Purchasing Power Isn’t the Same Thing as Exchange Rate
The purchasing power of a nation’s currency refers to that nation’s ability to purchase goods. Usually purchasing power is measured using a list of necessities such as certain groceries, utilities, and other requirements for daily life, but for simplicity’s sake, say that purchasing power is measured in beer.
Purchasing power by itself doesn’t really mean anything, but when used to track changes over time, it helps measure inflation. For example, if the price of beer goes up from $100 per keg to $101 per keg in a year, then the nation experienced 1 percent inflation that year.
Purchasing power also comes into play when you’re comparing the ability of your money to buy something in your home country and the ability of a foreign currency to buy the same something in the foreign nation. This comparison is called purchasing power parity (PPP).
For example, if $100 buys a keg of beer in the U.S., but that exact same keg of beer, when bought in Great Britain, costs 124 pounds, then the purchasing power parity of the pound in Great Britain to the dollar in the U.S. is USD100 = GBP124, USD1 = GBP1.24.
Probably the most famous way of measuring PPP is by using the Big Mac Index, which uses the price of a Big Mac in every nation to determine PPP.
Exchange rate, on the other hand, refers to how much foreign money you can buy with your money. As of this writing, you need $1.33 in U.S. dollars to purchase 1 British pound.
Note that the exchange rate is different from the PPP. If a nation has a very low exchange rate (meaning that you can buy a lot of its money for cheap) but the PPP in that nation is higher than your country’s PPP, then the two measurements tend to balance each other out as far as exports go.
For instance, if Great Britain has a purchasing power that’s 1 percent higher than the U.S. and an exchange rate that’s 1 percent lower than the U.S., then British prices would be the same as U.S. prices for any U.S. dollars that you exchange into pounds.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
