Constant Dollar Accounting

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

historical cost, current cost accounting, monetary items, non-monetary items