Inflation Accounting_Alankar

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                 I N F L AT I O N AC C O U N T I N G

Many countries, developed as well as developing, have been
experiencing inflation of high magnitude in recent times.
Inflation refers to state of continuous rise in prices . It brings
downward changes in the purchasing power of monetary unit.
Thus, financial statements prepared without taking into account
the change in purchasing power of the monetary unit lose their
significance. Thus, there is a demand that bus iness enterprises
should update their statements periodically, in order to make
them relevant to current economic and financial conditions. The
different ways through which financial accounts can be
adjusted for changing prices is studied under the subject
“Inflation Accounting”.

Misleading reporting under historical cost accounting

In most countries, primary financial statements are prepared on
the historical cost basis of accounting without taking into
consideration either the changes in the general level of prices
or increases in specific prices of assets held, except to the
extent that property, plant and equipment and investments may
be revalued. This results in the following:

     The asset values for inventory, equipment and plant do
      not reflect their economic value to the business.
     The impact of price changes on monetary assets and
      liabilities is not clear
     Future capital needs are difficult to forecast which
      increases the business's risk

Methods of Accounting for price level changes

Price level changes can be broa dly classified into general price
level changes and specific price changes. General Price
changes reflect the overall increase or decrease in the value of
monetary unit. The changes in wholesale price index (W PI) or
the consumer price index (CPI) are examp les of such price
level changes. Specific price refer to changes in the price of a
specific asset. They are

     Current Purchasing Power (CPP) method based on
      changes in general price level changes
     Current Cost Accounting (CCA) method, based on
      changes in prices of specific assets

      Items in the financial statements restated in terms of
       general purchasing power
      Ignores the actual rise or fall in the price of the given
      It is generally prepared from shareholders point of vi ew
      Unsuitable for financial decisions


      It matches current revenues with the current cost of the
      It is also known as Replacement Cost Accounting
      Money is retained as unit of measurement
      Different special indexes are applied to different items

Inflation adjusted financial statements would not only achieve
the objective of reliable profit and financial position, but would
also prove useful to management and external users in their

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. Following are the limitat ions:
1. Change in the price level is a continuous process.

2. This system makes the calculations a tedious task because
of too many conversions and calculations.

3. This system has not been given preference by tax


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.
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. But with more research and development of
accounting software in this field, there is no doubt that
Inflation adjusted accounting is the future of Financial

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