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Inflation Accounting

inflation accounting

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0% found this document useful (0 votes)

61 views29 pages

Inflation Accounting

inflation accounting

Uploaded by

ಡಾ. ರವೀಶ್ ಎನ್ ಎಸ್

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• A historical cost is a measure of value

(monetary value) used in accounting

• in which the value of an asset on the

balance sheet

• is recorded at its original cost when

acquired by the company.
• purchase price (cash and cash
equivalent cost )

• any additional expenses incurred to get

the asset in place and prepared for
use.
• ABC Ltd Purchased an Asset
for Rs.10,00,000/-
• ABC Ltd Purchased an Asset
for Rs.10,00,000/-

• Delivery Charges incurred

Rs.50,000/-
• ABC Ltd Purchased an Asset
for Rs.10,00,000/-

• Delivery Charges incurred

Rs.50,000/-

• Installation Charges incurred

Rs.50,000/-
11,00,000
9,90,000
8,91,000
8,01,000
7,21,710
6,49,539

Year- Year- Year- Year- Year- Year-

1 2 3 4 5 6
Value of the Asset in the books of ABC Ltd after charging
depreciation yearly
16,00,000
15,00,000
14,00,000
13,00,000
12,00,000
11,00,000

Year- Year- Year- Year- Year- Year-

1 2 3 4 5 6
Rs.11,00,000/
Rs.16,00,000/-
-
Inflation is a quantitative measure of
the rate at which the average price
level of a basket of selected goods
and services in an economy increases
over a period of time
• Difficult to replace fixed assets

• Capital does not remain intact

• Inaccurate determination of profit

• Mixing holding and operating profits

• Incomparable items in financial statements

• Failure to disclose the current worth of the enterprise

• Cost of Goods Sold
• Valuation of Closing Stock
• Assets side on the Balance Sheet
• Liability Side of the Balance Sheet
• Correct the usually distorted picture
of Financial Statements

• Proper inter-company comparisons

• Proper inter-period comparisons

• Correct measurement of income

• To avoid unfair decisions

Techniques used for inflation accounting should
be:

i) accurate,
ii) reasonable,
iii) effective and
iv) easy to implement
main methods proposed for inflation accounting
are:
1. Current purchasing power (CPP) method and
2. Current cost accounting (CCA) method
• In this method all the items in the financial
statements are restated in terms of constant unit of
money.

• In order to measure changes in price level and

incorporate changes in financial statements we use
general price index.
Conversion
Technique

Solutio
n
Converted Value
=90,000 x 300/150
=1,80,000/-
Mid Period
Conversion
Technique
• Inflation Accounting Committee (IAC) designed
CCA technique.

• Finalized by the issue of SSAP-16 (Statement of

Standard Accounting Practice).

• Considers Price changes that are relevent for

particular firm or industry.
• Fixed assets are shown not at their depreciated original
cost but at their net replacement value

• Stocks are shown at their net replacement value

• Gains/losses due to the changes in the price level are

shown in a separate statement

• Inventory consumed is valued at the price at the date

of consumption
• However, CCA is not generally accepted accounting
principle for primary financial statements.

• Due to the perceived importance of the data for

creditors and other investors, FASB requires that
certain companies to disclose.
• Inventories and
Property, Plant and > $125 Million
equipment
Or

• Total Assets > $1 Billion

• Productivity = Sales revenue / No. of employees

If the physical output and number of

employees remain the same while sales price
(and, hence, sales revenue) increase by 15%
due to inflation, productivity will increase by
15% despite the fact that real productivity
remains the same.
• As a result of inflation, the preparation of budgets by an
organization may need to be intensified. This can help to
achieve more effective use of existing resources.
• An additional form of the budget, namely
the requirement budget, may need to be
prepared, as is presently being done by
a few organizations.
• In a period of inflation, the board of directors must
ensure that they are mainly distributing current
earnings as dividends.
• The board of directors
must make sure that
they are not
unintentionally
distributing earnings from previous years.
• The financial statements lose their credibility as
the concept of objectivity is violated

• The method is not acceptable to most tax authorities