Prices in the economy have increased by 10% over the last year. Company A has monetary assets of £80,000 and monetary liabilities of £90,000, based on Current Purchasing Power Accounting (CPPA) which of the following statements is correct: Prices in the economy have increased by 10% over the last year. Company A has monetary assets of £80,000 and monetary liabilities of £90,000, based on Current Purchasing Power Accounting (CPPA) which of the following statements is correct: Company A will gain in real terms Cannot be established from this information Company A will lose in real terms There will be no effect on the company
Question
Prices in the economy have increased by 10% over the last year. Company A has monetary assets of £80,000 and monetary liabilities of £90,000, based on Current Purchasing Power Accounting (CPPA) which of the following statements is correct:
Prices in the economy have increased by 10% over the last year. Company A has monetary assets of £80,000 and monetary liabilities of £90,000, based on Current Purchasing Power Accounting (CPPA) which of the following statements is correct:
Company A will gain in real terms
Cannot be established from this information
Company A will lose in real terms
There will be no effect on the company
Solution
Company A will lose in real terms.
Here's why:
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Monetary assets are those assets that are in cash or can be converted into cash at their current value. In this case, Company A has monetary assets of £80,000.
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Monetary liabilities are the obligations that the company has to pay in cash. In this case, Company A has monetary liabilities of £90,000.
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When prices in the economy increase (inflation), the purchasing power of money decreases. This means that the same amount of money can buy less goods and services than before.
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In this case, prices in the economy have increased by 10%. This means that the real value (purchasing power) of Company A's monetary assets has decreased.
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At the same time, the real value of Company A's monetary liabilities has also decreased. However, since the company has more liabilities than assets, the decrease in the real value of liabilities is less beneficial to the company than the decrease in the real value of assets is harmful.
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Therefore, in real terms (taking into account the decrease in purchasing power due to inflation), Company A will lose.
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