P70,000 P74,725) P(4,725)
_____________
* Conversion factors: 220.5 / 200 = 1.1025
220.5 / 210 = 1.05
220.5 / 220.5 = 1.00
**Net monetary items, Jan. 1: Cash P10,000
Net monetary items, Jan. 1 P10,000
***Net monetary items, Dec. 31: Cash P25,000
 Financial Reporting and Changing Prices 39-7
Accounts receivable 75,000
Accounts payable (30,000)
Net monetary items, Dec. 31 P70,000

Requirement (b)

Fuego Company
Combined Statement of Income and Retained Earnings
Historical Cost / Constant Peso Basis
For 2013

Sales (P300,000 x 1.05) P315,000

Cost of goods sold:
Beginning inventory (P30,000 x 1.025) P 33,075
Purchases (P150,000 x 1.05) 157,500
Goods available 190,575
Ending inventory (P20,000 x 1.05) 21,000 169,575
Gross margin on sales 145,425
Operating expenses (P40,000 x 1.05) 42,000
Depreciation expense (P10,000 x 1.1025) 11,025 53,025
Income before taxes 92,400
Income tax expense (P36,000 x 1.05) 37,800
Income before purchasing power loss 54,600
Purchasing power loss (see solution part a) (4,725)
Net income 49,875
Retained earnings, Jan. 1 -0-
Less: Dividends (P14,000 x 1.00) 14,000
Retained earnings, Dec. 31 P35,875

Requirement (c)

Fuego Company
39-8 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Statement of Financial Position

Historical Cost / Constant Peso Basis
December 31, 2013

Cash P 25,000
Accounts receivable 75,000
Inventory (P20,000 x 1.05) 21,000
Land (P50,000 x 1.1025) 55,125
Equipment (P80,000 x 1.1025) P88,200
Less: Accumulated depreciation
(P10,000 x 1.1025) (11,025) 77,175
Total assets P253,300

Liabilities and Shareholders Equity

Accounts payable P 30,000

Ordinary shares (P170,000 x 1.1025) 187,425
Retained earnings (see solution to part b) 35,875
Total shareholders equity 223,300
Total liabilities and shareholders equity P253,300

Requirement (d)

The major conceptual differences are (1) in the historical cost/constant peso
statements, the elements are measured using the constant peso measuring unit,
not the nominal peso measuring unit, and (2) in the historical cost/constant
peso statements, the purchasing power loss is measured and reflected in net
income.

Multiple Choice Questions

MC39-1. B MC39- 6. B MC39-11. B

2. C 7. B 12. C
3. A 8. A 13. D
4. A 9. A 14. B
5. A 10. A 15. A
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