INFLATION

ACCOUNTING
Accounting for
Price Level
Changes
Unit - One

Introduction
The impact of inflation comes in the form of rising
prices of output and assets. As the financial
accounts are kept on Historical cost basis, so they
don't take into consideration the impact of rise in
the prices of assets and output. This may
sometimes result into the overstated profits, under
priced assets and misleading picture of business
etc.
So, the financial statements prepared under
historical accounting are generally proved to be
statements of historical facts and do not reflect the
current worth of business. This deprives the users of
accounts like management, shareholders, and
creditors etc. to have a right picture of business to
make appropriate decisions. Hence,2 this leads

Introduction
Accounting for changing prices (or
Inflation Accounting) is a system of
accounting which regularly records all
items in financial accounting at their
current values.
The system recognizes the fact that the
purchasing power of money is decreasing
day-by-day during inflation and finds out
profit or loss or states the financial
position of the business on the basis of
the current prices prevailing in the
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Introduction
Inflation accounting is a term describing a
range of accounting systems designed to
correct problems arising from historical cost
accounting (or original or acquisition cost) in
the presence of inflation. Inflation accounting
is used in countries experiencing high
inflation or hyperinflation. Hyperinflation is
inflation that is very high or "out of control".
For example, in countries experiencing
hyperinflation,
the
International Accounting Standards Board
requires corporate financial statements to be
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adjusted for changes in purchasing power

Introduction
Fair value
accounting
(also
called
replacement cost accounting or current cost
accounting) was widely used in the 19th and
early 20th centuries, but historical cost
accounting became more widespread after
values overstated during 1920s were
reversed during the Great Depression of the
1930s.
Principles
of
historical cost
accounting were developed after the
Wall Street Crash of 1929.
Decrease in purchasing power of money due
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to an increase in the general price level.

Introduction

The Great Depression was a severe worldwide economic depression in

the decade preceding World War II. The timing of the Great Depression
varied across nations, but in most countries it started in about 1929 and
lasted until the late 1930s or early 1940s. It was the longest, most
widespread, and deepest depression of the 20th century. The depression
originated in the U.S., starting with the fall in stock prices became
worldwide news with the stock market crash of October 29, 1929 (known
as Black Tuesday). From there, it quickly spread to almost every country in
the world.
The Great Depression had devastating effects in virtually every country,
rich and poor. Personal income, tax revenue, profits and prices dropped,
while international trade plunged by more than 50%. Unemployment in the
U.S. rose to 25%, and in some countries rose as high as 33%.
Cities all around the world were hit hard, especially those dependent on
heavy industry. Construction was virtually halted in many countries.
Farming and rural areas suffered as crop prices fell by approximately 60%.
Facing plummeting demand with few alternate sources of jobs, areas
dependent on primary sector industries such as cash cropping, mining and
logging suffered the most.
Some economies started to recover by the mid-1930s; in many countries
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the negative effects of the Great Depression lasted until the start of World

INFLATION ACCOUNTING
Inflation accounting has been adopted as a
supplementary financial statement in the
United States and the United Kingdom and
thereafter all countries in the world
followed the same. To cater to the needs of
an
Inflation
Accounting,
the
IASB
(International Accounting Standard Board)
came out with an Accounting Standard
known as IAS 29.
Effect of Inflation on Business
1. Impact on costs and revenue
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2. Impact on assets and liabilities

INFLATION ACCOUNTING

Aspects
Problems:
Subjectivity Frequent changes
Often complicated calculations
Benefits:
maintaining production capacity
shows the internal logic of accounting

INFLATION ACCOUNTING
The Change in the price level is described by
indexes
General index
Price Index of Gross Domestic Product (GDP)
Cost-of-living Index
Consumer Price Index
Wholesale Price Index
Production Price Index
Special index
Industry index
Commodity group index
Commodity index
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Approaches to Price Level

Accounting
CPPA - Current Purchasing Power
Accounting
CCA - Current Cost Accounting
SGPLA Specific and General Price
Level Accounting
Periodic revaluation of fixed assets
along with the adoption of LIFO
method of inventory
The Finnish AHI-Method
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Current
Purchasing Power Accounting
Based on changes
in general price level
(CPPA)

(
changes)
Under this method of adjusting accounts to price
changes, all items in the financial statements are
restated in terms of a constant unit of money i.e. in
terms of general purchasing power.

For measuring changes in the price level and

incorporating the changes in the financial statements
we use General Price Index, which may be considered
to be a barometer meant for the purpose. The index is
used to convert the values of various items in the
Balance Sheet and Profit and Loss Account.
This method takes into account the changes in the
general purchasing power of money and ignores the
actual rise or fall in the price of the given
item. CPP
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Current Purchasing Power

Accounting (CPPA)
For this purpose, historical figures are
converted into value of purchasing power
at the end of the period. Two index
numbers are required: one showing the
general price level at the end of the period
and the other reflecting the same at the
date of the transaction.
Profit under this method is an increase in
the value of the net asset over a period, all
valuations being made in terms of current
purchasing power.
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Current Cost
Accounting
(CCA)
(Based on changes in prices of specific assets)
The Current Cost Accounting is an alternative to the
Current Purchasing Power Method. The CCA method
matches current revenues with the current cost of the
resources which are consumed in earning them.
Changes in the general price level are measured by
Index Numbers. Specific price change occurs if price
of a particular asset changes without any general
price change. Under this method, asset are valued at
current cost which is the cost at which asset can be
replaced as on a date.
While the Current Purchasing Power (CPP) method is
known as the General Price Level approach, the
Current Cost Accounting (CCA) method is known as
Specific Price Level approach or Replacement
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Cost Accounting.

Specific and General Price Level

Accounting
This approach of accounting for price
level changes combines the two
approaches CCA and CPP while
preparing financial statements.
It takes into consideration both
changes in specific prices of individual
items and the influences of general
price level changes.
Under this approach, values shown in
financial statements are based on
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Periodic Revaluation of Fixed

Assets

The enterprise will be able to keep its operating

capability intact with regard to fixed assets and
inventories.
By adopting LIFO method, stock in hand is valued at
price which does not reflect current market price
and as a result closing stock will be understated or
overstated in the balance sheet.
Periodic revaluation say after every three or five
years may be inadequate for the purpose of
maintaining operating capability as is claimed in
this method if there is stepping inflation.
The purpose of periodic revaluation of fixed assets
is to charge depreciation on current cost of
replacement and the objective of following
LIFO
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The Finnish
AHI-Method
A combination of the CPP and CCAmethods
Specially developed for firm analysis
Calculations simple
Little extra information needed
Change in the general price level is
described by the wholesale price index
Adjustments are made on a yearly basis
the price level at the middle of the
accounting period as the base
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INFLATION ACCOUNTING
Nominal Statement of Income
Gross Turnover (+)Variable Costs
= Gross Profit (-) Fixed Costs
= Operating Profit
(-) Interest Costs (-) Depreciation
= Net Profit
Nominal Statement of Balance Sheet
Financial Assets (+) Inventories
(+) Fixed Assets = Total Assets
Debt (Liabilities) (+)Owners Equity
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Limitations of
Inflation Accounting
Though Inflation Accounting is more
practical approach for the true reflection of
financial status of the company, there are
certain limitations which are not allowing
this to be a popular system of accounting.
Change in the price level is a continuous
process.
This system makes the calculations a
tedious task because of too many
conversions and calculations.
This system has not been given 18preference

Conclusion
Every person on this earth has been affected
by Inflation, some positively but most of the
people negatively because the Inflation leads
to the erosion of general purchasing power.
The Inflation spares none and it equally
influences the Businesses like the people.
Historical cost accounting does not take into
account the changes in the rise in the value
of assets and its impact on Balance Sheet and
P&L Account due to inflation and does not
reflect the real worth of the business which is
very required for effective decision making.
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Conclusion
Inflation Accounting has removed this
drawback by providing methods for
adjusting the figure according to General
or Specific Price levels.
Despite a right method of presenting
financial
statements,
Inflation
Accounting is still not widely prevalent
due to certain limitations.
With more research and development of
accounting software, there is no doubt
that Inflation Accounting is the future of
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