INFLATION ACCOUNTING

By: Trina Bhagat

PRN: 09020242005
MBA-AB
2009-11
 Inflation: Definitions
 Decrease in purchasing power of money due to an
increase in the general price level
 “A process of steadily rising prices resulting in
diminishing purchasing power of a given nominal sum
of money”
The Penguin Dictionary of Economics
 “Rise in prices brought about by the expansion of the
supply of bank money, credit, etc.”
Oxford Advanced Learner’s Dictionary of Current
English.
INTRODUCTION
 One of the chief functions of money is to act as
the measure of value.
 During the period a country is either under the
grip of inflation or depression and thus the value
of its currency constantly and radically changes.
 As a result, the use of money as the yardstick for
the measurement of performance for a period of
time or value of anything at any point 'of time is
subject to severe doubts.
Continued..
 This phenomenon became glaringly apparent during the post World
War II period when the value of money began to steadily fall all the
world over..
 Accountants all over the world faced challenges primarily in two
spheres:
 how to have a true measure of performance and
 how to prevent erosion of real capital caused by widespread inflation.
As a result of this some tools and techniques such as revaluation
accounting, stabilized accounting, inflationary accounting came in to
picture.
PROBLEMS IN ACCOUNTING AND
FINANCE DURING INFLATION
 Costing and pricing of product,
 Replacement of capital assets,
 Maintenance of real capital,
 Payment of taxes and dividends.
 Valuation of inventory,
 Analysis and interpretation of financial
statements,
 Liquidity of funds.
 All these problems are interrelated.

 During inflation input costs tend to rise continuously.

 In order to maintain the same level of profitability,
prices of products have to be continuously increased.
 But this is neither desirable nor practicable every
time. Even if it is possible, there would always be a
time-lag between cost increase and price increase
 Continued…
 During the period of inflation the price of assets like plant,
machinery, furniture, etc also keeps on increasing.
 This would lead to constant depletion of capital in real terms.
 The depletion of real capital is caused by a number of factors,
namely:
 inadequate depreciation as it is charged on historical cost,
 payment of higher taxes on the basis of monetary profit,
 payment of dividend also on the basis of monetary profit,
 holding of fewer items or smaller quantity of inventory
compared with the amount of money locked up in inventory,
etc
INFLATION ACCOUNTING/
ADJUSTMENT TECHNIQUES
 These can be broadly divided into the following
groups:
 Partial Adjustments
 The Current Purchasing Power (CPP) Method
 Value Accounting
 Cash Flow Accounting
 Current Cost Accounting (CCA)
Current Purchasing Power [CPP]

 It is a simple method of presenting the published data

prepared on historical cost basis after suitably
adjusting these using appropriate price indices.
 Retains historic cost accounting conventions
 In U.S. General Purchasing Power (GPP)
 Expresses accounts in terms of “purchasing units”
 Maintains the general purchasing power of the
invested capital
Current Purchasing Power [CPP]
 Monetary items - financial assets and liabilities -
remain unchanged
 Inventories: FIFO purchase cost is corrected by a
suitable correction coefficient to correspond the
purchase power of the end of accounting period
 Fixed assets:
 The purchase cost is corrected to correspond the purchase
power of the end of the accounting period
 The balance value of the fixed assets is the same
percentage of the corrected purchase cost as the book value
is of the original purchase cost
Current Cost Accounting [CCA]
 This has been developed by a committee with F Sandilands (therefore,
called The Sandilands Committee) set up in UK in 1974.
 Subsequently, through what is known as Hyde Guidelines, CCA has
been given a more concrete shape.
 The guidelines require that published financial statements of
companies listed on the Stock Exchange should include a prominent
separate statement showing the financial results as amended by 4
separate adjustments:
 (a) a Depreciation Adjustment
 (b) a Cost of Sales Adjustment (COSA)
 (c) Monetary Working Capital Adjustment (MWCA)
 (d) Gearing Adjustment
 Current Cost Accounting [CCA]

 The guidelines deal only with the items in the profit

and loss account and leave balance sheet items
untouched.
 Although there have been numerous deliberations on
CCA, particularly in UK, it is yet to be officially
accepted as an inflation accounting method in UK
itself- let alone in other countries.
Reference
 http://www.xrefer.com/entry/445526
 http://www.drury-online.com/
 www.google.com
 www.wikipedia.org