Hi everyone.
I have aproblem to understand the Purchasing Power Gain/Loss of example 7 in Reading 20 (p.263). I know that monetary Assets and Liab. are not restated for inflation. In this example, we have Cash and Note Payables as mon. A&L.
Q1: why are tehy differentiating cash in two sub-categories (loss from holding cash @ beginning of the year vs. loss from increase during the year)?
Q2: why are they taking a price index of 125 for the loss during the year, whereas they are taking an index of 100 for the beginning cash?
Q3: how would it look like, if the cash balance during the year would not increase, but decrease? Wouldnt you getting a translation gain now? And…are you again making two steps for getting the cash adjustment (beginning cash vs. cash decrease during the year)?
Q4: What steops are you including in Purch. Power G/L if the Notes Payables would have been higher or lower at the end of the year??
I am really really thankful for every answer. I maybe spent 2 hours to find some answers to my questions…but I couldnt.
Took a stab at it: Q1: They have two categories because inflation ate at their cash over different durations of time—remember this BS is at the end of the year. The longer, the worse. The BS amount FC1,000 was exposed longer than the FC750 income because they used an average rate since the Revenue was earned over a the course of the year. (But, they had more monetary liabilities than cash, so overall inflation wasn’t a bad thing for them. Their debt was worth less, all else equal.) Q2: “The foreign country experienced significant inflation in 20X1, especially in the second half of the year.” Think of their version of CPI going from 100 → 200 over the whole 12 months, but they show that it wasn’t really until July that inflation heated up… so relatively speaking, based on looking at the average rate for the earnings, those dollars were affected more than dollars sitting on the BS. Similar to your Q1. Q3: This is a trickier one for me… I don’t think they’d have a gain in the pure sense of the word, but it might make sense to spend it sooner if your purchase was worthwhile? Say they bought some land in early January—that would be restated in a way that would help the BS, versus sitting in cash. More assets on paper relative to liabilities. Good thing. Now if they paid off some of their payables with the cash, that would not be as good. Moreover, yes, you would use the index level from the date you bought the non-monetary asset (assuming you didn’t pay off a monetary liability). Q4: Well, monetary items aren’t restated (in the sense that you always multiply by: the full increase in index divided by the entire increase in index, but that equals 1 since your increase time is 0—if that’s confusing ignore it), so you would just include it as part of your net gain/loss in net income. I’d think any gain you had on getting rid of the cash mid-year would be logically offset by the time you waited to purchase non-monetary assets and missed out on a higher restatement value.