Constant Purchasing Power (CPP)-Accounting

Inflation (changes in the purchasing power of money) is happening and we have to deal with it - no question about that - that is a certainty - the question is just how? By changing the measuring unit as CPP-accounting does? A change in some price index represents the 'exchange rate' between currency units of different dates. The essence of CPP is to translate all measurements in currency units into units at a common date. The logic would be that CPP provides a stable measuring unit to measure profit, whilst an 'unstabilised' i.e. not indexed currency unit, fails to do so.^[1]

After measuring period profit, a lot more has to be done; refer to Period Profit, 3 Basic Questions. The first question is how high or how low, what is the period profit? That must be clarified by profit measurement, after which the profit measurement problem has been solved.^[2] Is the profit enough? Did the company make progress? CPP goes beyond profit measurement and in doing so, it neglects the very essence of measuring. The first step in many CPP-calculations is to bring the opening balance sheet at t, which is expressed in U.S.-dollars at t, up to date into U.S.-dollars at (t + 1). CPP is trying to separate 'real' gains and losses (in constant U.S.-dollars) from 'fictitious' gains and losses (those due to changes in the value of the U.S.-dollars). The basic idea is a good one. Of course the diminishing value of money has to be incorporated into the measure of period profits. How? Not via CPP. CPP-accounting is re-writing history.^[3]

In order to measure, a fixed measurement-unit is needed. It is already enough that one has to deal with constantly changing foreign currencies. All values will be in a constant state of flux without a fixed stated currency. Moreover, money units are physical objects that can be exchanged. The periodical account is made up at the closing balance sheet date. All entries onto the starting balance sheet at t are B_t's (expressed in U.S.-dollars at t) while any amount in the closing balance sheet is a B_{t + 1}, expressed in U.S.-dollars at (t + 1). They remain facts forever.

Suppose, B_{t + 1} is 550 [million U.S.-dollars], to compare with B_t being 500 [million U.S.-dollars], while in the meantime 10 % inflation (diminishing money value U.S.-dollars), then no progress has been made if these figures are supposed to be subsequent period profits. CPP-accounting, busy with exchanging old dollars for new dollars, is trying to reach judgements like this one. That goes beyond profit measurement. Measurement is confined to getting the facts, not to judge them.

The profit of period 1, from t to (t + 1), is an amount B_{t + 1}, expressed in the stated currency at the closing balance sheet date. The measured profit figure is an historical event. Judging the performance starts with a clear picture in view of the facts as they were, a series of proven period profits in bare form. CPP is covering up the facts.

^[1] Sources of reference both for discussion and for numerical examples are the classic works of Edwards and Bell (1961) and of Sweeney (1936), particularly Chapter 3 of the latter.

^[2] This is like saying if you need to measure how much water is in a cup, you measure it and the measuring problem has been solved.

^[3] The balance sheet at t, expressed in U.S.-dollars at t, is a historical fact. It is authentic. The balance sheet is an instantaneous photograph. It stands forever. It is a piece of evidence.