Inflation Accounting

By: EconomyWatch   Date: 13 October 2010

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Inflation Accounting is a financial reporting procedure which records the consequences of inflation on the financial statements that a company prepares and publishes at the end of the financial year. It is based on the assumption that the currency is stable. But in certain countries this assumption is not valid specially for certain countries which are experiencing hyperinflation and the adjustments are done according to the changes in the purchasing power of the masses.

History of Inflation Accounting

Inflation accounting was practiced in the US by the American Institute of Certified Public Accountants for over 50 years. During the period of Great Depression many companies reconstructed their financial reports recording the inflation in them. During those 50 years many companies were encouraged to record the price-level adjusted statements in place of cost-based financial statements. The FSAB or the Financial Accounting Standards Board raised a proposal of publishing the price-level adjustment statements which was withdrawn by them later due to certain problems.

 

Historical Cost Accounting

Historical accounting replaced fair value accounting during the 1930s post Great Depression period. This was replaced since the values had been overstated by certain companies. The principles of historical cost accounting came into being post Wall Street Crash which took place in 1929 along with the assumption of stable currency.

 

Basic Principle of Inflation Accounting

One of the most important and basic principles of the accounting process is known as 'The Measuring Unit Principle'. The standard of measurement is the currency which is the most relevant one in the economy. The changes in the purchasing power is not deemed important to be considered. The assumption is that the value of the currency is fixed. However, the use of the principle actually led to misleading reports. The alterations in the price level were not always taken into account while preparing the reports. The price level is considered to be more or less fixed. This may lead to various types of distortions. The influence of price change is not clear, the profits are misquoted, the asset values do not reflect the economic value of the business, future earnings and future capital needs cannot be predicted properly. The misinterpretation of real economic performance has far reaching effects like tampering the whole of the socio-political system of a country.

Models of Inflation Accounting

Inflation Accounting is also referred to as the Price Level Accounting. In certain inflation accounting models price level costs were achieved by employing particular indexes. The second model is the Constant Dollar Accounting. This is yet another model of accounting. This model helps to convert the non monetary assets and equities into current dollars employing a general price index. The monetary assets are not taken into account during the conversion.

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