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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
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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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.
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.
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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