There are two main methods to perform an optimal update of financial statements:
The historical cost adjustment method for changes in the general level, also known as the Index Method, which consists of correcting the unit of measurement used for traditional accounting, using the currency valued at constant prices instead of nominal values.
The Specific Costs or Replacement Values Method, which is applied by quantifying current market values applicable to inventories, fixed assets and other tangible assets, as well as the costs and expenses related to said items.
Index method
It consists of correcting the unit of measurement used by traditional accounting, using constant monetary units instead of nominal monetary units.
Under this approach, historical costs in the financial statements are adjusted by the number of current monetary units that represent an equivalent value of purchasing power. Thus, all values are expressed in current units of equal purchasing power.
Since a general price index is used to establish historical costs, constant currency unit accounting shows the effects of changes on the general price level.
Specific cost update method, also called replacement values:
It is based on the measurement of values that are generated in the present, instead of values caused by exchanges made in the past.
This method differs from constant currency unit accounting in that assets and expenses are shown in the financial statements at current cost to replace those specific resources. The current replacement cost of a specific asset may rise or fall at a rate different from the general price level. Thus, current cost accounting shows the effects on specific price changes, rather than changes in the general price level.
For consistency reasons and to ensure that the figures that make up the accounting information have meaning, it is recommended not to mix the two methods in updating inventories and fixed assets. If carried out for practical reasons, it can only be carried out between assets of a different nature.
