mba - afm - inflation accounting

7/26/2019 MBA - AFM - Inflation Accounting

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INFLATION

ACCOUNTINGAccounting for

Price LevelChanges

Unit - One 1


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Introduction

The impact of ination comes in the form of risingprices of output and assets. As the nancialaccounts are kept on Historical cost basis so the!don"t take into consideration the impact of rise inthe prices of assets and output. This ma!

sometimes result into the overstated prots underpriced assets and misleading picture of businessetc.

#o the nancial statements prepared under

historical accounting are generall! proved to bestatements of historical facts and do not reect thecurrent $orth of business. This deprives the users ofaccounts like management shareholders andcreditors etc. to have a right picture of business to

make appropriate decisions. Hence this leads'


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Introduction

Accounting for changing prices (orInation Accounting) is a s!stem ofaccounting $hich regularl! records all

items in nancial accounting at theircurrent values.

The s!stem recogni(es the fact that the

purchasing po$er of mone! is decreasingda!)b!)da! during ination and nds outprot or loss or states the nancialposition of the business on the basis of

the current prices prevailing in the*


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Introduction

Ination accounting is a term describing arange of accounting s!stems designed tocorrect problems arising from historical cost

accounting +or original or ac,uisition cost- inthe presence of ination. &nation accountingis used in countries eperiencing highination or h!perination. Hperination isinationthat is ver! high or /out of control/.

0or eample in countries eperiencingh!perination the&nternational Accounting #tandards oard

re,uires corporate nancial statements to bead usted for chan es in urchasin o$er3
http://en.wikipedia.org/wiki/Historical_costhttp://en.wikipedia.org/wiki/Accountinghttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Hyperinflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/International_Accounting_Standards_Boardhttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Purchasing_powerhttp://en.wikipedia.org/wiki/Purchasing_powerhttp://en.wikipedia.org/wiki/Purchasing_powerhttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/International_Accounting_Standards_Boardhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Hyperinflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Accountinghttp://en.wikipedia.org/wiki/Historical_cost


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Introduction

0air value accounting +also calledreplacement cost accounting or current costaccounting- $as $idel! used in the 14th and

earl! '5th centuries but historical costaccounting became more $idespread aftervalues overstated during 14'5s $erereversed during the 6reat 7epressionof the

14*5s. Principles of historical costaccounting $ere developed after the8all #treet Crash of 14'4.

7ecrease in purchasing po$er of mone! dueto an increase in the general price level.9
http://en.wikipedia.org/wiki/Fair_valuehttp://en.wikipedia.org/wiki/Great_Depressionhttp://en.wikipedia.org/wiki/Historical_costhttp://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929http://en.wikipedia.org/wiki/Historical_costhttp://en.wikipedia.org/wiki/Great_Depressionhttp://en.wikipedia.org/wiki/Fair_value


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Introduction

The Great !epression $as a severe $orld$ide economic depression inthe decade preceding 8orld 8ar &&. The timing of the 6reat 7epressionvaried across nations but in most countries it started in about 14'4 andlasted until the late 14*5s or earl! 1435s. &t $as the longest most$idespread and deepest depression of the '5th centur!. The depressionoriginated in the :.#. starting $ith the fall in stock prices became

$orld$ide ne$s $ith the stock market crashof ;ctober '4 14'4 +kno$nas lack Tuesda!-. 0rom there it ,uickl! spread to almost ever! countr! inthe $orld.

The 6reat 7epression had devastating e


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&@0LAT&;@ ACC;:@T&@6

&nation accounting has been adopted as asupplementar! nancial statement in the:nited #tates and the :nited ingdom and

thereafter all countries in the $orldfollo$ed the same. To cater to the needs ofan &nation Accounting the &A#+&nternational Accounting #tandard oard-

came out $ith an Accounting #tandardkno$n as &A# '4.

"#ect of Ination on $usiness

1. &mpact on costs and revenue'. &m act on assets and liabilitiesB


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&@0LAT&;@ ACC;:@T&@6

Aspects

%ro&'es

#ub2ectivit! 0re,uent changes

;ften complicated calculations

$ene*ts

maintaining production capacit!

sho$s the internal logic of accounting

D


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&@0LAT&;@ ACC;:@T&@6

The Change in the price 'e+e' is descri&ed &inde,es

Genera' inde,

Price &nde of 6ross 7omestic Product +67P-

Cost)of)living &nde

Consumer Price &nde

8holesale Price &nde

Production Price &nde

pecia' inde, &ndustr! inde

Commodit! group inde

Commodit! inde

4


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Approaches to %rice Le+e'Accounting

CPPA ) Current Purchasing Po$erAccounting

CCA ) Current Cost Accounting #6PLA #pecic and 6eneral Price

Level Accounting

Periodic revaluation of ed assetsalong $ith the adoption of L&0;method of inventor!

The 0innish AH&)Eethod 15


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Current

%urchasing %o.er Accounting

(C%%A)( $ased on changes in genera' price 'e+e'changes) :nder this method of ad2usting accounts to price

changes all items in the nancial statements arerestated in terms of a constant unit of mone! i.e. in

terms of general purchasing po$er.

0or measuring changes in the price level andincorporating the changes in the nancial statements$e use 6eneral Price &nde $hich ma! be considered

to be a barometer meant for the purpose. The inde isused to convert the values of various items in thealance #heet and Prot and Loss Account.

This method takes into account the changes in thegeneral purchasing po$er of mone! and ignores the

actual rise or fall in the price of the given item. CPP11


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Current %urchasing %o.erAccounting (C%%A)

0or this purpose historical gures areconverted into value of purchasing po$erat the end of the period. T$o indenumbers are re,uiredF one sho$ing thegeneral price level at the end of the periodand the other reecting the same at thedate of the transaction.

Prot under this method is an increase inthe value of the net asset over a period allvaluations being made in terms of currentpurchasing po$er.

1'


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Current Cost

Accounting (CCA)+$ased on changes in prices of speci*c assets)

The Current Cost Accounting is an alternative to theCurrent Purchasing Po$er Eethod. The CCA methodmatches current revenues $ith the current cost of theresources $hich are consumed in earning them.

Changes in the general price level are measured b!Inde, Nu&ers. #pecic price change occurs if priceof a particular asset changes $ithout an! generalprice change. :nder this method asset are valued atcurrent cost $hich is the cost at $hich asset can be

replaced as on a date. 8hile the Current Purchasing Po$er +CPP- method is

kno$n as the Genera' %rice Le+e' approach theCurrent Cost Accounting +CCA- method is kno$n aspeci*c %rice Le+e' approach or /ep'aceentCost Accounting0 1*


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peci*c and Genera' %rice Le+e'Accounting

This approach of accounting for pricelevel changes combines the t$oapproaches CCA and CPP $hile

preparing nancial statements.&t takes into consideration bothchanges in specic prices of individual

items and the inuences of generalprice level changes.

:nder this approach values sho$n in

nancial statements are based on13


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%eriodic /e+a'uation of Fi,edAssets

The enterprise $ill be able to keep its operatingcapabilit! intact $ith regard to ed assets andinventories.

! adopting L&0; method stock in hand is valued atprice $hich does not reect current market price

and as a result closing stock $ill be understated oroverstated in the balance sheet.

Periodic revaluation sa! after ever! three or ve!ears ma! be inade,uate for the purpose of

maintaining operating capabilit! as is claimed inthis method if there is stepping ination.

The purpose of periodic revaluation of ed assetsis to charge depreciation on current cost of

replacement and the ob2ective of follo$ing L&0;19


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The Finnish

AHI-1ethod

A combination of the CPP and CCA)methods

#peciall! developed for rm anal!sis

Calculations simple Little etra information needed

Change in the general price level is

described b! the $holesale price inde Ad2ustments are made on a !earl! basis

the price level at the middle of theaccounting period as the base

1>


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&@0LAT&;@ ACC;:@T&@6

Noina' tateent of IncoeGross Turno+er (2)3aria&'e Costs

4 Gross %ro*t (-) Fi,ed Costs

4 Operating %ro*t

(-) Interest Costs (-) !epreciation

4 Net %ro*t

Noina' tateent of $a'ance heet

Financia' Assets (2) In+entories(2) Fi,ed Assets 4 Tota' Assets

!e&t (Lia&i'ities) (2)O.ners5 "6uit

1B

Li i i f


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Liitations of

Ination Accounting

Though &nation Accounting is morepractical approach for the true reection ofnancial status of the compan! there are

certain limitations $hich are not allo$ingthis to be a popular s!stem of accounting.

Change in the price level is a continuousprocess.

This s!stem makes the calculations atedious task because of too man!conversions and calculations.

This s!stem has not been given preference1D


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Conc'usion

Gver! person on this earth has been a


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Conc'usion

&nation Accounting has removed thisdra$back b! providing methods forad2usting the gure according to 6eneral

or #pecic Price levels. 7espite a right method of presenting

nancial statements &nationAccounting is still not $idel! prevalent

due to certain limitations. 8ith more research and development of

accounting soft$are there is no doubt

that &nation Accounting is the future of'5

mba - afm - inflation accounting

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