You are the management accountant of a manufacturing company where production is capital-intensive, using machinery that is estimated to have a five-year life. The present machinery is now approximately three years old. Whilst raw material stocks have a low turnover due to supply problems, finished goods are turned over rapidly and there is minimal work-in-progress at any one time. The technology incorporated in the means of production is thought to be stable.
In recent years, it has not been possible to increase the price of the company's outputs beyond the rate of general inflation without diminishing market share, due to keen competition in this sector. The company does not consider that it has cash-flow problems. The company is all equity financed. Although a bank overdraft is a permanent feature of the balance sheet, this is primarily due to customers being given a 60-day credit period, whilst most suppliers are paid within 30 days. There is always a positive balance of short-term monetary assets.
In the previous financial year, net profit after taxation on a strict historical cost basis was considered very healthy, and the directors felt that they could prudently distribute a major portion of this by way of dividend. The directors are considering whether, and if so how, to reflect price-level changes in their financial statements. They are concerned that this would affect their profit figure and therefore the amount they could distribute as dividend.
The following price-level changes have been brought to the attention of the directors:

You are required to prepare a report for your directors setting out in general terms how to explain to the shareholders the likely impact on the historical cost profit of possible methods of accounting for price-level changes.

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3 years previously 2 years previously 1 year previously Present Retail price index 100 104 107 112 Index for company's machinery 100 116 125 140 Raw materials stock index 100 102 108 120