Use of inflated capital - current cost accounting

Plant capital 100 million Historic plant capital Inflated plant capital 

100 kilotonnes of product with a fixed plant capital of 100 million in 1982 showing a 10% ROI at 1982 prices. For late 1988 with product prices and costs for materials, fuels and labour inflated using the appropriate indices but with capital on an historic basis the profit margin looks good and the ROI very attractive. However if the fixed capital is also inflated to a current value the profit is reduced and the ROI not particularly attractive. Furthermore, in the historic capital case, tax would be levied on a profit of which approximately 40% is needed to maintain the capital base of the company. 

In the situation shown in the historic capital column of Table 6.10 the tax paid and, on the whole company basis, the dividend paid resulting from the apparent profit shown by the above operation would in fact be taken from cash required to maintain the capital base of the company. To correct this highly undesirable situation the current cost accounting approach used in column 3 of Table 6.10, in which all factors in the cost build-up are expressed in terms of current values, is being increasingly adopted. The Institute of Chartered Accounts supports a system of this type and many major companies have worked together to develop a mutually acceptable system. 

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