Inflation Accounting

SIMSR | MFM | SEM - IV |

MFM Year 2000 10000 per anumMFM Year 2010 60000 per anumIn 10 years 600% RISE Milk Year 2000 10 per litterMilk Year 2010 50 per litterIn 10 years 500% RISE House (1 BHK Flat – Mumbai - Goregaon)1 BHK Flat Year 2000 – Rs.15 Lakhs1 BHK Flat Year 2010 – Rs.70 LakhsIn 10 years 500% RISE Almost 50% rise year on year in most of the essential commodities.

Overall Average Inflation is over 7% year on year for last 30 years

What is Inflation

This rise in overall prices for all goods produced in the Economy is called Inflation.

On the other side we can say fall in value of Money is due to Inflation.

Higher Inflation reduces the Purchasing Power

Lower Inflation increases the Purchasing Power.

InflationEffect

5. 2011 – 150% rise in Real Estate Price accounted in B.S. above.

6. This is how Inflation can affect B.S.

1. India Bulls2. 2005 – BKC Commercial

Space acquired @ 20,000 p.s.f.

3. 2005 - Balance Sheet RepresentationCost of BKC Commercial Space = 20,000 X 5000 s.f. = 1,00,000,00

2011 - Balance Sheet RepresentationValue of BKC Commercial Space = 50,000 X 5000 s.f. = 10,00,00,000

A1 B2What Inflation Can Do to Corporate B.S.?

A term describing a range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation.

Inflation Accounting

Incorporates such changes over the period in cost of different Assets, Products, Raw Material to give True representation of Real Values as on Today or in Future.

What is Inflation A/c1 Definition2Inflation Accounting

First was suggested in 1936 by Henry Sweeny of USA through his book “Stabilized Accounting”.

USA and England are the two countries that made prominent inroads to Inflation Accounting.

Inflation Accounting

Origin

3. The objective of charging depreciation is to spread the cost of the asset over its useful life and make reserve for its replacement in the future. But it does not take into account the impact of inflation over the replacement cost which may result into the inadequate charge of depreciation.

4. Future earnings are not easily projected from historical earnings.

1. Historical accounts do not consider unrealized holding gains arising from rise in the monetary value of the assets due to inflation.

2. Under historical accounting, inventories acquired a told prices are matched against revenues expressed at current prices. In the period of inflation, this may lead to the overstatement of profits due mixing up of holding gains and operating gains.

Limitations of historicalCost accounting 1 2

Inflation Accounting

ICAI realized the importance of Inflation Accounting very late (Feb 1982).

Indian corporate sector does not follow this method, as there is no fiscal law governing the presentation of company accounts in this basis.

Ashok Leyland Ltd., Carborandum Universal Ltd. & Tube Investment of India Ltd. were the first 3 companies who presented CPP accounts in 1973-74 annual reports.

Inflation Accounting

– Indian Scenario

BHEL and Tata Chemicals Ltd. are considered to be the pioneers in the presentation of inflation adjusted accounts.

But both discontinued after following for long period.

NTPC, MMTC & OIL are still following inflation accounting (CCA).

Inflation Accounting

– Indian Scenario

Current Cost Accounting (CCA) Method

Current Purchasing Power (CPP) Method

1 2

Techniques To measure the impact of inflation on financial statements, following are the techniques used.

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.

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.

Current Purchasing Power (CPP) Method 1

Techniques

Value of asset as per CPP =

Historical Cost of Asset x Conversion Factor

Conversion Factor =Price Index at the date of conversion / Price at the date of transaction

For converting historical value of money into purchasing power value as at the end of the period ,

Two index numbers are required :

1. Showing general price level at the end of the Period and another

2. Showing general price level at the date of the transaction

CPP Method1Techniques

The value of machinery as on 31-12- 2006 by CPP method will be calculated as under:

1,50,000*250/150 = Rs.2,50,000

Thus, Rs.2,50,000 being the new cost of machinery represents the current purchasing power at the end of 2006 of Rs.1,50,000 paid out in the beginning of 2004.

X Ltd. purchased machinery on1st Jan. 2003for Rs.1,50,000.

This machinery is to be expressed in current purchasing power terms at the end of 2006.

The approved general index has increased from150 in Jan.2003 to 250 at the end of Dec. 2006.

CPP Method1Techniques

The CCA method matches current revenues with the current cost of the resources which are consumed in earning them.

Under this method, asset are valued at current cost which is the cost at which asset can be replaced as on a date.

Current Cost Accounting (CCA) Method 2

Techniques

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 preference by tax authorities.

Inflation Accounting

– Limitations

1. CPA scores over CCA w. r. t. Verifiability

2. Comparatively not simple to use

3. International Accounting Standards Committees not in favor of CPP method to be adopted in hyperinflationary economies.

4. CCA is not the method, in force in Latin American countries, where inflation accounting is mandatory.

1. Verifiability

2. Comparative simplicity

3. International Accounting Standards Committees also in favor of CPP method to be adopted in hyperinflationary economies.

4. CPP is the only method, in force in Latin American countries, where inflation accounting is mandatory.

CPP Vs. 1 CCA

Techniques

2

Conclusion

Despite a right method of presenting financial

statements, Inflation Accounting is still not widely

prevalent due to certain limitations

Despite a right method of presenting financial

statements, Inflation Accounting is still not widely

prevalent due to certain limitations

Inflation Accounting by Group

Presented By :

Savargankar Vivek (49)Sen Vikram (50)Shukla Arun (51)Tanna Dimple (52)Tavade Mamata (53)Tawde Manish (54)