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INFLATIONis the erosion or reduction in the value of money.

Simply stated what one can buy for Rs.100 cannot buy
the same thing for Rs.100 after some time.
For e.g a vada pav was Rs.5/- some time back
but the same vada pav is around Rs.10/- today
One of the recent examples of inflation is also sugar

Inflation accountingis a
is a
term describing a range of
accounting systems
designed to correct problems
arising from historical cost
accounting in the presence of
inflation. .
Inflation accounting is used in countries experiencing high
inflation or
hyperinflation. .
For example, in countries experiencing hyperinflation the
International Accounting Standards Board requires corporate
financial statements to be adjusted for changes in purchasing
power using a price index
Accountants in the UK and US have discussed the effect of
inflation on financial statements since the early 1900s,
beginning with index number
theory and purchasing power
Irving Fisher's 1911 book
's The Purchasing Power of Money

was used as a source by Henry W. Sweeney in his 1936 book


Stabilized Accounting, which was about , Constant Purchasing Power Accounting
In March 1979, the Financial Accounting Standards Board
(FASB) wrote Constant Dollar Accounting, which advocated
, using the Consumer Price Index for All Urban Consumers (CPI
U) to adjust accounts because it is calculated every month.
During the Great Depression some corporations restated their
financial statements to reflect inflation
Under a historical cost-
-based system of accounting, inflation
based system of accounting, inflation
leads to two basic problems.
First, many of the historical numbers appearing on financial
statements are not economically relevant because prices
have changed since they were incurred....
Second, since the numbers on financial statements
represent dollars or rupeees expended at different points of
time and, in turn, embody different amounts of purchasing
power, they are simply not additive.
Suppose the
income statement
of a company
for 2006 -07 states sales figure of Rs.. 50 lakh andRs..75 lakh for for 2007-08
prima facie the sales show the performance better by 50 %,, the fact remains that
this entire increase is not due the performance of the the company but partly
because of increase in price

In most countries, primary financial statements are


prepared on the historical cost basis of accounting
without regard either to changes in the general level of
prices or to increases in specific prices of assets held,
except to the extent that property, plant and equipment
except to the extent that property, plant and equipment
and investments may be revalued.´
and investments may be revalued.´
Ignoring general price level changes in financial reporting creates distortions in
financial statements
Ignoring general price level changes in financial reporting creates distortions in
financial statements
such as
such as
reported profits may exceed the earnings that could be distributed to shareholders
without
reported profits may exceed the earnings that could be distributed to shareholders
without
impairing the company's ongoing operations
impairing the company's ongoing operations
the asset values for inventory, equipment and plant do not reflect their economic
value to the
the asset values for inventory, equipment and plant do not reflect their economic
value to the
business
business
future earnings are not easily projected from historical earnings
future earnings are not easily projected from historical earnings
the impact of price changes on monetary assets and liabilities is not clear
the impact of price changes on monetary assets and liabilities is not clear
future capital needs are difficult to forecast and may lead to increased leverage,
which increases
future capital needs are difficult to forecast and may lead to increased leverage,
which increases
the business's risk
the business's risk
when real economic performance is distorted, these distortions lead to social and
political
when real economic performance is distorted, these distortions lead to social and
political
consequenses that damage businesses (examples: poor tax policies and public
misconceptions
consequenses that damage businesses (examples: poor tax policies and public
misconceptions
regarding corporate behavior)
regarding corporate behavior)
Misleading reporting under historical cost accounting

bjectives of Inflation Accounting


‡ The user or the decision maker gets an information which shows the
Performance
‡ To facilitate the comparison of the performance of two different periods
it is necessary that the figures are adjusted for inflation.
‡ The monetary items and income and expenses do not show the correct
Purchasing power of money.T herefore their values should be adjusted
for inflation.
‡ To ascertain the current value of assets.
Methods of Inflation Accounting
A. Current Purchasing Power (CPP) Method
In CPP method common purchasing power of all the items and transactions
in the balance sheet are worked out.
For the purpose, an appropriate price index, wholesale or consumer price
index is used.
The method tries to find out the current purchasing power of transactions
as well as gains or losses arising out of holding the monetary items.
In case of cash (ASSET )value will reduce because of inflation
In case/payables (LIABILIT IES), inflation will result in gain as fixed/agreed
money payable by the company will have less purchasing power
Items of Income Statement ± CPP Method.
Opening and Closing inventory
Transactions for the period
Depreciation on fixed assets for the period
Loss or gain arising from holding the monetary items
B. Current Cost Accounting (CCA) Method
Current-cost accounting (CCA) is a method of accounting, recommended by the
Sandilands Committee set up by the UK Government in 1975 to consider the
most appropriate way to account for the effects of inflation in the published
accounts of companies.
In CCA, instead of showing assets at their historical cost (ie their original
purchase price), less depreciation where appropriate, the assets are shown at their
current cost (replacement cost: the price at which the assets of an organisation
could be replaced, broadly in their existing state.
Objective of CCA
To show Assets and Liabilities at
current replacement value.
Finding out profit or loss by matching
current cost and revenue
Advantages of Inflation Accounting
Assets are shown at real values uniformly.
Assets are shown at real values uniformly.
Financial statements of a company show correct and current information
Financial statements of a company show correct and current information
about the financial performance of the company.
about the financial performance of the company.
Inflation Accounting enables a company to get a fair price for its shares
Inflation Accounting enables a company to get a fair price for its shares
by showing the current values of fixed assets.
by showing the current values of fixed assets.
The value of the assets will be more accurate and closer to its intrinsic
The value of the assets will be more accurate and closer to its intrinsic
Value.
Value
Disadvantages of Inflation Accounting
Depreciation charging on replacement cost goes against the concept.
Depreciation charging on replacement cost goes against the concept.
Both the methods CPP and CCA have serious drawbacks and there is
Both the methods CPP and CCA have serious drawbacks and there is
no general consensus about the method to be used.
no general consensus about the method to be used.
Charging depreciation on replacement cost not acceptable to the income
Charging depreciation on replacement cost not acceptable to the income
tax authorities.
tax authorities
Impractical System
Industry experts are of the view that none of the methods of Inflation
Industry experts are of the view that none of the methods of Inflation
Accounting are foolproof and cannot give an accurate effect of the price
Accounting are foolproof and cannot give an accurate effect of the price
level changes.
level changes.
A more serious flaw is that it cannot be accepted as a statutory system
A more serious flaw is that it cannot be accepted as a statutory system
of accounting because of gap between theory of inflation and its practical
of accounting because of gap between theory of inflation and its practical
applicability.
applicability.
Eg : A company earns a profit of Rs. 25 lakh which, say is at a 5% rate
Eg : A company earns a profit of Rs. 25 lakh which, say is at a 5% rate
of return on its investments. If the rate of inflation is significantly more
of return on its investments. If the rate of inflation is significantly more
after adjusting price level changes, the figure of Rs.25 lakh may turn into
after adjusting price level changes, the figure of Rs.25 lakh may turn into
a loss figure.
a loss figure.
But the fact remains that the company is physically holding
Rs. 25 lakh (the value may be less than Rs. 25 lakh)
Importance of Inflation Accounting
INFLATION ACCOUNTING
Concept ± Important for Financial Planning and Decision Making
- Helpful for finding out the real value of money considering
the anticipated inflation rate.
Better Term
INFLATION AND FINANCIAL PLANNING & DECISION MAKING