Reviewed by Robert Bloom Concordia University
Using a historical framework, this book provides a critical analysis of the international development of concepts on accounting in an inflationary environment. The author argues that the historical development of price level accounting ideas disregarded “the contexts in which they first arose . . . [and] the specific purposes they were intended to serve” (p. xiii). Clarke contends that the concepts of accounting under inflationary conditions have been haphazardly recycled over time in an unproductive manner.
Specifically, he offers the following criticisms of the drift of ideas about inflation into accounting (pp. 12):
• the inconsistencies between accounting concepts and economic theory—e.g., income;
• the emphasis in much of the literature on consideration of either general price level changes or specific price changes as a complete solution to the problem of accounting for inflation; and
• the indiscriminate transplantation of ideas on replacement costing from the context of utility rate setting to financial reporting.
The book consists of four parts. Part 1 provides general background material on the principal issues analyzed in the book. Part 2 deals with the evolutionary development of accounting for changes in the general price level; Part 3 with changes in specific prices; and Part 4 considers combinations of general and specific price changes.
The historical development of ideas on accounting for inflation is perceptively investigated on the basis of issues rather than using a simple chronological approach. For example, in considering the evolution of accounting thought on general price level accounting, Clarke provides a comprehensive analysis of Middleditch’s work. Contrary to many authors, Clarke emphasizes the fact that Sweeney was not only in favor of general price level accounting but also specific price accounting. The author observes that before the period from 1963 to 1980, voluntary corporate indexation of accounts to reflect general price level changes was “undisciplined and uncoordinated,” largely the result of income tax considerations
Particular emphasis is placed in this study on the “accidental” drift of ideas into accounting from other sources without meticulous examination of their suitability. As a case in point, the author maintains that the use of “fair values” in utility rate regulation necessitated the consideration of both factual and speculative data regarding past and future revenues and expenses, whereas the transplantation of this concept to accounting failed to consider its “illusory nature” (p. 31). Clarke asserts that (p. 191):
Replacement prices and reproduction costs were treated as if they were indicative of the actual monetary worths of ordinary companies’ physical assets, even though no similar indications had been implied in the rate cases.
According to Clarke, accounting for general price level changes emerged as an outgrowth of the international need to stabilize currencies following World War I. Emphasis was placed on general purchasing power losses from holding liquid assets during an inflationary period. Clarke argues that this experience may be the source of the wellen trenched, erroneous idea that holding physical, non monetary assets during an inflationary period precludes the incurrence of general purchasing power gains and losses. In his words (p. 68):
Who gains and who loses general purchasing power during inflation depends not only on the amount of actual money each entity holds or owes, but also on whether the prices for which their vendible physical assets can be sold increase or decrease at a faster or slower rate than the rate of change in the general level of prices.
The author argues that there has been considerable advocacy of current replacement cost accounting as a surrogate model for discounted cash flows—not for its own relevance (p. 242). Also, Clarke asserts that Hicks’ definition of income has been largely misused in accounting literature on price level accounting relying on his ex ante rather than his ex post concept.
Clarke observes that Bonbright’s concept of “value to the owner” stemmed from a judicial opinion on the compensation to be paid those who lost property. Indemnification, says Clarke, does not apply to companies that are not deprived of their assets (p. 258). He also observes that current cost accounting skirts the issue of technological change (p. 292):
. . . various prescriptions have tried to nullify the effects of changing technology with explanations of replacement, in terms of modern equivalent assets.
From chapter to chapter, Clarke’s views are forthright, if not iconoclastic. Contrary to popular belief, he argues that Edwards and Bell provide nothing essentially new. As an example, he asserts that “holding gains,” with which Edwards and Bell are often associated, were introduced into the accounting literature well before their 1961 book.
Critical of gearing and monetary working capital adjustments, which are required for disclosure by some pronouncements on accounting for price level changes, Clarke contends that (p. 410):
The addition of ‘gearing’ . . . and ‘monetary working capital’ . . . adjustments merely accentuates the existing problems with the CCA [current cost accounting] mechanism. The former introduced a notion of capital gearing generally conflicting with that normally used in financial analysis; implied specific financing patterns, for which no empirical support was produced; and implied (and sometimes specified) that the gearing ratio and financing patterns were constant over time, contrary to the observable adaptive behavior of corporations.
Finally, Clarke believes that none of the pronouncements on accounting for changing prices which were issued prior to publication of this study furnishes “a serviceable method of incorporating the financial effects of price and pricelevel variation” (p. 421).
This detailed study, originally the author’s Ph.D. thesis at the University of Sydney, is carefully researched and well documented.
However, the current U.S. and U.K. pronouncements on accounting for changing prices are inadequately examined and sketchily treated. The Dutch contributions to current replacement cost accounting and Chambers’ exit value accounting model are both given short shrift. All in all, the book captures the profound confusion that has long prevailed in this subject area. A critical study, it is provocative and stimulating, shattering many widely held beliefs. Clarke’s study provides a fresh perspective, and is highly recommended reading, on the history of accounting for price changes.
