Chapter

Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

What is Inflation?

Inflation means an upward change in the prices of

goods & services of general consumption.

is due to
the fall in total supply of goods and services.
imbalance in total supply of goods &
services.
changes in general prices of basic
commodities.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Need for Inflation Accounting?

Traditional accounting based on historical cost

fails to

match current revenue against costs that are

current

costs of purchases or depreciation are

shown at historical costs, and are
much below current levels
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Need for Inflation Accounting?

Traditional accounting based on historical cost

fails to
match current revenue against costs that are
current
state profit realistically

as costs of purchases, depreciation

are understated, reported profits are high
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Need for Inflation Accounting?

Traditional accounting based on historical cost fails to

- match current revenue against costs that are
current
- state profit realistically
- provide adequate depreciation for
replacement of assets

depreciation is calculated on book value of assets

that are way below their current market price.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Need for Inflation Accounting?

Traditional accounting based on historical cost fails to

- match current revenue against costs that are
current
- state profit realistically
- provide adequate depreciation for
replacement of assets
- show true and fair view in the financial
statements
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Є Current Value Systems

 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Step # 1 – Convert figures in the balance sheet as

of beginning of the year into purchasing power of
beginning of the year.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Step # 1 – Convert figures in the balance sheet as

of beginning of the year into purchasing power of
beginning of the year.
Step #2 – Convert the figures derived above into
purchasing power at the end of the year.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)
Step # 1 – Convert figures in the balance sheet as of
beginning of the year into purchasing power of
beginning of the year.
Step #2 – Convert the figures derived above into
purchasing power at the end of the year.

Step #3 - Convert figures in the balance sheet as of

end of the year into purchasing power of end of the
year.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)
Step # 1 – Convert figures in the balance sheet as of
beginning of the year into purchasing power of
beginning of the year.
Step #2 – Convert the figures derived above into
purchasing power at the end of the year.
Step #3 - Convert figures in the balance sheet as of end
of the year into purchasing power of end of the year.
Final Step – find out difference between equity at step
two and step three to get profit for the year, expressed
in terms of purchasing power at end of the year.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Є Current Value Systems

Under this method, the current value of an

individual asset is based on the present value of
the future cash flows that are expected to result
from the ownership of the asset.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Є Current Value Systems

Under this method, the current value of an individual asset is
based on the present value of the future cash flows that are
expected to result from the ownership of the asset.

Such present values are calculated from

[a] the estimated cash amount of the future benefits [b] the
timing of these benefits & [c] an appropriate discount factor.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Methods of Inflation Accounting

Є Current Purchasing Power (CPP)

Є Current Value Systems

Under this method, the current value of an individual asset is
based on the present value of the future cash flows that are
expected to result from the ownership of the asset.

Such present values are calculated from

[a] the estimated cash amount of the future benefits [b] the
timing of these benefits & [c] an appropriate discount factor.
This discount factor usually equals cost of capital to the
company.
 Chapter
Chapter Nine
Nine -- Inflation
Inflation Accounting
Accounting

Conclusion
Methods of Inflation Accounting are
criticized as
They are subjective
They are based on estimation
They are not free from flaws
Discussion on this subject gained
momentum with the rise in the price
levels and the tempo died down with
the fall in inflation.