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Inflation Accounting

Reviewed by Anjaneyulu | Updated on Oct 05, 2020

Catalogue

Introduction

Inflation accounting is a unique method used to weigh on the published statistics of multinational firms in the effects of soaring or plummeting prices of products in some areas of the world.

Financial statements are adjusted as per price indexes to paint a clearer picture of a firm's financial position in inflationary environments, rather than relying solely on cost accounting. This method is also referred to as the price level accounting.

Understanding Inflation Accounting

Historical information on financial statements is no longer applicable when a business operates in a country where there is a large amount of market inflation or deflation. In some cases, companies are allowed to use inflation-adjusted figures to counter this issue, restating the numbers to reflect current economic values.

IAS 29 of the International Financial Reporting Standards ( IFRS) directs organisations whose operating currency is the hyperinflationary economy's currency. The IFRS describes hyperinflation as rates, debt, and wages linked to a price index that cumulatively rises 100% or more over three years.

Companies that fall under this category might require to update their statements periodically to make them relevant to prevailing economic and financial conditions, supplementing cost-based financial statements with regular price-level adjusted statements.

Methods Involved

Inflation accounting uses two primary methods, i.e. current purchasing power (CPP) and current cost accounting (CCA).

* - Current Purchasing Power (CPP):* Monetary items and non-monetary items are separated according to the CPP method. The monetary items accounting adjustment is subject to recording a net gain or loss. Non-monetary details are updated into figures with a conversion factor equivalent to price index at the end of the period divided by price index at the date of transaction.

* - Current Cost Accounting (CCA):* The CCA method values assets at their fair market value (FMV) rather than at historical cost, the price paid when the fixed asset was purchased. Under the CCA, currency, as well as non-monetary items, are restated to current values.

Advantages & Disadvantages

Inflation accounting comes with many benefits. Top among them, a much more practical analysis of productivity is given by comparing existing sales to current costs.

On the flip side, it can confuse investors by providing adjusted figures and allow companies to flag numbers that shine it in a better light. The process of changing accounts to a factor in market changes will lead to a constant restatement and alteration of financial statements.

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