What is Constant Dollar Accounting
Constant dollar accounting is a method of accounting that measures financial statements in figures adjusted for inflation. Constant dollar accounting requires the conversion of historical non-monetary assets and liabilities to current dollar values. The conversion is generally done by using a price index, commonly the consumer price index (CPI). Monetary items, such as cash and cash equivalent items, are not adjusted.
By standardizing financial statement for inflation, better comparisons across different time periods is available.
It is not uncommon to see constant dollar accounting reference as real-dollar value.
BREAKING DOWN Constant Dollar Accounting
Adjusting financial statements using constant dollar accounting allows analysts and investors to compare better companies that purchased assets in different years. However, one weakness of constant dollar accounting is that it relies on a general price index, such as the CPI, that may not accurately reflect the true price changes of their assets. For instance, certain assets may experience varying levels of price inflation or deflation based on regional or other unique factors of economic value production. As an example, manufacturing rich regions such as the Midwest may react more to changes in the price of steel than tourism-heavy states like Florida.
Although constant dollar accounting is helpful in measuring the purchasing power erosion of inflation, another important consideration is technological progress. Sectors such as information technology is an excellent example: The prices of many cellular technologies have fallen significantly over the past twenty years, but the technologies in products and services today are substantially better than 20 years ago. Thus, in many ways, people are spending far less for their cellular phones, but the devices are stronger by multiples of computers just years ago.
Another common example of constant dollar accounting occurs when adjusting incomes for the cost of living to more accurately measure wealth over time.