THE MEASUREMENT FUNDAMENTALS OF
At the beginning of the period, $4 billion would allow the corporation to buy a "basket of goods." Due
to the increase in the general price level, the same basket of goods would cost more than $4 billion at
the end of the period. Therefore, the corporation would have less purchasing power at the end of the
period than at the beginning of the period. The decrease in purchasing power would be computed as
Compute the cost of the basket of goods at the end of the period:
(1 + inflation rate)
1.02 = $4,080,000
Compute change in cost of the basket of goods for the period:
$4,080,000 – $4,000,000 = $80,000
This decrease in purchasing power would not be reflected in the corporation's financial statements.
Accountants adhere to the
stable dollar assumption
, which means that changes in the general
price level are ignored when determining the value of assets and liabilities. This assumption allows
users of financial statements to compare financial statements from different points in time.
Boeing would want to keep its cash balance as low as possible because money sitting as cash
makes very little to no investment income.
Most companies would try to maximize its interest income
by investing most of its cash.
At the same time the company would not reduce its cash balance to
zero because it has to have cash on hand to pay bills as they come due everyday.
Each land acquisition would be recorded at its original cost of $15,000, for a total of $30,000.
No, the company could not purchase the same basket of goods for $15,000 in 2005 as in 1987.
To purchase the same basket of goods in 2005, the company would need $24,000 [$15,000
+ 60%)]. Therefore, cash held by the company from 1987 to 2005 would be subject to an
economic loss of $9,000 ($24,000 – $15,000).
There are two alternatives for reporting the value of the land if the stable dollar assumption is
ignored. The first alternative is to report both pieces of land at 1987 dollars. The second
alternative is to report both pieces of land at 2005 dollars. The two alternatives are shown below.