Inflation Accounting 4-2-2014

1
Inflation Accounting
and Analysis

BHAGABAN DAS
PRAMOD KUMAR PATJOSHI
2

Inflation Accounting
and Analysis
[A Study of Indian Manufacturing Sector]

3

TO
Our
Beloved Parents
SMT. ANITA & LATE BISWANATH DAS
SMT. SANJUKTA & SHRI RAJ KISHORE PATJOSHI

FOR
Giving Us a Chance
To Prove and Improve Ourselves through All Walks Of Life

4

Contents

Preface
About the Authors
Acknowledgement
Abbrevations Used
1. Introduction
1.1 Background of the Study
1.2 Statement of the Problem
1.3 Importance of the Study
1.4 Rationale of the Study
1.5 Objectives of the Study
1.6 Hypotheses for the Study
1.7 Review of Literature
1.7.1 Impact of Inflation on Financial Performance
1.7.2 Impact of Inflation on Major Financial Ratios
1.7.3 Impact of Inflation on Stakeholders
1.7.4 Applying Models to Measure Impact of Inflation
1.8 Research Gap
1.9 Research Design
1.9.1 Nature and Sources of Data
1.9.2 Selection of Sample
1.9.3 The Period of Study
1.10 Tools and Techniques Used
1.10.1 Current Purchasing Power Method
1.10.2 Financial Statement Analysis
1.10.3 Descriptive Statistics
1.10.4 Statistical Analysis of the t-Test
1.10.5 Adjusted Model
1.11 Limitations of the Study
1.12 Organisation of the Study
2. Corporate Financial Reporting
2.1 Introduction
2.2 Objectives of financial reporting
2.2.1 Investment Decision-Making
2.2.2 Management Accountability
2.3 Development of Financial Reporting Objectives
2.3.1 The Trueblood Report
2.3.2 The Corporate Report, London, 1975
2.3.3 The Stamp Report, 1980, Canada
2.4 Benefits of Financial Reporting
2.5 Information need of stakeholders
2.6 Which are useful information?
2.7 Constraints on Relevant and Reliable Information
2.8 Financial Reporting across the World
5

2.9 Corporate Reporting Practices in India
2.10 Harmonisation of Corporate Financial Reporting
2.11 Summary
3. Inflation Accounting: The Concept and the Context
3.1 Introduction
3.2 History of Inflation Accounting
3.3 Inflation Accounting and Indian Economic Development
3.4 Methods of Accounting for Inflation
3.4.1 Current Purchasing Power Method/General Purchasing Power Method (CPP/GPP Method)
3.4.2 Current Cost Accounting Method (CCA Method)
3.4.3 Hybrid Method
3.5 Presentation of Price Level Adjusted Accounts
3.6 USA and Inflation Accounting
3.7 India and Inflation Accounting
4. Industrial Development and Manufacturing Sector in India
4.1 Introduction
4.2 Industrial development in India during plan periods
4.3 Indian manufacturing sector: an overview
4.3.1 Role of manufacturing in the Indian economy
4.3.2 The Sub-sectors in Indias Manufacturing
4.3.3 Manufacturing sectors recent growth spurt: Clues from IIP
4.4 Tapping the Global Market
4.5 Increasing competitiveness of Indian Manufacturing
4.5.1 Sector has an edge in the global arena
4.5.2 Encouraging research and fostering innovation
4.5.3 Government support for developing a skilled workforce
4.6 Current Trends in Indian Manufacturing
4.6.1 India emerging as a global manufacturing hub
4.6.2 Indian manufacturing growth outshining peers in the BRICs
4.6.3 Interesting trends in key manufacturing sub-sectors
4.7 Factors Driving the Indian Manufacturing Growth Story
4.8 Opportunities in Indian Manufacturing
4.9 Challenges for the Indian Manufacturing Sector
4.10 Issues related to technological know-how
4.11 Conclusion
5. Impact of Inflation on Corporate Financial Performance
5.1 Introduction
5.2 Financial Performance of Sample Companies under HCB Method
5.3 Financial Performance of Sample Companies under CPP Method
5.4 Impact of Inflation on GVA and NVA
5.5 Impact of Inflation on Profit/Loss
5.6 Sectoral Analysis of Impact of Inflation on Profit/Loss
5.7 Impact of Inflation on Profit After Tax (PAT)
5.8 Impact of Inflation on Retained Earnings
5.9 Summary
6. Impact of Inflation on Major Financial Ratios
6.1 Introduction
6.2 Impact of Inflation on Liquidity Ratios
6.3 Impact of Inflation on Profitability Ratios
6.4 Impact of Inflation on Activity Ratios
6

6.5 Summary
7. Impact of Inflation on Stakeholders
7.1 Introduction
7.2 Impact of inflation on Customers
7.3 Impact of inflation on Suppliers/Creditors
7.4 Impact of inflation on Employees
7.5 Impact of inflation on Financial Institutions
7.6 Impact of inflation on Government
7.7 Impact of inflation on Shareholders
7.8 Impact of inflation on Management
7.9 Summary
8. Adjustment of Inflationary Effects
8.1 Introduction
8.2 Application of Model
8.3 Assumptions for Model
8.4 The Model
8.5 Adjustment of Impact of Inflation on Financial Performance
8.6 Adjustment of Impact of Inflation on Real Operating Income (ROI)
8.7 Purchasing Power Loss during Inflation
8.8 Sectoral Analysis of Adjusted Gross and Net Operating Income
8.9 Sectoral Analysis of Purchasing Power Loss
8.10 Sectoral Analysis of Real and Reported Income
8.11 Cross Sectoral Analysis of Purchasing Power Loss
8.12 Adjusted Gross and Net Operating Income for different Sectors
8.13 Sectoral Analysis of Purchasing Power Gain/Loss on Net Operating Income
8.14 Summary
9. Summary of the Findings and Suggestions
9.1 Introduction
9.2 Summary of the Theoretical Findings
9.3 Summary of the Empirical Findings
9.3.4 Adjustment of Impact of Inflation on Financial Efficiency through Model
9.4 Conclusion
9.5 Suggestions
9.6 Scope for Further Research

7

Preface

Inflation continues to be an important reality of economic and constant fact of life in almost all the countries of
the world. High inflation rates have seriously eroded monetary values in these countries, which has attracted
wide attention in financial accounting in the last few decades, and has brought forth new patterns of economic
behaviour. Despite of that, the effects of inflation on the financial performance of economic units go
unrecognized in published financial statements. The primary purpose of the financial statements of a company
is to give a true and fair picture of financial performance (i.e. profit or loss) of the company for a particular
period and financial position (assets and liabilities) of the company on a particular point of time. The existing
accounting practice of preparation of financial statements is based on money measurement concept. This
concept allows accounting of those business transactions which can be measured by the monetary unit. Further
an assumption is made that the monetary unit is stable in nature so that there is uniformity in accounting. This
assumption, however, was valid only in those old days when the prices used to be generally stable and the
economy did not experience any significant inflation. In the present day world, however, the inflation has
become a necessary evil. Therefore accounts, compiled on the basis of transactions represented by rupee (i.e.,
the monetary unit prevalent in our country) of varying purchasing power, present a distorted view of the
profitability and financial position by overstating the former and understating the later. They thus, fail to serve
their primary purpose and lose their credibility. Income is highly overstated with the result that higher taxes
and dividends are to be paid. This resulted in erosion of capital of a company. Consequently a feeling is
cropping up in India among accountants, members of professional bodies, research organizations and
academics that keeping in view the drawbacks of historical cost accounting, there is a need to restructure
historical cost-based financial statements for accurate measurement of profit and reliable reporting of financial
performance. Inflation-adjusted financial statements would not only achieve the objective of reliable profit and
financial position measurements, but would also prove useful to management and external users in their
decision-makings. The present study is an effort towards organized and comprehensive analysis of the impact
of inflation on financial performance/efficiency of firms operating in India with limited financial disclosure.
The book is broadly divided into two parts. The first part examines in detail how the problem of inflation
affects companies' reports and distorts accounting information. The second part presents an empirical study
and shows how the problem might be dealt with in order to provide accurate accounting information for
decision-making. The content of this book is divided into nine chapters. Chapter 1 is introductory, which
embodies the statement of the problem, objectives and scope of the study, and the review of available literature
on the subject. It obviously serves as background to the detailed discussions in chapters that follow. In addition
this chapter illustrates the research design, sampling procedure, period of the study and statistical tools applied
for analysis of empirical data. Chapter 2 considers the development of corporate financial reporting, the needs
of users of these reports and harmonisation of financial reporting across the globe with a specific reference to
India. Chapter 3 conceptualizes the inflation accounting, discusses its history, and different methods of
accounting for inflation. The industrial development of India during different plan periods and current trends in
Indian manufacturing sector are overviewed in Chapter 4. The second part of the book presents an empirical
study of 42 Indian manufacturing companies, classified into seven industrial sectors: automobiles, cements,
chemicals, fertilizers, foods, petroleum and steel. In this context, Chapter 5 investigates the impact of inflation
on financial performance of sample companies by analyzing profit and loss accounts both under historical cost
based (HCB) method as well as under current purchasing power (CPP) method. Chapter 6 deals with analysis
of impact of inflation on major financial ratios and chapter 7 elaborates the financial condition of stakeholders
during the period of inflation. While Chapter 8 adjusts the impact of inflation on gross and net operating
incomes by application of a model, the final chapter presents the summary and conclusions of the study and
outlines the areas for further research.
8

BHAGABAN DAS
PRAMOD K. PATJOSHI

About the Authors

Bhagaban Das is Professor and Head in the Department of Business Management, Fakir Mohan University,
Balasore, Odisha. A national awardee throughout his career, Professor Das stood second in M.Com
Examination in Utkal University (1982). As a brilliant teacher, he has more than three decades of teaching
experience both at undergraduate and postgraduate level. In addition to authoring 15 books which are widely
appreciated by readers, he has published about 50 research papers both at national and international journals.
Thirteen scholars have already been awarded Ph. D under his guidance and 8 more are still working at present
for the purpose. He is as an active member of Indian Accounting Association, Indian Commerce Association
as well as All Odisha Commerce Association. His current areas of interest include Environmental Accounting
and Financial Literacy.
Pramod Kumar Patjoshi is an Associate Professor in Regional College of Management under Biju Pattanaik
University of Technology, Odisha. He holds a Ph. D. degree in management on Inflation Accounting in India.
He is having 12 years experience in teaching, research and industry. He has so far published about 15 research
articles and two books in different areas of business management. His areas of interest include Financial
Markets Services and Inflation Accounting.

9

Acknowledgement

This book is an outcome of the Ph. D thesis on Inflation Accounting in manufacturing sector of India
awarded under the F M University of India. However, the thesis was finally revised with inclusion of three
more theoretical chapters: Corporate Financial Reporting, Inflation Accounting: the concept and the context
and Indian Manufacturing Sector: An overview to meet the current requests of readers on the subject. In this
journey, we have not traveled in a vacuum. We would like to express our gratitude to the many people who
saw me through this book; to all those who provided support, talked things over, read, wrote, offered
comments, allowed us to quote their remarks and assisted in the editing, proofreading and design.
First of all, we bend over in reverence to Almighty Lord Sri Jagannath and Maa Samaleswari for the
abundant gracious blessings that they have bestowed upon us to complete this book.
We would like to thank Kanishka Publishers and Distributors, New Delhi for enabling us to publish this book.
Above all we want to thank our family members, who supported and encouraged us in spite of all the time it
took us away from them. It was a long and difficult journey for them.
We are also extremely indebted to Prof. Prabir Pal, Director and Prof. Sujata Mangaraj, Dean of Management
Studies at Regional College of Management (Autonomous), Bhubaneswar for providing necessary
infrastructure, courage and resources to accomplish this.
We would like to express our deep sense of gratitude to the authorities of XIMB, Utkal University, Fakir
Mohan University, Regional College of Management and Revanshaw Knowledge Centre for allowing us to
refer their library.
M/s Arpita Commercials have edited the draft. Their efforts are gratefully acknowledged and sincerely
appreciated. We would also like to thank friends who inspired to put our best efforts
Last and not least, we beg forgiveness of all those who have been with us over the course of the years and
whose names we have failed to mention.

BHAGABAN DAS
PRAMOD K. PATJOSHI

10

Abbreviations Used

ACPP Accounting for Current Purchasing Power
AICPA American Institute of Certified Public Accountants (USA)
APC Accounting for Price Level Changes
ASC Accounting Standards Committee (UK)
ASSC Accounting Standards Steeling Committee
CCA Current Cost Accounting
COSA Cost of Sales Adjustment
CPI Consumer Price Index
CPP Current Purchasing Power
CVA Current Value Accounting Method
DA Depreciation Adjustment
FASB Financial Accounting Standards Board (USA)
FICCI Federation of Indian Chamber of Commerce and Industries
GPPA General Purchasing Power Accounting
GAAP Generally Accepted Accounting Principle
HCBA Historical Cost Based Accounting
IA Inflation Accounting
ICAI Institute of Chartered Accountants of India
ICWAI Institute of Cost and Works Accountants of India
IAS International Accounting Standard
IASC International Accounting Standard Committee
MWCA Monetary Working Capital Adjustment
RCA Replacement of Cost Accounting
SEBI Securities and Exchange Board of India
SSAP Statement of Standard Accounting Practice
WPI Wholesale Price Index

11

Introduction

1.1 BACKGROUND OF THE STUDY
Inflation continues to be an important reality of economic life in almost all countries. High inflation rates have
seriously eroded monetary values in these countries over the past few decades, and have brought forth new
patterns of economic behaviour
1
. Despite of that, the effects of inflation on the financial performance of
economic units go unrecognized in published financial statements.
The primary purpose of the financial statements of a company is to give a true and fair picture of
financial performance (i.e. profit or loss) of the company for a particular period and financial position (assets
and liabilities) of the company for a particular point of time. The existing accounting practice of preparation of
financial statements is based on money measurement concept. Money is commonly used as measuring unit of
transactions, which are recorded in the books of account. Those transactions, which can be measured in terms
of money, are taken into consideration for recording in the books of account. Money Measurement Concept is
a basic characteristic of accounting. As per this accounting concept, only those business transactions which are
capable of being expressed in terms of money are open for recording by the accounting system. It is also
assumed that monetary unit, recording the business transactions, is stable in nature. On the contrary, price does
not remain constant over a period of time. They tend to change due to various economical, social, political
factors. Changes in the price level cause two types of economic conditions, one is Inflation and the other is
Deflation. Inflation may be defined as period of general increase in the price level, where as deflation causes
fall in it. These changes in the price level lead to inaccurate presentation of financial statements which
otherwise are prepared to present true and fair view of the companys financial health.

Hence it is clear that the measurement unit of various transactions (i.e. money) relate to different
points of time. But the value of money does remain constant over a period of time; it has different values in
different points of time due to changes in the price level. So we use to compare two unlike things the past and
present figures of the financial statements without taking into consideration of the price levels changes. The
profit or loss arrived from these transactions will not reveal a true and fair picture of the organization. It is
generally said that profits which arrives from profit and loss account on the basis of historical cost has a
tendency to overstate due to rise in price level. This is so because during inflation the selling prices indicate the
value realized in terms of increased prices but the costs which pertains to the earlier period shows the lesser
value. So the various expenses incurred, income earned, assets acquired and liabilities incurred used to be
shown in different financial statements have different values during inflation period.
Another point to consider for preparing the financial statements is the historical cost. In India the
financial statements used to present according to actual and cost concept. But this Historical Cost Concept is
based on the assumption that the unit of account, i.e. rupee has static value. Moreover, the purchasing power
used to change by the passage of time and in India the purchasing power of the rupee is changing and its
rising continuously.
These conditions and the absence of adequate historical cost accounting data seriously harm investors
ability to evaluate properly the performance of any organization. Investors apply a common adjustment factor
to all items in the income statement in assessing the impact of inflation upon a firm's performance. This
approach gives way to unsatisfactory results since it has based on the invalid assumptions that inflation affects
Chapter
1

12

all the components of a firm's income in the same way and that real income alone constitutes the only success
or failure decisive factor of management's anti-inflationary performance. This is, however, not true in practice
as all the countries have experienced inflation of a very high magnitude during different time spans. It is
obvious that financial statements prepared without any regard to the current purchasing power of the monetary
unit will definitely lose much of their significance and cannot be properly appreciated by their various users;
such as Investors, Lenders, Government, Employees and Management, who are interested in them, in a
meaningful manner. They, therefore, lose their credibility. However, their credibility can be brought back by
making adjustments for the changes in the purchasing power of the monetary unit. How these adjustments can
be made has been the subject matter of a fierce debate throughout the world, and more particularly in England
and USA. In India, though the post-independence era has seen high rate of inflation, not much awareness
seems to have developed about this problem. The present study concentrates on accounting for current
purchasing power of rupee (i.e., the monetary unit prevalent in India) and seeks to suggest an acceptable
solution to the problem in the Indian context. It is a common knowledge that transactions leading to the
presentation of the financial statements are recorded at their historical costs which makes the statements almost
free from the personal bias of the accountants and also verifiable with reference to the relevant documentary
evidence. The concept of Historical Cost Based Accounting was discussed in the upcoming paragraphs in short
and snappy view.
As accounting is a service activity, its main purpose in a business is to provide quantitative financial
information for different kinds of decision-making. It is a combination of different activities beginning with
observing, collecting, recording, analyzing, summarizing and finally communicating information to all its
users. So accounting is not merely concerned with record keeping, but also with a whole range of activities
involving planning, controlling, decision-making, problem solving, performance measurement and evaluating,
coordinating and directing, tax designing and cost planning and finally management accounting. In other
words accounting involves the process of accumulation, classification, measurement, analysis, interpretation,
and summarization of the results of each transaction that affects a business concern. Such financial information
is usually reported to the various users; viz. promoters, directors, managers, department heads, shareholders,
creditors, employees, customers, taxation authorities, financial analysts, advisors, suppliers and general public
basing on certain accounting concepts and conventions.
1.2 STATEMENT OF THE PROBLEM
The depleting nature of the shareholders capital resulting from the eroding effect of the historical cost
accounting principle has made government and companies to be more concerned about maintaining the
operating capital of the firm. The historical cost concept of accounting has not provided for any feasible
measures for reflecting the dynamic nature of business transactions, vis--vis changing prices. Due to this
deficiency, most users of accounts tend to make mental adjustments to figures in the historical cost accounts to
allow for the effect of inflation on the values of transactions.
The existence of inflation and its persistent nature call for an alternative to the historical cost accounting
method of profit reporting. One of the feasible alternatives to the historical cost accounting method is the
current cost accounting method. Current cost accounting method has, as a basic principle, that operating profits
should only be measured and reported after the capital of the firm has been maintained, (Dean, 1994). The
emphasis on capital maintenance is highly imperative in todays business environment if the business must
survive and succeed (Glautier and Underdown, 1998).
The capital of a business cannot be maintained in isolation of the principles, concepts and postulates employed
in the measurement of the business income. As the income of the business directly affects the shareholders
capital, it therefore follows that the methods employed in measuring the income will equally directly influence
the value of the shareholders capital.
The basic problem with the historical cost method is that dividends, taxes and depreciation are based on profits
measured by sales (which are at current values) less costs of sales and expenses measured on historical cost
values, (Berliner, 1993). This measurement approach reduces the operating ability of the companys assets and
does not maintain the capital of the firm.
13

To maintain the capital of the firm, current cost accounting (CCA) system makes use of the current cost of
transactions in arriving at the profit of the firm. The Statement of Standard Accounting Practice (SSAP),
(1991); states that current cost accounting was intended to provide management and shareholders with useful
information about financial viability, returns on investment, pricing policy, cost control, distribution and
gearing decisions. Despite stipulations and regulations on inflationary trends, published financial statements in
India have not made provisions to disclose the implications of price changes on the value of the balance sheet
and on the value of transactions.
The inflation rate in India was recorded at 7.52 percent in November of 2013. It was averaged 7.71 percent
from 1969 until 2013, reaching an all time high of 34.68 Percent in September of 1974 and a record low of -
11.31 percent in May of 1976. Thus, the need to have a meaningful profit measurement in the circumstance of
the ever-increasing rate of inflation in our economy is pertinent now than ever. This need has thrown a great
challenge on the accounting profession, governments and managements of businesses to effectively measure
and report the operating capabilities of the assets and maintain the capital of the companies intact. The concern
of accountants and accounting bodies now is how to measure and report profits which will strengthen the
capital of the firm even if inflation rate is persistently rising.
The historical cost principle, which is the traditional accounting reporting method, is grossly inadequate in
periods of rising prices. The problem with this method is that selling prices are stated in current prices while
costs of the assets used in generating sales are stated in historical costs, that is, acquisition costs. This approach
results in overstated profit leading to
overpayment of taxes and dividends.
Equally, fixed assets and stocks of
goods face the same problem. The
conventional practice is to record
fixed assets at their acquisition costs
throughout their useful life.
Depreciation is also charged based
on the acquisition cost of the asset
irrespective of the current
replacement cost of such asset.
Lund, B. (1974) has emphasised the
kind of information needed by
managers to measure the effect of
inflation, not only on profitability and shareholders' funds, but on planning, budgets, and control. As inflation
has serious effects on external reporting, it also affects internal reporting for measuring profit and leads to
wrong decisions. The distortions may be worse in internal reports than in external reports. Allardyce F. says:
The same distortion that can give false comfort in reporting financial results to the public
can also lead to internal complacency in judging the performance of operating units.
Worse yet, it can lead to wrong decisions. (Allardyce, 1983, p.48)
This problem has been recognised by the Chartered Institute of Management Accountants (CIMA), which
acknowledged the importance of studying the effect of inflation on management accounts, saying:
Management is concerned predominantly with day to day decisions in which inflation is
one of many factors to be considered. In the long term inflation becomes of great
importance and plays a major role even in short term decisions. We believe it is essential
to present the facts so that decisions may be properly based. (CIMA, 1974, p.195)
Managerial decisions have a major effect, not only on everything in the company, but also on national accounts
and government plans, and if these decisions go wrong then business and the national economic plan will not
give the expected results. Therefore, the manager needs a special kind, of information to help him to make the
right decision at the right time, unimpeded by the effects of inflation. In order to achieve this, these reports,
should be based on current cost data rather than historical costs.

14

1.3 IMPORTANCE OF THE STUDY
In the past few years of high inflation, companies have reported very high profits on the one hand but on the
other they have faced real financial difficulties. This is so because in reality dividend and taxes have been paid
out of capital due to overstated profits arrived by adopting the historical cost concept. This overstatement of
profits can have several further effects. When these reported profits are used as the basis of corporate taxes to
the government, it leads to larger tax payments, and the government becomes an important beneficiary of
inflation. Furthermore, if reported profits are used as a basis of corporate decision making, the companies may
not be setting prices sufficiently high to ensure an adequate rate of return on a long-term basis, if they have
some scope for pricing policies. In addition, dividends may be paid out to an excessive degree and thereby they
might not have an adequate level of internal reserves to maintain their real resources intact. Thus a change
from historical cost concept to price level or inflation accounting has been recommended by many experts in
the field.
In fact corporate profits, like any measurement, are no more reliable than the assumptions on which
they best. Financial reporting depends on a wide variety of assumptions and conventions: the use of historical
costs, the various methods of depreciation, and the criteria for distinguishing between capital expenditures and
revenue expenses and many others. While the effects of inflation on the performance of every economic unit
go unrecognized in published financial statements, businesses continue to report historical cost accounting data
without providing supplementary information on management's ability to protect its financial capital from the
erosive power of rising prices.
These same issues also arise in the context of estimating the financial performance, and the related
rates of return on total assets. The income statements and balance sheets are based on historic costs, so the
income as reported will be lower than replacement costs. Valuations of both profit/losses and balance sheets at
replacement costs can have a significant impact on rates of return (both on net trading assets and shareholder's
interest). Replacement cost rather than historic costs will lead to lower levels of corporate income and higher
levels of assets and unambiguously lower rates of total return on both assets and net equity.
1.4 RATIONALE OF THE STUDY
Even though the problems used to occur in accounting throughout the period of altering monetary values is a
subject of discussion in American and European countries for the most part, no or very less attention has been
paid to this subject in India. Even to-day, in the Indian scene both academics and business appears rather in
different to an effective solution of the problem. This state of affairs assumes special significance in view of
the fact that our country has been seriously affected by price rise during the past forty years or so. Such
conspicuous absence of consciousness and attention towards the problem of price level accounting is
attributable among others to the following important reasons.
(a) The problems appropriate to inflation were not so important and could assume national priority as the size
of the corporate sector in our country was comparatively small in the past.
(b) Since, the Indian companies have not yet come across the 'acute financial problem of replacing the fixed
assets which are either still new or need no replacement at present.
(c) The replacement of fixed assets in our country is not as speedy as it is happens in industrially advanced
countries, as the process of technological changes is slow here. It is due to that fact that the Indian
industrial scene during the first half of the century was dominated by large number of small sized
business units having short life span and the management of most of these units consisted of owners,
entrepreneur and managers. This led the entrepreneurs in the past protect their short-term interest. The tax
rates during those days were also not as high as they are today so that taxation of inflated profits did not
seem necessary burden to the business.
(d) Unfortunately, serious thinking on the problems of adjusting Historical Cost Based Accounting (HCBA)
for price level changes was rather scanty in academic and professional circles in our country. Original
work on the subject did not attract much professional attention during the last three decades and more.
The academicians, practicing accountants, branch managers and entrepreneurs have shown very little
interest either in undertaking case study to gauge the magnitudes of the problem created in accounts by
15

price level changes or in developing suitable techniques to deal with the problem. This is quite surprising
when one find that systematic work on price level accounting organized as early as 1936 with the
publication of Sweeny's Stabilized Accounting in West Germany. Since then a lot of research and
experimentation has been carried out in a number of countries particularly the U.K., the U.S.A., Canada,
Australia and small countries like Malaysia.
(e) The professional bodies of the country like Institute of Chartered Accountants of India (lCAI) and
Institute of Cost and Works Accountants of India (ICWAI) are also to share the blame. As they did not
take this problem in real earnest. One important reason for such passive attitude appears to be absence of
rapport between these institutions and industry.
(f) Manufacturing sector in India contributes about 15 per cent of Indias GDP and 50 per cent to the
countrys exports. Moreover, it employed 58 million people (about 12 per cent of the workforce) in 2008
and it is estimated that this sector will employ a further 12-13 million out of nearly 89 million additional
people who will enter the workforce by 2012. Studies have estimated that every job created in
manufacturing has a multiplier effect, creating 2-3 jobs in the services sector. In a country like India,
where employment generation is one of the key policy issues, this makes manufacturing sector a critical
sector to achieve inclusiveness in growth.
The above account makes clear the need and rationale of undertaking the present empirical study with the
purpose of bring to light the impact of changing price level on the financial accounts prepared according to
existing accounting practices in Indian manufacturing sector.
1.5 OBJECTIVES OF THE STUDY
The main objective of the study is to measure and record the effects of price level changes on the Historical
Cost Based Accounting (HCBA) of selected Indian companies. The study focuses attention on significant
aspects of the problem of price level changes in HCBA and in particular attempts:
a) To examine impact of inflation on book profits of selected firms in India.
b) To find out the factors affecting the profitability of firms during the period of inflation.
c) To study the impact of inflation on liquidity, profitability and activity through major financial ratios.
d) To find out the impact of inflation on operational efficiency of firms.
e) To analyze the impact of price level changes on overall performance.
f) To find out the impact of inflation on different industrial sectors.
g) To find out impact of inflation on various stakeholders.
1.6 HYPOTHESES FOR THE STUDY
To study the research problems and to attain the research objectives, six hypotheses have been framed.
Broadly, attempts have been made to test the null hypothesis against the alternative hypothesis. The null
hypothesis and the alternative hypothesis framed for the purpose are as follows:
1. Null Hypothesis (H
01
): There is no significant difference between reported financial performance and
inflated financial performance.
Alternative Hypothesis (H
a1
): There is a significant difference between reported financial performance
and inflated financial performance.
02
): Inflation affects all the industrial sectors uniformly.
a2
): Inflation does not affect all the industrial sectors uniformly.
03
): There is no significant difference in between reported financial ratios and
inflated financial ratios.
a3
): There is a significant difference in between reported financial ratios and
inflated financial ratios.
04
): Inflation affects all the stakeholders of company uniformly.
a4
): Inflation does not affect all the stakeholders uniformly.
16

05
): There is no difference between in reported gross operating income and inflated
gross operating income.
a5
): There is difference between in reported gross operating income and
inflated gross operating income.
06
): There is no difference between reported net operating income and inflated net
operating income.
a6
): There is difference between reported net operating income and inflated
net operating income.
The way in which research is conducted may be conceived of in terms of the research philosophy subscribed
to, the research strategy employed and so the research instruments utilized (and perhaps developed) in the
pursuit of a goal the research objective(s) - and the quest for the solution of a problem. We have outlined our
research objectives in Chapter One. This chapter focuses on the scope of the study, time period, data
collection, statistical tools used in the analysis of data, and the limitations of the study.
1.7 REVIEW OF LITERATURE
Various studies have been conducted in India and abroad relating to impact of inflation on corporate financial
performance. As the main objective of this study is to find out the impact of inflation on financial performance
of Indian corporate sector and its impact on corporate stakeholders, the available literature was reviewed under
the following four categories:
a) The first part reviews the impact of inflation on financial performance,
b) The second part reviews impact of inflation on the major financial ratios,
c) The third part reflects the impact of inflation on stakeholders and
d) The last part reviews literature on impact of inflation on financial performance through application of
a models, methods and techniques.
1.7.1 IMPACT OF INFLATION ON FINANCIAL PERFORMANCE
First of all, H.W. Sweeny (1936), in his publication known as Sweeny's Stabilized Accounting published as
early as 1936 in West Germany studied Inflation Accounting a systematic way in the early part of nineteenth
century. In his publication he proposed an accounting technique to deal with impact of changing price level on
firms financial performance.
A study conducted by the American Institute of Certified Public Accountants (AICPA) in 1948, felt that no
basic change in the accounting treatments of depreciation of plant and equipment is practicable under present
conditions to meet the problem created by the decline in the purchasing power of dollar. Such a change would
confuse readers of financial statements and nullify many of the gains that have been made towards clear
presentation of corporate finance. The AICPA in 1963 advocated inflation accounting very seriously in a study
entitled "Reporting the Financial Effects of Price Level Changes". About six years later, the Accounting
Principles Board of AICPA published its Statement NO.3 in June, 1969 on Financial Statements restated for
general price level changes". The Financial Accounting Standard Board (FASB) was formed in1973. It
prepared a few exposure drafts and brought out some standards most notable among them is Financial
Accounting Standard (FAS)-33 issued by it in 1979. Besides, the Securities and Exchange Commission (SEC)
also contributed to the discussion by issuing "Accounting Series Release (ASR) 190" to provide additional
information on the estimate cost of replacing the inventories etc. In spite of these expository papers and
tremendous amount of discussions that have been provoked it appears to be a very low degree of consensus as
to the exact method of Inflation Accounting that has to be adopted. Until very recently SFAS-33 was emerging
as the correct Accounting for Price Level Changes (APC) standard in the U.S.A. But in December, 1986
another Standard was issued entitled SFAS-89 by the FASB, which emerges as the latest APC standard in the
U.S.A.
A study conducted by Institute of Chartered Accountants in England and Wales published in January
(1973)
.
As a companions to the Exposure Draft (ED 8) on "Accounting for Changes in the Purchasing Power
of Money" issued by the Accounting Standard Steering Committee (ASSC). The Exposure Draft (ED-B) was
debated at length and in May, 1974 it was followed by ASSC's Statement of Standard Accounting Practice
17

(No.7 in a series of SSAP's). This document provisional in its nature required the quoted companies to provide
Inflation adjusted accounts prepared under historical conventions.
Sinha S. L. N. (1974),

in his study on the Impact of Inflation on Company Finance' noted that with respect to
the Reserve Bank study of 350 companies with an aggregate paid-up capital and reserve of Rs. 2,267 crores,
the picture of corporate performance in the three years from 1971 to 1973 suggests that while during the year
1971-72 there was 4 per cent rise in the index number of wholesale price than in the year 1970-71, profit
before tax rose by less than 3 per cent. Again while in 1972-73 the index number of wholesale prices was
about 10 per cent higher than 1971-72, profits before tax declined fractionally, by about 0.25 per cent. If
profits after tax were taken into account, the position would be far worse. To conclude, these companies could
not take benefit of the inflationary price rise in the country and thus a strong case for adjusting company
accounts on the basis of historical values to their current prices emerges to show a more realistic picture.
Shoven B. John, and Bulow I. J (1976), this article is the second of two complementary papers by the authors
concerning inflation accounting and non-financial corporate profits asserted that each balance-sheet entry
warrants restatement relative to current practice in order to compute real profits and provide an accurate
detailed picture of the position of the firm in periods of inflation and of adjustment in relative prices. The
accounting treatment of inventories as well as depreciable assets was examined in detail, and estimates
regarding the impact of adopting accounting.
Gupta Ramesh (1976) in his book entitled "Inflation Accounting" explain that the SSAP-16 came into effect
since January 1, 1985 and is applicable to all the listed and unlisted companies except some small nonrealistic
companies which satisfy at least two of the following three criteria namely: (a) turnover is less than $5 million
per annum (b) balance sheet total in historical cost accounts at the beginning of the period is less than $
25,000, (c) average number of employees is less than 250. The Standard also exempts the value-based
companies (e.g. insurance, investment, real estate etc.) and wholly owned subsidiary companies besides non-
profit making entities such as charities, friendly societies, trade unions and pension funds. The current' cost
accounts may either be regarded as the main accounts, which arc supplemented by the H.C. Accounts or vice
versa, or the CCA Accounts may be presented as the only accounts to have adequate historical cost
information. Thus, the standard provides for current cost. Information, which is included in annual financial
statement in addition to historical cost information should show the effect of Current Cost Adjustments
namely, depreciation Adjustment (DA), Cost of Sales Adjustment (COSA), Monetary Working Capital
Adjustment (MWCA) and Gearing adjustment (GA). In addition gross current cost of fixed assets and
inventories and accumulated current cost depreciation should be disclosed separately. Finally, the Accounting
Standard Committee (ASC) of the U.K. has in the beginning of the year 1986 proposed to the six major
accountancy bodies in the U. K., that SSAP-16 should be withdrawn.
Gupta R. and Bhandari L. C (1978), in their working paper they have mentioned that whether the
accountants should be required to adjust reported income for inflation or not. The objective of this article is to
measure the impact of inflation on reported profits and relevant financial ratios. The earnings of 57 companies
covering 9 industries have been restated for a period of 7 years (1970-1976). The study shows that the impact
of inflation on individual companies and industry groups varies greatly. The result emphasizes the differential
effects on companies with varying inflation rates. The effects of restatement on dividend payout and tax
burden have been suitably highlighted.
Gupta Ramesh (1978) in his working paper A Case Study of the Bharat Heavy Electricals Ltd. reviewed the
recent developments in inflation accounting as well as the role played by the accounting professional bodies in
the U.K., U.S.A and in India. In this paper, a detailed study of the BHEL Current Cost Accounts (CCA) for
the year 1976-77 has been made. The BHEL profitability on historical cost and CCA basis has been evaluated
during this period and found the understatement of profits.
Arie Baran, Josef Lakonishok and Aharon R.(1980), had discussed in their article entitled "The
Information Content of General Price Level Adjusted Earnings: Some Empirical Evidence" in the year 1980
that general price level restated data contain information not included in currently available historical cost data.
The results obtained in this study appear to support the hypothesis that price level restated data contain
information which is not included in the financial reports currently available.
18

William C. Norby (1981), this article Inflation Accounting Information, The SAXE Lecture in Accounting
was related to the impact of inflation accounting adjustments on companies and industry groups for investment
decisions; and demonstrate managerial uses of inflation accounting for internal control as well as strategic
decisions. The analysis was based primarily on covering the eight year period 1972-1980, and concluded with
an appraisal of the advantages and limitation of inflation accounting for practical decision-making.
D. J. Daly (1982), in the article Inflation, Inflation Accounting and its Effect, Canadian Manufacturing, 1966-
82, provides estimates of the effects of inflation in Canada on the reported rate of return in manufacturing
firms from 1966 to 1982. Comparisons are made with similar studies for the United Kingdom. Such studies
show that reported profits are overstated and total assets are undervalued during and after periods of inflation.
The paper also discusses a number of factors that have contributed to the marked drop in the rate of return in
Canadian manufacturing when both income and assets are valued at replacement costs. Some of these factors
are also present in the other industrialized countries, such as increased raw materials prices, and a slower
increase in productivity. Other factors have been relatively more important in Canada than in other countries,
such as the historically higher level of production costs in Canada than in the United States and Japan, the two
most important countries in Canadian trade.
Walter B. Meigs and Hobert P, Meigs (1983), in his book entitled "Accounting- the basis for Business
Decisions" discussed on "Inflation- The Greatest Challenge to Accounting" they define inflation as either an
increase in the general price level or a decrease in the purchasing power of the money (Dollar). The general
price level is the weighted average of the prices of all goods and services in the economy. Changes in general
price level are measured by general price index with a base year assigned a value of 100. The index compares
the level of current prices with that of the base year. They studied that the techniques for restating financial
statements for change in the general price level has been known for many years. Current Cost Accounting is
much newer idea and appears to be gaining acceptance in many countries. They also explained that one factor
contributing to support for current cost accounting is that constant dollar financial statements are based upon
the general price level and not upon the price of specific goods and services. On the other hand a significant
advantage of constant dollar accounting is its high degree of objectivity. Since all adjustments are made by
using the same general price index, valuations are not, based on estimates or personal opinion. Also, the
constant dollar accounting and current cost accounting convey different types of useful information. Both
approaches may be used within the single set of financial statements.
Nunley, Terry James (l983), in his thesis; Effects of Changing Pieces be audited, has studied that the FASB
has indicated that it will reconsider the present requirement for disclosing the effects of inflation. By using the
assertion classifications contained in SAS No. 31, the study examined the types of evidence available to prove
a declaration, which changes a firms performance significantly arc those of valuation and allocation.
Porwal L.S., and Mishra, N. (1983)

investigated into corporate practices in inflation accounting in India. They
investigated 235 large private and public sector companies in India through questionnaires. Around 34per cent
of the total sample (80companies out of 235 companies) has responded to their study, which are from
important industrial groups and were scattered all over the country. The study was mainly for investigating the
need for inflation accounting and inflation accounting practices adopted by different corporate sectors. This
study reveals that very few companies are approaching for the inflation accounting. All the private sector
companies considered inflation only for management accounting purposes, and none showed such information
in their impact of inflation of their financial performance in their published annual reports.
Nigam, R. S., (1983), surveyed the Inflation Accounting in the Developing World. He noted that in the
developing world, in Trinidad and Tobago, some serious efforts have been made in recent years and a high
level committee (popularly named after its Chairman Mr. Joseph Punder) was set up by the Cabinet on
September 22, 1977, with the following terms of reference: To investigate the effects of inflation on companies
accounts and to recommend where necessary appropriates amendments to the Companies Ordinance, and to
examine the effects of inflation on tax paid by companies and other persons and where necessary to
recommend changes in the tax laws.
Antonios A. Papas (1986), in the article Assessing the impact of inflation on business Performance under
conditions of limited Financial Disclosure: The Case of firms Operating in Greece mentioned proper
19

assessment of the effect of inflation upon the performance of firms is seriously impaired by the absence of a
suitable adjustment method and adequate historical-cost accounting data. The methodology proposed herein
provides a sophisticated approach in evaluating inflation-related performance under conditions of limited
financial disclosure. It is built around the General Price Level Adjustment model. Its significance is tested in
assessing the impact of double-digit inflation rates upon the performance of a sample of firms operating in
Greece.
Parchure Rajas (1987), in his book entitled "Inflation and Accounting Theory" observed that the inflation
accounting is a subject which gained wide spread use in U.S., U.K., Canada, Australia, the Latin American and
the Scandinavian countries. In India too there has been a continuing discussion on this subject in which
accountants, economists, industrialists and the government have participated. Despite the general agreement
the need to account for inflation in preparation of financial statements, there is no agreement on the method
which should be used for inflation accounting.
The book entitled "Inflation Accounting and Corporate Taxation" by Sen T.K (1987), studied the term
'inflation' came into use in the latter half of the 19th century or so but such development and discussion
remained almost confined to academics only. In around 1915 during the First World War, this term used into
general. The war put an end to this stability and the wholesale price index stood double, before the prices fell
back to the new level of 1920's. During the Second World War, there was a rapid increase in the prices and
wholesale prices index stood at all time high of about 160 per cent of the 1926 level.
Thanos Catsambas (1988), this paper challenges the mechanical application of inflation accounting to public
sector shortfalls. Although the theoretical considerations underlying the proposed adjustment for the inflation
premium of interest payments are well taken, the new approach has fundamentally focused on measurement
issues with little attention paid to the behavioral aspects of microeconomic adjustment. This paper, therefore,
raises skepticism about the usefulness of inflation accounting, if such a correction is not accompanied by a
conceptual model that links behavioral responses of individuals to balance sheets and other stock variables. In
a departure from previous investigations, the paper also points out the possibility that inflation accounting
might have more relevant implications for public, rather than private, spending
Vernonkam (1990), his book entitled "Accounting Theory" discussed inflation accounting. He defined the
term inflation which is usually understood by the people to mean an excessive rise in price. In economics there
is no general agreement as to its definition but it is frequently referred to as an increase in the general price
level or decrease in the value of money or an increase in the value of national income greater than the increase
in its real income. The common characteristics appear to be a relationship between money on the one hand and
goods and services in general on the other. Therefore, it is safe to say that the inflation pertains to increase in
the general level of prices. Inflation can only be measured indirectly through a general price index.
Gupta, R. L., and Radhaswamy M., (1991), in their book entitled 'Financial Accounting' explained inflation
accounting as the recording of business transaction under the assumption that monetary unit is stable as known
as historical cost approach (HCA). Under historical cost accounting, assets are recorded by business at the
price at which they are acquired and there will be no changing of their values even if the market values of such
assets change. Under this method no recognition is given to change in the value of money as a result of
inflation for example if a building is purchased at Rs. 50,000 in 1970 and another at Rs. 1, 00,000 in 1990,
building will be shown in balance sheet as Rs150,000 without taking into account the fact that a rupee in 1970
is much more than a rupee of 1990 as a consequence of the inflation. In such adding, there is an implied
assumption that the rupee of 1970 and rupee of 1990 are homogeneous in value which is not correct. In other
hand liabilities are recorded at the amounts contracted for and such amounts are not revised to compensate for
changing price level. In other words, cost convention is an important attribute of HCA. Assets are recorded at
the cost of acquisitions ignoring the other values such as replacement cost of economic value of the assets.
Most of the controversy in financial accounting center rounds this convention. The author explain the
limitation of historical accounting, Concepts of capital maintenance, Profit measurement under different
systems of accounting, Methods of accounting for changing price, Guidance note issued by the Institute of
Chartered Accountants of India in respect of accounting for changing prices.
The book entitled "Accounting Theory and Practice edited by Surgan C. Jain, N.D. Mathur in (1994), he
20

edited 18 articles of celebrated authors in various areas like Material Management, return on investment etc.
One of them is the Inflation Accounting in India-Perception of Chartered Accountants written by Subhash
Chandra and J.S. Arora. They studied that historical is the basis of traditional accounting and historical cost
accounts is based on the 'cost or objectivity concept'. It is assumed that under this concept every transaction
must be supported by facts and material evidence. The unique property of historical cost is that it is based on
recording of events which have actually occurred rather than upon contingent events. The financial statements
are prepared by cost management and financial accountant have generally enjoyed a high rate of confidence
and credibility among the internal as well as external users. The financial statements are still prepared on the
basis of historical cost system which has lost its efficiency in view of the significant reduction in the
purchasing power of money. Conventional historical accounts present a misleading view about the companys
results and its value. Sen. Gupta (1976) conducted a study on "Inflation Accounting in India". The study
highlighted the problem of the measurement of price changes through price indices and suggested a combined
method of Current Purchasing Power Accounting (CPPA) and CVA for use. Ram Narain & Nigam (1978) in
his study of "Valuation of Corporate Property and Inflation Accounting" focused on the evolution of suitable
modification of financial statements, accounting methods and development of management information system
so that financial documents reflect a realistic model of the physical situation. The Federation of India
Chambers of Commerce and Industry (FICCI) organized a workshop on 'Inflation Accounting' in Mumbai in
1979. The Indian Institute of Management (I.I.M.) Ahmadabad published a monograph on 'Inflation
Accounting Practices in India' in 1980.
N. Mishra (l982) in his work "Accounting for Price-Level Changes" highlighted the nature of the problem
encountered in times of inflation and the measures suggested for the purpose. The study was undertaken with a
view to measure the effects of price level changes on financial statements of four selected companies by
applying General Purchasing Power Accounting (GPPA) method. Institute of Chartered Accountant of India
(1982) issued a discussion paper on "Treatment of Changing Prices in Financial. Statements" and favoured
current cost accounting method of price level accounting as it seems to be most appropriate in the context of
economic environment in India.
Ashit. B. Saha (1995) in an article entitled "Accounting for Price Level Changes: Evolution Perspective and
Prospectus gives a brief review of the evolution of the Accounting for Price Level Changes (APC) in certain
countries of the world, more particularly the status of APC in the U.K., the U.S.A. The author also highlights
the concern of academic community as well as of the accounting bodies as to the desirability of introducing
APC, although the matter is still subject to controversy.
Shukla, M.C, Grewal, T.S., and Gupta, S.C (1997), in their book entitled "Advanced Accounts" in 1997
explain, due to inflation, the matching principle, vital to preparation of proper financial statements, is violated.
If sales are entered in profit and loss account in terms of 1988 rupee, it is but proper that the relevant costs
should also be in terms of 1988 rupee. That obviously is not so in the case of depreciation, but will the
matching principle be satisfied if the goods sold were purchased say in 1986? To satisfy this principle, it will be
necessary to restate the 1986 purchases in terms of 1988 prices. It is now generally agreed that there is an
imperative need for inflation adjusted financial statements to be prepared and presented to the shareholders and
other interested parties. This is because the phenomenon of inflation is widespread and also has continued for a
long time now; as a result, financial statements prepared on this historical cost basis do not, as a rule, portray
the real state of affairs neither the results of operations nor the financial position. However historical cost
financial statements will continue to be presented; only they will be supplemented by U.K. and the U.S.A. In
U.K. the position has been formalized by the Institute of Chartered Accountants in England and Wales through
SSAP 16 and in U.S.A the Securities and Exchange Commission has framed regulations to require
supplementary inflation adjusted accounting statement. SEC permits the use of the current purchasing power
method called "Constant Dollar Method" as well as the current cost accounting method. In India the position is
that there is no compulsion as yet for any company to present accounts otherwise than on the basis of historical
costs. Some companies have revalued their fixed assets but the purpose in their cases appears to be quite
different from that of inflation accounting since even the reported profit remains largely unaffected. A few
companies, on their own, have prepared supplementary financial statements on the basis of inflation but the
objective seems to have been either to get a prize from the Institute of Chartered Accountants of India, which
the Institute awards annually for the best presented accounts, or to show how the real profits are lower than the
21

reported profits and how tax and bonus to employees were unreasonably high. The author also explains the
current purchasing power method and current cost accounting method and evaluation of current cost
accounting.
Ambrish Gupta (2000), the book entitled to Inflation Accounting: The Indian Context, this study was a
modest effort towards a systematic and comprehensive analysis of various aspects for inflation accounting and
looks for offering an acceptable solution to this problem in the Indian context. The study discusses the problem
as well as the need for Inflation accounting in India, its origin, subsequent developments the world and the
alternative approaches to Inflation Accounting. It also made an assessment of its effect of inflation on the
profitability plus financial position, respectively, of the corporate entities. He took into consideration different
companies and reflected the effect of inflation on financial performance and position of those firms.
Okumus H. Saduman (2002), in his article The Effect of Inflation on Measures of Profitability in Turkish
Banking aims to demonstrate the disfiguring effects of inflation on the financial statements of Turkish banks,
and the corresponding effects on measures of profitability performance. It is observed that after inflation
adjustment, the level of profitability in Turkish banking over the period 1989-1995 is lower (overall) with
respect to profitability measures calculated using historical cost based on financial statements. In addition to
this, a significant change in ranking by bank group, according to profitability performance is noted. This
clearly reflects the importance of considering the potential distorting effects of inflation on the financial
statements of Turkish banks.
Fr. Paratre (2003), this study is related to most of the countries which have suffered from inflation within
recent memory and countries in Latin America and the former Soviet Union have lived with very high rates of
inflation for several years. Under inflation, national accounts at current as well as at constant prices will be
seriously distorted unless special adjustment techniques are applied. By explaining these in a systematic
fashion, the author brings new insights into the definition and measurement of income as well as the
calculation and interpretation of price indices.
Mohd. Rizwan Ahmad (2003), the book Inflation Accounting Practices in Indias Corporate Sectors has
mentioned the framework of inflation accounting, inflation accounting practices in Indian companies as well as
practices in foreign countries. It also lucidly highlighted and discussed role of existing system of inflation
accounting operated in different corporate sectors and its impact on corporate profitability.
Ross Jennings and Gustavo Maturana (2005), in their study The Usefulness of Chilean Inflation
Accounting, examined the usefulness to investors of the monetary correction required under Chilean
accounting standards. The monetary correction arises when nonmonetary assets, liabilities and owners equity
are restated for changes in the purchasing power of the Chilean peso, and when assets and liabilities
denominated in other currencies are restated for changes in the exchange rate between that currency and the
Chilean peso. This paper provided three separate sets of empirical results that examine the relation between the
monetary correction and both unexpected returns and security prices, conditional on the remainder of reported
earnings. Taken together, the results suggested that the monetary correction provides useful information for
investors.
Yaniv Konchitchki, (2011), in his article Inflation and Nominal Financial Reporting: Implications for
Performance and Stock Prices studied the Monetary Unit fundamental accounting assumption relies on a
stable currency as the unit of record. Even during periods of low inflation, nominal financial statements violate
this assumption. Moreover, because inflation affects firms differently depending on the structure of their assets
and liabilities, these effects vary across firms and over time. First, it showed that unrecognized economic gains
and losses from inflation manifest in future cash flows. Second, it found that investors do not adequately
incorporate this information in their pricing decisions.
Charles N, Daniel L. Blakley, L.William Murray, and Marolee Beaumont Smith (2011), in their article
Econometric Analysis of Functional Relationship between Inflation and Growth of Firms in South Africa:
Empirical Research Findings this research is to investigate the impact inflation and other factors on the
growth of business firms operating in South Africa. Data sets of South African firms financial statements over
the period of 1983-1990 were assembled to permit a detailed examination of the impact of inflation on firms
22

financial pertinences. Employing both direct and indirect measures of inflation, it has concluded that inflation
affects growth in a negative manner.
1.7.2 IMPACT OF INFLATION ON MAJOR FINANCIAL RATIOS
Gupta Ramesh and Bhandari L C (1978), in their working paper mention whether accountants should be
required to adjust reported income for inflation. The objective of this article is to measure the impact of
inflation on reported profits and relevant financial ratios. The earnings of 57 companies covering 9 industries
have been restated for a period of 7 years (1970-1976). The study shows that the impact of inflation on
individual companies and industry groups varies greatly. The results emphasize the differential effects on
companies with varying inflation rates with general price level adjustments and the significance of monetary
gains and losses. The effects of restatement on dividend coverage and tax burden have been suitably
highlighted.
D J. Daly (1982), in the article Inflation, Inflation Accounting and its Effect, Canadian Manufacturing, 1966-
82, provides estimates of the effects of inflation in Canada on the reported rate of return in manufacturing
firms from 1966 to 1982. It provides estimates for several different concepts of rate of return (both for all
assets, whether financed by equity or debt, and for the narrower equity to the owners) and for both a narrow
and wide range of financial assets. Comparisons are made with similar studies for the United Kingdom.
Shalom Hochman and Oded Palmon (1985) in his article The Impact of inflation on the Aggregate Debt-
Asset Ratio demonstrates the impact of inflation on the aggregate debt-asset ratio cannot be determined
theoretically. However, it is shown that inflation is likely to increase this ratio when personal income tax
schedules are indexed to the price level and/or when leverage-related costs are relatively high and the personal
tax rate on income from holding common stocks is relatively low.
Whittington G, Saporta V and Ajit Singh (1997), in their working paper The Effects of Hyper-Inflation on
Accounting Ratios Financing Corporate Growth in Industrial Economies described the hyper-inflation can
have a severe distortionary effect of the pattern of corporate finance which is apparent from company accounts.
A simple algorithm, based upon the method of inflation accounting applied in Brazil, is developed and applied
to the accounts of Turkish listed companies for the period 1982-90. The adjusted figures give a more plausible
picture of corporate profitability and growth, and this suggests that the adjustment method is substantially
successful. The financing patterns emerging from the adjusted data support the proposition of Singh and
Hamid (1992) and Singh (1995) that (a) the corporate sector in developing countries tends to rely more on
external finance than on internal finance for growth and (b), among the external sources of funds, it uses new
share issues to a surprisingly high degree. Further adjustments to the measurement of the external finance
variable for Turkey and other countries also support this proposition. This contradicts the "pecking order"
hypothesis, which suggests that retained profits are the preferred source of finance, and also runs contrary to
the belief that the capital markets of developing countries are inadequate to support substantial corporate
growth by external financing, including equity financing.
Ambrish Gupta (2000), the book entitled to Inflation Accounting- the Indian Context, this study was a
looks for offering an acceptable solution to this problem in the Indian context. It also made an assessment of
the its effect of inflation on the profitability plus financial position, respectively, of the corporate entities, in
addition to above it attempt to make an overall review of the financial statements, through ratio analysis and
funds flow analysis, in the light of inflation. This study moreover reflects effects of inflation, over sixteen
years between 1983-84 to 1998-99, on the financial health of Oil India Ltd. which has been following the
current cost accounting approach to inflation accounting since 1983-84 to date In the last it identified the
barriers in the implementation of inflation accounting in India in addition to concluded with suggestions for
adopting and implementing Inflation Accounting in India.
Karapinar A. and Zaif F (2005), (The Effect of Inflation Accounting on Financial Statement Analysis) In
their study, Karapinar and Zaif examined the effects of inflation on accounting practice of companies
financial ratios. Their sample covered the 73 non-financial companies listed Istanbul Stock Exchange as of
2003. The ratios were calculated on both historical and adjusted numbers of financial statements to form two
23

sets of ratios. Results showed that there was no significant change in liquidity, financial, profitability and
activity ratios except fixed asset turnover ratios.
Charles, Daniel L. Blakley, L.William Murray, and Marolee Beaumont Smith (2011), in their article
Econometric Analysis of Functional Relationship between Inflation and Growth of Firms in South Africa:
Empirical Research Findings this research is to investigate the impact inflation and other factors on the
growth of business firms operating in South Africa. Data sets of South African firms financial statements over
the period of 1983-1990 were assembled to permit a detailed examination of the impact of inflation on firms
financial ratios. It has concluded that firm's debt-to-equity, sales-to-assets, and profitability ratios are all
positively associated with growth and adversely affected by high inflation; a firm's working capital-to-sales
ratio is negatively related to growth and is positively affected by high inflation; and there is a real, measurable
impact of the financial instabilities associated with apartheid on firms growth.
Aydn Karapinar, Figen Zaif and Rdvan Bayirli (2012), this study investigates the impact of inflation
accounting application on key financial ratios. These studies related to the financial statements of 132
companies listed in the Istanbul Stock Exchange (ISE) are studied. An analysis of paired samples t test has
been conducted on the financial ratios of the companies. The results showed that a significant difference
between adjusted cost based financial ratios and historical cost based financial ratios occurs only for current,
ratios, equity ratios and noncurrent turnover ratios. The study offered valuable information as to analyzing
companies operating in hyper inflation economies. In India serious thinking on having to adjust historical cost
accounts to price level change has been rather few and far between.
1.7.3 IMPACT OF INFLATION ON STAKEHOLDERS
Shukla, M.C, Grewal, T.S., and Gupta, S.C. (1997), in their book entitled "Advanced Accounts" in 1997
explain, that it is now generally agreed so as to there is an imperative need for inflation adjusted financial
statements to be prepared and presented to the shareholders and other stakeholders. This is because the
phenomenon of inflation is widespread and also has continued for a long time now; as a result, financial
statements prepared on this historical cost basis do not, as a rule, portray the real state of affairs neither the
results of operations nor the financial position.
An article entitled "The Inflation Accounting Cycle: A British-Australian Comparative Perspective by Rowles
T, & Burrows G, (1997), this paper seeks 10 extend understanding of the 'accounting-cycle' hypothesis by
comparing the Australian, and United Kingdom (U.K.) experiences with inflation accounting. The paper
confirms that the most of the phases identified in respect of inflation-accounting cycles in the U.K. are,
broadly, also identifiable in Australia. The Australian experience also largely confirms in relation to inflation
accounting model of standard setting in which change is driven by stake-holders with conflicting attitudes
towards the degree of standardization of treatments prescribed by accounting standards. Here the authors argue
that in Australia inflation continued at a high rate after interest in inflation accounting ceased. A counter
hypothesis is suggested: that interest in inflation accounting would have wanted in the UK irrespective of the
level of inflation. Although the Australian evidence supporting concept is quite strong, detailed analysis of the
attitudes and behaviour of the various stake-holders in inflation accounting standards is more diverse.
Complicating U.K.-Australia comparisons arc different socio-economic environments and differing political
responses to the problem of financial reporting under high levels of inflation. The nature of these differences
and the manner in which they may have affected inflation accounting standard setting is explored. Further,
they argue that the a typical character of inflation accounting makes it dangerous to draw too many parallels
between inflation accounting and other, more singular accounting problems, in the context of developing
accounting standards.
Ambrish Gupta (2000), the book entitled to Inflation Accounting- in the Indian Context, this study was a
as well as the need for Inflation accounting in India, its origin, subsequent developments the world and the
alternative approaches to Inflation Accounting. It also made an assessment of its effect of inflation on the
profitability plus financial position. In addition to above it attempts to make an overall review of the financial
statements, through of different corporate sectors and impact of inflation on the different stakeholders of those
24

companies. This study moreover reflects fiscal incentives vis-a-vis inflation, analyses as to how the various
stakeholders associated with business as well as industry have been affected by inflation vis-a-vis the corporate
entities and discusses some implicit issues, effects of inflation, over sixteen years between 1983-84 to 1998-99,
Ross Jennings and Gustavo Maturana (2005), in their study The Usefulness of Chilean Inflation
Accounting, examines the usefulness to the stakeholders mainly investors that monetary correction required
under Chilean accounting standards. The monetary correction arises when nonmonetary assets, liabilities and
owners equity are restated for changes in the purchasing power of the Chilean peso, and when assets and
liabilities denominated in other currencies are restated for changes in the exchange rate between that currency
and the Chilean peso. This paper provided three separate sets of empirical results that examine the relation
between the monetary correction and both unexpected returns and security prices, conditional on the remainder
of reported earnings. Taken together, the results suggested that the monetary correction provides useful
information for investors.
Tarun C Hordia and L. Shivakumar (2005), in their article Inflation Illusion and Post-Earnings-
Announcement Drift examines the cross-sectional implications of the inflation illusion hypothesis for the
post-earnings-announcement drift. The inflation illusion hypothesis suggests that stock market investors as a
stakeholders of the company fail to incorporate inflation in forecasting future earnings growth rates, and this
causes firms whose earnings growths are positively (negatively) related to inflation to be undervalued
(overvalued). They argue and show that the sensitivity of earnings growth to inflation varies monotonically
across stocks sorted on standardized unexpected earnings (SUE) and, consistent with the inflation illusion
hypothesis, show that lagged inflation predicts future earnings growth, abnormal returns, and earnings
announcement returns of SUE-sorted stocks. Interestingly, controlling for the return predictive ability of
inflation weakens the ability of lagged SUE to predict future returns of SUE-sorted stocks.
Yaniv Konchitchki, (2011),

in his article Inflation and Nominal Financial Reporting: Implications for
Performance and Stock Prices studied the Monetary Unit fundamental accounting assumption relies on a
stable currency as the unit of record. Even during periods of low inflation, nominal financial statements violate
this assumption. Moreover, because inflation affects firms differently depending on the structure of their assets
and liabilities, these effects vary across firms and over time. First, it showed that unrecognized economic gains
and losses from inflation manifest in future cash flows. Second, it found that stakeholders do not adequately
incorporate this information in their pricing decisions.
1.7.4 APPLYING MODELS TO MESURE IMPACT OF INFLATION
An article entitled "The State of Current Value Accounting" by Edgar O Edwards, in (1975), observed the
volatility of price during this decade suggests a review of current value accounting technique is in order, where
it stands today and what its future might be. The literature indicates a substantial acceptance of current value
accounting technique in accounting theory, but difficult to implement in accounting practice. Nevertheless,
current value accounting seems to have found a grouping number of adherents to its principle, there are yet
some major differences, many rough edges and a few blind alleys exposed in the theoretical literature.
An article entitled "Current Cost Accounting-Some Basic Problems" by Fisher, John published in U.K.
(1976) make a comprehensive study of Accounting Price Level Changes (APC) standard is SSAP-16 which
was issued in March, 1980. Although it is mandatory and calls for a complete set of current cost statements
including income statement and balance sheet of many companies have shown reservation in complying with
it. Despite very high degree of resistance or reservations shown by the companies it survived because it
(SSAP-16) has many strong points in favour of it. Firstly, it is honorable because a government appointed
committee (The Sandilands Committee, 1975) in the U.K. has recommended the use of this accounting
technique to overcome the distortions caused in accounts by changes in price levels. Secondly, the view of the
committee that earnings and assets of a firm should be measured by reference to valuation is quite logical and
justified. Thirdly, the CCA recognizes that it is the current cost only that should be deducted from current
income in order to extract the earning for a given period. Fourthly, Separation of holding gains (difference
between the current value of assets and its, original cost) from operating profit/earning enables the
management to evaluate its financial performance. Fifthly, the breakup of details of values of assets and
25

liabilities as give under the CCA method represents a more accurate and realistic approach as to the financial
position.
The book on Inflation Accounting: A Guide for the Accountant and The Financial Analyst written by Sidney
Davidson, Clyde P. Stickney and Homan L. Well in U.S.A. in 1976,

mentioned that the economy in recent
years has experienced steady rising prices. There are various ways of seeking to reflect this increase in prices
in the accounts. The most widely discussed type of reporting is variously known as "financial reporting in units
of general purchasing of power", and "PPU (Purchasing Power Unit) Accounting". The most persistent and
significant comment about accounting in recent years is that ignores in economic fact of life. This has probably
been the single most important economic phenomenon of 1970s. Yet this significant fact goes unrecognized
today under general purchasing power accounting throughout the English speaking world and is similarly
ignored or effectually dealt with in the accounting procedures much of the rest of the world. In this book the
authors discussed three methods of accounting for inflation: (i) historical dollar, conventional accounting, (ii)
current value accounting and (iii) general price level adjusted accounting based on historical cost.
Mohinder N Kaura (1982), his article Recent Development in Inflation Accounting: A Critique discusses
the recent development in inflation accounting worldwide. It analyses broadly the two solutions for inflation
accounting (1) the current purchasing power method on financial performance; and (ii) current cost accounting
method on financial performance. In particular, the paper goes in detail about the current cost accounting
approach and describes the procedure for various adjustments needed. The Indian scene portrays the latest
developments in this field, and concludes that the time is ripe now to adopt the inflation accounting in India on
a large scale by the industry and government.
Edward V. Mclntyre (1982), in their article entitled "Interaction Effects of Inflation Accounting Models and
Accounting Techniques" explain the choice of accounting techniques as well as evaluations of accounting
numbers, are based in part upon a knowledge of the relative profit patterns associated with alternative
techniques. It is generally understood that inflation accounting models change profit patterns, and the general
effects of changes from historical cost accounting to various inflation accounting models have been analyzed.
In addition to their general effects, however, there are specific effects due to the interactions of conventional
accounting techniques such as Last-In-First-Out (LIFO) and First-in-First Out (FIFO) and specific inflation
accounting models. This study analyses the interaction effects of conventional inventory accounting methods
and several inflation accounting models to demonstrate that these effects can produce significant and non-
intuitive changes in relative profit patterns among alternative accounting techniques.
Daniel Boussard (1984), in his article The Impact of the Definition of Inflation on the Effectiveness of
Inflation Accounting Adjustments views in tests of inflation accounting methods. The example presented here
deals with a different case: inflation is characterized by changes in the structure of prices. In particular, prices
of articles bought and articles sold do not vary at the same rates. In this context, it is observed that adjustments
are not effective, i.e. they do not have the potential to report real or nominal rates of return. This result should
be considered as a criticism of the coherence of inflation accounting methods.
Antonios A. Papas (1986), in his paper Assessing the impact of inflation on business Performance under
conditions of limited Financial disclosure: the case of firms Operating in Greece mentioned that proper
assessment of the effect of inflation upon the performance of firms is seriously impaired by the absence of a
suitable adjustment method and adequate historical-cost accounting data. The methodology proposed herein
provides a sophisticated approach in evaluating inflation-related performance under conditions of limited
financial disclosure. It is built around the General Price Level Adjustment model. Its significance is tested in
assessing the impact of double-digit inflation rates upon the performance of a sample of firms operating in
Greece.
Jeffrey J. Archambault and Marie E. Archam bault (1999),

this paper develops a model to identify
characteristics that may affect inflation accounting practice among countries. Parametric and nonparametric
tests are conducted to determine the effect of inflation rate, national culture, legal system, economic system,
accounting system, and other accounting policies on inflation accounting practice. Countries that use price
level adjustment have higher inflation than countries that use historical cost or historical cost with some
revaluation. The results indicate that national culture, accounting system, economic system, and financial
26

statement disclosure are also important factors in explaining the cost basis used by businesses operating in
various countries.
Ambrish Gupta (2000),

the book entitled to Inflation Accounting- The Indian Context, this study was a
as well as the need for Inflation accounting in India, its origin, subsequent developments in the world and the
alternative approaches to Inflation Accounting. It also made an assessment of the effect of inflation on the
profitability plus financial position, respectively, of the corporate entities, in addition to above, it attempted to
make an overall review of the financial statements, through ratio analysis and funds flow analysis, in the light
of inflation. This study moreover reflects fiscal incentives vis--vis inflation, analyses as to how the various
stakeholders associated with business as well as industry have been affected by inflation vis-a-vis the corporate
entities and discusses some implicit issues. effects of inflation, over sixteen years between 1983-84 to 1 998-
99, on the financial health of Oil India Ltd. which has been following the current cost accounting approach to
inflation accounting since 1983-84 to date In the last it identified the barriers in the implementation of inflation
accounting in India in addition to concluded with suggestions for adopting and implementing Inflation
Accounting in India.
Tugui AI, Alexandru Jr. (2001), in his article A New Model for Inflation Accounting studied the result of
nine years of research in the doctoral field. Inflation Accounting, having performed a comprehensive
documentation in the field, and have arrived at the conclusion that the existing accounting models hide
information needed by management and accounting activities. So he proposed this multiple-value or account-
unit accounting model.
Mohd. R Ahmad (2003), the book Inflation Accounting Practices in Indias Corporate Sectors has
mentioned the framework of inflation accounting, inflation accounting practices in Indian companies as well as
practices in foreign countries. It also lucidly highlighted and discussed role of existing system of inflation
accounting operated in different corporate sectors and its impact on corporate profitability. It also mentioned
the different methods of inflation accounting like Accounting for Current Purchasing Power and Current Cost
Accounting Method to approach to the inflation accounting.
Yang, David C, Vasarhelyi, et, al (2005), this paper analyzes the differences in methods of calculating and
disclosing net assets between Statement of Financial Accounting Standards #33 (FAS33) and other existing
current cost and constant dollar methods. Furthermore, this paper provides empirical evidence on the methods
employed by a sample of 78 companies that calculated net assets for FAS33 reporting. They found that there
are many methods being applied to determine net assets. The lack of uniformity reduces the effectiveness of
net assets disclosure required by FAS33. This study demonstrated that the Financial Accounting Standards
Board should issue statements that are more well-defined and less ambiguous about preferred net asset
disclosure methods.
1.8 RESEARCH GAP
From the above discussion, it is found that there have seen a few studies conducted in India on the subject
while the inflation during this period has been very high from last some decades. During this period the
literature on the subject at international level has undergone vast changes and a number of developments, such
as pronouncements from professional accounting bodies, withdrawal of CCA in England and USA, settlement
of controversies on different aspects of ACPP, have taken place. Not much, however, has been done in India.
Whatever little was done during 1975-76 has become outdated and obsolete. The ICAI has also not carried
further its efforts. It is the need of the hour to carry out a systematic and comprehensive research study in the
light of latest developments on inflation accounting which highlights and analyses its various aspects. Hence,
an effort has been made here in this study to deal with the problem. It is expected that the study will be a major
stepping stone in creating awareness about the problem among the accountants, business and industry as well
as the Government.
1.9 RESEARCH DESIGN
27

This research is pursued with the help of secondary data. It intends to determine the impact of inflation on
financial performance, financial ratios and stakeholders. In order to pursue the objectives mentioned above, the
research methodology comprises of the followings.
(a) Collection of secondary data from various published/unpublished sources.
(b) Classification and tabulation of collected data according to their specific characteristics relevant to this
research.
(c) Processing of data with the help of analytical tools through computer programmes.
1.9.1 Nature and Sources of the Data
The data required for the purpose of the study is secondary in nature. Those have been collected from various
websites; viz. moneycontrol.com, hindieconomictimes.indiatimes.com and different companys annual reports.
A good amount of data has also been collected from different journals like Capital Market Review, SEBI
Bulletin, Dalal Street, Chartered Financial Analyst, Portfolio Organizer, Economic & Political Weekly,
Economic Survey, Chartered Accountant and Finance India, etc. Various financial newspapers, press notes,
publications of various bankers have also been consulted.
1.9.2 Selection of Sample
As discussed earlier inflation affects the corporate profitability mainly due to exaggeration of material cost and
depreciation, therefore the sample data for the study has been taken only from manufacturing companies
operating in India. In this study data for a period of five years, from 2004-05 to 2008-09, have been taken for
different manufacturing companies operating in India.
Normally in terms of statistics, a sample size of 25 to 30 is considered reasonable for a large
population. This is not a subjective assessment but a technical fact. Thus the SENSEX represents the market as
a whole even through it consists of only 30 stocks
1
. As this study took 42 manufacturing companies as sample,
classified into 7 industrial sectors (selecting 6 companies from each sector), therefore we are sure the sample
represents the population. The forty-two firms selected were profitable and followed the same accounting
practices over a period of five years (2004-05 to 2008-09). The firms, those belong to different Sectors include;
Automobiles, Cements, Chemicals, Fertilizers, Foods, Petroleum and Steel with varying degrees of debt
exposure and capital intensity. This diversity helps to exemplify the impact of inflation on monetary items, and
the applicability of the model on firms with different capital structures. The sample companies included in
each sector are as follows:
Automobile Sector comprises of Hero Honda Motor, Maruti Suzuki, JBM Auto, Munjal Auto, Setco
Automotive and TVS Motor.
Cement Sector includes Birla Corporation, Chettinad Cement, J K Cement, Sagar Cements, Shree
Cements and Ultra Tech Cement.
Chemical Sector consists of Aditya Birla Chemicals, Chemfab Alkalis, Daikaffil Chemicals, Gujarat
Alkalis & Chemicals, Jayshree Chemicals and Tata Chemicals.
Fertilizer Sector takes account of Asian Fertilizers, Basant Agro Tech, Bharat Fertilizer, Gujarat
Narmada Valley Fertilizers, Madras Fertilizers and National Fertilizers.
Food Sector includes Agro Tech Foods, Chordia Food Products, DFM Foods, Flex Foods, JR Foods
and Sita Shree Food.
Petroleum Sector consists of Andhra Petrochemicals, Bharat Petroleum, Chennai Petroleum
Corporation, GAIL, Mangalore Refinery and Petrochemicals and Oil & Natural Gas Corporation.
Steel Sector comprises of Bajaj Steel, Facor Steels, Gangotri Iron & Steel, Lloyds Steel, Tata Steel
and Visa Steel.

1.
Raghunathan V. and Rajib P., (2008): Stock Exchanges, Investments and Derivatives: Tata McGrawHill, p
27.

28

1.9.3 The Period of Study
For the analysis, 42 companies are selected as sample from firms listed either in Bombay Stock Exchange
(BSE) or National Stock Exchange (NSE) which are largest stock markets in the country. The firms are
selected on the basis of their turnover in a particular sector: High, Medium and Low. The period of study
ranges from 2004-05 to 2008-09.
1.10 TOOLS AND TECHNIQUES USED
In the present study, the data collected from the sample companies are analyzed with the help of an inflation
accounting method called Current Purchasing Power Method (CPP), a Model as well as Financial Statement
Analysis (FSA). Statistical tools such as; Average, Variance, Standard Deviation, Skewness, Kurtosis and t-
test have been employed for the analysis of data and to draw meaningful conclusion there from.
A number of analytical tables have been constructed for the effective presentation of the results of analysis.
Various tools and techniques used in the study have been discussed below:
1.10.1 Current Purchasing Power Method
Current Purchasing Power Method of accounting requires the companies to maintain the financial statements
on conventional historical cost basis, but it further requires presentation of supplementary statements in items
of current purchasing power of currency at the end of the accounting period. In this method the various items
of financial statements, i.e. balance sheet and profit and loss account are adjusted with the help of recognized
general price index. The consumer price index or the wholesale price index prepared by the Reserve Bank of
India can be taken for conversion of historical costs. Following are the steps to be followed for inflation
accounting.
Choice of the method
There are various methods of Price Level Accounting or Inflation Accounting viz. Current Purchasing Power
Method (CPP), Replacement Cost Accounting Method (RCA), Current Value Accounting Method (CVA) and
Current Cost Accounting Method (CCA). Out of these four, the Current Purchasing Power Method (CPP
Method) scores over others mainly because of its objectivity, verifiability, simplicity and economy. Had there
been no inflation the CPP accounts would be the same as historical accounts. The CPP, therefore, maintains
the basic character of accounts. Defining inflation in terms of specific price changes for specific industries are
highly sophisticated and advanced economic concept which is yet to find acceptance of the economists and
economic thinkers. Therefore, in the present economic environment of India, the CPP is the most suitable
solution to the problem of inflation accounting. It may also be noted and appreciated here that IASC has also
advocated the CPP approach to be adopted.
Selection of Index
The accounting bodies in USA, England, Latin America, India and the IASC have recommended the
restatement of financial statements using a general price index that reflects changes in general purchasing
power. In India there are two Major contenders for this purpose:
(a) All India Average Consumer Price Index (CPI), published by Labor Bureau.
(b) All India Wholesale Price Index (WPI) published by The Economic Adviser to the Government of
India, Ministry of Industry.
Out of these two, WPI is the most updated price index and also more broad-based than CPI associated with
wholesale industrial and non-consumer transactions which, unlike CPI, concern the corporate sector. The WPI
is, therefore, the obvious choice for restating the financial statements in terms of current purchasing power of
rupee. However, in conformity with IAS-29, WPI (All Commodities) is being used in this study,
Conversion Process
For analyzing the impact inflation on financial performance the Historical Cost Based (HCB) accounting,
financial statements for all the years from 2004-05 to 2008-09 were converted into Accounting for Current
29

Purchasing Power (CPP) financial statements in terms of the index number prevailing in the month of March
2009. The adjustments for inflation are based on movements in wholesale price index.
Table-5.1
Wholesale Price Index in India
Year Average
2004-05
End
Year End
2004-05
End
2000-01 83.19 100.00 84.00 100.00
2001-02 86.18 103.59 85.48 101.76
2002-03 89.12 107.13 90.60 107.86
2003-04 93.98 112.97 94.93 113.01
2004-05 100.07 120.29 100.00 119.05
2005-06 104.50 125.62 105.70 125.83
2006-07 111.40 133.91 112.80 134.29
2007-08 116.60 140.16 121.50 144.64
2008-09 126.00 151.46 123.50 147.02
Source: Handbook of Statistics on Indian Economics: RBI, 2008-09 Sept15 2009
The conversion process is explained hereunder
(a) All items of Profit &Loss Account, except Inventory Cost, Depreciation, Taxation, and Equity Dividend
have been restated with reference to the "average price index of the year/period" as applicable to the
individual year.
(b) Inventory cost has been restated after segregating opening balance of inventories, purchases of raw
materials and closing balance of inventories as follows:
- Opening balance of inventories restated in previous year average price index.
- Closing inventories and purchases of raw materials restated in average year price index as applicable
to the individual year.
(c) Fixed Assets and Depreciation cost of all the years of study has been adjusted to year base year 2000-01 at
year end price index.
(d) Taxation, Dividend on equity shares have been restated with reference to the "end of the year/period
index" as applicable to the individual year
(e) The CPP Method divides the Balance Sheet items into two categories: Monetary items and Non-monetary
items. Monetary items are those assets and liabilities the amounts of which are fixed by contract or statute
in terms of the number of rupees irrespective of the changes in the purchasing power of rupee. Items which
comes under monetary in nature are as follows:
- Monetary assets include Investments, which are fixed in rupees, Current Assets other than
Inventories.
- Monetary Liabilities include Secured Loans, Unsecured Loans, Current Liabilities and Provisions
Since the value of monetary items is fixed in rupees, they are already expressed in terms of current purchasing
power of rupee and, therefore, need no restatement.
For Calculating purchasing power gain/loss, the balance of net monetary liabilities/assets as on the date of the
Balance Sheet is bifurcated into opening balance and additions/decrements thereto during the year. The
opening balance is restated with reference to the index prevalent on that date. Additions/decrements are
restated with reference to the average index of the year. The closing balance is deducted from the total of
restated opening balance and additions/decrements. The resultant figure, if positive, is gain otherwise loss in
the case of net monetary liabilities and vice versa in the case of net monetary assets.
1.10.2 Financial Statement Analysis
It can be defined as the process of identifying financial strengths and weaknesses of the firm by properly
establishing relationship between the items of the balance sheet as well as the profit and loss account. There
are various methods or techniques that are used in analyzing financial statements, such as; comparative
30

statements, schedule of changes in working capital, common-size statement, funds analysis, trend analysis, and
financial ratio analysis. In this study the comparative statement, common-size statement and financial ratios
have taken into consideration.
Comparative Statements Analysis
Comparative Financial Statement analysis provides information to assess the direction of change in the
business. In this study profit and loss account figures under HCB Method are compared with those of the CPP
Method.
Common Size Financial Statements Analysis
In common size statements, balance sheet and income statement are shown in analytical percentage. The
figures are shown as percentage of total assets, total liabilities, or of total sales/total revenue. In this study
profit and loss account figures under HCB Method and CPP Method items are shown as percentage of total
revenue.
Financial Ratio Analysis
Financial ratio analysis is a study of ratios between various items or groups of items in financial statements.
Although ratios can be classified into different categories, for this study liquidity ratio, activity ratio and
profitability ratio has been taken into consideration to study the impact of inflation on financial performance.
Liquidity Ratios
These ratios are calculated to comment upon the short term paying capacity or liquidity position of a firm or a
firms ability to meet its current obligations. The important liquidity ratios are current ratio and quick ratio.
- Current Ratio is a measure of general liquidity and is used to make the analysis of a short-term
financial position or liquidity of an organization. It represents the margin of safety.
Current Assets
Current Ratio =
Current Liabilities

- Quick Ratio is also known as Acid Test Ratio or Liquid Ratio. It is a fair measure of liquidity. It is
based on those current assets those are highly Liquid. Inventories are excluded from the current assets.
Quick Assets
Quick Ratio =
Current Liabilities

Profitability Ratio/Profit Margin Ratio
This ratio measures the results of business operations on overall performance and effectiveness of the firm.
The main profitability ratios are Gross Profit Margin, Operating Profit Margin and Net Profit Margin, etc.
- Gross profit margin measures the relationship of gross profit to sales. It ratio indicates the margin left
after meeting all manufacturing costs.
Gross Profit
Gross Profit Margin = X100
Sales

- Operating profit margin shows the relationship between operating profit (profit before interest and
tax) and sales. The operating profit for the purpose is calculated by deducting depreciation and other
operating costs but before interest from gross profit.
Operating Profit
Operating Profit Margin = X100
Sales

- Net Profit Margin establishes a relationship between net profits (profit after tax) and sales and it
indicates the efficiency of the management in manufacturing, selling, administrative and other
activities of an organization. It shows the overall performance of an organization.
31

Net Profit
Net Profit Margin = X100
Sales

- Return on Investment is yet another important ratio used to measure the efficiency of an organization,
as the objective of each organization is to maximize its earning.
Profit before Interest and Tax
Return on Investment =
Capital Employed

- Dividend Payout Ratio is the dividend paid by a firm with respect to its earnings. It is the percentage
of dividend paid out of the earnings. The formula for dividend payout ratio is:
Dividend per share
Dividend payout ratio =
Earnings per share

Activity Ratios
It referred to as turnover ratio or asset management ratios, measure how efficiently the assets are employed by
the organization. The important turnover ratios are inventory turnover ratio, receivable turnover ratio, average
collection period, fixed assets turnover ratio, and total assets turnover ratio. Activity ratios are calculated to
measure the efficiency with which the resources of a firm have been employed.
- Debtor turnover ratio indicates the velocity of debt-collection of an organization. In simple words, it
indicates the number of times debtors (receivables) are turned over during a year. Generally a high
turnover ratio indicates efficiency in management of debtors.
Sales
Debetor Turnover Ratio =
Average Trade Debtors

- Creditor Turnover Ratio: In course of business operations an organization makes credit purchases and
incurs short-term liabilities. Suppliers of goods are naturally interested in finding out how much time an
organization likely to take to repay its creditors.
Purchase
Credit Turnover Ratio =
Average Trade Creditors

- Inventory Turnover Ratio: Organization has to maintain the inventory so as to able to meet the
requirement of the business, but the level of inventories should not be too high or too long.
Sales
Inventory Turnover Ratio =
Average Inventory

1.10.3 Descriptive Statistics
It is a set of brief descriptive coefficients that summarizes a given data set, which can either be a representation
of the entire population or a sample. Descriptive statistics are most often used to examine:
- Central tendency (location) of data i.e. where data tend to fall, as measured by the mean, median,
and mode.
- Dispersion (variability) of data i.e. how far data is spread out, as measured by the variance and its
square root, the standard deviation.
- Skewness (symmetry) of data i.e. how data is concentrated at the low or high end of the scale, as
measured by the skew index.
- Kurtosis (peakedness) of data i.e. how far concentrated data is around a single value, as measured
by the kurtosis index.
Any description of a data set should include examination of the above. As a rule, looking at central tendency
via mean, median, and mode and dispersion via the variance or standard deviation is not sufficient. Hence in
32

this study in addition to mean, variance, and standard deviation; kurtosis and skewness have also been taken
into consideration.
Mean
It is the most common measure of central tendency and may be defined as the value which is obtained by
dividing the sum of the values of various given items in a series by the total number of items.
1 2 3 1
...
( )
n
n i
X
x x x x
Mean X
n n
=
+ + + +
= =

Variance
It is expressed as the sum of the squares of the differences between each observation and the mean, which
quantity is then divided by the sample size.
( )
2
2
( )
X X
Variance
n
o

=

Standard Deviation
Standard deviation is the commonly used measure of dispersion. It is defined as the square root of the average
of squares of deviations, when such deviations for the values of individual items in a series are obtained from
the arithmetic mean. It is calculated as under:

Skewness
Measures of skew describe how concentrated data points are at the high or low end of the scale of
measurement. Skew indicates the degree of symmetry in a data set. The more skewed the distribution, the
higher the variability of the measures, and the higher the variability, the less reliable are the data. Skew is
calculated by either multiplying the difference between the mean and the median by three and then dividing by
the standard deviation or by summing the cubes of the differences between each observation and the mean and
then dividing by the cube of the standard deviation. The values of the equations noted above will indicate left
skew with a negative number and right skew with a positive number.
Kurtosis
Measures of kurtosis describe how concentrated data are around a single value, usually the mean. Thus,
kurtosis assesses how peaked or flat is the data distribution. The more peaked or flat the distribution, the less
normally distributed the data and the less normal the distribution, the less reliable the data.
|
o
=
4
2
4

k
k o
4 4
2
2 4
2
= = -3

Here
4
is the fourth moment about the mean and is the standard deviation.
Three degrees of kurtosis are noted:
- Meso-kurtic distributions are, like the normal bell curve, neither peaked nor flat.
- Platykurtic distributions are flatter than the normal bell curve.
- Leptokurtic distributions are more peaked than the normal bell curve.
( )
2
( )
X X
SD
n
o

=

33

The ideal value rendered by the equation for kurtosis is 3, the kurtosis of the normal bell curve. The higher the
number above 3, the more leptokurtic (peaked) is the distribution. The lower the number below 3, the more
Platykurtic (flat) is the distribution.
1.10.4 Statistical Analysis of the t-Test
There are different types of t-test each for different purpose. Some of the popular types are:
Students t-test for single mean is used to test a hypothesis on a specific value of the population mean.
Statistically speaking, we test the null hypothesis H
0
: =
0
against the alternative hypothesis H
1
: ><
0

where is the population mean and
0
is a specific value of the population that we would like to test for
acceptance.
The t-test for difference of means is used to test the hypothesis that two populations have the same mean.
- A paired t-test is usually used when the two samples are dependent- this happens when each
individual observation of one sample has a unique relationship with a particular member of the other
sample.
- A t-test for correlation coefficient is used for testing an observed sample correlation coefficient (r).
- A t-test for testing significance of regression coefficient is used to test the significance of
regression coefficients in linear and multiple regression setups.
But in this study paired t-test have been applied.
Paired t-Test
Given two sample paired sets X
i
and Y
i
of n measured values, the paired t-test determines whether they differ
from each other in a significant way under the assumptions that the paired differences are independent and
identically normally distributed.
To apply the test, let
( )
i i
X X X =
(1)
( )
i i
Y Y Y =
(2)
Then defined by
( )
( )
2
1
( 1)

n
i i i
n n
t X Y
X Y
=
.
This statistic has (n-1) degrees of freedom.
P-values
The P value (calculated probability) is the estimated probability of rejecting the null hypothesis of a study
when that hypothesis is true. The null hypothesis is usually a hypothesis of "no difference" and use to define
clearly before the start of the study.
The term significance level (alpha) is used to refer to a pre-chosen probability and the term "P value" is used
to indicate a probability that calculate after a given study. The alternative hypothesis is the opposite of the
null hypothesis; in plain language terms this is usually the hypothesis set out to investigate. If the P value is
less than the chosen significance level then we reject the null hypothesis i.e. accept that sample gives
reasonable evidence to support the alternative hypothesis. Here in this study the level of significant has taken
as 5 percent confidence level.
1.10.5 Adjusted Model
The study proposes to adopt a methodology for the assessment of a firm's performance under conditions of
high inflation rates but with limited financial disclosure. It is based on an adjustment mechanism (model)
which is both concise and unambiguous. The new mechanism utilizes a number of ratios in adjusting
historical-cost data to general price-level increase. The proposed model has already been applied to a number
34

of firms operating in Greece, a country of high inflation rates like India.
2
The relevant findings demonstrate the
significance of the new method to stakeholders in assessing the impact of inflation on their command over
resources, and its limitations in evaluating inflation-related performance on Sector-wide basis.
The new model consists of a series of conversion ratios that express relationships between (1) adjusted
gross operating income and reported gross operating income, (2) adjusted net operating income and reported
net operating income, (3) purchasing power gain (loss) on monetary items and (4) total gain/loss in General
Purchasing Power. The Model and each conversion ratio is determined, analyzed, and interpreted in details has
described in chapter-7.
1.11 LIMITATIONS OF THE STUDY
The followings are the limitations of the present study:
a) The study is based on secondary data. So, the limitations of secondary data may also creep in and have
an impact on the present study also.
b) The present work is based on the limited financial disclosure for the information obtained from the
published annual reports of the firms and different websites.
c) This study is of a micro-nature, based on research of selected 42 companies in the manufacturing
sector of India
d) This study is based on only a period of 5 years (2004-2005 to 2008-2009) financial performance of the
selected companies.
e) In order to analyze the financial data, those are grouped and sub-grouped as per the requirement.
f) The change in accounting policies of the company, accounting concepts and conventions are not taken
into consideration at the time of collection of data for the present study.
g) Financial analysis is based on only monetary information, and non-monetary facts are ignored.
h) Financial and Statistical tools used in this study do have their own limitations.
Therefore, the user of the study may make use of the findings with much care and prudence. In spite of these
limitations, the findings of the study are of utmost relevance both for the industry and other stakeholders.
1.12 ORGANISATION OF THE STUDY
The book is broadly divided into two parts. The first part examines in detail how the problem of inflation
affects companies' reports and distorts accounting information. The second part presents an empirical study
and shows how the problem might be dealt with in order to provide accurate accounting information for
decision-making. The content of this book is divided into nine chapters. Chapter 1 is introductory, which
embodies the statement of the problem, objectives and scope of the study, and the review of available literature
on the subject. It obviously serves as background to the detailed discussions in chapters that follow. In addition
this chapter illustrates the research design, sampling procedure, period of the study and statistical tools applied
for analysis of empirical data. Chapter 2 considers the development of corporate financial reporting, the needs
of users of these reports and harmonisation of financial reporting across the globe with a specific reference to
India. Chapter 3 conceptualizes the inflation accounting, discusses its history, and different methods of
accounting for inflation. The industrial development of India during different plan periods and current trends in
Indian manufacturing sector are overviewed in Chapter 4. The second part of the book presents an empirical
study of 42 Indian manufacturing companies, classified into seven industrial sectors: automobiles, cements,
chemicals, fertilizers, foods, petroleum and steel. In this context, Chapter 5 investigates the impact of inflation
on financial performance of sample companies by analyzing profit and loss accounts both under historical cost
based (HCB) method as well as under current purchasing power (CPP) method. Chapter 6 deals with analysis
of impact of inflation on major financial ratios and chapter 7 elaborates the financial condition of stakeholders
during the period of inflation. While Chapter 8 adjusts the impact of inflation on gross and net operating
incomes by application of a model, the final chapter presents the summary and conclusions of the study and
outlines the areas for further research.
***

2
Antonios A. P., (1986) The Impact of Inflation on Business Performance under conditions of Limited Financial Disclosure: the case of
firms Operating in Greece, SPOUDAI, University of Piraeus, p 25-42

35

Corporate Financial Reporting

2.1 INTRODUCTION
Financial reporting may be defined as communication of published financial statements and related
information from a business enterprise to third parties (external users) including shareholders, creditors,
customers, governmental authorities and the public. It is the reporting of accounting information of an entity
(individual, firm, company, government enterprise) to a user or group users. Corporate Financial Reporting
(CFR) is a total communication system involving the company as issuer (preparer); the investors and creditors
as primary users, other external users; the accounting profession as measures and auditors and the company
law regulatory or administrative authorities. The concept has gained much significance due to the expansion
and growth of company form of organization, increased competition and increase in the information needs of
the users (Singh, 2005).
The subject of financial reporting has gained significance during the recent years because of various compelling
factors, such as the expansion and growth of the company form of organization; shift in the emphasis from the
concept of shareholders to stakeholders and increase in their informational needs; the enactments and
amendments in disclosure laws in various countries; professionalism of management; emergence of accounting
as a recognized profession; and the pronouncements on disclosure made by various professional accounting
bodies in India and abroad (Chander,1992). A series of scandals that have rocked the financial markets and
shaken investor confidence have further increased the importance of financial reporting.
There is a general consensus among professionals that a disclosure should be full, fair and adequate. Full
disclosure requires that financial statements should be designed and prepared to portray accurately the economic
events that affected the firm for the period and to contain information sufficient to make them useful and not
misleading to the average investor (Porwal, 1989). The need for adequate, fair and full disclosure is irrefutable
in a free enterprise economy. One cant over-emphasize the importance of availability of information in
investment decisions. It assists the investors in selecting the best portfolio for their investment (Lal, 1985). In the
absence of adequate information investors would not be in a position to make wise investment decisions,
because it will be difficult to distinguish between potentially successful and unsuccessful business. (Chander,
1992)
Besides investors, disclosure is significant from the point of view of large number of other potential users. Such
potential users include, present and prospective investors, lenders, suppliers, creditors, employees, management,
customers, financial analysts and advisors, brokers, underwriters, stock exchange authorities, legislators,
financial press and reporting agencies, labour unions, trade associations, business researchers, academicians and
above all the public at large. Disclosure has behavioral implications for such a wide range of users. There is an
obvious need for reliable information which they can use to acquire an essential knowledge of the way in which
business enterprises are behaving in relation to the public interest. By perceiving enterprise behavior through
communicated information, interested parties can use this knowledge to amend or adopt their own behavior vis-
-vis. the enterprise concerned (Lee, 1976). Thus financial reporting in fact is an effective communication of
accounting information.
The concept of fair disclosure implies that the accounting and other information should be unbiased and
impartial. Its objective is to provide equal treatment to all potential financial statement readers (Chahal, 1990).
The task of defining the term adequate disclosure is more difficult because the adequacy of disclosure cannot
be tested accurately and precisely since no definite test exists in financial reporting to measure it and moreover,
it is a subjective term. In very comprehensive terms a disclosure can be an adequate disclosure when it entails
Chapter
2

36

the answers of to whom, why, how much, what and when the information to be disclosed (Chahal, 1990).
2.2 OBJECTIVES OF FINANCIAL REPORTING
Financial reporting is not an end in itself but is a means to certain objectives. The objectives of financial
reporting and financial statements have been discussed for a long time. While there is no final statement on
objectives, to which all parties (of financial reporting) have agreed, some consensus has been developing on
the objectives of financial reporting. The following may be described as the primary objectives of financial
reporting:
Investment Decision-Making
Management Accountability
2.2.1 Investment Decision-Making
The basic objective of financial reporting is to provide information useful to investors, creditors and other
users in making sound investment decisions. The Trueblood Committee stated that. .the basic objective of
financial statements is to provide information useful for making economic decisions.. Recently, the FASB
(USA) in its Concept No. 1 also concluded that .financial reporting should provide information that is useful to
present and potential investors and creditors and other users in making rational investment, credit and similar
decisions.
It is essential to have an understanding of the investment decision process applied by external users in order to
provide useful information to them. The investors seek such investment which will provide the greatest total
return with an acceptable range of risk.
Investment return is comprised of future interest or dividends and capital appreciation (or loss). The investors
while making investment decision aim to determine the amount and certainty of a companys future earning
power in order to estimate their future cash return in dividends and capital appreciation. Earning power is the
ability of a business firm to produce continuous earnings from the operating assets of the business over a
period of years, which may differ from accounting net income. The financial statements and other business
data are analysed in relation to the enterprises environment to project this future earning power. Investors
compare returns on alternative investments relative to risk, which (risk) is the degree of uncertainty of future
returns. In this way, investment funds tend to flow toward the most favourably situated companies and
industries and away from the weaker and less promising companies.
2.2.2 Management Accountability
A second basic objective of financial reporting is to provide information on management accountability to
judge managements effectiveness is utilizing the resources and running the enterprise. Management of an
enterprise is periodically accountable to the owners not only for the custody and safe-keeping of enterprise
resources, but also for their efficient and profitable use and for protecting them to the extent possible from
unfavourable economic impacts of factors in the economy such as technological changes, inflation or deflation.
Management accountability covers modern performance issues based on efficiency and effectiveness notions.
The management accountability concept includes information about future activities, budgets, forecast
financial statements, capital expenditures proposal etc. Accountability is beyond the narrow limits of
companies legal responsibilities to shareholders (and sometimes debenture holders and creditors). It obviously
includes the interest of persons other than existing shareholders.
Management accountability is of very great interest not only to existing shareholders and other users but also
to potential shareholders, creditors and users. A company generally offers shares, debentures etc. to the
respective investing public and therefore it should accept accountability responsibilities to prospective
investors also. Certainly annual and other financial statements are intended to play a major role in this regard.
2.3 DEVELOPMENT OF FINANCIAL REPORTING OBJECTIVES
The subject of financial reporting objectives has been generally recognised as very important in accounting
area since a long time. Many accounting bodies and professional institutes all over the world have made
attempts to define the objectives of financial statements and financial reporting which are vital to the
37

development of financial accounting theory and practice. This section describes developments in this area at
the international level, particularly USA, UK and Canada.
2.3.1 The Trueblood Report
In view of the criticisms of corporate financial reporting and the realization that a conceptual framework of
financial accounting and reporting was needed, the AICPA formed two study groups in 1971 . one was called
The Study Group on the Establishment of Accounting Principles, headed by Francis M. Wheat (its
recommendations, which led to the establishment of the FASB and the other was called .The Study Group on
the Objectives of Financial Statements., headed by Robert M. Trueblood. The report of the second group,
called the Trueblood report was published in October 1973. This Committee was asked to consider the
following four questions:
a) Who need financial statements?
b) What information to they need?
c) How much of the needed information can be provided by accountants?
d) What framework is required to provide the needed information?
The Committee was charged with the development of the objectives of financial statements. The Committee
comprised nine members representing industry, the accounting profession, the academics, and the Financial
Analysts Federation. The staff was drawn from academicians, practitioners, and consultants. Views of more
than 5000 corporation and other organizations were solicited by the Committee. It conducted more than 50
interviews and held 35 meetings with interested institutional and professional groups. The Trueblood
Committee recommended twelve objectives.
The main objective is stated as under:
The basic objective of financial statements is to provide information useful for making
economic decisions.
The other eleven objectives are stated below:
1. An objective of financial statements for governmental and not-for-profit organizations is to provide
information useful for evaluating the effectiveness of the management of resources in achieving the
organizations goals. Performance measures should be quantified in terms of identified goals.
2. An objective is to provide a statement of financial activities useful for predicting, comparing, and
evaluating enterprise earning power. This statement should report mainly on factual aspects of enterprise
transactions having or expected to have significant cash consequences. This statement should report data
that require minimal judgment and interpretation by the preparer.
3. All objective is to provide a statement of financial position useful or predicting, comparing, and
evaluating enterprise earning power. This statement should provide information concerning enterprise
transactions and other events that are part of incomplete earnings cycles. Current values also be reported
when they differ significantly from historical cost. Assets and liabilities should be grouped or segregated
by the relative uncertainty of the amount and timing of prospective realization of liquidation.
4. An objective of financial statements is to provide users with information for predicting, comparing, and
evaluating enterprise earning power.
5. An objective of financial statements is to provide information useful for the predictive process. Financial
forecasts should be provided when they will enhance the reliability of users predictions.
6. An objective is to provide a statement of periodic earnings useful for predicting and evaluating enterprise
earning power. The net result of completed earnings cycles and enterprise activities resulting in
recognizable progress toward completion of incomplete cycles should be reported. Changes in the values
reflected in successive statements of financial position should also be reported, but separately, since they
differ in terms of their certainty of realization.
7. An objective of financial statements is to provide factual and interpretive information about transactions
and other events which is useful for predicting, comparing, and evaluating enterprise earning power.
Basic underlying assumptions with respect to matters subject to interpretation, evaluation, prediction, or
estimation should be disclosed.
38

8. An objective of financial statements is to supply information useful in judging managements ability to
utilize enterprise resources effectively in achieving the primary enterprise goal.
9. An objective of financial statements is to provide information useful to investors and creditors for
predicting, comparing, and evaluating potential cash flows to them in terms of amount, timing, and
related uncertainty.
10. An objective of financial statements is to serve primarily those users who have limited authority, ability
or resources to obtain information and who rely on financial statements as their principal source of
information about an enterprises economic activity.
11. An objective of financial statements is to report to those activities of the enterprise affecting society
which can be determined and described or measured and which are important to the role of the enterprise
in its social environment.
The Trueblood Report also presented seven qualitative characteristics which the financial statement
information should possess in order to satisfy user needs.
Relevance and Materiality
Substance rather than Form
Reliability
Freedom from Bias
Comparability
Consistency
Understandability
2.3.2 The Corporate Report, London, 1975
Great Britain had a new look at the corporate objectives. The Accounting Standards Steering Committee
(ASSC) of the Institute of Chartered Accountants in England and Wales (ICAEW) published the Corporate
Report as a discussion paper to review the list of users, purposes, and methods of modern financial reporting in
the United Kingdom.
The purpose of this study undertaken by an eleven-member working party was to reexamine the scope and
aims of published financial reports in the light of modern needs and conditions; to determine the public
accountability of economic entities of all kinds, but especially business enterprises; to identify the persons or
groups for whom published financial reports should be prepared; and to consider the most suitable means of
measuring and reporting the economic position, performance and prospects of undertakings for the purposes
and persons identified above.
The basic philosophy of the Report was that financial statements should be appropriate to their expected use by
the potential users, i.e. they should attempt to satisfy the informational needs of their users. The report
assigned responsibility for reporting to the .economic entity. having an impact on society through its activities.
If further defined users as those who have a reasonable right to information and whose information needs
should be recognized by corporate reports.
To satisfy the fundamental objectives of annual reports set by the basic philosophy, seven desirable
characteristics of a corporate report were cited, viz, relevance, understandability, reliability, completeness,
objectivity, timeliness, and comparability.
The Corporate Report rejected the assumption that general purpose financial statements can satisfy the
information needs of all user groups. It suggested the need for the following additional statements:
1. An employee report dealing with size and composition of work force, efficiency, productivity,
industrial relations, the benefits earned, personnel policies, etc.
2. A statement of transactions in foreign currency showing overseas borrowings and repayment,
dividends received and paid by the government to other countries.
3. A statement of corporate objectiveness showing management policy and strategies
4. A Statement of Value Added to show how the wealth was produced, and how it has been distributed
among employees, the state, the providers of capital and its reinvestment for maintenance and
expansion.
39

5. A statement of money exchanges with government showing sales tax, corporation tax, rates, royalties
and other taxes paid to government, i.e., financial relationship between the enterprise and the state.
6. A statement of future prospects showing forecasts of profits, employment and investment.
The report draws attention to the concept of .social accounting. and makes an attempt to move in that direction.
The report rejected, after assessing measuring bases against theoretical acceptability, utility and practicability,
the use of historical cost in favour of current values.
While, greater emphasis in USA in on investors and creditors, in UK it is on all types of users. The emphasis in
UK according to this report, is on accountability of economic entities. .Accountability arises from the social
role of the entity and not solely from legal requirements. The report states:
Such organizations, which exist with the general consent of the community, are afforded special legal and
operational privileges, they compete for resources of manpower, materials and energy, and they make use of
community owned assets such as roads and harbours.
It is claimed in the USA that taking care of the information needs of the investors and creditors will
automatically protect the interests of other users. The SFAC No. 1 has already moved in the direction of
protecting the interests of other users by adding the words .and other users. In fact, the USA in the past decade
has been moving steadily towards the social accounting concept. Hence, the additional statements required in
the Corporate Report are being taken care of in the chairmans speech, directors report, etc. In India, some
large companies in the private and the public sector, disclose their accounting policies, social welfare
programmes, social income statements and social balance sheets in their annual financial statements.
In conclusion, thought it was felt that .a comparison of the principal findings and recommendations of the
Corporate Report and the Trueblood Report cannot be made without considering the different economic and
political environments in Great Britain and the United States., we feel that the two are coming closer towards
disclosing the economic and social impact of an entitys activities to investors, users, and others (such as
employees, community, customers and the society).
The argument about why business should be made to pay for providing such additional information required
by the Corporate Report is also losing validity in view of the growing social responsibility of business.
FASB Concepts Statement No.1: .Objectives of Financial Reporting by Business Enterprises, November 1978.
After consideration of the Trueblood Committee Report and the responses to the discussion memorandum
(DM) on the report, the FASB issued Tentative Conclusions on Objectives of Financial Statement of Business
Enterprises in 1976. Two years later, the FASB issued SFAC No. 1. The SAFC No. 1 was not limited to the
contents of financial statements. Para 39 of the Statement said:
Financial reporting includes not only financial statements but also other means of communicating
information that relates, directly or indirectly, to the information provided by the accounting system.
that is, information about an enterprises resources, obligations, earnings, etc,
The SFAC No.1 laid down the following objectives:
Financial reporting should provide information that is useful to present and potential investors and
creditors and other users in making rational investment, credit, and similar decisions. The information
should be comprehensible to those who have a reasonable understanding of business and economic
activities and are willing to study information with reasonable diligence
Financial reporting should provide information to help present and potential investors and creditors and
other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends
or interest and the proceeds from the sale, redemption, or maturity of securities or loans. The prospects for
those cash receipts are affected by an enterprises ability to generate enough cash to meet its obligations
when due and its other cash operating needs, to reinvest in operations, and to pay cash dividends and may
also be affected by perceptions of investors and creditors generally about that ability, which affect market
prices of the enterprises securities. Thus financial reporting should provide information to help investors,
creditors, and others assess the amount, timing, and uncertainty of prospective net cash inflows to the
related enterprise.
40

Financial reporting should provide information about the economic resources of an enterprise, the claims
to those resources (obligations of the enterprise to transfer resources to other entities and owners. equity),
and the effects of transactions, events, and circumstances that change resources and claims to those
resources.
Financial reporting should provide information about an enterprises financial performance during a
period. Investors and creditors often use information about the past to help in assessing the prospects of an
enterprise. Thus, although investment and credit decisions reflect investors. and creditors. expectations
about future enterprise performance, those expectations are commonly based at least partly on evaluations
of past enterprise performance.
The primary focus of financial reporting is information about an enterprises performance provided by
measures of earnings and its components.
Financial reporting should provide information about how an enterprise obtains and spends cash, about its
borrowing and repayment of borrowing, about its capital transactions, including cash dividends and other
distributions of enterprise resources to owners, and about other factors that may affect an enterprises
liquidity or solvency.
Financial reporting should provide information about how management of an enterprise has discharged it
stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it.
Financial reporting should provide information that is useful to managers and directors in making
decisions in the interest of owners.
In brief, the main objectives can be restated as follows:
a) To provide information, this is useful to investors, creditors and others in making rational decisions.
b) To assist investors and creditors in assessing future net cash flows to the enterprise in respect of
amount, timing, and uncertainty.
c) To identify entity resources (assets) and claims (owners equity).
d) To show how an enterprise obtains resources and what it uses them for.
e) To provide information about enterprise performance and earnings potential.
Objectives number 3, 4 and 5 are achieved directly by means of preparing a balance sheet, cash flow statement
and income statement respectively. Objectives number 1 and 2 are achieved by using these financial statements
and other reports taken together.
The recommendations of the Trueblood Committee were interpreted to mean (this impression was confirmed
by public utterances of some of the committee members) that the authors of the report were advocating a return
to cash account. This impression was corrected by the FASB in its SFAC No.1 by firmly adopting accrual
accounting as the basis of financial reporting. However .cash flow accounting. is a different concept of
accounting and reporting. However, cash flow accounting is a different concept of accounting and reporting. It
adopts the accrual basis but rejects the allocation basis of accounting. Perhaps some members mistook cash
flow accounting as cash accounting.
The SFAC No. 1 also highlights that:
Financial reporting is not an end in itself but is intended to provide information that is useful in
making business and economic decisions.
The objectives of financial reporting are not unchallengeable, they are affected by the economic, legal,
political, and social environment in which financial reporting takes place.
The objectives are also affected by the characteristics and limitations of the kind of information that
financial reporting can provide.
The objectives in this statement are those of general purpose external financial reporting by business
enterprises.
The terms .investor. and .creditor. are used broadly and apply not only to those who have or
contemplate having a claim to enterprise resources but also to those who advise or represent them.
Although investment and credit decisions reflect investors and creditors expectations about future
enterprise performance, such expectations are commonly based at least partly on evaluations of past
enterprise performance.
41

The primary focus of financial reporting is information about earnings and its components.
Information about enterprise earnings based on accrual accounting generally provides a better
indication of an enterprises present and continuing ability to generate favourable cash flows than
information limited to the financial effects of cash receipts and payments.
Financial reporting is expected to provide information about an enterprises financial performance
during a period and about how management of an enterprise has discharged its stewardship
responsibility to owners.
Financial accounting is not designed to measure directly the value of a business enterprise, but the
information it provides may be helpful to those who wish to estimate its value.
Investors, creditors, and other may use reported earnings and information about the elements of
financial statements in various ways to assess the prospects for cash flows. They may wish, for
example, to evaluate managements performance, estimate. earning power, predict future earnings,
assess risk, or to confirm, change, or reject earlier predictions or assessments. Although financial
reporting should provide basis information to aid them, users do their own evaluating.
Management knows more about the enterprise and its affairs than investors, creditors, or other outsiders, and
accordingly, many often increase the usefulness of financial information by identifying certain events and
circumstances and explaining their financial effects on the enterprises.
2.3.3 The Stamp Report, 1980, Canada
A report on Corporate Reporting: Its Future Evolution, written by Edward Stamp, was published in June
1980 by the Canadian Institute of Chartered Accountants (CICA).
The Report states the following major objectives:
(i) The objectives of financial reporting should be taken to be directed toward the needs of users who are
capable of comprehending a complete (and necessarily sophisticated) set of financial statements or
alternatively, to the needs of experts who will be called on by the unsophisticated users to advice them.
(ii) One of the primary objectives of published corporate financial reports is to provide an accounting by
management to both equity and debt investors, not only a managements exercise of its stewardship
function but also of its success (or otherwise) in achieving the goal of producing a satisfactory economic
performance by the enterprise and maintaining it in a strong and healthy financial position.
(iii) It is an objective of good financial reporting to provide such information in such a form as to minimize
uncertainty about the validity of the information, and to enable the user to make his own assessment of
the risks associated with enterprise.
(iv) It is therefore necessary that the standards governing financial reporting should have ample scope for
innovation and evolution as improvements become feasible.
It will be seen that these objectives concern accountability, uncertainty and risk; change and innovation; and
complexity and the unsophisticated users respectively.
The Report has expressed the view that the FASB.s conceptual framework is not suitable for Canada because
of the environmental, historical, political, and legal differences between the two countries. Corporate Report,
1975, London had also expressed similar views. Because of the broader accountability concept in Canada, the
range of users is also broader. The users in Canada include present and potential shareholders; long-term and
short-term creditors; present analysts and advisers serving the above; past, present and potential employees and
customers; present and potential non-executive directors; suppliers; present industry groups: labour unions,
governmental departments and ministers; the public, regulatory agencies; other companies, both domestic and
foreign; standard setters and academic researchers.
The following categories of user needs are proposed: assessing performance; assessing management quality;
estimating future prospects; assessing financial strength and stability; assessing solvency; assessing liquidity;
assessing risk and uncertainty; aiding resource allocation; making comparisons; making valuation decisions;
assessing adaptability; determining compliance with the law or regulations and assessing contribution to
society.
To test whether the published financial statements are meeting the needs of users and the objectives of
financial reporting, the information in the financial statements should meet the following criteria: objectivity,
42

comparability, full disclosure, freedom from bias, uniformity, materiality and cost-benefit effectiveness,
flexibility, consistency and conservatism.
The FASB.s conceptual approach was deemed too normative and too narrow in scope. It was concerned
primarily with the investors. The Canadian framework is evolutionary and concerned with the reasonable
needs of the legitimate users of financial reports.
The Stamp Report has been regarded by some, as impractical or too costly to implement.
2.4 BENEFITS OF FINANCIAL REPORTING
The financial reporting, if adequate and reliable, would be useful in many respects. The benefits of financial
reporting may be listed as follows:
Managers Decisions
The accounting data published in financial reports may have economic effects through its impact on the
behaviour of the managers of corporate enterprises. The inclusion of accounting numbers in management
compensation schemes, or the fear of market misinterpretation of accounting reports may influence a
managers operating and financing decisions. Shareholders prefer accounting procedures that mirror economic
events as closely as possible. However, shareholders also must be concerned that the managers might
manipulate the reported data to increase their compensation. Therefore, shareholders, like creditors and union
leaders, also want numbers that are reliable and objectively determined. Considering the problems of obtaining
measurements of income and net worth that are both objectively determined and valid representations of
economic reality, it seems likely that management and shareholders would adopt compensation schemes that
recognise the limitations of the data, such that the expected payments conform to the market price for
managerial services.
To sum up, information contributes much towards better investment decision making, promoting
understanding and creating an environment to cooperate. Financial reporting generates confidence and has
favourable effect on the companys cost of capital. In the long run, financial reporting can retain its credibility
only if it does what is designed to do-provide society with relevant and reliable information about economic
events and transactions-and does not attempt to move the economy in one direction rather than another. Donald
Kirk, the former Chairman of the FASB, made this point in 1979. The role of financial reporting is to provide
information that assists in assessing the relative returns and risks of various investment opportunities. Business
manager, investors, and creditors make those decisions: It is not a function of financial reporting to try to
determine or influence their outcome. No matter how well intentioned the standard setter may be, if
information is well designed to indicate that investment in a particular enterprise involves less risk than it
actually does, or designed to encourage investment in a particular segment of the economy, financial reporting
will suffer an irreparable loss of creditability..
Economic Decisions Making
The ultimate goal of any economy is to maximize the social welfare for which an efficient allocation of
resources is required. This goal is of particular significance in developing economies where resources are not
plentiful. The availability of capital is once of the scarce and major productive factors needed to pursue
economic activity and to achieve the goal of efficient allocation of resources. Companies compete in the
securities market to obtain their capital as easily as possible. Since owners of capital, like business enterprise,
attempt to maximize their own wealth and well-being, they require information to help them in making sound
economic decisions. This process is assumed to lead to the broader social goal of efficient allocation of
resources throughout the economy.
Mautz and May observe:
Financial disclosure is essential to the functioning of a free enterprise economy. One aspect of a market
oriented economy is the allocation of a capital on a market basis.
Financial disclosure is required to support a viable capital market is essential to resource allocation within the
economy. It is in the capital market that a major portion of the nations resources are allocated to those
companies which serve customers effectively, and capital is refused to those companies who do not serve
customers effectively.
43

The two important economic decisions that influence allocation of resources and which external users usually
make are (a) security investment (b) credit decision. AICPA Study Group states that .the basic objective of
financial statement is to provide information useful for making economic decision...2 Sound economic
decisions require assessment of impact of current business activities and developments on the earning power of
a company. Both economic decisions required detailed information to determine benefits (to be received) in
lieu of sacrifices (resources given). Information about economic resources and obligations of a business
enterprise is also needed to form judgments about the ability of the enterprise to survive, to adapt, to grow and
to prosper amid changing economic conditions. In this task, financial reporting can provide information
important in evaluating the strength and weakness of an enterprise and its ability to meet its commitments. It
can supply information about transactions within the business and factors outside the company such as taxation
policy, trade restrictions, technological changes, market potentialities etc., which affect the earning power of a
business enterprise.
Customer Decisions
The data presented in financial statements may affect the decision of a companys customers and hence have
economic consequences. Customers like employees, may use financial statement data to predict the likelihood
and/or timing of a firm going bankrupt or being unable to meet its commitments. This information may be
important in estimating the value of a warranty or in predicting the availability of supporting services or
continuing supplier of goods over an extended period of time. Financial institutions also may use the financial
statements to asses their present and future solvency and hence, the likelihood that the will be able to repay
funds or meet promises as contracted. It is likely that the sophisticated customers will be able to see through
arbitrary or misleading accounting practices. Unsophisticated customers, however, may be misled by
accounting procedures, particularly when newly adopted procedures result in sudden changes in reported data.
With respect to customer decisions the economic consequences of accounting procedures are likely to be
limited to the period of uncertainty that occurs when a change is instituted. Even then, sophisticated customers
are not likely misinterpret the change.
Employee Decisions
Employee decisions may be based on perceptions of a companys economic status acquired through financial
statements. In particular prospective and present employees may use the financial reports to assess risk and
growth potential of a company and therefore, job security and future promotional possibilities. These decisions
affect the allocation of human capital in the economy. Labour unions and individual employees may use
financial statement data as a basis for making contractual wage and employment benefit demands. Should this
occur, data that incorrectly reflect the economic position and prospects of an enterprise may mislead
employees into making or justifying unrealistic demands.
Furthermore, unionized companies showing large increases in earnings are likely to be faced with successfully
negotiated demands for large wage increases. Hence, as regards employee decisions, accounting techniques
that result in greater fluctuations in reported earnings appear to be costly to shareholders, sharp increases in
profits are likely to generate demands for large wages increases, while sharp decreases may lead to employee
fears of bankruptcy or financial difficulties. Management also wants to avoid charges of manipulation of net
profit data. Thus, an apparently objectively determined series that tends not to change sharply is desirable.
Historical cost based accounting meets these requirements.
Cost of Capital
Adequate disclosure in annual reports is expected, in the long run, to enhance market price of company shares
in the investment market. Higher prices of company shares resulting from the full disclosure will have a
favourable impact on the companys cost of capital. It also enhances the future marketability of subsequent
issue of companys shares. Choi argues-that if analysts are kept well informed then, over the long run, an
individual companys share prices will be relatively higher. Higher security prices would mean that a primary
security issue could be priced higher and that the net proceeds from the issue would be higher. Thus the firm
would experience larger receipt from a given issue and hence experience a lower cost of capital.
A Report for Arthur Anderson and Company stated:
Consistently good financial reporting should have a favourable long-run effect on the Companys
cost of capital. Over a period of time, good reporting leads to informed investors who, because they
44

understand the company, will pay a fair price for its securities.. Minimum or inconsistent reporting
often leads to some loss of investors confidence in the quality of company information and,
ultimately in the price they will pay in the market. Creditability is a subtle intangible of great
importance to any company; corporate reporting practices have a major effect on it.
We have often observed this connection between creditability, corporate reporting, and the cost of capital.
Good corporate reporting is a long-term policy applicable to good times and bad. Thus data expansion would
have a favourable effect on the cost of capital. However, some doubts have been expressed about the
disclosure regulation (for increased disclosure) resulting in a lower cost of equity capital. It is argued that
managers have strong incentives to minimize the possibility of shareholder unrest by controlling the flow of
information to eliminate fluctuations in performance measures, thereby misleading shareholders with respect to
the relative riskiness of the firm. If managers manipulated, or simply did not publish adverse financial data to
hide poor performance from investors, subsequent disclosure of such information due to the passage of some
regulation might result in a lower market price for the related shares and a higher cost of equity capital.
Similarly, if managers attempted to avoid or manipulate disclosure in the hope that this practice would cause
investors to perceive the firm to be less risky than it really is, subsequent disclosure might well result in higher
risk as perceived by investors. This increase in perceived risk presumable would result in an increase in the
cost of equity capital to the firm. Manipulation and/or misrepresentation, once discovered, will lead to loss of
investor confidence in the quality of company information and that, in turn, will lower the price they will pay
for its securities.
Thus, the above discussion implies that a disclosure regulation would be expected to have a favourable effect
on the cost of equity capital of the affected firms. Implicit in this discussion is the assumption that a disclosure
regulation would result in an improvement in the financial disclosure of the affected firms. A study conducted
by Dhaliwal to examine the impact of disclosure regulations on the cost of equity capital of affected firms
concluded that segment disclosure requirement had a favourable effect on the cost of equity capital because
disclosure requirement improved the quality of financial disclosure of affected firms and that, in turn, it
reduced un-certainty about their stocks.
Fluctuations in Share Price
Adequate disclosure will tend to minimize the fluctuations in companys share prices. Fluctuation is in share
prices occur because of the ignorance prevailing in the investment market. Fluctuations show an element of
uncertainty in investment decisions. If the securities market is in possession of full information, the ignorance
and uncertainty will be reduced and share prices will tend to maintain equilibrium. Besides, increased
disclosure would prevent fraud and manipulations and would minimize chances of their occurrences.
Additionally, all investors would be treated equally as far as the availability of significant financial information
is concerned. Ethics in disclosure demands that no caste system for release of corporate information-telling the
sophisticated first and the general public later or not at all-should be followed by corporate managements.
2.5 INFORMATION NEED OF STAKEHOLDERS
Shareholders
The term shareholders includes present shareholders as well as prospective investors. Both require
information that helps in reaching share trading decisions. Arnold, J. stated that:
A major decision facing shareholders (or potential investors) in a particular company is
whether to buy, hold, or to sell shares in that company. In order to make the decision, the
shareholder must estimate the value to himself of owning shares in the company and compare
that value with the current market price of the shares. If the value of the shares to the investor
exceeds their current market value he should buy shares and vice-versa. (Arnold, 1977,
pp.111-12)
This necessitates the provision of information to shareholders (actual and potential) to guide their investment
decisions, and to inform shareholders of the uses to which their funds have been applied and the legality of -
those uses with a view to enable them to exercise legal remedies. Shareholders are interested in knowing future
45

cash flows receipts, and the ability of a company to pay given dividends. In this respect Edey, H.C., raises the
following point:
The owners of businesses are, so far as economic decisions are concerned, interested ultimately
only in the amount of purchasing power committed to the investment, the future flow of cash
receipts (dividends) they expect to receive, and the potential liquidity in the form of available
cash which the investment will give them at all future times. (Edey, 1963, p.1002)
A shareholder is also interested to know whether the increase in the net worth of his firm represents a real
increase in purchasing power, or is merely an imaginary one due to inflation. Moreover, he wishes to know the
physical capital of his firm and whether it is being maintained.
Investment Analysts and Advisers
The group of investment analysts and advisers provides information and interpretation to shareholders,
creditors, and others who use financial reports. Therefore, the information needed by this group is likely to be
similar to that needed by other user groups whom the information directly serves. Their requirements are that
accounts should show whether a company is maintaining the value of its physical capital and that all gains
should not be reported as profits. The second major requirement of this group is a reporting system which
enables accounts of two or more companies to be compared
Creditors and Lenders
This group includes existing and potential holders of debentures, and providers of short and long term loans
and finance. The information needs of investors and creditors are essentially the same, since both are
concerned with an enterprise's ability to generate cash flows and the ability to predict, compare and evaluate
the amounts, timing, and related uncertainty of future cash flows. Thus, lenders will be interested in reported
data which will assist them to evaluate a company's ability to repay existing or potential debt and any interest
due thereon. Information related to a company's liquidity and cash flow position is of crucial importance in that
it aids lenders and creditors to estimate the risk involved with investment, the consequences of default and the
probable timing of repayment.
This group is also interested in the valuation of a company's assets, because they may be in a position
to establish charges over some or all of the company's assets and wish to know the value of assets covered by
these charges (Sandilands, 1975).
Business Contact Group
Within this group we can find several sub-groups such as: customers, suppliers and industry groups, and in a
different sense, competitors, as well as those who are interested in mergers or takeovers. Customers are
interested in the financial affairs of a company, so they can decide how much business to do with it. Suppliers
are interested in the same sort of information as well as the company's demand for their products. The
industrial group is interested in those financial reports which give them information suitable to industrial
decisions.
Employees and Trade Unions
Employees, including existing, potential and past employees (and their representatives), need information
which indicates the ability of the employer to meet wage claims and management intentions regarding
employment levels, locations and work conditions. They look also for the services provided by employers,
promotion prospects, and management attitude regarding staff participation in the decision-making process.
Employees need information on the financial position of the company in order to ensure their future.
Trade unions need financial information for collective bargaining. They also need to assess the economic
stability and vulnerability of a business, so that better decisions can be made to secure the jobs of their
members.
General Public
46

This group may include tax-payers, consumers and special interest groups such as political parties, researchers
and other public bodies. Most of the data needed by this group are obtained through the press, government
pronouncements and debates, and publication of economic statistics. In recent years it has become clear that
the objectives of a firm should not be confined to the maximization of profit, but should also meet many other
social responsibilities (e.g. pollution caused by a company's activities and the social effects of a company in a
particular location, and so on). A firm is a part of society at large and should react to its needs. The public is
interested in energy usage, the effective use of subsidies and contribution to charities in money or other forms.
Much of this information is of a non-financial nature.
Management
Originally, business enterprises were mainly managed by the owners themselves since they were
uncomplicated and there was little or no diversification. Today, however, businesses have become very
complex and their control needs experience of a different nature. Hence the responsibility of managing their
activities has been taken over by skilled agents who are entrusted to manage businesses in the interest of
owners. The success of a firm depends mainly on the ability of participants to make decisions, as well as the
usefulness of the information they receive through financial reports. Income statements and balance sheets can
give managers a review of a company's financial position and progress, but the question still arises whether
management is really interested in a company's published reports. As no good management team is going to
anxiously await the preparation of financial accounts required by the Indian Companies Act, to be told the
position of the company. The final accounts, as such, would mean as much or as little to management as to
anybody outside of that management. In reality, there is always uncertainty; hence the need for management to
be interested in the external accounts-but solely to the extent of ensuring that the investing population
understands and approves the company's action and performance.
Management not only has responsibility for accounting, but also has to put policies into operation.
Therefore, in inflationary circumstances, management should know the effect of inflation on the ability of the
firm to continue in business and how effectively the firm is performing its activities under such conditions.
Moreover, management should also be able to determine how it will deal with the effect of inflation on its
operations.
The information required by management should enable it to compare the budgeted figures with those
achieved, enabling it to make better use of the resources of the company. Management should also have
adequate information on the liquidity and the cash position of the company; which in turn enables it to form an
idea of the future cash flows of the company and its expected need for funds. Another requirement is to know
the value of assets on alternative bases so that the potential gain from selling the assets instead of employing
them within the business can be calculated. Other areas where financial information is required by
management are: credit control, maintenance policies, wages policy and negotiation, price-setting, replacement
decisions, division of income and profit - sharing. Above all, the management is responsible for ensuring that
these reports accurately reflect what has taken place in the business.
From the above, it may be seen that there are several users of financial reports, each of whom has
different information needs, and a different relationship with the company. The financial reports cannot serve
all of them in the same degree; however, they must have certain general characteristics to render them suitable
for most users.
2.6 WHICH ARE USEFUL INFORMATION?
Bevis, H.W., stressed that:
Usefulness is inherent in the full discharge of the accounting function.
(Bevis, 1961, p.9)
He defined useful information as that which corresponds to the needs of users. Financial reports should present
information about economics, resources, and the performance of a firm, and provide useful data for making
decisions. Therefore, useful financial reporting should have at least the following characteristics:
Relevance
47

Relevance is a dominant criterion in taking decision regarding disclosures of information (Gupta and Mehra,
2002). Relevant information is that which satisfies the informational needs of the users and helps them in
evaluating the management and its policies for the purpose of their decisions (Jiloka and Verma, 2006).It
implies that all those items of information should be reported that may aid the users in making economic
decisions. (Saeed, 1990) information is relevant if it has the capacity to confirm or change a decision makers
expectations. First of all, purpose for which the information is sought, should be identified, only when the
information is purpose oriented and it becomes useful in making rational decisions (Bhattar, 1995) The
Accounting Principle Board has described relevance as the primary qualitative objective of financial
accounting information. FASB in its concept No.1 has stated that relevant accounting information must be
capable of making a difference in a decision by helping users to form predictions about the outcomes of past,
present and future events or correct expectations. The True Blood Report, the Corporate Report London and
the Financial Accounting Standards Board in its conceptual framework 2006 have also mentioned relevance as
the qualitative characteristic of decision-useful financial reporting information. The whole of the exercise of
corporate disclosure is futile, if the information disclosed is not relevant to the needs of the users (Chander,
1992). Thus the information, which is not relevant, is useless for the users.
Objectivity
Objectivity means that data provided by financial accounts are not biased. Thus auditors are concerned that a
company's accounts should show an unbiased "true and fair view" and are not simply based on the
uncorroborated subjective view of directors. However, it is not clear what is meant by the term "true and fair".
Stamp said information should be fair to the recipients of the data provided, but surely, some fairness is also
due to the producer of the data (Briston, & Fawthrop, 1971).
It is not suggested that objectivity ought to be rigidly applied to the accounts where a subjective judgment
might be necessary in measuring and describing the financial position of a company. Subjective judgment
already enters in a significant way into the preparation of accounts.
Timeliness
Information should be available to users at the time that they need it. If information is not provided at the right
time, effort and cost are wasted. It is necessary to prepare and present information at the time that it is likely to
be most useful. Timeliness is an ancillary aspect of relevance, which means information must be available to
decision makers before it loses its capacity to influence decisions. (Anonymous, 2006).The Accounting
Principle Board (APB) in its Statement No.4 (1970) Basic Concepts and Accounting Principles Underlying
Financial Statements of Business Enterprises has mentioned timeliness as one of the qualitative objectives
of financial reporting. According to this statement, timely financial accounting information is communicated
early enough to be used for economic decisions which it might influence and to avoid delays in the making of
these decisions (Kohli, 1998). Similarly the Corporate Report London (1975) issued by the Accounting
Standards Steering Committee (ASSC ) of the Institute of Chartered Accountants in England and Wales
observed that if the reports are to be useful and to fulfill their fundamental objectives, they must possess
timeliness as one of the characteristics. Further Financial Accounting Standards Board (FASB) in its
conceptual framework in the year 2006 has also mentioned timeliness as one of the qualitative features of
financial reporting. Timeliness means having information available to decision makers before it loses its
capacity to influence decisions (Meena, 1995). Timeliness alone cannot make information relevant but a lack
of timeliness can rob information of relevance it might otherwise have had (Singh, 2005). Timely disclosure is
fundamental to good investors relations. If information would be disclosed timely, decisions could be taken
by the users promptly and exactly (Jiloka and Verma, 2006). Thus the accounting information must be
communicated before its usefulness is lost or when its decision is due, it should be available to its users.
Information has its time value (Bhattar, 1995).
Completeness
Completeness implies that all the information that is reasonably needed to fulfill the requirement of the other
qualitative objectives should be reported. Information is useless unless it is relevant and material to users
decision. Information should be as free as possible from any biases of the preparer. In making decisions user
should not only understand the information presented, but also should be able to assess its reliability and
48

compare it with information about alternative opportunities and previous experience. In all cases information is
more useful if it stresses economic substance rather than technical form (Bhattar, 1995). Similarly, Corporate
Report London has suggested completeness as an essential feature of financial reporting. The accounting
information must be complete from the point of view of statutory requirements and materiality. The users of
accounting must be provided with full information so that they may take right decisions at right time (Bhattar,
1995). However; completeness is relative because financial statements cannot show everything. To try to
include in financial reporting everything that any potential user might want would not be cost beneficial and
might conflict with other desirable characteristics, such as understandability. (Anonymous, 2006) Thus
information disclosed through financial reporting must be complete within the bounds of materiality and cost
(Gupta and Mehra, 2002). An omission can cause information to be false or misleading and thus unreliable and
different in terms of its relevance.
Understandability
Users of financial reporting have different levels of ability as regards understanding accounting information.
The information must be understandable, so that one can make use of it without any specific knowledge of the
subject (Bhattar, 1995). The information should be presented in reports in such a way that it can be understood
by reasonably well informed as well as by sophisticated readers (Chander, 1992). Accounting information is
more understandable if it is quantifiable, is consistent, is comparable with similar information, and is simple.
So consistency and comparability are the two significant attributes of information which make it
understandable and hence useful to the users. Consistency refers to use of identical accounting practices,
procedures and concept by the enterprise from one period to another. Consistency is an important criterion in
disclosure mechanism. It makes the information comparable and thus helps the users in decision making.
However, it should not prove a bottleneck in bringing improvements in accounting practices and policies.
Whenever users; needs change over a period of time and require improvements in accounting policies and
practices, the new practices or procedures should be adopted and followed. Thus consistency is desirable until
a need arises to improve practices, policies and procedures (Bhattar, 1995).
Comparability
Comparability is an outcome of consistency. It can be viewed from two angles, i.e. comparability of
information between periods in case of a single firm and comparability between firms (Chander, 1992).To
make the information comparable an enterprise should adopt the generally accepted accounting principles and
accounting standards, make disclosure of changes in accounting policies and explain about companys
accounting policies. Understandability does not necessarily mean simplicity or using elementary terminology.
It means the presentation of information in clearest form so as to help in making best use of information by the
users and avoid confusion in their minds (Bhattar, 1995).
Reliability
Reliability implies that information communicated should represent what it purports to represents and further
being free from error and bias also (Bhattar, 1995). The True Blood Report and the Corporate Report London
also emphasized reliability as one of the qualitative features of financial reporting. Reliability helps in decision
making process. Reliable information can create confidence in the minds of the users. It is need for reliable
information that underlies the requirement that financial reports be audited by independent auditors (Jiloka and
Verma, 2006).Information has the quality of reliability when it is free from material error and bias and can be
depended upon by users to represent faithfully that which it either purports to represent or could reasonably be
expected to represent (Chander, 1992). For information to be reliable; it must be verifiable to some degree, and
it must be free from bias, i.e. objectivity or neutrality. The AAA committee says that verifiability requires that
essentially similar measures or conclusions would be reached if two or more qualified persons examine the
same data. Freedom from bias means that facts have been impartially determined and reported. It also implies,
that the events or results should be reported in the financial statements without the bias or prejudice of the
persons concerned with reporting such information (Chander, 1992).Thus financial reporting should provide
information that is useful to the present and the potential investors and creditors and other users in making
rational investment, credit and similar decisions.
Economy
49

The preparation of financial accounts should not require a disproportionate amount of effort and expense. The
cost of its preparation should be less than the value which could be obtained from the information presented.
The choice of the income measurement system should be based on cost benefit analysis of each as a financial
information system, and that one which furnishes the most useful information in relation to the cost of
operating the system should be chosen.
Neutrality
Neutrality means that the accounting information is directed towards the common needs of the users rather
than the particular needs of specific users. The accounting information must be fair; it must be measurable and
reported with as much objectivity and neutrality as possible. The information must be based on firm verifiable
evidence and it must not tend to benefit a particular user at the cost of other users (Bhattar, 1995). Financial
Statements are not neutral if, by the selection or presentation of information; they influence the making of a
decision or judgment in order to achieve a predetermined result or outcome.
2.7 CONSTRAINTS ON RELEVANT AND RELIABLE INFORMATION
Timeliness
If there is undue delay in the reporting of relevant information it may lose its relevance. To provide
information on a timely basis it may often be necessary to report before all aspects of a transaction or other
event are known thus impairing the reliability. Conversely, if reporting is delayed until all aspects are known,
the information may be highly reliable but of little use to users who have to make decisions in the interim. In
achieving a balance between relevance and reliability, the overriding consideration is how best to satisfy the
information needs of users (Anonymous, 2000).
Balance between Benefit and Costs
The balance between benefit and cost is a pervasive constraint rather than a qualitative characteristic
(Anonymous, 2000). The benefits derived from any information should exceed the cost of providing it. FASB
says in its conceptual framework, the benefits and costs from financial information are usually difficult or
impossible to measure objectively. Different persons will honestly disagree about whether the benefits of the
information justify its costs. Furthermore, the costs do not fall on those users who enjoy the benefits. Benefits
may also be enjoyed by users other than those for whom the information is prepared. For these reasons it is
difficult to apply cost-benefit test in any particular case. According to Singh (2005), the major benefits of the
financial reporting to the investors are the reduction of the likelihood that they will misallocate their capital. As
far as costs are concerned he has classified them into three parts: The cost of developing and disseminating
information, the cost of litigation attributable to informative disclosure, and the cost of competitive
disadvantage attributable to disclosure.
Balance between Qualitative Characteristics
A trade-off between various qualitative characteristics is very much necessary. The relative importance of
different characteristics varies from case to case. Generally the aim is to achieve an appropriate balance
between the characteristics in order to achieve the objective of financial reporting (Anonymous, 2000).
Therefore, the financial reports should be concerned with the best possible ways of describing economic
activities, and methods of improving the means of communicating financial reports information should be
actively explored. Moreover, they should be timely and be presented frequently and regularly.
2.8 FINANCIAL REPORTING ACROSS THE WORLD
There are major international differences in accounting practices in reporting across the world. The factors,
which impact accounting development at the national level also contributes to accounting diversity at the
international level. These may be broadly classified as:

50

1) The type of capital market
2) Diversify taxation and financial reporting: If the legal framework allows two sets of reporting, one for
taxation where profits are understated to minimize taxation and external reporting is legally allowed to be
presented on glossier terms to attract investment.
3) Size of business houses: Larger business houses, consisting of large variety of products, employing
thousands of people and operating in many countries, characterize developed countries. Financial
reporting in these countries will be detailed and complete since it is needed to capture the economic
substance of the entities of these economies. They are therefore very different from financial reporting
rules sufficient for smaller and less complex entities.
4) Legal system: The legal system in countries like Rome, Germany, France etc. may be called the code
law type where accounting is regulated mainly through an account code, which tends to be highly detailed,
prescriptive, procedural and is generally set by the legislature. The emphasis is on protection of creditors
of the company. This is in contrast to the common law countries like United Kingdom, U.S.A. and
Australia accounting regulations are set on a procedural basis, typically by a private sector standard setting
body, with emphasis on presenting a true and fair picture to shareholders. This type of reporting is more
timely and transparent, and regarded as being more adaptive and innovative.
Level of enforcement
Where stringent enforcement prevails, accounting and reporting practices are largely in compliance with
regulatory requirements. In some countries, political patronage and proximity to the ruling group enables
business entities to circumvent existing financial reporting requirements. Investors, who assumed there was
compliance when there was actually not, suffered sufficient losses when the true financial position of such fl
outing companies was disclosed. Sometimes, countries that adopted accounting standards of other countries do
not have the resources to implement and enforce the standards. Business entities need trained personnel to
apply these standards, while regulatory agencies need adequate budgets to monitor compliance. When
countries lack these resources, there is a gap between the requirements and actual practice.
Inflation Levels
Countries such as U.K. and U.S., who usually keep inflation under check, tend to use the historic cost model,
where as countries like Bolivia and Mexico; have to use inflation adjusted models of Financial reporting to
provide more decision relevant information.
Political and economic ties
Where a country was colonized for an extended period of time, it typically adopted the accounting system of
the colonial power. Singapore and Malaysia continued with the British system and Philippines, with the U.S
system, even after gaining independence, where as Indonesia discarded its pre independence Dutch system in
favour of the U.S. model after independence.
Status of the accounting profession
In common law countries like the U.S., Canada and U.K, accounting is held in high esteem as a profession. In
such countries the accounting profession is largely self regulating and plays a major role in setting accounting
and auditing standards, as well as establishing educational and licensing requirements for entering and staying
in the profession. In code law countries like France and Germany, the accounting profession has considerably
less statute and power, and the Government takes the lead role in regulating the profession. In yet other
countries like Russia, accounting has historically been equated with book keeping a clerical task.
Quality of Accounting Education
In some countries, there is a long history of including accounting as a very important course, attracting some of
the countrys best talent. This in turn, produces quality in the accounting practices. Other countries which treat
accounting as a clerical vocation get into a vision cycle of non-improvement in the countrys
accounting/regulatory bodies.
51

2.9 CORPORATE FINANCIAL REPORTING PRACTICES IN INDIA
There are few studies that deal with Indian practices of corporate financial reporting. The Institute of Chartered
Accountants of India has made survey of corporate reporting practices in India from time to time (1981; 1985).
Other notable studies on financial reporting in India are Dasgupta Lal, Chakraborty and Banerjee. An analysis
of the findings of these studies reveals that Indian corporate reporting practices are coping with changing needs
of the economy and the society. Furthermore, the compliance with statutory disclosure requirement is a general
phenomenon. However, in a recent study by Das reveals that there are cases of non-compliance with
mandatory disclosure requirements. Thus, there is scope of improvement in the area of reporting of even
mandatory disclosure items and role of management is important since the ultimate responsibility of providing
information to the users rests on management. It may also be noted that there is a great amount of diversity in
corporate reporting. The quality of information provided by the big companies has improved considerably and
reports of some Indian companies are internationally competitive. With this brief introduction, we discuss in
the following section the current reporting practices of Indian companies.
2.9.1 Published Financial Statements: Annual report is major vehicle through which Indian companies are
publishing their financial statements. Like companies of any developed countries, Indian annual reports now
include much more than the legal minimum requirements. Regarding elements of annual reports, the following
are most common:
Notice of annual general meeting
Chairmans report
Summary of financial results
The financial highlights for a number of years
Directors report
Management discussion & analysis
Corporate governance report
Auditors report on financial statements
Balance sheet
Profit and loss account
Significant accounting policies
Schedules and notes accounts
Cash flow statement
Supplementary statement u/s 212 of the Companies Act
CAGs Comments on Accounts (in case of Government Companies)
Audited consolidated financial statements
Information on human resources
Value added statement
Corporate social report
Environmental report
Information on Brand/ Intangibles
EVA report
Business Responsibility Report
2.9.2 Abridged form Balance Sheet: Indian Companies Act requires that a copy of every balance sheet
(including the profit and loss account, the auditors report and every document required by law to be annexed
or attached, as the case may be, to the balance sheet) which is to be laid before a company in general meeting
shall, not less than twenty-one days before the date of the meeting, be sent to every member of company. Such
balance sheet may be called full version balance sheet. It may be mentioned that sending abridged balance
sheet is not a common practice among Indian companies.
2.9.3 Business Responsibility Report: SEBI recently mandated that the top 100 listed entities based on
market capitalization of BSE and NSE should include business responsibility reports in their annual report.
Other listed entities may voluntarily disclose business responsibility reports. According to a SEBI circular, an
entitys business responsibility performance will be assessed based on nine principles, business responsibility
reporting is a step in the right direction, as it is expected to align Indian reporting requirements with global
52

standards. Business responsibility reports can help entities demonstrate to key stakeholders including
investors, employees, the government and consumers that their businesses are not detrimental to the
environment, society or employees. This will positively impact brand reputation, attract, motivate and retain
employees, provide access to global markets and attract foreign capital. To comply with the new reporting
requirements, entities would need appropriate systems, mechanism and processes. This requirement is
applicable from financial year ending on or after December 31.
As Indian economy integrates more and more with the global market, Indian companies have to present
themselves as environmentally and socially responsible to become competitive. So Indian companies should
adopt sustainability approach and report the various dimensions of it. Indian companies to a certain extent have
responded to the new economic realities by adding more information in its annuals reports. New dimensions of
financial reporting, which were ignored by the accountants and managements, have been reported by certain
companies. True success of a business entity is in the truthful expression of the performance when it is
measured. The fast pace of globalisation has resulted in Indian accounting standards and corporate governance
requirements in line with international practices. But Indian companies are not reporting the much needed
voluntary disclosures in their annual reports. The disclosure of some of these issues is mandatory in Western
countries, but in India these form part of voluntary disclosures done by companies. Most of the Indian
companies disclose what is required by law to be disclosed. The reporting of this information in corporate
annual reports will increase its relevance and usefulness. ICAI should address the important issues and make
them mandatory, wherever it is necessary. Indian companies should also report the current issues for attaining
global standards in corporate disclosure.
2.10 HARMONIZATION OF CORPORATE FINANCIAL REPORTING
Having understood the causes for differences and suitably classifying the accounting system across the world,
it is necessary to achieve harmony or uniformity in the accounting system. This is the need of the hour,
considering the levels of multi-nationalisation and telecommunication, which are really shrinking the world.
Presently, when international financial reporting is becoming more important as the tool of communication
among traders, entrepreneurs, financiers, ad investors due to growth in trade across national frontiers;
variations are evolving in accounting principles, audit practices, financial statement presentations, and
professional standards. If accounting reports are to become a universal means of communication, action must
be taken to harmonise the worldwide efforts to meet the international users needs.
Harmony will ensure easy comparability, which is essential in the context of global funding and multinational
companies regulators who monitor capital markets, and the securities industries (including stock exchanges).
2.10.1 Definition
Harmonisation may be defined as the process aimed at enhancing the comparability of financial statements
produced in different countries accounting regulations.
It simply means maintaining uniformity in financial accounting standards and practices at the international
level.
2.10.2 Standardisation and Harmonisation
Standardisation involves
(i) more uniform application of accounting concepts, principles and rules, reporting procedures and
legislation;
(ii) adherence to more unified charts of accounts and statements, which specify the classification
categories by economic units, industries and sectors, and which preferably are applicable on an
international scale; and
(iii) greater systematization of all accounting activities, particularly standardized plans of accounts (this
would not only include the classification charts but also the quantitative and qualitative aspects of
data).
Thus, the term harmonisation is not the same thing as standardisation. Noble distinguishes these two terms
clearly: Harmonisation is a process of increasing the compatibility of accounting practices by setting bounds to
53

their degree of variation. Standardisation appears to imply the imposition of a more rigid and narrow set of
rules. However, within accounting, these two words have almost become technical terms, and cannot rely upon
the normal difference in their meanings.
2.10.3 Arguments for Harmonisation
There are strong pressures in favour of greater international harmonisation, and virtually all of the countries in
the world now support International Accounting Standards Committee (IASC) efforts to develop a set of
international accounting standards. The fact that so many different international organisations are now engaged
in international standardisation is a clear evidence that the need for such harmonisation has become widely
recognised. F.M. Richard, president of the Ninth International Congress of Accounts held at Paris in 1976
remarked:
Almost all the international and national authors are in favour of the harmonisation of accounting and auditing
principles, and some even considered that this harmonisation is essential and really urgent..
There are many interest groups (beneficiaries) such as investors, multinational companies, large international
accounting firms, regional economic group, and developing countries who would benefit from harmonisation
and who have contributed towards harmonisation.
Developing Countries
There is an argument that countries, that do not have any domestic accounting standards would benefit from
international standards in that it would enable them to adopt a readymade system. They would not have to
produce their own, they could adopt (perhaps with some slight modification) the international standards. If this
were possible it would be course save them a great deal of time and expense.
Many developing nations do take a great interest in international standards. Nigeria, for example, one of the
developing countries who are members of IASC have adopted these standards, and companies over a certain
size are required to produce accounts that conform to such standards.
Multinational Companies
A major force in the movement toward international harmonisation has been the economic self-interest of
multinational companies. Multinational firms are the prepares of financial information. With diversity in
accounting standards from country to country, these firms face a myriad of accounting requirements from the
countries in which they operate. The burden of this financial reporting would be lessened with increased
harmonisation which would simplify the process of preparing individual and group financial statements.
Multinational companies would benefit from harmonisation on the following counts.
(a) Consolidation of overseas subsidiaries would be easier due to harmonisation as financial statements
from all round the world would be prepared on the same basis.
(b) Many large companies want to raise money in more than one country and in international markets, and
so need to produce accounts which can easily be understood by investors in many countries. For this
reason the World Federation of Stock Exchanges is said to be encouraging the acceptance of
international accounting standards.
(c) The task of preparing comparable internal information for the appraisal of the performance of
subsidiaries in different countries would be made much easier.
Many aspects of investment appraisal, performance evaluation and other decision-making uses of management
accounting information would benefit from standardisation. Management control would be more easily
accomplished.
The appraisal of foreign countries for potential takeovers would also be greatly facilitated. Multinational
companies would also find it easier to transfer accounting staff from one country to another.
Investors
54

A strong case for increased harmonisation can be made from the viewpoint of the users of accounting and
financial information, mainly the investors who wish to invest outside their own country, that is, both
transnational companies investing directly and individual investors wishing to invest part of portfolio of funds.
If comparability of accounting standards helps economic decision-making and the efficient allocation of
economic resources within a nation, the same can be said about economic decision-making and economic
resource allocation on a world-wide base. Without world-wide accounting and auditing standards, it is
difficult, if not impossible, to assess the relative merits of alternative investment opportunities, or to make
valid comparisons of the financial performance of companies in different countries.
Harmonisation, thus, could lead to improvements in the allocation of financial resources. It would help to
avoid confusion and possible misallocation of resources by bringing uniformity in accounting standards and
practices. Cummings and Chetkovich comment that .it is obvious that there is a need to harmonise accounting
and reporting standards.. They recognise that it .may not always be possible to achieve universal acceptance of
a single method of accounting and reporting. the fact is that the promulgation of an international standard
reduces the alternatives available under varying circumstances and that the required disclosures facilitate
understanding and comparison..
Although international harmonisation would make financial statements easier, with not so many adjustments
being required, it has also been argued that international investment and business has and still does go on
without standardisation, and harmonisation. It has, in fact, not been found that the variety of systems really act
as a restraint on international investment and international business.
International Auditing Firms
Another major force in the movement toward international harmonisation was the economic self interest
international auditing firms have in such standards, so that they can sell their services as experts in many
different parts of the world. McComb points out that .the thrust of the movement toward the harmonisation of
accounting standards on the international level has come mainly from accountants in public practice rather than
academic accountants.. It would make life very much easier for them if similar practices existed throughout the
world. Many auditing firms have clients (in the form of subsidiary or branch) operating in foreign countries.
The preparation, consolidation and auditing of these companies financial statements would become less
onerous if accounting practices were standardized. The international auditing firms would also to quote
international accounting standards to clients, to give them backing for recommending certain ways of
reporting.
Growth in International Business
The main stimuli for harmonisation come from the enormous expansion that has taken place in world trade and
in international investment since the end of World War II. As international business and investment multiples,
accountings international dimension broadens, international financial reporting has become more important as
the tool of communication among businessmen, entrepreneurs, financiers and investors. At the same time,
variations are evolving in accounting principles, audit practices, financial statement presentations, and
professional standard. If accounting reports are to become a universal means of communication, action must be
taken to harmonise worldwide efforts to meet the international users. need. John C. Burton at 1980
Proceedings or Arthur Young Professors Round Table on The International World of Accounting &
Challenges and Opportunities remarked:
Today, as more business is done internationally, as more capital crosses borders, as more
investors seek investment opportunities in other countries, as more manages of international
business attempt to better understand performance of foreign subsidiaries, the problem of diverse
accounting standards becomes more acute. There is also the argument for a common need to
communicate. A common language problem suggests that, it is useful if we talk in the same
terms. The world is too small today to have national boundaries create many bases for totally
different principles of economic environment.
Robert L. May: President of International Federation of Accountants, in his speech (1986) delivered at
Australian Accountants Centenary Congress, Sydney, observes:
55

There is a greater need than ever before for comparability of international financial data.
Government, lenders, businesses, shareholders everywhere, they all need information in a form
that is reliable, that is understandable, and that will encourage the flow of international investing
rather inhibit it. In a world where finance and trade are international, it seems utterly incongruous
that the accounting standards are not in a world where the word multinational is almost clich; it
seems strange that it has had so little application to accounting. In a world where national
economies are so linked together that a crises in one can send shock waves rolling into every
corner of the universe, it seems entirely against logic that accountancy professionals must heed
the out-of-date doctrines of separatism.
Other Interest Groups
One group who it is said would benefit from a greater degree of harmonisation would be tax authorities. They
would find their work less complicated when dealing with foreign income. It must be said, however, that it is
taxation rules that are responsible for many of the differences that do exist in accounting practices. Tax is and
will remain a national matter. Accounting measurement may be harmonized, but it would need to be
recognised that standardized accounting practices may need to be adjusted for national tax purposes.
At the Twelfth International Congress of Accountants in Mexico City in October 1982, John N. Turner, former
Minister of Finance, Minister of Justice and Attorney-General of Canada, and firs Chairman of the Interim
Committee of the International Monetary Fund, cited these advantages of universally applicable standards..
The greatest benefit that would flow from harmonisation would be the comparability of international financial
information. Such comparability would eliminate the current misunderstanding about the reliability of foreign
financial statements and would remove one of the most important impediments to the flow of international
investment. A second advantage of harmonisation would be the time and money saved that is currently spent to
consolidate divergent financial information when more than one set of report is required to comply with
different national laws or practices. A third improvement from harmonisation would be the tendency for
accounting standards throughout the world to be raised to the highest possible level and to be consistent with
local economic, legal and social conditions.
2.10.4 Need for Harmonisation
Current trends in the international accounting point towards a need for uniformity in accounting and reporting
standards. The trends towards uniformity are stimulated by a desire for comparability in the worldwide
investment community. At the 1980 Proceedings of the Arthur Young Professors Round Table on the
International World of Accounting challenges and Opportunities the harmonisation in international
accounting standards was emphasised.
Over the time, each nation of the world has developed its own rules of accounting and auditing, sufficient to
the needs of its own commerce and maturity of its industry. And while the basic accounting techniques spring
from the same basic body of accounting knowledge, principles and techniques have tended to develop
differently in each country.
Today, the principles and practice that guide the accounting profession in one country are sharply divergent
from those in another. The principles that guide the valuation of assets allocation, foreign currency translation
and accounting for changing prices may, in fact, be do different from one country to the next as to defy
comparability and frequently, credibility as well. The result is that a businessman in one country attempting to
understand the financial statements of a business in another country, may be at a serious loss to understand or
use information vital to his needs.
Today, as more business is done internationally, as more capital crosses borders, as more investors seek
investment opportunities in other countries, as more managers of international business attempt to better
understand performance of foreign subsidiaries, the problem of diverse accounting standards becomes more
acute.
There is also the argument for a common need to communicate; a common language problem suggests that it is
useful if we talk in the same terms. The world is too small today to have national boundaries and create many
bases for totally different principles of economic measurement.
56

John Buckley suggested that a major force in the movement toward international standards was the economic
self interest international accounting firms and multinational corporations have in such standards, so that they
can sell their services as experts or so that they can have administrative convenience in operating in many
different parts of the world.
2.10.5 IASC and Harmonisation
To date, the IASC appears to be the most influential body involved in the standardisation and harmonisation
programmes. International Accounting Standards (IASs), according to IASC, are in the best interest of the
users and prepares of financial statements.
Prudent investment and managerial decisions in this increasingly complex and internationally oriented world
require such standards. Generally accepted International Accounting Standards mean that investors, bankers,
creditors, mangers, employees, and governments have less difficulty in understanding and analyzing annual
and interim reports prepared in countries other than their own, and that they can have confidence in those
reports.
The IASC agreement provides that the professional accountancy bodies (who are members of IASC) agree to
support the standard promulgated by the committee and to use their best endeavours:
a) To ensure that published financial statements comply with these standards or that there is disclosure of
the extent which they do not and to persuade governments, authorities controlling securities markets
and the industrial and business community that published financial statements should comply with
these standards.
b) To ensure (a) that the auditors satisfy themselves the financial statements comply with these standards
or, if the financial statements do not comply with these standards, that the fact of non-compliance is
disclosed in the financial statements, (b) that in the event of non-disclosure reference to non-
compliance is made in the audit report.
c) To ensure that, as soon as possible, appropriate action is taken in respect of auditors whose audit
reports do not meet the requirements of (2) above
The IASC has made substantial progress in setting accounting standards and has tried its best to influence the
member accountancy bodies for adoption of international accounting standards. The General Electric Company
is the first major US Corporation to disclose that its financial statements are in conformity with International
Accounting Standards.
2.10.6 Organizations involved in Harmonisation
The following are the main organizations that are involved in global accounting harmonization
The International Accounting Standards Committee (IASC)
It is an independent private sector organization that was established in 1973 by professional accounting
organizations from 10 countries Australia, Canada, France, Germany, Ireland, Japan, Mexico, The
Netherlands, The U.K and the U.S. Now, more than 140 countries are members of the IASC. The objectives of
the IASC are:
- To formulate and publish in the public interest accounting standards to the observed in the
presentation of financial statements and to promote their world wide acceptance and observance.
- To work generally for the improvement and harmonization of regulations, accounting standards and
procedures relating to the presentation of financial statements.
IASC is supported by international organization of securities commission (IOSCO), which consists of
representatives of the securities regulatory organizations in over 60 countries. Where IASC lacks the authority
to enforce its standards globally, IOSCO helps by enforcing these standards in its member countries.
The International Federation of Accountants (IFAC)
57

This is a body of national professional accounting organization that represents accountants employed in public
practice, business and industry, the public sector and education as well as some specialized groups that
interface frequently with the profession. It was formed in 1997 to develop the profession and harmonise its
standards world wide to enable public accountant to provide good services in the public interest. Currently,
IFAC has about 150 member organizations in 103 countries, representing 2 million accountants. IFAC issues
International Standards on Auditing (ISA) that are aimed at harmonizing auditing practices globally.
Another initiative of the IFAC is the establishment of international public sector standards applicable to all
levels of government. IFAC has also spearheaded the organization of a forum on the development of the
accounting profession, bringing together, various development banks and agencies, to determine how best to
marshal the combined resources of the accounting profession, local and national governments and
development agencies to meet the basic needs for an accounting framework in developing countries.
The IFAC may also be credited with reports to maintain auditors independence in todays complex and
competitive business environment.
International Organisation of Securities Commission (IOSCO)
It was formed in 1983 and is comprised of securities regulators from more than 115 securities regulatory
agencies from around the world and about 85% of worlds capital markets. Its general secretariat is based
in Montreal. IOSCO strives to promote high standards of regulations to maintain just efficient sound markets
with integrity by establishing standards and surveillance of international securities transactions and ensuring
enforcement of the standards.
IOSCO has already endorsed half the IASC standards, and is in the process of endorsing the remaining, subject
to its satisfying itself with a comprehensive core set of high quality accounting standards.
United Nations
Initially in the 1970s, the UN has its group of experts on ISA produce a list of financial and non-financial
disclosures to be provided by multinational companies. The list was detailed and included requirements for
disclosure of transfer pricing policies, segment information, R&D expenditure and employee information.
Those being proprietary in nature, the recommendations were rejected by most industrialized countries. More
recently, the UN has worked to harmonise the accounting standards by discussing and supporting best
practices, including those stipulated by the IASC. It has focused on issues such as environmental disclosures.
The UN has provided funding a technical assistance towards a sound financial reporting regime in accordance
with international standards, in a number of Communist bloc countries which lacked such initiative.
Organisation for Economic Corporation and Development (OECD)
The OECD comprises 29 member countries producing two-thirds of the worlds goods and services. It has an
adhoc working group on accounting standards which supports current efforts on accounting harmonization by
international, regional and national bodies and the UN.
2.10.7 Global Scenario of Harmonisation
The countdowns to the harmonization of national and international accounting standards and an improvement
in the quality of financial reporting at a global level are best tracked chronologically.
The current world scenario on the subject of harmonization gets going on 12 March 2002, when the EU
Commission directed all European companies trading in the European Securities Market to adopt IAS in 2005,
and all non- European companies (following US GAPP or any other standards) up to 2007.
In June 2004, the Australian Accounting Standards Board (AASB) had issued standards and interpretations
that all accounting standards of Australia that are equivalent to International Financial Reporting Standards (A
IFRS) must be adopted from 2005 in their country.
Many countries like Korea, Barbados, Trinidad and Tobago, Zimbabwe, Mongolia, Malta, and Uganda are
adopting IAS. The information about accounting principles applicable in Syria and Tunisia indicates that they
58

are similar to international accounting standards. At present, all companies and banks in Russia are required to
prepare their financial statements in accordance with IAS.
New Zealands Accounting Standards Review Board (ASRB) and Financial Reporting Standards Board (NZ
FRSB) have adopted 36 new accounting standards and 12 interpretations in January 2005. And these formed
New Zealands equivalent of the International Financial Reporting Standards (NZ IFRS). It is going to
implement IASB standards with effect from 1st January 2007.
Hong Kong is an important international financial hub. Its stock market ranks second largest in Asia and eight
largest in the world in terms of market capitalization. The Hong Kong Institute of Certified Public Accountants
(HKICPA), the standard setting body of Hong Kong has been pursing the policy of aligning its standards with
IAS since the early 1990s.
Most recently, HKICPA has further committed time and resources to support convergence. Philippines have
also adopted national standards that are identical to IFRS from 2005. Singapore has adopted many accounting
standards from IFRS that essentially word for word. Now these are known as Singapores equivalents of IFRS
(S IFRS).
Japan, the major player in the global capital market and the second largest capital market in the world, is a
strong supporter of IASB. The Japanese Institute of Certified Public Accountants is now working in
collaboration with the IASB to make the Japanese standards essentially equivalent to international standards.
Japan too has undertaken a joint project in collaboration with IASB to remove the differences between
Japanese Accounting Standards (JAS) and IFRS by January 2005.
The Canadian Accounting Standard Board (CASB) has also announced its intention to adopt International
Financial Reporting Standards (IFRS) in five years. Canadas decision to adopt IFRS means that out of
original G4 nations, US is the only member that has not gone over to international standards.
In Egypt, Egyptian Accounting standards have prepared to comply with international accounting standards
except for certain minor differences to adopt Egyptian economic environment. Therefore, all companies listed
in the Cairo Stock Exchanges must follow IAS. Kuwait adopted IAS as its national standards. Therefore, all
Kuwaiti companies are following IAS for the purpose of listing. All companies in Jordan, both domestic and
foreign, listed in the Amman Stock Exchange must follow IAS. However, in Turkey, foreign companies may
follow any one out of three standards, such as, International Accounting Standards, UK GAAP and US GAPP
for listing in Istanbul Stock Exchange.
In the Middle East, most of the countries have welcomed the International Accounting Standards. For cases in
point, Bahrain, Qatar, Lebanon, and Oman are considering IAS as the replacement to their domestic standards.
Of course, Iran and Israel had shown reluctance for the use of International Accounting Standards. In Iran, all
companies to be listed in Iranian Stock exchange must have to follow Iranian accounting principles. Similarly
all companies must have to follow Iranian accounting principles, if they want to be listed in Tel Alive Stock
exchange.
On January 1, 2007, more than 1,100 Chinese companies switched to new accounting standards that brought
their books in line with international norms. From next year, the companies will have to apply a new set of 38
standards, under the China Accounting Standards System, that are basically in line with IASB (International
Accounting Standards Board) norms. But, there is far more at stake than improving accounting practices at
Chinas listed firms. Chinese companies are increasingly looking overseas for funds and acquisitions.
Adopting international standards will make this easier by increasing their transparency and credibility.
In Bangladesh, the Institute of Chartered Accountants of Bangladesh (ICAB) set standards for the country
through its Technical and Research Committee. Till date, it has adopted all eight IFRSs and twenty six IASs.
In terms of standards, the gap between IASs and the standards as followed in Bangladesh is insignificant
though some national laws give contradictory prescription in single situation. Another milestone reached by
Bangladesh is that it has enacted the Financial Reporting Act 2008 to control financial reporting activities and,
at the same time, to do the watchdog function of the accounting and auditing profession that will further
strengthen the harmonization process.
59

From above deliberations, it can be believed at this moment that, the IOSCOs endorsement of the IASC
standards has paved the way for unification of accounting standards globally and emergence of the true
artificial language designed for global use in the field of accounting (Srkant, 2005). Today the world of
accounting feels that International Accounting Standards should be that language, as it is the only set of
standards that has been prepared through wide international consultations and participations.
2.11 SUMMARY
The system of financial reporting is a function of the economic, legal and political institutions in a country.
The changes taking place in the commercial world due to globalisation and deregulation has urged the need for
greater transparency in corporate reporting. In early times, accounting was merely concerned with
ascertainment of results of business enterprises. But corporate financial reporting has a new orientation in these
days owing to the increased needs of users of accounting information. There have been major changes in
financial reporting in India since the economic reforms and globalisation began in the early 1990s. Companies
formerly operating in a planned economy encountered significant difficulties when attempting to operate in a
market economy. Today's dynamic business environment is heading towards a revolution for and the way in
which accounting data is utilised. In this context, annual reports should reflect the economic reality of a
company's business. Companies should supplement mandated financial information with voluntary
information in detail.

60

Inflation Accounting:
The Concept and the Context

3.1 INTRODUCTION
The basic objective of Accounting is the preparation of financial statements is a way that they give a true and
fair view of the operating results and the financial position of the business to its various users, namely
investors, creditors, management, Government, trade unions, research institutions etc. These financial
statements are prepared based on certain accounting concepts and conventions. The money measurement
concept is a basic attribute of accounting.
The money measurement concept states that only those business transactions that are capable of being
expressed in terms of money can be recovered in the books of account. It also assumes that the monetary unit
used for recording the transaction is stable in nature. However, this is not true in practice as 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. There is a demand that business enterprises should prepare inflation
adjusted financial statements. The different ways through which financial accounts can be adjusted for
changing prices is studied under the subject Inflation Accounting. Given that price changes can also be
downward, it is more appropriately called Accounting for price level changes.
Price Level Accounting
Price level accounting may, therefore, be defined as that technique of accounting by which the financial
statements are restated to reflect changes in the general price level. Such changes may be either inflationary or
deflationary. Of course, inflation has come to stay and, therefore, price level accounting is more concerned
with inflationary tendencies.
Inflation Accounting: Definition
According to the American Institute of Certified Public Accountants
Inflation accounting is a system of accounting which purports to record as a built-in
mechanism all economic events in terms of current cost.
Thus, inflation accounting is a system of maintaining the accounts just like historical accounting. The
difference lies in the process of matching-cost against revenue. In historical accounting cost represents
historical cost wherein inflation accounting it represents the cost prevailing at the reporting date or time. This
matching process in inflation accounting should be automatic and inbuilt in the system itself and not ad hoc in
nature dealing only with some economic and financial events. In other words, it will be wrong to equate
replacement cost accounting with inflation accounting. The distinctive features of inflation accounting are as
follows:
a) The recording procedure is automatic.
b) The unit of measurement is not assumed to be stable.
c) It considers all elements of the financial statements and is not concerned only with fixed assets or
closing stocks.
d) Realisation principles are not followed rigidly, particularly, when recording long-term loans and fixed
assets at the current value.
On the basis of the above explanation, it is clear that inflation accounting should not be confused with current
cost accounting or current purchasing power accounting. Of course, they are the two important techniques
which are being used for prevention of distortion of the results shown by the financial statements on account of
Chapter
3

61

inflationary tendencies. Accounts all over the world have still to go a long way before developing a really
effective and acceptable inflation accounting system.
Limitations of Conventional Financial Statements
The income statement and the balance-sheet prepared according to conventional or historical cost accounting
system have been the subject of criticism by accountants, investors, financial analysts, etc. on account of the
following reasons:
a) Fall to disclose current worth of the enterprise: The financial statements prepared under the conventional
system are merely statements of historical facts. They do not show the true current worth of the enterprise.
b) Creates problems at the time of replacement: According to the conventional method, depreciation is
charged on the historical cost of the asset. Problems, may, therefore, arise when the asset has to be replaced
and larger funds are required on account of inflationary conditions. For example, if a machine was
purchased for Rs.1lakh and its life was expected to be 10 years, a sum of Rs 10,000 would be charged as
depreciation every year. If after ten years, the same asset can be purchased for Rs 1, 50,000, the firm may
have to face serious problems because of insufficiency of funds. The main purpose of providing
depreciation may, therefore, be defeated.
c) Mixes holding and operating gains: In conventional accounting, gains on account of holding the inventories
may be mixed up with the operating gains. For example, a business purchased 100 units .of a product at Rs
6 per unit in 2010. It could sell only 50 of such units in that year. In 2011, it purchases another 100 units at
Rs 8 per unit and sells all 150 units at Rs 10 per unit. In such a case the profit in2011 as per historical
accounting will be as follows:
Rs.
Sales (150 units x Rs 10) 1,500
Less: Cost of sales (50 x 6 + 100 x 8) 1,100
400
As a matter of fact out of the total profit of Rs 400, a sum of Rs 100 (i.e., 50 x 2) is only on account of holding
the inventory. This is because if all the units sold had been purchased during 1991, the profit would have been
only Rs 300 (i.e., 150 units x Rs 2). Thus, Rs 100 is the holding profit while Rs 300 is the operating profit. The
historical accounting system, as seen above, does not make this distinction.
In general, it can be said that under inflationary conditions the reported profits are overstated and assets are
under-stated when accounts are prepared according to conventional or historical accounting. Over-reporting of
profits gives rise to a number of problems, viz. heavy taxation, heavy dividend, etc., resulting ultimately in
heavy financial strain on the company. Moreover, it brings heavy erosion in the interpretative value of
financial statements. All this has put more onerous responsibilities on management as observed Peter Drucker:
There are the costs of today and the costs of tomorrow. I know of no business today which
operates at such a rate of return that it can meet the costs of tomorrow. With todays rates of
inflation businesses are not making profits but only destroying capital. One of the primary
tasks of management is to reduce the costs of tomorrow and extract the maximum possible
out of available capital.
3.2 HISTORY OF INFLATION ACCOUNTING
The usefulness of conventional financial reporting based on the assumption of a stable monetary unit has
become the subject of intense debate during recent periods of high inflation, for it does not adequately
accommodate the economic reality of price changes. Thus, the impact of price changes on a business needs to
be recognised if financial reporting is to be useful for decision-making, setting budgets, determining costs of
production and for economic planning generally. As price changes occur at a rapid pace, so does the pressure
on accountants, both theorists and practioners, to provide a reporting basis which will reflect the impact of
inflation.
So far there have been two distinctly different views of the problem. One view considers the impact of
inflation on the unit of measurement, and the remedy is to restate historical accounting measurements in terms
of units of Current (General) Purchasing Power (CPP). A second view is that the problem is basically related
62

to the attributes being measured and that the cure is to eliminate reliance on transactions and historical
exchange prices and to, adopt some notion of current value. This view sees Current Cost Accounting (CCA) as
the proper solution to the problem.
The basic ideas of both CPP and CCA were known before the 1
st
World War. Irving Fisher, in his book "The
Purchasing Power of Money" in 1911, advocated the method of indexation as a means of overcoming the
iniquities resulting from inflation when contracts are negotiated in money terms, and gave many examples
from different countries of contracts that provided for the payment of money equal in value to a specified
amount of a commodity or group of commodities (Tierney, 1963, pp.61-2).
The policy of indexation has subsequently been adopted by certain Latin American countries, notably Brazil.
Although Fisher did not deal with inflation in accounting, he advocated the use of consumer price indices to
eliminate the distortion of money in a period of inflation.
The first writer in English on inflation accounting was Middleditch, L., who wrote two articles in 1917 and
1918, the second of which dealt with the changing value of money in accounts. He argued that the central
problem is to adjust all open accounts in terms of the same monetary unit. Adjustments should be made in the
profit and loss statement to restate current accounts on the books at the beginning of the period in terms of the
dollar at the end. Fixed assets should be adjusted for balance sheet purposes, in terms of the current dollar.
The adjustment differences should be debited to an account such as "monetary fluctuation of fixed assets" and
credited to, a reserve on direct net worth (Middleditch, 1918, pp.116-9). Of course, these adjustments would
not affect earnings available for dividends, and they ignore the other items in the balance sheet, such as
inventory, monetary items and loans.
Paton, W.A. and Stevenson, R. A, in their book, Principles of Accounting, stated that the financial reports
should always show the present value of the assets used by an enterprise for production purposes, if accounting
statistics are to provide the entrepreneur with information to make rational use of the economic resources at his
disposal ( Paton and Stevenson, 1916, p.14 & p.101). They concentrated on present values and focused only on
the entrepreneur, and not other users of financial reports. Although they did not define present value, it is
apparent that they meant contemporary price or valuation.
Many Germans have written on inflation accounting. For example, Schmalenbach E, in his book Dynamic
Accounting, advocated the stabilisation of historical cost, rather than replacement cost, as a method of dealing
with inflation and preferred a unit based upon a general price index applied to historical cost values (Tweedie
and Whittington, 1984, p.19).
The basic idea of Schmalenbach was to shift the emphasis of accounting from static statements, e.g. the
balance sheet, to dynamic statements of changes in position, e.g. the profit and loss account. He argued that the
dynamic system should be dominant because it was only by an accurate assessment of earnings that the
business as a whole could be valued. His method was to match cost to revenue within the traditional
accounting framework, placing emphasis on the accuracy of the allocations to the profit and loss account, and
regarding the balance sheet as a mere statement of accruals, recording sunk cost not yet allocated to the profit
and loss account, rather than as a serious attempt to value the assets of the business (ibid., p.21). Furthermore,
he concentrated on the quality of profit and loss account by emphasising the matching process:
The statist asks whether the addition has increased the value of the fixed assets. The
dynamist asks whether the addition is to be booked as expenditure in the year of purchase or
manufacture, or requires division into expenditure applicable to several years, and he has in
mind not only the year in which the addition is made, but also the years to come. He treats
these years as his children, not wishing to favour one to the disadvantage of another.
(Schmalenbach, 1959, p.85)
Mahlberg, W. in 1921 provided the first book-length price-level-adjustment model in the literature. He saw the
effect of specific price-level changes exceeding general inflation as giving rise to unavoidable future losses
that should be recognised currently. His valuation theory concerned the effect of inflation on the management
of a firm ( Graves, 1989, p.22). Moreover, he regarded profits during inflation as primarily a function of a
manager's ability to manage monetary items and only then as his ability to manage normal operations.
63

According to this view, income is a result of overriding monetary speculation, whereas Schmalenbach had
contended that income determination was an early detection of incipient change in the operating efficiency of a
firm (ibid., p.25).
Mahlberg argued that a balance sheet has two types of, inflationary gains and losses, related to the nature of the
assets held, and including both avoidable and unavoidable gains and losses. The avoidable gains and losses
were those associated with the holding of monetary items and of nonmonetary items not essential to the
operations of the firm, whilst the unavoidable gains and losses were ' those associated with the holding of
working plant and equipment and with the maintenance of stock (ibid p.26). Mahlberg may well have provided
Sweeney, with the concept of current cost/ constant dollar that led to his idea of unrealised appreciation.
Mahlberg's valuation theory perhaps provided the basis for the first conception of a holding gain, net of
inflation" (ibid., p. 29).
Schmidt F. may be regarded as the writer of the first theoretical treatise on current cost accounting. In his
article The Importance of Replacement Value", he stated that replacement cost provides the best basis for
producing financial reports for managerial purposes, or for use in planning mergers and reorganizations where
the status of an enterprise as a whole is under consideration ( Schmidt, 1930, p.235). He regarded replacement
cost as the market price, for which one can obtain the economic good in, question on the day of real or
assumed replacement, i.e. actual purchase or replacement is unessential, it is only necessary that purchase
could be made at the specific price at the time of evaluation (ibid., p.239). Moreover, in replacement cost
accounting every change in value is to be entered in a correction account and at the same time is to be entered
in the profit and loss account, and a split made between operating profit and other profits. Schmidt
concentrated on capital maintenance, arguing:
Differences in value between original cost and current replacement costs have the character of
value changes in capital, conditioned by changing current market prices for production goods.
Therefore, they logically belong in accounting for capital and not in accounting for operations.
(Schmidt, 1931, p.289)

His theory of accounting was concerned with the role of the individual firm in the national economy, and the
idea that accounting practices should lead to an appropriate allocation of resources in the economy. He asserted
that this would be the case only if profit were calculated by deducting from revenue the current replacement
cost of the resources used in earning it
If one wishes to seize the opportunity of a situation of value differences in order to make a
profitable turnover, the necessary calculation must take place at the moment the resolution is
made. One must therefore compare the cost value and the sale volume as of the same day and
estimate how far this value could be changed between the beginning of production and the day of
sale. (Schmidt, 1930, p.236)
Schmidt identified a number of problems which are still being debated today, such as the entity view of capital
maintenance, his concept of profit, and the gearing adjustment. From the technical bookkeeping point of view,
Schmidt's approach shows great similarity with that of Limperg, T., in the Netherlands.
Limperg, T. argued that the profits shown by historical cost accounting are exaggerated and make credit for
expansion too readily available, resulting in overinvestment and continuing inflation. His idea is summarized
as follows:
The value of a commodity is its realizable value or its replacement value, but always the
lower of the two. As to the realisable value a distinction should be made with regard to
factors of production between the direct and the indirect realisable value; of these two the
higher is always relevant. (Limperg, 1964, p.141)
The main object of Limperg's system was to provide a comprehensive set of cost information which would aid
management and at the same time be appropriate to shareholders. He regarded accounting as only one aspect
of economic activity and devised his theory of accounting as part of a wider theoretical view of business
management and its role in the economy. He also shared with the German authors the basic assumption of the
continuity of business. Replacement value according to Limperg was concerned with the minimum cost of
64

replacing the factor service, not the replacement cost of the actual factor used in production. However, his
theory is a "normative theory of value; it is microeconomic - oriented although it claimed to be
macroeconomic based". (Burgert, 1972 p114)
The main difference, between Schmidt's and Limperg's views is in the concept of value. Schmidt adopted the
replacement cost concept, while Limperg adopted the replacement value concept, that is, the latter was
concerned with the minimum cost of replacing the factor service, not the replacement cost of the actual factor
used in production.
In 1936, Henry W. Sweeney regenerated interest in inflation accounting through publication of his doctoral
thesis and he is often considered as the father of price level accounting in the USA. His work reflected his
studies of accounting reports in Germany where his thinking was influenced by the works of Schmalenbach
(who preferred the CPP method) and Schmidt (who advocated the CCA method).
His proposal, stabilised accounting, represented a hybrid form of price level accounting and combined the
teachings of Schmalenbach and Schmidt. He looked at the problem of general inflation as being best dealt with
by the application of a general index adjustment to both the balance sheet and the income statement. He
believed that capital, to be maintained intact, must be measured in terms of real command over goods and
services in general, rather than in terms of the specific assets owned by the firm, as advocated by Schmidt or
Limperg. (Sweeney, 1937 p.198)
Sweeney was not alone in advocating an explicit accounting recognition of general price movements.
Coughenour, R.J., made his first contribution to price level literature in June 1935, and wrote another article in
September 1935 which preferred the adjustment of historical cost to current value. He presented a
comprehensive numerical illustration which demonstrated how adjusted figures would depart vastly from
conventional measurements. (Coughenour, 1935, pp.171-97)
By the beginning of the 2nd World War, Germany and France had provided the basic work on the CPP
method, while the Germans and Dutch had provided the CCA method. Sweeney had developed the concept of
CPP in English speaking countries, and had suggested combining current values of assets, specific prices and
general indices. After the 2nd World War there were two periods of rapid inflation in the UK: the first
occurred during 1951 and 1952; the inflation rate increased from 2.8% to 9.1% and 6% for the years 1950,
1951 and 1952 respectively; the second began in the late 1960s, and accelerated until the end of 1977. In this
period, the first debate about inflation accounting began. A number of exposure drafts and statements for
debate were issued. However, the first issue of an accounting standard on the subject was in the UK in 1974.
Later in the same year, CPP proposals were issued in the USA, and by the Canadian and Australian
professional bodies. In 1975 a current purchasing power exposure draft was published in New Zealand and a
discussion paper for South Africa came in the same year. There were also important CPP method
developments in Brazil and Chile in 1974.
3.3 INFLATION ACCOUNTING AND INDIAN ECONOMIC DEVELOPMENT
At present, Indias corporate accounting is mainly based on historical cost, with corresponding accounting
requirements on assets, liabilities, equity, costs, expenses, income and other accounting elements. However, in
the case of inflation, due to increased money supply, real purchasing power declines. If we follow traditional
assumption of unchanged currency and historical cost principle of accounting, it will inevitably lead to
distortion, resulting in a series of negative effects. Therefore, it is an economic necessity to actively promote
inflation accounting, which is the premise to ensure the accuracy, relevance and usefulness of accounting
information.
Improving the stability of accounting units: The traditional assumption of unchanged currency and historical
cost accounting model neither consider changes in monetary value nor price changes for measured production
factors. Therefore it cant reflect the information of price changes. In the case of continuous inflation, the use
of this accounting model will lead to the following serious problems. What the historical cost accounting uses
is named currency unit. In the case of price change, the result must be lack of economic practical significance.
When price rises, the historical cost of assets may be much lower than the market price of prepared statement,
which is difficult to reflect assets, especially the real value of fixed assets. Monetary depreciation of assets will
65

cause loss of purchasing power to some degree; the real value of assets held is undervalued, and equity is
underestimated in the whole. So it seriously affects the accuracy of financial statement, greatly reduces the
usefulness of accounting information, and even affects the benefits of the company, investors and creditors.
Properly compensates the cost of production factors and maintains reproduction capacity: For historical cost
accounting, within foreseeable period, on accounting an enterprise will not recognize and reflect unrealized
gains or losses of fixed assets because of price up and down, i.e. the enterprise will neither enjoy the benefits
of price change nor suffer the losses of that. In the case of inflation, the income of traditional accounting is the
real income of current period. But most of consumed assets among the matching cost were pre-purchased,
which has been calculated on historical cost. In an inflation environment, with rising price, income and
expenses lose the ratio based on the same price calculation, resulting in higher real income than the cost of
inputs. Therefore, it inevitably results in inadequate cost compensation, threatens the scale of corporate
reproduction, causes vicious circle, increases business risks, and is difficult to maintain simple reproduction.
Correctly calculates corporate profit and loss: If assets are calculated on historical cost, the costs in each
period should be determined by the historical cost of consumed assets. In the case of inflation, the income that
an enterprise gains is reflected by prevailing money purchase power, however, the matching costs and
expenses mostly reflected previous money purchase power at low price. So the overestimation of gains and
underestimation of cost must lead to inflated profits, and the profits derived from business cant accurately
reflect current corporate performance. Therefore, the reflected business performance and corporate gain power
are distorted. Under the inflation environment, the accounting information provided by traditional financial
accounting statement is seriously false.
Ensures the comparability of accounting information between enterprises: The principle of comparability
requires not only the accounting indicators approach between enterprises be the same, i.e. comparable, but
comparable in different accounting period. Because of inflation, the previous financial statements can be
directly compared with current ones on values. But the statements users had better compare them on real
volume, which often leads to conscious adjustment equivalent on price change level. Therefore, the accounting
information provided by traditional historical cost accounting often does not meet the reality, whose relevance,
comparability and adaptability are poor. In the case of high inflation rate, if we still base on the principle of
historical cost and assumption of stable currency accounting and make accounting statements, but not
correspondingly adjust and deal with it, the comparability of accounting information will not be that reliable.
Improves corporate decision-making ability on investment: False accounting information causes corporate
management and investors to make bad business decisions and investment decisions. Thus, it is difficult to
make a correct assessment on business performance according to false accounting information. Even the bad
decisions bring big mistakes to an enterprise, so it is hard to achieve the ultimate goal of the enterprise. When
price rises, the non-discounted investment decision-making method is clearly no longer desirable. And the
discount methods are more difficult due to the influence of inflation.
Meanwhile, inflation easily leads to the rapid rise in capital flowing to the products or industries with faster
price rise. If it is lack of necessary macro-control and restraint, it may result in unreasonable allocation of
social resources and waste. Under the condition of inflation, traditional accounting model is has been difficult
to accurately describe the real performance of the enterprise, therefore, it is imperative to seek measures to deal
with inflation accounting and make accounting information accurately express business performance.
Meets the international practice: Many countries have adopted different inflation accounting treatments: to
weaken the impact of inflation. In addition, relevant international accounting organizations have also issued a
number of provisions. As a member of WTO, India plays an increasingly important role in international trade,
whose foreign accounting information attracts more attention from international community. So it is of
practical significance to implement inflation accounting in India, which is the need for India to meet
international practice and integrate with foreign accounting systems. We shall suggest establishing the inflation
accounting model with Chinese characteristics and propose countermeasures to effectively eliminate the
influence of inflation on accounting, through the comparison of inflation between India and other countries,
analysis on the reasons of the differences, referring to international accepted inflation accounting model, and
combining with Indias national conditions.
66

3.4 METHODS OF ACCOUNTING FOR INFLATION
The following are the generally accepted methods of accounting for price level changes:
Current Purchasing Power Method/General Purchasing Power Method (CPP/GPP Method).
Current Cost Accounting Method (CCA Method).
Hybrid Method, i.e., a mixture of CPP and CCA methods.
3.4.1 Current Purchasing Power Method (CPP Method)
The method of current purchasing power was evolved by the Institute of Chartered Accountants of England
and Wales. According to this method, all items in the financial statements are to be restated for changes in the
general price level. For this purpose, any approved price index is used to convert the various items of the
balance sheet and the profit and loss account. For example, an asset purchased for a sum of Rs 200 in 1970
would be valued in 1990 according to CPP Method at the amount which would be needed to buy the asset as
per change in the general price index in 1990 as compared to 1970. Presuming that general price index was
ISO in 1970 and 300 in 1990, the asset would be valued at Rs.400 (i.e., 200 x 300/150) as per CPP Method.
This is because the current purchasing power of a sum of Rs 200 spent in 1970 is equivalent to Rs 400 in 1990.
It should be noted that under the CPP Method, only the changes in general purchasing power of money are
taken into account. It does not consider the changes in the value of individual assets. For example, a particular
machine may have become cheaper over the last few years, whereas the general price index may have risen. In
such a case, the value of the machine will also be raised in accordance with the general price index.
Preparation of the financial statements according to CPP Method
The following steps are taken in preparing the financial statements.
(i) Conversion factor: CPP Method requires the restatement of historical figures as disclosed in the financial
statement at current purchasing prices. This is done by multiplying the historical figures by the conversion
factor calculated as follows:

The retail price index is considered to be the appropriate price index under CPP Method. In case one desires to
know only the difference between existing value and the converted value of an item it can directly be known
by applying the following
Formula:
Difference = Existing value (conversion factor - 1)
(ii) Mid-period conversion: In case of transactions occurring throughout a period, it will be advisable to
convert them according to the average index of the period. Such transactions generally include revenue items
such as sales and purchases of goods, payment of expenses, etc. In case the information regarding average
index is not available, it may be calculated by taking the average of the index numbers at the beginning and at
the end of the period.
(iii) Monetary and non-monetary items: While converting the figures under CPP Method, a distinction is to be
made between monetary items and non-monetary items.
Monetary items are those whose amounts are fixed by contract in terms of monetary units (rupees, dollars,
pounds, etc.) regardless of changes in the general price level. Examples of monetary items are cash, debtors,
creditors, loan capital, outstanding expenses, etc. Holders of monetary assets lose general purchasing power
during a period of inflation, since their claims against the firm remain fixed irrespective of any change in the
general price level. The converse applies to those having monetary liabilities. For example, a person lends to a
firm a sum of Rs. 1,000 on 1st Jan. 1990, payable on 31st December, 1990. The price index on 1.1.90 is Rs.
100 while it is Rs. 150 on 31st December, 1990. On account of increase in the price level if the creditor is to be
compensated for loss in purchasing power, he should be paid a sum of Rs. 1,500 (i.e., 1,000 15/100). However,
67

he will be paid as per contract a sum of Rs. 1,000. Thus, the debtor (i.e., the firm) is gaining Rs. 500 while the
creditor (i.e., the lender) is losing a sum of Rs. 500.
Monetary items need no conversion since they are already stated in current rupees (dollars or pounds) at the
end of the period to which the accounts relate.
Non-monetary items: These are the items that cannot be stated in fixed monetary amounts. They include
tangible items such as buildings, machinery, inventories of materials of finished goods meant for slae. For
example, a building costing Rs. 15,000 in 1976 may sell for Rs. 35,000 today though it has been used and may
also be of old fashion. This may largely be due to change in the general price level.
Thus, non-monetary items do not carry a fixed value like monetary items. Hence, under CPP method, all such
items are to be restated current general purchasing power.
Investments in bonds or debentures have the characteristics of fixed monetary claims and, therefore, they come
in the category of monetary items. Preference shareholders also generally have a right to get only the fixed
amount of their share capital and, therefore, they also fall in the category of monetary items. However, the
holders of the equity share capital have the residual claim on a companys net assets. The equity interest is,
therefore, a non-monetary item.
(iv)Gain or loss on monetary items: It has already been stated above that change in the purchasing power of
money affects both monetary as well as non-monetary items. Of course in case of monetary items, the firm
receives or pays amount fixed as per terms of the contract but it does gain or lose in terms of real purchasing
power. Such gain or loss, termed as .general price level gain or loss., should be taken into account under the
CPP method but it should be shown as a separate item in the restated income statement to arrive at the overall
profit or loss. This is particularly important in case of gain since the amount may not be available for
distribution by way of dividend on account of inadequate liquidity.
(v) Cost of Sales and Inventories: The cost of sales and value of inventories depend upon the cost flow
assumptions, i.e., first in, first out (FIFO) or last in, first out (LIFO). According to the first in, first out method,
inventories first purchased are taken to be first issued to production or sold to customers; while according to
last in, first out method inventories purchased in the last are taken to have been first issued to production or
sold to customers. While restating the figures under CPP Method, it would be appropriate to keep in mind the
cost flow assumptions, since they affect both the cost of sales and closing inventory as shown below:
First in First Out (FI FO) Method
Cost of Sales: It comprises entire opening stock and current purchases less closing stock.
Closing Inventory: It comprises entirely current purchases. However, in case total sales are even
less than the opening inventory, a part of the opening inventory may also become a part of the
closing inventory.
Last I n First Out (LIFO) Method
Cost of Sales: It comprises current purchase only. However, if the current purchases are less than
cost of sales, a part of the opening inventory may also become a part of cost of sales.
Closing Stock: It comprises purchases made in the previous year or years.
The following indices are used under CPP Method for restating the historical figures:
For current purchases: Average index of the year.
For opening stock: Index at the beginning of the year.
For purchases of the previous year(s): Average indices for the relevant year(s).
Determination of Profit
The profit under CPP Method can be determined in two ways:
Net change method
This method is based on the normal accounting principle that profit is the change in equity during an
accounting period. In order to determine this change the following steps are taken:
68

(a) Opening balance sheet prepared under historical cost accounting method is converted into CPP terms
as at the end of the year. This is done by application of proper conversion factors to both monetary as
well as non-monetary items. Equity share capital is also converted. The difference in the balance sheet
is taken as reserves. Alternatively, the equity share capital may not be converted and the difference in
balance sheet be taken as equity.
(b) Closing balance sheet prepared under historical cost accounting is also converted. Of course, monetary
items are not restated, as explained earlier. The difference between the two sides of the balance sheet
is put as Reserves after converting the equity capital. Alternatively, the equity capital may not be
restated in CPP terms and the balance be taken as equity.
(c) Profit is equivalent to net change in Reserves (where equity capital has also been converted) and net
change in Equity (where equity capital has not been restated).
Conversion or restatement of income statement method
In case of this method, the income statement prepared on historical cost basis is restated in CPP terms
generally on the following basis:
(a) Sales and operating expenses are converted at the average rate applicable for the year.
(b) Cost of sales is converted as per cost flow assumption (FIFO or LIFO) as explained in the preceding
pages.
(c) Fixed assets are converted on the basis of the indices prevailing on the dates they were purchases. The
same applies to depreciation,
(d) Taxes and dividends paid are converted on the basis of indices that were prevalent on the dates they
were paid.
(e) Gain or loss on account of monetary items should be calculated and stated separately in Restated
Income Statement to arrive at the overall figure of profit or loss.
Criticism of the CPP Method
The Current Purchasing Power Method contained in SSAP-7 did not find favour with a large number of
accountants, economists, and Government authorities on account of the following reasons:
(a) CPP Method is based on Index Nos. which are statistical averages. The method cannot, therefore, be
applied with precision to individual firms.
(b) The selection of a suitable price index is a difficult task, since there are various price indices
characterising different price situations.
(c) The method deals with changes in the general price level and not with changes in prices of individual
items, except in so far as individual prices happened to move in step with general price index.
3.4.2 Current Cost Accounting Method
In view of the general complaint that CPP method is not adequate for reporting price level changes, the U.K.
Government appointed a committee under the chairmanship of Sir Francis Sandilands. The report of the
committee was published in September, 1975 and SSAP-7 was withdrawn. In its report, the committee
recommended the adoption of Current Cost Accounting System as a method for correcting the deficiencies of
the historical cost accounting which fails to provide sufficient information as required by the users of accounts.
The current cost accounting system has been extensively studied and debated. It has now been finalised by the
issue of Statement of Standard Accounting Practice-16 (SSAP-16) in March, 1980, by the Accounting
Committee of U.K.
Main Features
The main features of the CCA method are as follows:
Meaning:
The method requires each item of financial statements to be restated in terms of the current value of the item.
No cognizance is taken of changes in the general purchasing power of money. Assets are shown in terms of
what such assets would currently cost.
69

Similarly, the profits are computed on the basis of what the cost would have been at the date of sale rather than
the actual amount paid. For example, if goods purchased for Rs.8 are worth Rs 10 on the date of sale are sold
for Rs 12, profit will be taken as Rs 2 (and not as Rs 4) based on their current cost.
Objectives
The method seeks to ensure that adequate provision/adjustments are made for the maintenance and
replacement of the operating assets of the company, at least at the minimum physical levels at which the
enterprise can operate efficiently and not only for the year under the review but also for the future. The
operating assets of an enterprise comprise (a) the fixed assets, (b) the stock-in-trade (of raw materials and
finished goods), and (c) the net monetary working capital (that is, the amount of its debtors less the amount of
its creditors). Under the historical basis of accounting these assets are shown at their depreciated original cost
under the current cost accounting system, whereas, these are shown at their current cost or value which may be
higher or lower than the former. This provides a more realistic statement of the present value of the assets
employed in the business and thus enable a more meaningful assessment to be made of the real profit earned
on the real value of such assets.
In order to achieve the objectives stated above, the following adjustments/provisions are usually made.
Revaluation Adjustment: The fixed assets are shown at their Value to the business and not at their depreciated
original cost. Value to the business means the amount which the company would lose, if it were deprived of
the assets. It may be defined in any one of the following ways;
(a) Net current replacement value: This refers to the money now required to buy a new asset of the same type
as an existing one less an amount of depreciation that recognises the fact that the true replacement of the
asset would not be a new asset but an asset which has the same remaining useful life as the existing asset.
For example, a machine whose total life is 10 years and which has already run for five years can now be
purchased as a new piece for Rs 60,000. Assuming that the machine has no scrap value, the net
replacement cost of the machine would be Rs 60,000 less depreciation for 5 years, i.e., Rs 30,000.
(b) Net realisable value: This is the value which is represented by the net cash proceeds if the existing asset is
sold now.
(c) Economic/Recoverable Value: This refers to the present value of net income that will be earned for using
the existing assets during the rest of its life. For example a machine purchased 10 years ago for Rs 50,000
has a book value of Rs 25,000 after being used for 5 years. The machine is expected to generate a net cash
inflow of Rs 6,000 each year for the remaining period of its life of 5 years, i.e., Rs 30,000 in total.
However, the sum (Rs. 30,000) will accrue over the next 5 years and not immediately. Hence, it should be
discounted at a proper rate and the present value of the future cash inflows should be ascertained.
Out of the three values discussed above, SSAP-16 recommends the use of net current replacement value. Such
value should generally be determined on the basis of price indices for the various fixed assets. For this purpose
even different types of production equipments are also being treated as different assets. However, in case the
economic/recoverable value of fixed assets is less than its replacement value, it should be valued on the former
basis. The difference between the values of fixed assets under Current Cost Accounting System and Historical
Cost Accounting System is transferred to a capital reserve styled as Current Cost Accounting Reserve.
Evaluation of CCA System
CCA System, on the whole, has been found to be satisfactory by accountants all over the world. It measures
the real profit or loss for the relevant accounting year by taking due care of the inflationary factors. The system
also works well if the prices fall. The CCA technique can also be built into book-keeping system which is not
possible in case of CPP technique. Financial statements can, therefore, be prepared under CCA method on
regular basis. It also provides for accumulating sufficient funds for replacing of assets by charging depreciation
on current values. It may, therefore, be said that CCA is a good system for recording price-level changes.
However, the CCA system does not fully solve the problem of price-level changes on account of the following
reasons:
a) It does not provide adequately for backlog depreciation: The CCA system takes due care of the current
years depreciation but fails to provide adequately for backlog depreciation. As already explained, the
70

backlog depreciation is provided under this system by charging against the current cost accounting
reserve, which is a capital reserve. It will be appropriate to charge such depreciation against revenue
reserve available for dividend. If this is done, the management can be restrained from disposing of profits
which are really required for replacement of assets.
b) Fails to provide funds for replacement of new types of assets: Depreciation under CCA system is provided
on the basis of the current value of the existing assets. Thus, the funds accumulated by way of such
depreciation will possibly be sufficient for replacement of the present type of assets. They may not be
adequate for replacement of assets which are of a new type and which may be required because of the
companys desire to diversify.
c) Inadequate gearing adjustment: No gearing adjustment is done under the CCA method in respect of value
of fixed assets and inventories. These assets are also partly financed by loans. It, therefore, seems to be
improper not to subject these assets to gearing adjustments.
d) Materiality Factor: Materiality factor is a basic accounting principle and, therefore, CCA technique is also
no exception to this. This means that a firm should not be required to make a particular adjustment as
required under CCA method if it feels that it is rather insignificant. The implication of this suggestion is
that each firm should decide for itself whether any of the adjustments required under CCA can be ignored.
For example, a firm; like oxygen company, which does not use much material, should be permitted to
ignore cost of sales adjustments (COSA).
e) Subjectivity element: There is too much of subjectivity element in CCA method. For example, the
valuation process is subject to the discretion and the personal judgment of the managers and there is no
single method of valuation. Sandilands Committee also observed,
the process of valuation is inevitably more subjective than the ascertainment of historical
cost, in that not only the value placed on as asset, but even the choice of the basis of
valuation, is more dependent on the judgment of the valuer than the ascertainment of cost,
and less susceptible to verification by reference to independent factual evidence.
However, it should be admitted that there can be no logical comparison between HCA method and CCA
method. In case such comparison is desired, it should be with other available accounting techniques for price
level changes. CCA method gives better results than all such other techniques.
f) Ignores gains or losses on monetary items
CCA method ignores purchasing power gains and losses on the monetary items of the firm. Such gains and
losses are in the nature of cost of holding monetary assets and liabilities during a period of changing price
levels. They are of immense importance to companies whose assets and liabilities are mostly monetary in
nature. Such companies would gain or lose in terms of purchasing power very heavily on the monetary
balances in periods of changing price levels.
g) Variations in Accounting Methods: The CCA method is based on this presumption that firms use uniform
accounting methods and practices. It also assumes that firms maintain plant registers on uniform basis.
However, this is not true in actual practice. The accounting methods and practices, maintaining of plant
registers differ from firm to firm. Moreover, in many cases, the plant registers are either incomplete or fail
to provide adequate information required for valuation purposes.
On account of the above limitations of the CCA system, many accountants have begun doubting the capacity
of the system to depict the true financial position of business during periods of changing price levels. The
following remark of Professor Baxter correctly explains the dilemma faced by the accountants, because of
inflation the old pattern must change abruptly. Accountants have been ordered to take a great leap forward.
They are being pressed to bring in a big reform for which their tradition and training fit them poorly. They are
to choose between strange concepts and leam novel techniques. For comparability, they must squeeze the same
reform on to all types of businesses. They are being exhorted to hurry, yet they know that a false move will do
much harm to business, to investors and to their own profession. Small wonder they are rattled and rebellious.

71

3.4.3 Hybrid Method
Recently some authorities have suggested another method which is essentially a compromise formula between
CPP method and CCA method. According to this method the adjustments of fixed assets and inventories are to
be made with reference to specific indices in place of a general index as is the case under CPP method.
Besides this, purchasing power gains and losses in respect of monetary items are also considered which are
ignored under CCA method.
Advocates of this method argue that by combining these two methods, the advantages of both can be obtained.
The method, on the face, appears to be a satisfactory compromise formula but its acceptance may prove
difficult because of theoretical objections against such a compromise. Moreover, the method is also subject to
the limitations of both CCA and CCP methods.
The method is still in its evolutionary stage and suggestions varying in nature and implications would continue
to be made in the coming years. It will take a long time before a set of well defined procedures and guidelines
is developed. The method cannot, therefore, be recommended for practical application at the present moment.
3.5 PRESENTATION OF PRICE LEVEL ADJUSTED ACCOUNTS
There is no consensus as regards the presentation of financial information reflecting price level changes. Some
advocate the preparation of the primary financial statements after giving due effect to the price level changes,
while others suggest preparation of financial statements on Historical Cost Basis and reflecting the effects of
price level changes only by means of supplementary statements. The International Accounting Standards
Committee has recommended the furnishing of information regarding price level changes on a supplementary
basis unless the primary financial statements present information, reflecting changes in price levels. The
committee has further observed that such enterprises as are not required to and do not present information
reflecting the effects of the changing prices either in their primary financial statements or on a supplementary
basis should disclose this fact. In most countries since accounts adjusted as per price level changes are not
acceptable to tax authorities, the accounts are generally prepared on Historical Cost Basis and information
regarding effects of price level changes are given by means of supplementary financial statements. SSAP-16
issued by the Institute of Chartered Accountants in England and Wales also provides for current cost
information to be included in annual financial statements in addition to historical cost information.
3.6 USA AND INFLATION ACCOUNTING
The Financial Accounting Standards Board was established in U.S.A. in 1972. The FSAB has issued a number
of statements of accounting standards dealing primarily with specific problems. In October 1979, it issued a
statement No.33 entitled Financial Reporting and Changing Prices, popularly known as Financial
Accounting Standard 33 (FAS-33). The standard requires companies to compute inflationary effect on profits
in two different ways: (i) constant dollar method, and (ii) current cost accounting method.
The first method adjusts inventory costs and depreciation for changes in the consumer price index since the
related assets were purchased. The second method adjusts these key items for price changes of specific assets
that a company usually holds. However, this information has to be given only as supplementary information.
At the time of issue of FAS: 33 it was mentioned that the FASB will undertake a comprehensive review of this
statement not later than five years after its publication. Consequently the Board issued an Exposure Draft in
December 1984, which relates to current cost/constant purchasing power disclosure together with all
pronouncements relating to FAS-33 made from time to time.
However in October 1985, the FASB at its meeting decided that the present changing price disclosures required
by FAS-33 should be retained for the time being and the Exposure Draft issued in December 1984, as referred
above, will not be issued as a final statement.
3.7 INDIA AND INFLATION ACCOUNTING
The subject of inflation accounting has attracted very scant attention of the industry, accounting bodies and
researchers in India. One reason, probably, is that accountancy profession in our country follows the British
and US developments, that too very late. It is interesting and revealing to note here that England and USA had
inflation within the range of 9-10% to 4-5% (barring aberrations during a few years) only during 70s and mid
72

80s. When the subject witnessed a fierce and extensive debate, research and professional pronouncements over
there and despite comparatively higher inflation rates during this period India did not witness any worthwhile
activity on the subject. The academicians and the industry have, however, off-late kept a silent in England and
USA, though the accounting bodies of these countries still encourage the disclosure of inflation adjusted
financial statements on a unitary basis, because the rate of inflation in these two countries is now insignificant
(USA 1 .6% - December 98, UK 2.8% - December 98, CPI, as per Express Investment Week, 22.2.99) which
explains the dying down of interest in the subject over there. In our country, however, the situation is different.
Inflation accounting is, therefore, totally relevant in our country in the current economic scenario and there can
be no two opinions that we have to go a long way to bring down the inflation to the level of England and USA.
Most economists feel that the rate of inflation is not going to stabilize at declined levels in India in the near
future, as in India inflation is very high from last two decade. It is also to be noted that internationally,
particularly at the level of IASC and in England, despite the low rates of inflation the thinking has moved
towards revaluation of fixed assets to reflect their current prices and charging to the profit and loss account the
depreciation on the revalued figures.
The Institute of Chartered Accountants of India (ICAI) realized the importance of the subject of
Inflation Accounting very late. It was only in February 1982, that it issued a discussion paper Treatment of
Changing Prices in Financial statements to generate discussion and to create awareness about the subject. The
main aim of the paper was to examine how and to what extent the techniques of Inflation Accounting
designed in western countries are applicable to the Indian situation. The paper discussed the different
approaches to Inflation Accounting based on SSAP-7 (ACPP), SSAP-16 (CCA) and Periodical Revaluation
of Fixed Assets and then raised a few issues for discussion such as the choice of the method, selection of the
general and specific indices, status of the information reflecting the price changes, the need for reforms in tax
laws, social implications of Inflation Accounting and above all, possible improvement in the two methods-
ACPP & CCA. In December 1982, the ICAI issued a guidance note Accounting for changing Prices.
The most relevant aspects of the Guidance Note are as follows:
(i) The adoption of a system of accounting for changing prices would require a considerable amount of time,
money and specialised skills. Also the various techniques are still in the process of development. However, in
view of the importance of the subject, it is recommended that enterprises, particularly the large enterprises,
may develop the necessary systems to prepare and present this information.
(ii) Out of the various methods of accounting for changing prices, the Current Cost Accounting Method seems
to be most appropriate in the context of the economic environment in India. The periodic revaluations of fixed
assets and the adoption of LIFO formula for inventory valuation are partial responses to the problem of
accounting for changing prices. Current Purchasing Power Accounting, though simple to apply, does not
ensure the maintenance of the operating capability of an enterprise. Current cost accounting, on the other hand,
is a rational and comprehensive system of accounting for changing prices, as it considers the specific effects of
prices on individual enterprises and thus ensures that profits are reported only after maintaining the operating
capability. However, the introduction of a full-fledged system of Current Cost Accounting on a wider scale in
India will inevitably take some time. During this transitional phase, periodic revaluations of fixed assets along
with the adoption of LIFO formula for inventory valuation would reflect the impact of changing prices
substantially in the case of manufacturing and trading enterprises.
(iii) Adequate data base has presently not been developed in India for accounting for changing prices. Every
enterprise, therefore, may have to select the price indices depending on its own circumstances. The detailed
price indices published in its monthly bulletins by the Government of India can be adopted in a number of
cases. There is no doubt that further steps will have to be taken for the timely publication of statistical
information required by various industries for the implementation of accounting for changing prices.
(iv) Considering the importance of the information regarding the impact of changing prices it is recommended
that while the primary financial statements should continue to be prepared and presented on the historical cost
basis, supplementary information reflecting the effects of changing prices may also be provided in the financial
statements on a voluntary basis, at least by large enterprises.
73

Since the presentation of statements adjusted for the impact of changing prices is voluntary, the enterprises
may or may not get this information audited. However, the audit of such statements would enhance their
credibility.
(v) Apart from its utility in external reporting, accounting for changing prices may also provide useful
information for internal management purposes. Accounting information system is designed primarily to
provide relevant information to various levels of management with a view to assist in managerial decision
making, control and evaluation. However, in periods of rapid and violent fluctuations in prices, the information
provided by historical cost-based accounting system may need to be supplemented by information regarding
the impact of changing prices. The areas in which such information may be of prime importance to
management include investment decisions and allocation of resources, divisional and overall corporate
performance evaluation, pricing policy, dividend policy, etc.
(vi) In countries like the United Kingdom, there have been some reforms in the tax structure in the wake of
introduction of accounting for changing prices. Though, the tax legislation in India at present does not give
recognition to such an accounting system, even then accounting for changing prices, would be useful for
generating relevant information for internal and external decision making.
There is no denying the fact that inflation has come to stay. It is, therefore, the responsibility of the business as
well as the government and professional bodies to take the bold step of making a positive recommendation
regarding providing the shareholders and other concerned with reliable information disclosing the way
inflation really hits the profits. The system recommended should be simple, suitable to Indian conditions and
duly recognised by the government.

74

Industrial Development and Manufacturing Sector in India

4.1 INTRODUCTION
Manufacturing sector is the backbone of any economy. It fuels growth, productivity, employment, and
strengthens agriculture and service sectors. Astronomical growth in worldwide distribution systems and IT,
coupled with opening of trade barriers, has led to stupendous growth of global manufacturing networks,
designed to take advantage of low-waged yet efficient work force of India. Manufacturing sector in India has
gone through various phases of development over the period of time. Since independence in 1947, it has
traveled from the initial phase of building the industrial foundation in 1950s and early 1960s, to the license-
permit Raj in the period of 1965-1980, to a phase of liberalization of 1990s, emerging into the current phase
of global competitiveness. It has grown at a robust rate over the past ten years and has been one of the best
performing manufacturing economy. Manufacturing sector contributes about 15per cent of Indias GDP and 50
per cent to the countrys exports. Moreover, it employed 58 million people (about 12 per cent of the
workforce) in 2008 and it is estimated, based on current economic projections, that this sector will employ a
further 12-13 million out of nearly 89 million additional people who will enter the workforce by 2012. Studies
have estimated that every job created in manufacturing has a multiplier effect, creating 2-3 jobs in the services
sector. In a country like India, where employment generation is one of the key policy issues, this makes
manufacturing sector a critical sector to achieve inclusiveness in growth.
4.2 INDUSTRIAL DEVELOPMENT IN INDIA DURING PLAN PERIODS
Overview of the Industrial Policy
India started her quest for industrial development after independence in 1947. In 1948-49, the industrial
backwardness of Indian economy was evident as only 6.6per cent of the national income was earned by
Factory Establishments, employing just 1.8 per cent (about 2-4 million) of the total of the working population
of the country. The Industrial Policy Resolution of 1948 marked the beginning of the evolution of the Indian
Industrial Policy. The Resolution not only defined the broad contours of the policy; it delineated the role of the
State in industrial development both as an entrepreneur and as an authority. Successive policy resolutions also
reiterated this basic tilt in favour of the public sector. The Industrial Policy Resolution of 1956 gave the public
sector a strategic role in the economy. It categorised industries, which would be the exclusive responsibility of
the State or would progressively come under State control and others. Earmarking the pre-eminent position of
the public sector, it envisaged private sector coexisting with the State and thus attempted to give the policy
framework flexibility.
Since then, the industrial development in the country, in terms of industrial policy and the framework has seen
many changes befitting the growing globalization and liberalization of the economy. Besides, industry being in
Concurrent List of the Constitution, a simultaneous effort is also made in this direction by the respective State
Government. The industrial policy has been deeply embedded into the Five Year Plan (FYP) framework for
the industrial development.
India s strategy for industrial development witnessed a paradigm shift in 1991. Industrial development until
then was largely based on product market regulations, with capacity licensing being its principal instrument.
Though this strategy had successfully created an industrial base, it had encouraged rent seeking to a
considerable extent. There were limited incentives for product innovation and for a competitive push.
Economic reforms initiated in 1991 gradually removed these product market licenses. The new industrial
development strategy, therefore, envisaged a significantly bigger role for private initiatives.
First Five Year Plan (1951-56)
Chapter
4
75

Lewis economic growth framework guided First Five Year Plan, where an economy transforms gradually from
a low productivity sector (i.e. Agriculture) to a relatively high productivity sector (i.e. industry). The first Five
Year Plan (FYP) recognized the linkages between Industry and Agriculture sectors. Agriculture could serve
industry in terms of sharing its surplus labour force, producing raw material and consuming a part of industrial
production. On the other hand the higher productivity in Industry had the potential to generate relatively more
savings than Agriculture, which could be further invested.
As per index of industrial production, the progress of industry during the first five year plan could be counted
as satisfactory, though; it did not achieve the requisite objectives, priorities and levels of capacity and
production which had been envisaged for different industries when the plan was drawn up.
Second Five Year Plan (1956-61)
The first plan period was used as a preparatory work for studying a wide range of problems relating to markets,
availability of raw materials and fuels, choice of processes, costs of production and the building up at different
levels of the technical and managerial experience required for running undertakings, to give a big push for
large-scale industrial development especially heavy industries. This could not be possible without foreign
technical assistance for the development of a number of industrial big projects.
The Industrial Policy, 1948 was revised as Industrial Policy, 1956 and gave the States greater responsibility for
development of industries. The new policy was to speed up industrialization and, in particular, to develop
heavy industries and machine making industries, to expand the public sector, and to build up a large and
growing co-operative sector.
The industries that got priority were iron and steel, heavy chemicals, including nitrogenous fertilizers, and
heavy engineering and machine building industries. Besides, the capacity expansion was envisaged in
developmental commodities and producer goods such as aluminum, cement, chemical pulp, dyestuffs and
phosphoric fertilizers, and essential drugs. In addition priority was given modernization and re-equipment jute
and cotton textiles and sugar.
The first two Plans could be considered as a turning point in industrial development in India because of its
thrust for building a strong industrial base along with diversification of industry. Besides completing three new
steel works, each of one million tons capacity in the public sector and two existing steel works in the private
sector, the foundation was also laid down for heavy electrical and heavy machine tools industries, heavy
machine building and other branches of heavy engineering, and the production of machinery for the cement
and paper industries.
Third five Year Plan (1961-66)
The third plan s thrust was to lay the foundation for further rapid industrialization over the next 15 years with
focus on basic capital, and producer goods industries and special emphasis on machine building programme
accompanied by acquisition of related skills, technical know-how and designing capacity. Besides, the focus
was on to increase production of major basic raw materials and producer goods like aluminium, mineral oils,
dissolving pulp, basic organic and inorganic chemicals and intermediates inclusive of products of
petrochemical origin.
Fourth Five year Plan (1969-74)
Industrial progress had been uneven during Third Plan and the subsequent Annual Plans mainly due to low
rates of growth in textiles and food industries, metals and machinery industries. The hostilities in 1965 and the
two successive droughts, shortage of raw materials and components arising from the pause in external aid in
1965 were responsible for the distortions in business environment. The two year agricultural drought caused a
considerable decline in savings, investments and purchasing power, along with shortage of raw material for
agro-based industries. The deficiency of demand in the wake of agriculture drought, especially at the time
when a substantial capacity in industries had been added, accentuated the problem of unutilized capacity in
many industries and more particularly in the capital goods industries.
Based on the review of the industrial performance during Third FYP, a modified approach for the industrial
development was strategized in the Fourth FYP with three objectives, one to achieve speedy self-reliance,
76

second, dispersed industrial development, and third, avoidance of technological un-employment among the
workers in traditional industries under the impact of unregulated spread of capital intensive modern technology
during the period of transition. In other words, the thrust was to correct imbalances in the industrial structure
and optimize the utilization of capacity already built.
A review of the licensing system was done to accelerate industrial development and improve administrative
efficiency. The Industrial Licensing Policy Inquiry Committee recommended that the licensing should be
confined to industries which come within the basic, strategic and critical sectors, for which detailed industry
plans should be prepared, and where the major inputs would have to be assured and the targets implemented.
Fifth Five Year plan (1974-79)
This plan period witnessed inflationary pressures build up and the worsened balance of payment position on
account of steep rise in the prices of imported oil and other materials. Food articles and industrial raw materials
accounted for about two-third of the price increase. 28. The industrial growth low fell to as low as 2.5per cent
during 1974-75 and 5.7per cent during 1975-76 especially in industries like passenger cars, consumer durables
and cotton textiles though the basic industries like steel, coal, cement, non-ferrous metals and power
generation fared better.
Efforts were made to decontrol licensing to revive industrial growth, whereby 21 industries including cotton
spinning, basic drugs and industrial machinery were delicensed, 29 selected industries including foreign and
MRTP companies were permitted to utilise their installed capacity without limit. Besides, to promote exports
of engineering goods, 15 engineering industries were allowed to set up units.
Sixth Five Year Plan (1980-85)
Industrial production during first thirty years 1950-1980, was reviewed and it was found that industrial
production had increased about five times, with a diversified industrial structure. The average growth rate has
been about 4 per cent per annum during 1970-71 to 1979-80. The major constraints identified includes
infrastructural requirements and other vital inputs (such as; power, transport, coal, cement), unremunerative
administered prices, disturbed industrial relations and to an extent inefficient management during this period.
The Industrial Policy Statement of July, 1980 emphasized on improving efficiency and productivity in the
industrial sector through optimum utilization of existing capacity. The technological improvements and labor
productivity become forefronts for capacity creation.
Seventh Five Year Plan (1985-90): Paradigm of change the advent of liberalization
The major issues faced by industry during the Sixth Plan included power shortage, prolonged labour unrest and
insufficient demand in the case of textiles, raw material shortage in the case of jute manufactures, scarcity of
coking coal in the case of steel and inadequate availability of the appropriate quality of steel in the case of a
number of steel using industries were assigned the major reasons.
The main strategy in the Seventh plan was on restructuring of industry by enabling shift from traditional
industries to basic metals, fertilisers and industrial manufactures with an increasing share for the emerging
technology intensive industries; efficient use of capital; improving infrastructural facilities: modernisation and
upgradation of technology and improving productivity. In order further boost the symbiotic and
complementary relationship between public and private sectors as visualized in the Industrial Policy
Resolution of 1956, public sector investments in infrastructure were expected to provide inputs and facilities as
well as markets for private manufacturing and encourage involvement of the private sector for the development
of 'sunrise' industries such as telecommunications, computers, microelectronics, ceramic composites and
biotechnology. It was also felt that the time had come to inject an element of competition within the public
sector and in certain cases with the private sector.
Eighth Five Year Plan (1992-97)
The major initiatives undertaken during the Seventh FYP enabled an annual industrial sector growth rate of
8.5per cent which was much higher than the 3.5per cent achieved during the Sixth Plan. The growth rate for
manufacturing sector was as high 8.9 per cent. 35. The factor that boosted the industrial growth during Seventh
77

FYP were significant improvements in the performance of the infrastructure viz., power, coal, etc., changes in
the area of licensing and procedures; import of technology; higher import of capital goods; better utilisation of
installed capacities; and allowing broad banding of products in a number of industries.
The liberalisation measures taken during Seventh FYP included raising the assets limit for exemption to
companies from the purview of MRTP Act; exempting 83 industries under the MRTP Act for entry of
dominant industries; grant of exemption from licensing for industrial units with an investment of upto Rs.50
crores in backward areas and Rs.15 crores in other areas on the basis of a negative list; and delicensing non-
MRTP, non-FERA companies for 31 industry groups and MRTP/FERA Companies in backward areas for 72
industry groups.
A series of reforms in the industrial, fiscal, trade and foreign investment policies set the path for globalization
to de-regulate and allow industry to adjust to the changes in internal as well as external environment and meet
the needs of a dynamic market, to optimize its operations and improve its competitiveness.
The new Industrial Policy of July 1991 further shifted the paradigm of industrial development by reducing the
role of public sector to 8 industries from earlier 29, concentrating on basic and core sectors which were
important strategy, security etc.. These reforms were expected to enhance competitiveness, by improving
comparative advantage, increase the scale of the companies, and allow greater integration of indigenous
production with outside. Joint ventures were allowed to exploit the complementarities of resource endowments
in this country and the concerned foreign country.
Ninth Five Year Plan (1997-2002)
The beginning of liberalization of policy measures started in 1985 continued during the Ninth five year Plan. A
review of the major reforms undertaken during the Eighth plan is given below.
a) Number of industries requiring industrial licenses reduced to 6 only 4 industries reserved for Public
sector
b) Foreign direct investment policy liberalized
c) Disinvestment Commission constituted for preparing an overall long term disinvestment programme
for PSEs referred to it and the modalities for disinvestment.
d) Sick Industrial Companies Act (SICA), 1985 amended to bring PSEs within the ambit of SICA,1985
and BIFR
e) National Renewal Fund set up to protect the interest of workers likely to be affected due to
restructuring or closure of industrial units
f) Growth Centres Scheme taken up to develop infrastructure in backward areas to promote
industrialization
g) To promote development of specific hilly, remote and inaccessible areas, Transport subsidy scheme
extended till March, 2000
h) Drugs Price Control Order amended to give freedom to private sector including fixation of drug
prices. Number of drugs under price control reduced from 143 to 72
i) New National Minerals Policy announced opening Mining industry to private sector including 50 per
cent foreign equity in 13 minerals
j) Technology Development Board set up to facilitate development of new technologies and assimilation
of imported technologies
The industrial growth was 7.3 per cent during the Eighth Plan period. The industrial growth doubled from 6.0
per cent in 1993-94 to 12.1 per cent in 1995-96 though it slumped to 7.1 in 1996-97.( one reason was the East
Asia crisis of 1997). The causes cited for lower growth during the Eighth FYP as compared to Seventh plan
included sudden exposure to foreign competition on account of liberalization of imports and a drastic reduction
in import duties. The downfall in capital goods sector was caused by reduction in tariffs for imports and
postponed investment plans by entrepreneurs expecting more concessions. There was also slowdown of public
investment to control the fiscal deficit. Private investment also slowed down drastically under the
underdeveloped capital market, high cost of borrowings, and imposition of Minimum Alternate Tax (MAT).
78

Inadequate & quality of infrastructure e.g. power and transportation bottlenecks, inadequate handling facilities
at ports increasing imports of basic materials and intermediate goods and components, second-hand machinery
due to anomalous tariff structure also affected industrial production.
The Ninth Plan emphasized on the quality of infrastructure, exports, review of SSI reservation for critical
export industries such as toys, garments and leather goods, labour legislation, disinvestment of PSEs, balances
in industrial development, investment in domestic R&D & linking of R&D with industry. Besides, the
simplification or streamlining of procedures at State Governments level, the Government also decided to
dismantle the administered price mechanism in respect of petroleum products in a phased manner.
Tenth Five Year Plan (2002-07)
The industrial growth during Ninth FYP was 4.5per cent while that for manufacturing; mining and electricity
generation were 5.3 per cent, 2.5 per cent and 5.5 per cent respectively. Internal factors cited for the slowdown
were slowdown in domestic and global demand continuing high real interest rates, infrastructure bottlenecks in
power and transport, lack of reforms in land and labour markets, decline in private investment and delays in
establishing appropriate institutional and regulatory frameworks in some key sectors. The terrorist attacks of
11 September 2001, also had adverse impact on air transport, communications and tourism..
The Tenth plan strategy was on providing conducive policy environment though labour, fiscal reforms and
streamlining of procedures, legal and procedural reforms, bankruptcy and foreclosure laws, world-class
infrastructure, clusters, augment resource base, stronger capital and institutional finance markets/Institutions,
attract higher level of FDI, optimize resource allocation , pricing policy, increased flows into high growth
areas, leverage resources through effective public-private, release of unproductive resources partnerships,
expeditious closure of non-revivable PSUs, expeditious divestment of non-strategic PSUs, improving
productivity and efficiency of transitional PSUs.
It recommended efficiency enhancing policies in the areas of innovations, technology upgradation,
modernization, R&D, skill upgradation, export thrust, assist States for updating export infrastructure, Special
Economic Zones , standardization, accreditation and certification, market access initiatives, making
products/processes/practices eco-friendly, level playing field, rationalization of taxes and duties, cost of
finance and credit availability, intellectual property rights regime, world class infrastructure, modernizing
patent offices, rationalization of Indirect Taxes etc..
Eleventh Five Year Plan (2007-12)
The dynamism in manufacturing during the Tenth plan increased its growth rate to 8.7per cent compared to
3.8per cent in the Ninth Five Year Plan. The CAGR recorded at 8per cent in the Tenth Five Year Plan
compared to 4.5per cent in the Ninth Five Year Plan. The improved demand in both domestic and external
markets was a major contributory factor along with cumulative effect of industrial and fiscal policy changes
carried out since the economic reforms of 1991-92. The environment for investment was optimistic. On the
employment front, however, the performance of the organized manufacturing sector continued to be a source
of concern. The rationalization of staffing and closure of the sick units in the public sector led to a massive
decline in employment following in some units. In the early post-reform years, some rise in private sector
employment compensated the decline in the public sector however, during the Tenth Five Year Plan the
manufacturing employment declined in private sector as well.
A conductive investment climate for the industry was attempted through elimination of entry barriers,
decontrolling location restrictions from entrepreneurs liberalization of Foreign Direct Investment (FDI) policy,
elimination of exit barriers by reforming Chapter V-B of the Industrial Disputes Act 1947 under which units
with more than 100 employees cannot exit an unprofitable enterprise without the consent of the concerned
State Government. The e-Governance project MCA 21 launched to computerize and speed up the process of
registration of companies. The quantitative restrictions on trade had already been progressively eliminated.
Against the background of a growing manufacturing scenario, the growth target for 11th FYP for industry and
manufacturing were set at an average annual rate of 9.8per cent. The emphasis was on creation of world-class
Infrastructure, especially on quality of electricity, power, roads, railways, ports, and airports etc. Tax policy
recognized as an important determinant of the investment climate since the rates of direct taxes determine the
79

structure of incentives to work, save, and invest, while the level and structure of indirect taxes influences the
aggregate demand and thus the scale of operations on the one hand and relative prices of different goods and
services on the other..
The plan recommended efforts to correct inverted duty structure, where there was elimination or reduction of
duty on value-added products, while higher duties apply on the raw material and intermediate products
increased competition from imports in manufacturing products. These arose due to lowering of customs duties
in compliance of Most-Favoured-Nation duties, and / or Regional Trading Arrangements (RTAs) that India.
The early introduction of Goods and Service Tax (GST) was recommended.
A skill deficit in virtually all areas of manufacturing had emerged as one of the major impediments to growth
in manufacturing. Reforms in labour market were recommended for skill development to make the workforce
employable in such industries. The manufacturing, employment growth as per 61st Round (2004 05) NSS was
3.9per cent per annum, raised the sectoral share of manufacturing in employment from 12.13per cent in 1999
2000 to 12.9 per cent in 2004 05.
Twelfth Five Year (2012-17)
An assessment of the performance in the Eleventh Plan showed that it was marked by unfavorable global
economic conditions brought about by the financial sector crisis of 2007-09 followed by sovereign debt crisis
from mid 2011 onwards. This led to slackening demand, exchange rate volatility, domestic difficulties such as
poor implementation and delayed reforms, all of which slowed down the growth in the manufacturing sector.
While 2009-10 witnessed a resurgence of manufacturing buoyancy largely on account of sectors like
automotive, cotton, leather, food products etc., the growth moderated in 2011-12. India was not able to
leverage the opportunities provided by the dynamic sub globalization and the shift of manufacturing capacities
to rapidly developing economies unlike China. It is estimated that by 2025, RDE production will account for
more than 55per cent of global production as compared to 36per cent presently.
The manufacturing growth rate peaked at 14.3per cent in 2007-08 and then started decelerating. The decline in
manufacturing growth was primarily responsible for slowed down of GDP in 2011-12, while global economic
meltdown, fragile economic recovery in US and EU, rising interest rates and rupee depreciation also
contributed to the slow down. The rate of growth of manufacturing in GDP has declined from 10.3per cent in
2007-08, to 4.3per cent in 2008-09, revived in 2009-10 and 2010-11 to 9.7per cent and 7.6per cent
respectively. It is estimated to have declined to 3.9per cent in 2011-12.
As regards employment, manufacturing contributed to 44 million in 1999-2000 and rose marginally 48.54
million in 2009-10. Agriculture still continued to be the major employment provider (providing employment
to about 240-250 million) but it will not be able to offer employment to 250 million additional job seekers
joining the work force in the next 15 years. Therefore unless manufacturing sector is able to absorb at least 100
million additional jobs, the unemployment scenario in the country is likely to severe.
The National Manufacturing Policy which was introduced in 2011 has the underline objective of increasing the
share of manufacturing in the GDP from 15-16per cent per cent to 25per cent by 2025 and also provide
employment to 100 million additional job seekers.
The Twelfth plan laid down the essential features of a Manufacturing Eco System that can deliver rapid
industrial growth on the lines of strategies that have been adopted by different countries like Korea, China,
Japan etc, where a close coordination is there between producers and Government policy makers.
4.3 INDIAN MANUFACTURING SECTOR: AN OVERVIEW
4.3.1 Role of manufacturing in the Indian
economy
Manufacturing holds a key position in the Indian
economy, accounting for nearly 16 per cent of real
GDP in FY12 and employing about 12.0 per cent of
Indias labour force. Growth in the sector has been
80

matching the strong pace in overall GDP growth over the past few years. For example, while real GDP
expanded at a CAGR of 8.4 per cent over FY05-FY12, growth in the manufacturing sector was marginally
higher at around 8.5 per cent over the same period. Consequently, its share in the economy has marginally
increased during this time to 15.4 per cent from 15.3 per cent. Growth however has remained below that of
services, an issue that has not escaped the attention of policy makers in the country. Strong growth has been
accompanied by a change in the nature of the sector evolving from a public sector dominated set-up to a
more private enterprise driven one with global ambitions. In fact, according to UNIDO, India (with an
exception to China) is currently the largest producer of textiles, chemical products, pharmaceuticals, basic
metals, general machinery and equipment, and electrical machinery. In the coming year, the sectors
importance to the domestic and global economy is set to increase even further as a combination of supply-side
advantages, policy initiatives, and private sector efforts set India on the path to a global manufacturing hub.
4.3.2 The Sub-sectors in Indias Manufacturing
Among sub-sectors in manufacturing, the top five are food products, basic metals, rubber and petrochemicals,
chemicals, and electrical machinery. Together they account for over 66 percent of total revenues in
manufacturing. However, these verticals rely primarily on domestic demand for a major part of their revenues.

4.3.3
Manufacturing sectors recent growth spurt: Clues from IIP
Manufacturing accounts for a large chunk of Indian industry, a fact borne out by the sectors 75.5 per cent
share in the Index of Industrial Production (IIP). With CAGR of 8.7 per cent during FY05-FY12, the
manufacturing sector helped the overall
industrial sector get over low growth in the
other two sub-segments of IIP, Mining and
Quarrying (14.2 weightage in IIP) and
Electricity (10.3 weightage in IIP) witnessed
CAGR of 3.4 per cent and 5.8 per cent
respectively. On an even more encouraging
note, the manufacturing sector has strengthened
in FY11 compared to the previous fiscal an
analysis of 121 sub-sectors by the
Confederation of Indian Industry (CII) reveals
that only 5 of them recorded declines in FY11
81

compared to 25 in FY10. At the same time, key sub-sectors like machine tools, ball and roller bearings, textile
machinery, and utility vehicles recorded either excellent (above 20 per cent) or high (10-20 per cent) growth,
thereby adding to value creation in manufacturing.
4.4 TAPPING THE GLOBAL MARKET
4.4.1 Indias growing manufacturing exports
Indias manufacturing exporters have played a key role in promoting the sectors prowess to consumers across
the world. While on one hand, sectors such as textiles, gems and jewellery have been Indias brand
ambassadors in global markets since ancient times, the
country has also made its presence felt in key industries
such as engineering goods and chemicals. In fact, analysis
of Indias export data for FY11 reveals that engineering
goods had the highest share in manufacturing exports (40.4
per cent), followed by gems and jewellery (25.2 percent)
and chemicals and related products (17.2 per cent). Overall,
total manufacturing exports in FY11 grew to USD168.0
billion from USD115.2 billion in FY10. The sectors
exports grew at a CAGR of 19.6 per cent during FY03-11.
Within manufacturing exports, engineering goods was one
of the fastest growing the segment recorded a CAGR of
26.0 per cent during the period FY01-FY11. Other sub-sectors with high growth rates include gems and
jewellery and chemicals, which grew at a rate of 18.6 per cent and 17.3 per cent respectively. Within
engineering goods, transport equipment led the field with a CAGR of 34 per cent (FY01-FY10), followed by
electronic goods (24 per cent) and machinery and instruments (22 per cent). In the chemicals sub-sector,
growth in exports was primarily led by pharmaceuticals exports rose 18.0 per cent during the stated period.
4.5 INCREASING COMPETITIVENESS OF INDIAN MANUFACTURING
4.5.1 Sector has an edge in the global arena
India ranks second in the world as per the 2010 Global Manufacturing Competitiveness Index (GMCI),
prepared by the US Council on Competitiveness, and Deloitte. The
index factors in market dynamics as well as policy issues
influencing the sector. India is ahead of major developed and
emerging economies like the US, South Korea, Brazil and Japan.
Looking ahead, Indias competitiveness will increase further with
its index score set to improve to 9.01 (out of 10) in the next five
years from the 2010 figure of 8.15. In terms of rank, the country is
set to maintain its global second rank over the same period. The
table attached here highlights segments of the GMCI and ranks
assigned to nations in 2010.
Quality standards in Indian manufacturing have improved
significantly and the sector is now well known globally for its high
quality. Over the last decade, Indian manufacturers extensively
adopted the Total Quality Management (TQM) approach. As a
result, the sector now enjoys cost advantage in the range of 15-20
per cent compared to the beginning of the decade. Ongoing and
new best practices will continue to benefit the sector in the medium-term through their influence on both the
top line and the bottom line.
Meanwhile, India is currently second only to Japan in hosting companies awarded for quality excellence.
These include 21 companies who have been awarded the Deming Excellence Award and 153 companies with
the Total Productive Maintenance (TPM) Excellence Award by the Japan Institute of Plant Maintenance
(JIPM). Also, of the 165 Indian companies that have been awarded with the CII-Exim Bank Awards for
82

Business Excellence, around 80 per cent are in the manufacturing sector. It is to be noted that this award is
globally accepted as one equivalent to the European Foundation of Quality Award.
4.5.2 Encouraging research and fostering innovation
Innovation be it product or process has received a boost due to growing R&D in the country. Although,
less than emerging market peers like China, Indias share in global R&D spending has been increasing. In
2011, for example, Indias R&D spending is estimated to have made up 2.8 per cent of the world total, higher
than the 2.6 per cent share the year before. The Intellectual Property (IP) applications registered in India are
also on the rise. Over FY06-FY10, IP applications filled for patents rose to 34,287 from 24,505; for designs the
rise was to 6,092 from 4,949. Interestingly, the patentee with the largest number of IP applications from India
in FY10 was from the manufacturing sector Hindustan Unilever (FMCG sector, 103 applications).
Pharmaceutical companies were not far behind the top five Indian firms had filed for 112 IP applications.
Both the government as well as private players in the Indian manufacturing sector realise that R&D is a key to
their global ambitions. Consequently, investments towards research have been speeded up. The Indian
manufacturing sector is now replete with innovations that have become outstanding illustrations globally.
Though examples abound, the one regarding introduction of a new process by Mahindra & Mahindra in
development of a new vehicle is noteworthy. M&M introduced a new process (Integrated Design and
Manufacturing) while developing its multi-utility vehicle Scorpio. The process involved cross-functional
teams (including Tier I suppliers) who collaborated extensively in the product development process
designing, testing and marketing. The result was a shorter product development cycle and M&M was able to
roll out the Scorpio on an investment of USD120 million in the project one-fifth of the average spent on
similar projects globally.
4.5.3 Government support for developing a skilled workforce
India adds 500 PhDs, 2,00,000 engineers, 3,00,000 non-engineering postgraduates, and 21,00,000 other
graduates to its workforce annually. This ensures the availability of a pool of skilled manpower to support the
nations industrial development. However, industry sources have often expressed concern regarding a potential
shortage of talent, given the fast pace of economic growth in the country. There are also concerns pertaining to
employability with a recent CII estimate, putting the share of employable graduates in the country at 39.5
percent. Taking cognizance of such concerns, the government has acted in a proactive manner. The number of
technical institutes (including IITs and NITs) has been increased and foreign direct investment in education
encouraged.
The government also launched the Technical Education Quality Improvement Programme (TEQIP) towards
making the technical education system more responsive to national as well as global economic and
technological developments. The TEQIP was outlined as a 10-12 year program to be implemented in 3 phases
with the assistance of the World Bank. The central government has announced the launch of Phase II of the
program with an investment worth USD519 million. This amounts to 26 per cent of total funding with the rest
coming from the World Bank (72 per cent), state governments (27 per cent), and unaided institutions (1 per
cent). The government has also set up a National Skills Development Council to encourage private
participation/management of Industrial Training Institutes.
4.6 CURRENT TRENDS IN INDIAN MANUFACTURING
4.6.1 India emerging as a global manufacturing hub
The process of evolving as a global manufacturing hub has already started in India with global manufacturing
majors setting up shops in India along with their domestic counterparts. A strong pipeline of existing projects
from both global and domestic firms highlights the growing importance of the country as a market as well as a
production hub. Some of the major investments have been highlighted in the table below:
International Manufacturing Companies and India
Company Investments in India
Automotives and auto components
83

Nissan Motor
Ltd
Plans to increase its auto components sourcing from India from USD10
million in 2010 to USD40 million in 2012
VE Commercial
Vehicles(VECV)
Announced investment of USD61.9 million for a production base for Volvo's
medium-duty engine
Hyundai Manufactures its model i
10
exclusively in India (second largest
manufacturing base after Korea) and exports it to the world
Ford Shifting to India for engine manufacturing base
Skoda Auto Chose India for a manufacturing facility to serve the Indian market and
exports destined for Nepal, Sri Lanka, Burma and Bangladesh
Electronics
Nokia Manufacturing facility in India exports mobile handsets to North America,
Europe, Middle East, Asia, Australia and New Zealand
LG Plans to set up a mobile manufacturing facility to serve the domestic market
and Europe and the Commonwealth of Independent States
Samsung Announced investment of USD100 million for setting up manufacturing plant
in Chennai, India
Others
Airbus
Industries
Plans to set up manufacturing base in India within 3-4 years
Doosan Heavy
Industries &
Construction Co
Plans to set up power equipment manufacturing unit in India
Cumins Has outlined India as its upcoming manufacturing hub
High-end
fashion brands
Luxury leather goods brand - Louis Vuitton; premium brand for linen and
home dcor Frette are considering India for their manufacturing facilities
Source: Company sources, news articles, Aranca Research
4.6.2 Indian manufacturing growth outshining peers in the BRICs
Current trends for this year suggest that growth in the manufacturing sector in India is outpacing that of peers
in the BRICs. Although a number of production indices are used to measure industrial growth in these nations,
the HSBCs Manufacturing Purchasing Managers Index (PMITM) is used here for comparison. The HSBC
manufacturing PMI for India incorporates five factors new orders, output, employment, suppliers delivery
time, and stock of items in order to gauge the pace and direction of activity in the manufacturing sector of the
country. Any figure above 50 for the index indicates expansion while anything below it denotes a contraction.
Data for 2012 reveals that the index for the Indian
manufacturing sector has been higher than those for other
BRIC nations, thereby indicating a faster pace of expansion
for the sector in India. In fact, Indias manufacturing PMI
for March 2012 stood at 54.7, indicating an expansion. This
was in stark contrast to contraction in China (48.3), while
manufacturing in Russia (50.8) and Brazil (51.1) grew at a
relatively slower pace for the same month. Much of this
difference could be because of the fact that the
manufacturing sector of countries such as Chinas are
heavily geared towards exports. With key destinations like
the US and Western Europe facing recessionary pressures
once again, demand fundamentals for Chinas exporters
have weakened. In contrast, in India, domestic consumption
is the key driver of the manufacturing sector and with strong GDP growth likely to continue, demand
fundamentals remain strong.
4.6.3 Interesting trends in key manufacturing sub-sectors
Computers: India is the fastest growing IT systems and hardware market in the Asia-Pacific region
Communication and Broadcasting Equipments: India is set to overtake the US as the worlds largest
DTH market by 2012
Automotive: Tata Motors has brought out the worlds cheapest car the Tata Nano
Alternative fuel distribution: The CNG distribution network is projected to spread to 250 cities in
India by 2018 from 30 cities in 2009
Cement production: Major Indian cement manufacturers are increasingly shifting to alternate sources
of energy (especially bio energy) to fire their kilns and thereby cut energy costs
Textiles: The sector saw investments worth USD43 billion in FY10 under the governments
Technology Upgradation Fund Scheme (TUFS), wherein spinning accounted for largest share of total
investments at 33 per cent
Electrical Machinery: Players in this sector are forming strategic alliances and tie-ups with technology
suppliers to upgrade capabilities
84

Engineering: More than 2,500 firms in the engineering sector have the ISO 9000 accreditation
4.7 FACTORS DRIVING THE INDIAN MANUFACTURING GROWTH STORY
4.7.1 Fortification in demand enabling sustainable growth of sector
Domestic demand fundamentals for the manufacturing sector in India have never been rosier as it is now.
Strong growth in per-capita income, a young and growing population, rapid urbanization, and changing
lifestyles will ensure that demand growth will keep the manufacturing sector busy for the coming decades.
Percapita nominal GDP, for example, is slated to expand at a CAGR of 6.9 per cent over 2010-15. Demand-
push from increasing incomes will be augmented by a rising middle class and a young population, which
currently has a median age of 25 years. According to McKinsey, Indias middle class is likely to expand 12
times (to about 583 million people) over the period 2005-25.
During this time, urbanisation is likely to increase to 38 per cent from 29 per cent. As a result of these varied
factors, India will emerge as the worlds fifth largest consumer market by 2025 with aggregate consumption in
the country slated to rise by about four times over 2005-25. A small example here will best illustrate the
evolving nature of consumer preferences in India. Harley Davidson, the iconic US bike maker, announced in
November 2010, its plan for setting up a unit in India. Interestingly, this will be the companys second unit
outside the US.
Demand for Indias manufacturing exports so far has been led by advanced economies, consuming 29 per cent
of total products exported from the country. The US and Western Europe are the key destinations within
advanced economies. However, this trend is likely to change as the growth in emerging economies of Asia,
Africa and the Middle East is expected to outpace that of developed markets.
Already some change is visible, with the Middle East emerging as a key market for a number of Indian
products like engineering goods, readymade garments, and gems and jewellery. Closer trade ties with ASEAN
nations, China, Latin America, and Africa in the coming decade will intensify the above trend.
4.7.2 Technology development initiatives
Technology is the key to expanding the manufacturing base in the country and increasing Indias presence in
the global market. The government recognizes this fact and has therefore provided a number of incentives to
facilitate technology development.
Pharmaceuticals: No duty for upgrading technology through the Export Promotion Capital Goods
Scheme
Textiles: A maximum of USD438 million of subsidies on investment of USD10.4 billion across the
value chain under the revised Technology Upgradation Fund Scheme
Food processing: No import duty on capital goods for 100 per cent export oriented processing units
The government has also launched a number of schemes for technology development in micro, small and
medium enterprises (MSMEs). These include:
Lean Manufacturing Competitiveness Scheme: Implemented under the Public Private Partnership
(PPP) mode with 42 Lean Consultants , the project aims to reduce manufacturing waste, and increase
productivity and competitiveness
Design Clinic Scheme: This is a platform to enable MSMEs to avail expert advice and cost effective
solutions to real-time design issues. The scheme includes two projects Design Awareness and
Design Project Funding
Marketing Assistance and Technology Upgradation: The scheme focuses to upgrade technology for
increasing competitiveness in marketing. Activities included in this scheme are technology
upgradation for packaging, competition studies, and development of marketing techniques
Technology and Quality Upgradation: The scheme aims to encourage MSMEs to adopt global
standards so as to improve the quality of goods produced
4.7.3 Encouraging Foreign Direct Investment (FDI)
85

Over the years, the increasing attractiveness of the Indian market has lured investors from across the world.
The country was among the top five preferred destinations for Foreign Direct Investment (FDI) from Asian,
European and North American investors as per The 2010 A.T. Kearney FDI Confidence Index. In The 2012
A.T. Kearney FDI Confidence Index, India is positioned second in the world with many developed and
emerging countries lagging behind.
4.7.4 The National Manufacturing Competitiveness Council (NMCC)
To develop a coherent strategy for developing the manufacturing sector, the government set up the National
Manufacturing Competitiveness Council (NMCC) to increase the global competitiveness of the sector.
Recently, NMCC, in coordination with the Department of Industrial Policy and Promotion, and the Planning
Commission, has been instrumental in framing the National Manufacturing Policy (NMP). Key objectives of
the NMP include:
Raise the manufacturing sectors contribution to GDP to 25 per cent by 2025 from the current share of
16 per cent
Encourage investments and competitiveness to make the country a global manufacturing hub
Double employment generation in the sector from its current levels.In keeping with the objectives of
the NMCC, the government is also planning to set up National Manufacturing and Investment Zones
(NMIZs) to encourage investments and thereby boost the share of manufacturing in GDP to 25 per
cent by 2022. According to the Prime Minister's Office (PMO), the NIMZs will be mega investment
projects involving state-of-the-art infrastructure. Apart from the above the government has also been
toying with other policy measures to support manufacturing growth. Apart from encouraging FDI,
other measures to develop manufacturing include fiscal support for development of indigenous
technology, training programs for skill development, and labour reforms.
4.8 OPPORTUNITIES IN INDIAN MANUFACTURING
4.8.1 A lucrative domestic market for the Indian market itself offers significant growth opportunities to a
wide gamut of industries in the manufacturing sector. Some of them have been discussed below:
Power equipment: Despite strong economic growth over the past decade, power consumption in India is
among the lowest in the world. Growth in demand clearly outpaces power generation growth. With economic
activity expected to continue on a fast-paced trajectory in the coming decades as well, the trend is likely to
continue. For example, energy shortfall for FY12 stood at 10.3 per cent. However, the government has not
been blind to the current power scenario in the country and has earmarked power generation as a priority focus
area. Under its five-year plans, the government has announced plans to add 55GW of power generating
capacity by 2012 and an additional 100GW by 2017. The power equipment industry will thus emerge as a
high-growth opportunity. At the same time, policies including The Electricity Act 2003, which did away with
licenses for power generation projects, and other incentives like tax benefits, and permission for trading of
power will enthuse the private sector.
Construction equipment and cement: The construction equipments sector and cement will benefit from the rise
in demand for housing and commercial real estate space. With rising incomes and rapid urbanisation has come
strong growth in demand for housing and this is likely to accelerate by 4.25 million units in 2014 from 2010.
Strong growth is also expected on the commercial real estate front with rising demand for office space, retail,
and hospitality. Consequently, the real estate sector is projected to grow to USD126 billion by 2015 from
USD55.6 billion in 2010. Construction equipment and cement will further benefit from a renewed policy focus
on infrastructure. The government has earmarked USD514 billion of investments under the 11th Plan and a
further USD1 trillion under the 12
th
Plan.
Food Processing: India is among the worlds leading food producers. The country is the largest producer of
milk, pulses and tea in the world. With its large agriculture sector, the country is also the worlds second-
largest producer of fruits and vegetables, and the third-largest fish producer. However, currently only 6 per
cent of perishables in the country are processed. The Ministry of Food Processing Industries (MFPI) estimates
this to increase to 20 per cent by 2015. MFPI also expects value addition to increase from 20 per cent to 35 per
cent over the same period. On the back of rising incomes, a growing middle class, rapid urbanisation, and a
86

young population, processed food demand is projected to double by 2020 from current levels. The food
processing sector has and will continue to benefit from policy support. These include easier credit access,
focus on supply-chain infrastructure, and setting up of Agri Export Zones and mega food parks. Consequently,
the sector is set to induce investments worth USD21.9 billion investment by 2015.
4.8.2 Manufacturing off-shoring and India: An example from auto components
India is emerging as a favourite destination for global manufacturers. Foreign companies have been attracted
by Indias cost competitiveness, its skilled workforce, and favourable government policies. The best example
of this can be found in the auto components sector.
Due to a cost-effective manufacturing base, the auto components sector in India saves 10-25 per cent
on operations compared to peers in Europe and Latin America.
The sector also has high quality standards, a fact borne out by the number of quality awards won by
firms Total Productive Maintenance (TPM) Award (15 players), the Deming Award (11), and the
Japan Institute of Plant Maintenance (JIPM) Award (3)
Greater access to key automotive markets like the Middle East and Europe Major Original Equipment
Manufacturers (OEMs) are keen to make India their sourcing hub. Recent investment announcements
bear testimony to this.
Volkswagen: The German auto giant plans to increase Indias share in total global sourcing to 70 per
cent; Volkswagen Group has recently announced plans to double its component sourcing from India to
USD924 million in 2012
Honda: The Japanese auto major has made India its export base for key engine components
Ford: The US company has announced plans to make India a manufacturing base for engines to serve
the Asia-Pacific region as well as Africa
4.8.3 Emergence of a Manufacturing Exports Hub
While India exports a wide variety of manufactured goods, there are some sectors in which the country has a
distinct advantage. We present here two such sectors gems and jewellery, and textiles both of whom have
played a major role in the countrys economy.
Gems and jewellery: Gems and jewellery exports from India increased at a CAGR of 18.43 per cent over
FY06-FY12. The two major constituents in these exports are cut and polished diamonds, and gold jewellery.
Together they accounted for just over 93 per cent of total gems and jewellery exports in FY12. The country
has been able to leverage its past experience in the sector and improvise further leading to value addition of
final products. India particularly enjoys a strong competitive advantage in global cut and polished diamonds
market. Cost of production is low while a large pool of skilled manpower is available. India in fact has a major
share in the global diamond polishing business with 11 out of the worlds 12 diamonds being cut and polished
in the country.
Textiles: Cost competitiveness is a key driver of the Indian textiles exports. This is mainly due to synergies
achieved by Indian players while expanding capacity. Exports from the sector have been growing at a CAGR
of 9.5 per cent during FY05-FY11. Textile exports are dominated by readymade garments (40 per cent of the
total in FY11), a segment that entails high value addition compared to other segments.
Interestingly, SMEs have made a strong contribution to growth of the Indian textiles sector. Due to their strong
presence, the Ministry of Textiles has undertaken a cluster based development approach for the efficient
growth of the sector. According to UNIDO, 80 per cent of production of textiles comes from about seventy
clusters. The major clusters include Panipat, Tirupur and Ludhiana. The Panipat cluster produces 75 per cent of
Indias blankets, Tirupur accounts for 80 per cent of the countrys hosiery exports, and Ludhiana has a share
of 95 per cent in the production of woollen knitwear.
4.9 CHALLENGES FOR THE INDIAN MANUFACTURING SECTOR
The various factors are as follows:
87

Cost disability: Higher input costs for the Indian manufacturing sector can be attributed to factors like;
cascading effect of indirect taxes on selling prices of commodities; higher cost of utilities like power, railway
transport, water; higher cost of finance and high transactions costs.
Low operating surplus: A detailed investigation of 15 major manufacturing sector in India shows that the share
of operating surplus in the total value of output averaged 15per cent in India much lower compared to
22.6per cent in Malaysia, 29.4 per cent in Indonesia and 30.6per cent in Korea.
High costs of input materials and utilities: A comparison of costs of input materials and utilities in India,
China, Malaysia and Korea across 15 important manufacturing segments showed that on the average the share
of input materials and utilities in total output value was as high as 81.3per cent in India as against 75.5per cent
in China, 68.7per cent in Malaysia and only 58.5per cent in Korea.
Agenda for accelerating growth and improving competitiveness of Indian Manufacturing
Infrastructure facilities: New initiatives for encouraging entry of more private sector investors in
important sectors like electricity distribution, aviation, roads, railways, ports and airports.
Development finance: Concrete steps that would enable the development financial institutions to
double the distribution of funds in the next year.
Inspector Raj: Announcing of new initiatives for self-regulatory checks and self certification measures
by entrepreneurs.
Labour legislation: A new bill for reducing plethora of regulations and for introducing a uniform labor
laws for the whole country should be introduced in the next session of Parliament.
Contract labor: A new bill for encouraging Contract labor in all areas even while protecting the social
security payments and minimum wages should also be introduced.
Opening up of small-scale sector: Removal of all restrictions on investment in labor-intensive small-
scale industries should be done by the end of the first 100 days.
Fiscal policies: Steps for reducing incidence of indirect taxes on manufactured goods should be
reduced to international benchmarks along with a simultaneous move to bring more and more services
come under the indirect tax net.
Removing negative cross subsides: Announcing a time bound program for removing negative cross
subsidies on inputs use by industries namely power, water, railway freight.
Exit of firms: An efficient bankruptcy law with foreclosure provisions will be major step in this
direction should be introduced in the next session of Parliament. This will also help reduce industrial
sickness and help reduce the non-performing assets of the banking sector.
Credit to small units: It is important that small and medium borrowers in manufacturing are able to get
loans at not more than 4 per cent higher than triple rated borrowers.
Power supply is a crucial factor in sustaining this pace of growth. Any industry that is growing very rapidly or
has got mega plans is setting up its own captive power, an investment not permitted even five years ago. This
huge step forward notwithstanding, companies in the private sector are still unable to expand their power
business because the state electricity boards control the majority of power distribution. Transmission is also in
the domain of the national government. If this area is opened up, it could become the engine of growth for the
manufacturing industry. Manufacturing advocates a growth rate of 1214 percent for the sector for the next 10
years and lists action points toward this goal.
4.10 ISSUES RELATED TO TECHNOLOGICAL KNOW-HOW
These are the various issues related to technological know- how:
Various routes: Technology may be transferred either from a company or from a country, which possesses the
required technology through negotiations or purchase of equipment and establishment of units. International
Sub-contracting arrangements and Industrial Co operation agreements also play a very effective role.
Legal aspects: One of the major legal issues which may arise in the case of technology transfer transactions,
are the terms and conditions which the transferor will seek to impose as a result of his superior bargaining
power.
88

Legal avenues: There are various legal avenues available under the Indian Law with regard to Foreign
Technological Collaborations. Of these, the most important is the maintenance of confidentiality. Another
important aspect is the specific performance of contract. If a party to a contract commits a breach, the other
party may either opt for the specific performance of the contract or claim for the damages. As an alternative, he
may even apply an injunction before the competent Court.
Legal responsibilities: With the increase in transfer of technology, and the incidents of industrial hazards in
recent years, the Legislature and Judiciary has come out with stringent laws (Bhopal Tragedy Case).
Protection under IPR copyright: Technology may be in the form of literature or it may be in the form of
computer devices such as CD-ROM. The Indian Copyright Law is made available to the copyright owner or
the assignee or the License holder. On violation of Copyright Law, one may be held liable and made to pay for
counterfeiting as well as for rendition of the accounts.
Patent: The existence of patent license agreement in developing countries or inclusion of patent related clauses
in a composite agreement is usually a condition imposed by the licensor. The licensor may also insist on
incorporating patent clauses in a contract to protect his know-how.
Trademarks/geographical indications: Under Trademark Law, the proprietor of the trademark represents and
demonstrates that s/he is the owner of a trademark in a particular territory for a class of goods and grants
permission to the licensee to use the same and has the licensee registered as the permitted user of trademark for
those goods.
R.B.I regulations: To inject technological dynamism in the Indian industry and to promote industrial
environment, foreign technology induction is encouraged through Foreign Direct Investment and through
foreign collaboration agreements and they are permitted either through automatic route under the RBI or by
way of specific permission from the Secretariat of Industrial Approval.
Royalties: Royalty is calculated based on the net ex-factory sale price of the product, exclusive of excise duties
minus the cost of components, irrespective of source of procurement etc. The payment of royalty will be
restricted to the license capacity plus 25per cent in excess thereof, for items requiring Industrial license. The
royalty would not be payable beyond the period of the agreement. E.g. In the private sector, the Hindustan
Motors Earthmoving Equipment Division was established in1969 at Tiruvallur, near Chennai with technical
collaboration from Terex, UK for manufacture of wheel loaders, dozers & dumpers. This factory has since
been taken over by Caterpillar for their Indian operations. The machines manufactured by Caterpillar in the
Tiruvallur factory are marketed by TIL and GMMCO. In 1974, L&T started manufacturing hydraulic
excavators under license from Poclain, France.
4.11 CONCLUSION
India has emerged as a global manufacturing hub due to its cost competitiveness, skilled workforce and
favourable government policies. Furthermore, the most fundamental factor fostering growth in the sector is the
presence of strong market locally. India is one of the fastest growing economies. The Consumer trend in the
country is enabling domestic players to flourish and also attracting international players. During FY11, 41 out
of 121 manufacturing sub-sectors registered excellent growth of more than 20 per cent. While the sector
predominantly has been expanding, just five of 121 sectors shrunk during the period.
Though the sector has registered strong growth in the past, the Indian market offers a wide range of untapped
opportunities. India, which has placed high priority on infrastructure development, offers high growth for
cement and power equipment manufacturers, with its current consumption pattern way below the world
average. Another example is prospects in the food processing industry. The worlds second most populous
country and one of the largest food producers processed a meagre six per cent of the perishables.
The evolving trends of manufacturing off-shoring in India, as seen in the automobile sector, and the growth of
manufactured exports, portrayed in subsectors such as gems & jewellery and textiles, illustrates the long-term
sustainability of growth in the sector.

****
89

Impact of Inflation on Financial Performance

5.1 INTRODUCTION
It has been pointed in the first chapter that, during inflation profit under Historical Cost Based (HCB) method
is overstated as compared to Current Purchase Power (CPP) method due to undercharging of depreciation cost
as well as cost of inventory to the profit and loss account. To study this, the present chapter analyzes the profit
and loss accounts of sample companies under both the methods. Further the impact of inflation on Gross Value
Added (GVA) and Net Value Added (NVA) and on different sectors is also studied in the present chapter.
5.2 FINANCIAL PERFORMANCE OF SAMPLE COMPANIES UNDER HCB METHOD
The Table-5.1 shows the reported profit/loss of sample companies under HCB method for the period under our
consideration, i.e. from 2004-05 to 2008-09. The various components of profit and loss accounts are
investigated and their trend during the period is analyzed in the following paragraphs.
Table 5.1
Financial Performance of Sample Companies
[Under Historical Cost Based Method]
(Rs. in crores)
Year 2004-05 2005-06 2006-07 2007-08 2008-09 Growth (%)
Total Revenue 209652.18 251492.77 303716.50 339848.84 401655.13 91.58
Raw Material Cost 127841.43 163991.38 197634.80 221236.79 272756.67 113.36
Other Expenditure 28235.77 29893.58 36029.39 37516.24 40835.55 44.62
Gross Value Added (GVA) 53574.98 57607.81 70052.31 81095.81 88062.91 64.37
Depreciation 6257.40 8159.35 8156.90 9445.44 10419.58 66.52
Net Value Added (NVA) 47317.58 49448.46 61895.41 71650.37 77643.33 64.09
Employee Cost 6599.01 7281.63 9762.71 14030.58 15917.70 141.21
Interest 5010.08 5171.62 5580.27 7684.02 13655.17 172.55
Tax 12146.10 12339.09 15124.38 17278.93 14778.17 21.67
Profit After Tax(PAT) 23562.39 24656.12 31428.05 32656.84 33292.29 41.29
Equity Dividend 8623.03 9256.95 10271.06 10527.49 10371.96 20.28
Retained Earnings 14939.36 15399.17 21156.99 22129.35 22920.33 53.42
Source: Compiled from Annual Reports of sample companies
From the above, it is observed that under the HCB method, the total revenue of sample companies, consisting
of sales and other income, shows an upward trend. The total revenue, which was Rs.209652.18 crores in the
year 2004-05, increased to Rs.251492.77 crores to the next year and finally reached at Rs.401655.13 crores in
the last year, with an overall increase of almost 91.58 percent during the entire period of study. Similarly, the
raw material cost gone up to Rs.272756.67 crores from Rs.127841.43 crores during the same period, but with
overall increase of nearly 113.36 percent. From this it is clear that through growth, both total revenue and raw
Chapter
5
90

material cost has shown a rising trend, the growth of later is more prominent than that of the former. This is the
main reason for which the Gross Value Added (GVA) has increased by 64.37 percent only. Similarly, the Net
Value Added (NVA) shows a rising trend, from Rs.47317.58 crores at the commencement of the study to
Rs.77643.33 crores to the final year with an overall growth of 64.09 percent. This indicates that the sample
companies were able to generate some positive values during the period of study and it is encouraging.
As we know the Net Value Added is distributed amongst the different stakeholders in different forms
viz. employees in the form of salaries/wages, government in the form of taxes, providers of capital in form of
interest/dividends and entity itself in the form of retained earnings for re-investment. It is found from the Table
that, during the period our study the employees cost has increased by 141.21 percent, payment of interest
increased by 172.55 percent, tax paid to Government by 21.67 percent, dividend paid by 20.28 percent and the
retained earnings by 53.42 percent for sample companies taken together. As payment of interest has highest
growth, it can be said that sample companies have relied heavily on debt rather than equity for their long-term
growth during the period.
5.3 FINANCIAL PERFORMANCE OF SAMPLE COMPANIES UNDER CPP METHOD

Table-5.2 shows the inflated Profit/Loss Accounts of sample companies under Current Purchasing Power
(CPP) Method for the entire period of study. The figures in Table are arrived by adjusting the Profit/Loss
figures by price level in terms of the wholesale price index prevailing at the end of March 2009 (described in
table-5.1).
Table 5.2
Financial Performance of Sample Companies
Under Current Purchasing Power Method
(Rs. in crores)
Year 2004-05 2005-06 2006-07 2007-08 2008-09
Growth
(%)
Total Revenue 258739.34 297218.72 336705.46 359960.06 393685.81 52.16
Raw Material Cost 158880.87 194812.43 220866.79 235559.79 269792.75 69.81
Other Expenditure 34846.78 35328.78 39942.82 39736.33 40025.32 14.86
Gross Value Added (GVA) 65011.68 67077.51 75895.85 84663.94 83867.74 29.00
Depreciation 9199.87 11996.19 11992.59 13887.05 15319.26 66.52
Net Value Added (NVA) 55811.82 55081.32 63903.27 70776.89 68548.48 22.82
Purchasing Power Loss 5361.21 3652.31 1719.35 -131.98 -54.18 -
Employee Cost 8144.08 8605.56 10823.11 14860.86 15601.87 91.57
Interest 6183.12 6111.91 6186.39 8138.73 13384.23 116.46
Tax 15000.43 14417.01 16559.05 17563.36 14778.17 -1.48
Equity Dividend 10649.44 10815.83 11245.35 10700.78 10371.96 -2.61
Retained Earnings 10473.53 11478.70 17370.01 19645.14 14466.42 38.12
The absolute figure of total revenue under Current Purchasing Power Method (CPP) for sample companies
taken together was Rs.258739.34 crores in the first year of the study, which increased to Rs.393685.81 crores
in the last year showing an overall growth of 52.16 percent during the period of study. In the similar manner,
the raw material cost showed an upward trend starting from Rs.158880.87 crores to Rs.269792.75 crores with
an overall growth of 69.81 percent.
The Gross Value Added (GVA) by the sample companies which was Rs.65011.68 crores in the year
2004-05 was improved to Rs.84663.94 crores in the year 2007-08, although finally it came down to
Rs.83867.74 crores in the year 2008-09. Conversely depreciation, which was Rs.9199.87 crores in the year
2004-05 advanced to Rs.15319.26 crores in the year 2008-09 after plummeting to Rs.11992.59 crores in the
year 2006-07 showing overall a positive trend. The Net Value Added (NVA), which is an outcome of Gross
Value Added minus depreciation, showed a fluctuating trend in the entire study period varying between
Rs.55811.82 crores (in 2004-05) to Rs.70776.89 crores (in 2007-08).
91

Purchasing power gain/loss on monetary items is responsible for business profitability. It has been
observed from the Table-6.2 that, the monetary items have affected purchasing power of sample companies
adversely in first three years of study (from 2004-05 to 2006-07) resulting into losses and favorably in the last
two years (2007-09) resulting into gains. The purchasing power losses of sample companies was Rs. 5361.21
crores in the year 2004-05 and it has come down to Rs.1719.35 crores in the year 2006-07 and thereafter the
trend was reversed. In the last two years of study i.e., 2007-08 and 2008-09, the purchasing power gain was
Rs.131.98 crores and Rs.54.18 crores respectively. From the above discussion, one thing is very clear that
financial performance of sample companies in beginning years are more affected by inflation as compared to
the later years.
The sharing of Net Value Added among the different stakeholders under CPP method reveals that
Employees cost has increased from Rs.8144.08 crores to Rs.15601.87 with an overall growth of 91.57
percent, while payment of interest has increased from Rs.6183.12 crores to Rs.13384.23 crores with overall
growth of 116.46 percent. On the other hand, payment of tax has decreased from Rs.15000.43 crores to
Rs.14778.17 crores and payment of dividend from Rs.10649.44 crores to Rs.10371.96 crores with negative
growth of -1.48 percent and -2.61 percent respectively. Finally, the retained earnings have increased from
Rs.10473.53 crores to Rs.14466.42 crores with overall growth 38.12 percent during the period of under study.
5.4 IMPACT OF INFLATION ON GVA AND NVA
After analysing the different items of Profit & Loss Account under both HCB and CPP the methods, it is found
that Gross Value Added (GVA) and Net Value Added (NVA) are the two fundamental items for evaluating the
financial performance of an organization. Therefore Table-5.3 makes a comparative analysis of these two
items under both the methods.
Table 5.3
Comparative Analysis between GVA and NVA
(Rs. in Crores)
Year 2004-05 2005-06 2006-07 2007-08 2008-09
Gross Value Added (GVA)
HCB Method 53574.98 57607.81 70052.31 81095.81 88062.91
CPP Method 65011.68 67077.51 75895.85 84663.94 83867.74
Difference -11436.70 -9469.70 -5843.54 -3568.13 4195.17
Raw Material
to Sales
61.87% 66.20% 66.51% 66.58% 69.41%
Net Value Added (NVA)
HCB Method 47317.58 49448.46 61895.41 71650.37 77643.33
CPP Method 55811.82 55081.32 63903.27 70776.89 68548.48
Difference - 8494.24 - 5632.86 -2007.86 873.48 9094.85
Net Fixed Assets to
Total Assets
41.64% 38.81% 33.89% 29.14% 27.67%
It is evident from Table-5.3 that the absolute figures for Gross Value Added (GVA) is overstated under CPP
Method in comparison that of HCB Method during the entire period of study except for the year 2008-09.
However, the discrepancy between these two figures gradually reduced from Rs.11436.70 crores in 2004-05 to
Rs.3568.13 crores in 2007-08 except the in the year 2008-09, where the GVA under the HCB method is found
to be Rs.4195.17 crores more as compared to under CPP method. Thus it can be said that the GVA of sample
companies has been affected by inflation in all the years of study. As GVA of a particular company is affected
by its sales and raw material cost, we became more interested to find out their ratio for different years and after
analysis, it is clear that years with relatively high raw material cost in relation to sales are less affected by
inflation and vice-versa. For case in point in the year 2004-05, when raw material costs to sales was lowest
(61.87%), the Gross Value Added was affected to its maximum extent. On the other hand, in the year 2008-09,
where raw material cost to sales was highest (69.41%) the Gross Value Added was least affected.
92

Similarly, the figure for Net Value Added (NVA) is understated under HCB Method in the first three years,
whereas it was reversed in the last two years i.e. 2007-08 and 2008-09. Though negative deviation was
compressed year after year from Rs.8494.24 crores to Rs.2007.86 crores up to 2006-07, it was reversed and a
higher positive deviation was observed in the last two years (Rs.873.48 crores and Rs.9094.85 crores
respectively in 2007-08 and 2008-09). Therefore, it can be said that like GVA, NVA is also affected by
inflation in all the years of study. NVA and Depreciation are inversely related, higher the depreciation less is
the NVA and vice-versa. In this context, a close look to Table-5.3 reveals that years with relatively low Net
Fixed Assets in relation to Total Assets are less affected by inflation. For incidence in the year 2008-09, Net
Fixed Assets was 27.67 percent of the Total Assets (lowest) and the Net Value Added was at its maximum
point. On the other hand, in the year 2004-05 when Net Fixed Assets to Total Assets was highest (41.64
percent), Net Value Added has suffered to its maximum extent as compared to other years. It is due to impact
of inflation on depreciation of fixed assets of the sample companies.
5.5 IMPACT OF INFLATION ON PROFIT/LOSS
Financial Statements are said to be store house financial information. If properly analyzed and interpreted, they
can provide valuable insights into an organizations performance and position. Though there are many
analytical devices used for analyzing financial statements (viz. financial ratios, common size statements,
comparative analysis, and trend analysis), we have used the common-size statement and comparative statement
to study the impact of inflation on sample companies for different years of study.
The Tables-5.4 to 5.8 shows the Profit and Loss Accounts of Sample companies both under Historical
Cost Based (HCB) Method as well as under Current Purchasing Power (CPP) Method for the years 2004-08.
They depict different items in their absolute figures as well as relative variation between two accounting
methods under discussion. Since direct comparison is impossible between HCB Method and CPP Method, the
financial statements have been re-casted to a common basis. The methodology is to equate Total Revenue of
the relevant year as 100 and recasting all other figures, from raw materials to profit before tax, accordingly as a
percentage of total revenue. Again, the profit before tax (PBT) has been equated to 100 and recasting all other
items, from tax to retained earnings, as a percentage of PBT. The detailed analysis of different components and
their trend is discussed in detail in the following paragraphs.
5.5.1 Impact of inflation on Profit/Loss for the Year 2004-05
In the year 2004-05, the total revenue of sample companies was Rs.209652.18 crores as per HCB method,
whereas under CPP method it was overstated by Rs.49087.16 crores (23.41 percent) due to inflation. The
material cost was found to be Rs.127841.43 crores under HCB method and that in CPP method Rs.158880.87
crores. The higher figure of material cost under CPP method by Rs.31039.44 crores (24.28 percent) over and
above the HCB method is due to the impact of inflation. However, the material cost for the year under
consideration was more or less identical as a percentage of total revenue under the both methods, (60.98
percent under HCB method and 61.41 percent under CPP method).
Table 5.4
Impact of Inflation on Profit/Loss for the Year 2004-05
(Rs. in crores)
Particulars HCB Method CPP Method Change % of Change
Total Revenue 209652.18 100.00 258739.34 100.00 49087.16 23.41%
Raw Material Cost 127841.43 60.98 158880.87 61.41 31039.44 24.28%
Other cost 39844.86 19.01 49173.98 19.01 9329.12 23.41%
Cost of Goods Sold 167686.29 79.98 208054.85 80.41 40368.56 24.07%
Depreciation 6257.40 2.98 9199.87 3.56 2942.47 47.02%
Purchasing Power Loss 0.00 0.00 5361.21 2.07 5361.21 -
Profit Before Tax 35708.49 100.00 36123.41 100.00 414.92 1.16%
Tax 12146.10 34.01 15000.43 41.53 2854.33 23.50%
Profit After Tax 23562.39 65.99 21122.97 58.47 -2439.42 -10.35%
Equity Dividend 8623.03 24.15 10649.44 29.48 2026.41 23.50%
Retained Earnings 14939.36 41.84 10473.53 28.99 -4465.83 -29.89%
93

While the cost of goods sold for the year 2004-05 as per HCB method was 79.98 percent of the total revenue,
it was slightly higher (80.41 percent) as per CPP method. The absolute figure of cost of goods sold was
Rs.167686.29 crores under HCB method and Rs.208054.85 crores under the CPP method leading to a
deviation of 24.07 percent due to inflation. Similarly, depreciation as a percentage of total revenue was 2.98
percent and 3.56 percent as per HCB and CPP method respectively. The absolute figure of depreciation was
found to be Rs.6257.40 crores as per HCB method, which lowers by Rs.2942.47 crores (47.02 percent) under
CPP method due to inflation. Moreover, from the Table it is observed that the profit before tax (PBT) was
higher by Rs.414.92 crores under CPP method as compared to HCB method due to interface of total revenue,
cost of goods sold, depreciation and purchasing power loss.
The HCB profit and loss account reveals that the sample companies had paid 34.01 percent of the
profit before tax as tax in the year 2004-05, whereas the corresponding figure under the CPP method was as
high as 41.53 percent. Thus the sample companies have paid excess tax to the amount of 7.52 percent in real
terms bringing out clearly the hazardous impact of inflation on their tax burden. As a result, the profit after tax
(PAT) under CPP method was dropped by Rs.2439.42 crores constituting about 10.35 percent of the PBT.
Lastly, Table-6.4 reveals that the equity shareholders were overpaid to the tune of 5.33 percent as return on
their capital as per CPP method keeping lesser amount as retained earnings for future growth.
5.5.2 Impact of Inflation on Profit/Loss for the Year 2005-06
It is clear from Table-6.5 that the total revenue of sample companies has been inflated by Rs.45725.95 crores
(18.18 percent) in the year 2005-06. Its absolute figure under HCB method was Rs.251492.77 crores, which
increased to Rs.297218.72 crores under CPP method. In the same way the material cost as per HCB method
was Rs.163991.38 crores but it was exaggerated by Rs.30821.05 crores (18.79 percent) due to inflation (as
disclosed by CPP method).
As evident from the Table, the cost of goods sold of sample companies was overstated by Rs.38520.48
(18.67 percent) under CPP method in the year 2005-06 due to inflation. Likewise, the absolute figure of
depreciation stood at Rs.8159.35crores and Rs.11996.19 crores respectively under HCB and CPP method. It
was 3.24 percent of total revenue as per HCB method and 4.04 percent as per CPP method. Therefore it can be
said that depreciation was understated by 47.02 percent (Rs.3836.84 crores) due to inflation.
Table 5.5
(Rs. in crores)
Total Revenue 251492.77 100.00 297218.72 100.00 45725.95 18.18%
Other cost 42346.83 16.84 50046.25 16.84 7699.42 18.18%
Depreciation 8159.35 3.24 11996.19 4.04 3836.84 47.02%
Profit Before Tax 36995.21 100.00 36711.53 100.00 -283.68 -0.77%
Tax 12339.09 33.35 14417.01 39.27 2077.92 16.84%
Profit After Tax 24656.12 66.65 22294.53 60.73 -2361.59 -9.58%
Equity Dividend 9256.95 25.02 10815.83 29.46 1558.88 16.84%

Due to the above incidence, profit before tax for the year 2005-06 was overstated by Rs.283.68 (0.77 percent)
in HCB method. It was found to be 14.71 percent and 12.35 percent of the total revenue respectively as per
HCB and CPP method. Again it can be observed from the Table that the sample companies had paid additional
tax of 5.92 percent in real terms during the year 2005-06. As a result PAT has understated by Rs.2361.59
crores (9.58 percent) due to burden of inflation. Lastly, Table-5.5 reveals that the sample companies had paid
94

more dividends due to inflation in the year 2005-06, which could have retained by the sample companies for
their future development.
The Table-5.6 depicts impact of inflation on profit/loss of sample companies for the year 2006-07. From that
Table, it is clear that the total revenue was enhanced by Rs.32988.96 crores (10.86 percent) due to inflation.
The total revenue for the year under consideration was Rs.303716.50 crores as per HCB method which
increased to Rs.336705.46 crores as per CPP method. Similarly the figure for material cost which stood
Rs.197634.80 crores under HCB method was adversely affected to the extent of Rs.23231.99 crores (11.76
percent) due to inflation. However the material cost for the year as a percentage of total revenue was recorded
at 65.07 percent and 65.60 percent respectively under HCB method and CPP method.
Table 5.6
(Rs. in crores)
Particulars HCB Method CPP Method Change
% of
Change
Total Revenue 303716.50 100.00 336705.46 100.00 32988.96 10.86%
Other cost 51372.37 16.91 56952.31 16.91 5579.94 10.86%
Depreciation 8156.90 2.69 11992.59 3.56 3835.69 47.02%
Tax 15124.38 32.49 16559.05 36.66 1434.67 9.49%
Profit After Tax 31428.05 67.51 28615.37 63.34 -2812.68 -8.95%
Equity Dividend 10271.06 22.06 11245.35 24.89 974.29 9.49%
It is depicted from the Table that the cost of goods sold under CPP method was overstated by Rs.28811.93
crores (11.57 percent) as compared to HCB method. It is found to be at 81.99 percent and 82.51 percent of the
total revenue respectively under both the methods. The absolute figure of cost of goods sold was Rs.249007.17
crores only under HCB method but under the CPP method, it was Rs.277819.10 crores. The main factors
which attributed to this divergence in cost of goods sold were inflated material cost as well as other costs
attached to it. In the same way, depreciation was inflated by Rs.3835.69 crores (47.02 percent) under the CPP
method as against the HCB method for the year 2006-07. The figure of depreciation as per HCB method was
Rs.8156.90 crores (2.69 percent of the total revenue), which magnified to Rs.11992.59 crores (3.56 percent
total revenue) under CPP method due to inflation.
Taking above incidences into consideration, the profit before tax for the year 2006-07 was understated
by Rs.1378.01 crores (2.96 percent) under CPP method. The absolute figure of profit before tax was
Rs.46552.43 crores under HCB method which decreased to Rs.45174.42 crores under CPP method in 2006-07
due to purchasing power loss. Consequently the sample companies have paid more tax to the extent of 4.17
percent in real terms as revealed by HCB method. Table-4.6 also reveals that dividend paid was 22.06 percent
as per HCB method and 24.89 percent as per CPP method, adversely affecting the retained earnings by
Rs.3786.98 crores.
As it depicted in Table -5.7, the total revenue for the year 2007-08 as per HCB method was Rs.339848.84
crores, while as per CPP method it was Rs.359960.06 crores. Thus CPP total revenue was overstated by Rs.
20111.22 crores (5.92 percent) as compared to HCB total revenue due to inflation. On the contrary, the
material cost for the year under consideration was more or less same as percentage of total revenue under both
the methods of accounting, i.e. 65.10 percent and 65.44 percent. The material cost was Rs.221236.79 crores as
95

per HCB method and Rs.235559.79 crores as per CPP method. The deviation of Rs.14323.00 crores (6.47
percent) between two methods of accounting is attributable to the impact of inflation.
In the year 2007-08, cost of goods sold are found to be Rs.280467.63 crores in case of HCB method
and Rs.298295.72 crores in case of CPP method, which is the cause of overstatement of cost of goods sold of
sample companies to the extent of Rs.17828.09 crores (6.36 percent of total revenue). On the other hand, the
depreciation for the year was found to be 2.78 percent of total revenue as per HCB method and 3.86 percent
under the CPP method as a result of which it was reduced by Rs.4441.61 crores (47.02 percent) in HCB
method. This is certainly due to change price level or inflation.
Table 5.7
(Rs. in crores)
Total Revenue 339848.84 100.00 359960.06 100.00 20111.22 5.92%
Other cost 59230.84 17.43 62735.92 17.43 3505.08 5.92%
Depreciation 9445.44 2.78 13887.05 3.86 4441.61 47.02%
Purchasing Power Loss 0.00 0.00 -131.98 -0.04 -131.98 -
Tax 17278.93 34.60 17563.36 36.66 284.43 1.65%
Profit After Tax 32656.84 65.40 30345.92 63.34 -2310.92 -7.08%
Equity Dividend 10527.49 21.08 10700.78 22.34 173.29 1.65%
Due to above interaction between total revenue and cost of goods sold, the profit before tax was understated by
Rs.2026.49 crores (4.06 percent) even though the sample companies have recorded a purchasing power gain of
Rs.131.98 crores under CPP method. Again Table-5.7 clearly indicates that the sample companies had paid tax
up to 34.60 percent and 36.66 percent of their profit before tax respectively under HCB and CPP method. That
means the sample companies had paid excess tax of 2.06 percent of their profit before tax due to inflation in
the year. Consequently during the year 2007-08, profit after tax has been reduced by Rs.2310.92 crores (7.08
percent) under CPP method.
The dividend paid stood at 21.08 percent of profit before tax as per HCB method and 22.34 percent as
per CPP method, which clearly articulates additional payment in the year 2007-08 under the traditional HCB
method. All these truth were responsible for understatement of the retained earnings by Rs.2484.21 crores in
2007-08 in case of CPP method.
As revealed in Table-5.8, the total revenue for the year 2008-09 was Rs.401655.13 crores under HCB method
and reduced by Rs.7969.32 (1.98 percent) under CPP method due to change in price level. In the similar
manner, material cost was found Rs.272756.67 crores (67.91 percent) under HCB method and reduced by
Rs.2963.92 (1.09 percent) under CPP method due to change in price level.
Table 5.8
Rs in crores
Total Revenue 401655.13 100.00 393685.81 100.00 -7969.32 -1.98%
Raw Material Cost 272756.67 67.91 269792.75 68.53 -2963.92 -1.09%
Other cost 70408.42 17.53 69011.43 17.53 -1396.99 -1.98%
Cost of Goods Sold 343165.09 85.44 338804.18 86.06 -4360.91 -1.27%
Depreciation 10419.58 2.59 15319.26 3.89 4899.68 47.02%
Purchasing Power Loss 0.00 0.00 -54.18 -0.01 -54.18 -
96

Tax 14778.17 30.74 14778.17 37.30 0.00 0.00%
Profit After Tax 33292.29 69.26 24838.38 62.70 -8453.91 -25.39%
Equity Dividend 10371.96 21.58 10371.96 26.18 0.00 0.00%
The reduction of material and other costs was responsible understatement of cost of goods sold in the year
2008-09 under CPP method. The cost of goods sold as a percentage of total revenue was found to be 85.44
percent as per HCB method and 86.06 percent under CPP method as result of change in the level of prices. On
the other hand, the depreciation has been overstated by Rs.4899.68 crores (47.02 percent) under CPP method
as contrast to HCB method for the year 2008-09. It was recorded at 2.59 percent of the total revenue as per
HCB method and 3.89 percent of total revenue under CPP method. The absolute figure of depreciation was
Rs.10419.58 crores as per HCB method, which has inflated to Rs.15319.26 crores in the case of CPP method.
Owing to the above incidence, the profit before tax and profit after tax in the last year of study i.e.
2008-09 has been understated by Rs.8453.91 crores in CPP method as compared to HCB method. In the same
year, it was manifested that under CPP method, the profit before tax came down from Rs.48070.46 crores to
Rs.39616.55 crores and profit after tax from Rs.33292.29 crores to Rs.24838.38 crores even though the sample
companies had recorded purchasing power gains of Rs.54.18 crores under CPP method. The CPP method
adjustments have thus proved that historical profit is a myth. On the other hand, it is obvious from HCB profit
and loss account that the sample companies had paid tax @30.74 percent of profit before tax in the year 2008-
09 and 37.30 percent as per CPP profit and loss account. This indicates that sample companies have paid extra
tax in real terms than exposed by HCB method to the extent of 6.56 percent. Moreover, the sample companies
have also paid more dividends due to overstatement of profits leaving a smaller amount for Retained Earnings
in 2008-09.
5.6 SECTORAL ANALYSIS OF IMPACT OF INFLATION ON PROFIT/LOSS
In preceding paragraphs we have analyzed and interpreted the impact of inflation on financial performance of
sample companies operating in India. However inflation does not affect all the sectors of the economy in
parallel manner, it affects the different sectors differently. Therefore impact of inflation on financial
performance can be explained more visibly by dividing the sample companies into different sectors. For this
purpose the total sample companies have been divided into seven Sectors viz. Automobile, Cement, Chemical,
Fertilizer, Foods, Petroleum and Steel with varying degrees of debt exposure and capital intensity. The detail
analysis regarding impact of inflation on profit of different sectors has been discussed below.
Table 5.9
Impact of Inflation on PAT
Rs. in crores
Year 2004-05 2005-06 2006-07 2007-08 2008-09 Mean SD t- Value P- Value
Total Sample
HCB Method 23562.39 24656.12 31428.05 32656.84 33292.29 29119.14 4638.36

CPP Method 21122.97 22294.53 28615.37 30345.92 24838.38 25443.43 3970.00 2.6672 0.0349
Change -2439.42 -2361.59 -2812.68 -2310.92 -8453.91 -3675.70 2678.34

% of Change -10.35% -9.58% -8.95% -7.08% -25.39%

Automobile Sector
HCB Method 1739.47 2266.40 2392.10 2489.05 2460.38 2269.48 308.47
CPP Method 2456.42 3154.69 2930.72 2619.15 1798.76 2591.95 519.54 -0.6715 0.2750
Change 716.95 888.29 538.62 130.10 -661.62 322.47 618.05
% of Change 41.22% 39.19% 22.52% 5.23% -26.89%
Cement Sector
HCB Method 213.16 451.02 1575.56 2150.13 2036.56 1285.29 900.29
CPP Method -867.24 -479.90 846.06 1553.15 1280.80 466.57 1079.64 10.9725 0.0008
Change -1080.40 -930.92 -729.50 -596.98 -755.76 -818.71 188.52
97

% of Change -506.85% -206.40% -46.30% -27.76% -37.11%
Chemical Sector
HCB Method 480.99 591.72 658.94 714.53 842.62 657.76 135.10
CPP Method 285.20 466.36 541.36 677.67 634.67 521.05 155.30 3.4879 0.0199
Change -195.79 -125.36 -117.58 -36.86 -207.95 -136.71 68.97
% of Change -40.71% -21.19% -17.84% -5.16% -24.68%
Fertilizer Sector
HCB Method 316.23 280.86 379.43 375.54 243.59 319.13 59.16
CPP Method -157.42 -28.27 127.78 192.86 23.70 31.73 136.59 8.9954 0.0016
Change -473.65 -309.13 -251.65 -182.68 -219.89 -287.40 113.98
% of Change -149.78% -110.07% -66.32% -48.65% -90.27%
Food Sector
HCB Method 19.27 16.62 22.57 26.15 21.78 21.28 3.58
CPP Method -11.24 5.16 10.43 17.07 0.87 4.46 10.66 5.1761 0.0060
Change -30.51 -11.46 -12.14 -9.08 -20.91 -16.82 8.87
% of Change -158.31% -68.96% -53.81% -34.71% -95.99%
Petroleum Sector
HCB Method 17287.62 17691.02 22141.08 22472.58 22954.53 20509.37 2775.71
CPP Method 17335.88 16713.64 20410.19 20554.48 17142.39 18431.31 1886.49 2.4015 0.0479
Change 48.26 -977.38 -1730.89 -1918.10 -5812.14 -2078.05 2226.11
% of Change 0.28% -5.52% -7.82% -8.54% -25.32%
Steel Sector
HCB Method 3505.65 3358.48 4258.37 4428.86 4732.83 4056.84 597.39
CPP Method 2081.38 2462.85 3748.83 4731.55 3957.18 3396.36 1097.96 1.7406 0.0900
Change -1424.27 -895.63 -509.54 302.69 -775.65 -660.48 632.93
% of Change -40.63% -26.67% -11.97% 6.83% -16.39%
The Table-5.9 epitomizes impact of inflation on profit after tax (PAT) of sample companies from 2004-05 to
2008-09. From the Table, it is evident that the figures of profit after tax of sample companies in case of CPP
Method is understated in all the years of study from 2004-05 to 2008-09 as compared to HCB method. It was
lowest (Rs.2310.92 crores) in the year 2007-08 and highest (Rs.8453.91 crores) in 2008-09. The reason of such
differences is mainly due to increase in material cost, depreciation and purchasing power loss on monetary
items. The year-wise deviations of PAT stuck between two accounting methods expressed in trend percentage
are found to be 10.35 percent, 9.58 percent, 8.95 percent, 7.08 percent and 25.39 percent respectively from the
year 2004-05 to 2008-09. Due to this, the sample companies have paid more tax and more dividend and kept
lesser retained earnings. As the p value is 0.0349, it can be said that the impact of inflation on profitability of
sample companies is significant difference for all years under study. So the analyses clearly suggest that there
is a significant difference between reported and inflated financial performance. This has clear that our Null
Hypothesis (H
01
), there is no significant difference between reported and inflated financial performance is
rejected. Therefore Alternative Hypothesis (H
a1
) is accepted which is there is a significant difference between
reported and inflated financial performance.
From Table-5.9, it can be observed that PAT in Automobile Sector has been understated in the first
four years of study, i.e. from 2004-05 to 2007-08 and overstated in the last year, i.e. 2008-09 under HCB
method. The year-wise underestimation in PAT from 2004-05 to 2007-08 are respectively Rs.716.95 crores
(41.22 percent), Rs.888.29 crores (39.19 percent), Rs.538.62 crores (22.52 percent), Rs.130.10 crores (5.23
percent). The reason behind such understatement of profit is mainly due to the proportionate increase in sales
as compared to other costs and purchasing power gains on monetary items. However, there is an overstatement
in the last year of study of Rs.661.62 crores (26.89 percent). The p-value is calculated to be 0.2750, which
indicates that impact of inflation for Automobile Sector on financial performance is insignificant.
98

Conversely the PAT for Cement Sector is being deflated in case CPP method as compare to HCB method in all
the years of study varying between Rs.596.98 crores (lowest) in 2007-08 and Rs.1080.40 crores (highest) in
2004-05. However, the percentage of difference in HCB and CPP methods are 506.85 percent, 206.40 percent,
46.30 percent, 27.76 percent and 37.11 percent from 2004-05 to 2008-09 respectively. The profitability of
Cement Sector is significantly difference between the two accounting methods, as the p-value has come
0.0008.
The PAT for Chemical Sector has understated under CPP method for all the years of study from 2004-05 to
2008-09. The percentage of understatement varied from 5.16 percent (lowest) in 2007-08 to 40.71 percent
(highest) in 2004-05. The absolute figures of profit after tax are Rs.195.79 crores, Rs.125.36 crores, Rs.117.58
crores, Rs.36.86 crores, and Rs.207.95 crores from 2004-05 to 2008-09 respectively. In the case of Chemical
Sector the change in financial performance of HCB significantly differs from that of CPP, as p value is 0.0199.
PAT for Fertilizer Sector has similarly performed as per Cement and Chemical Sectors. It has recorded lower
in case of CPP method as compared to HCB in all the years of study (from 2004-05 to 2008-09). It was lowest,
i.e. Rs.182.68 crores in the year 2007-08 and highest Rs.473.65 crores in the first year of year of study i.e.,
2004-05. The year-wise deviations in PAT between two accounting methods expressed in percentage are found
to be 149.78, 110.07, 66.32, 48.65 and 90.27 from the year 2004-05 to 2008-09. However as p-value of
Fertilizer Sector is 0.0016, so change in profitability is significant.
Over again PAT for Food Sector was found to be modest under CPP method in the entire period of study from
2004-05 to 2008-09. It has recorded highest deviation of Rs.30.51 crores in 2004-05 and lowest of Rs.9.08
crores in the year 2007-08. The percentage of deviation in PAT are found to be 158.31 percent in 2004-05,
68.96 percent in 2005-06, 53.81 percent in 2006-07, 34.71 percent in 2007-08 and 95.99 percent in the last
year of study i.e., 2008-09. The change of financial performance in this Sector is significant as p-value for
Food Sector has come 0.0060.
In case of CPP method of accounting, the PAT of Petroleum Sector has been understated as compared to HCB
method for the entire study period except for the first year. It has recorded a highest understatement (25.32
percent) in 2008-09 and lowest of (5.52 percent) in 2005-06. This Sector has recorded an overstatement of
PAT in CPP method of Rs.48.26 crores (0.28 percent) in the first year of study i.e. 2004-05. The p-value of
Petroleum Sector is found to be 0.0479, which is less than 0.05, thus change in profitability is significantly
different.
The PAT of Steel Sector under HCB method understated throughout the period of study except for the year
2007-08 and the percentage of understatement are 40.63 in 2004-05, 26.67 in 2005-06, 11.97 in 2006-07 and
16.39 in the last year of study. The absolute figure of understatement profit recorded highest Rs. 1424.27
crores and lowest Rs.509.54 crores. However, it has recorded an exaggerated PAT of Rs.302.69 crores (6.83
percent) in the year 2007-08. In the case of Steel Sector, the impact of inflation on financial performance is not
insignificant because the p-value has come 0.0900.
The above findings give a clear picture of impact of inflation on financial performance of different industrial
Sectors under our study. The calculated p-value for Automobile and Steel Sectors found respectively to be
0.2750 and 0.0900 indicates that impact of inflation on their financial performance is insignificant among the
two accounting methods. On the other hand, there is significant difference in financial performance of all other
Sectors: Cement, Chemicals, Fertilizers, Food and Petroleum under two methods of accounting as their p-
values stood respectively at 0.0008, 0.0199, 0.0016, 0.0060 and 0.0479. Thus our second Null Hypothesis
(H
02
): Inflation affects all the industrial sectors uniformly is rejected and consequently its Alternative
Hypothesis (Ha2) is accepted.
5.7 IMPACT OF INFLATION ON PROFIT AFTER TAX (PAT)
Table-5.10 indicates the statistical result of PAT by descriptive statistics and t-test. Descriptive statistics
provides simple summaries about the sample and about the observations that have been made. The mean of
PAT is found to be higher under HCB Method as compared to that of CPP method, leading to the conclusion
that profitability position of sample companies has been affected damagingly by inflation under the period of
the study. On the other hand, lower standard deviation in HCB as compared to that of CPP clearly indicates
99

former is more consistent than the later. Even though value of kurtosis is found to be more than 3 under both
the methods, it is higher in CPP as compared to HCB. Therefore it can be concluded that the PAT under the
CPP method is more peaked than that of the HCB method. The correlation value of 0.9867 indicates that there
is higher degree of positive correlation between HCB and CPP method. The p-value of 0.0123, which is less
than 0.05, indicates a significant difference in the value of PAT between HCB and CPP methods at 5 percent
level of significance.

Table 5.10
Statistical Results of Profit After Tax (PAT)
Particulars HCB Method CPP Method
Mean (Rs.) 693.3131 605.7955
Standard Error 370.9975 415.8843
Standard Deviation 2404.3385 2695.2381
Sample Variance 5780843.5086 7264308.3618
Kurtosis 33.2689 34.9394
Skewness 5.5730 5.7419
Range 15213.0900 17749.5217
Minimum(Rs.) -115.4980 -808.7356
Maximum(Rs.) 15097.5920 16940.7861
Sum(Rs.) 29119.1500 25443.4092
Count 42 42
Confidence Level (95.0%) 749.2446 839.8953
Pearson Correlation 0.9867
Hypothesized Mean Difference 0.0000
Df 40
t Stat 2.3350
P(T<=t) one-tail 0.0123
t Critical one-tail 1.6839
P(T<=t) two-tail 0.0246
t Critical two-tail 2.0211
This concludes that our Null Hypothesis (H
01
) is rejected and the Alternative Hypothesis (H
a1
) is accepted as
there is a significant difference between reported and inflated financial performance.
5.8 IMPACT OF INFLATION ON RETAINED EARNINGS
The results of descriptive statistics and t-test for retained earnings under both HCB and CPP methods are
elaborated in Table-5.11.
Table 5.11
Statistical Results of Retained Earnings

Particulars HCB Method CPP Method
Mean(Rs.) 459.7393 349.6842
Standard Error 218.4572 248.7392
Standard Deviation 1415.7643 1612.0145
Sample Variance 2004388.5131 2598590.7007
Kurtosis 28.1730 30.6164
Skewness 5.0588 5.2749
Range 8725.1440 10949.4915
Minimum(Rs.) -115.4980 -1129.1676
100

Maximum(Rs.) 8609.6460 9820.3238
Sum(Rs.) 19309.0520 14686.7355
Count 42 42
Confidence Level (95.0%) 441.1832 502.3391
Pearson Correlation 0.9608
Hypothesized Mean Difference 0.0000
Df 40
t Stat 2.4077
In case of retained earnings the mean value under HCB method is more than that of CPP method. The standard
deviation of HCB is less than CPP, which reveals that there is less consistency in CPP as compared to HCB.
Also, there is a high degree of correlation between HCB and CPP retained earnings. Skewness of retained
earnings found to be positive both in case of HCB and CPP method. The p-value (0.0104) shows a significant
difference between HCB and CPP with respect to retained earnings. The factors influencing the inflation were
tested for the degree of relationship among them to find whether the fluctuation in one factor affects the others
or otherwise. For this purpose, the factors were measured for bi-variate correlation with respect to each other
and their coefficients were given in the above Table. From the Table, it is clear that there is a significant
correlation existing between the factors of retained earnings of HCB and CPP.
5.9 SUMMARY
From the above discussion, it is clear that due to inflation the financial performance of sample companies has
been understated, resulting additional payment of tax and dividend, but reduction in shareholders funds by
dropping retained earnings. Moreover, the dismal performance revealed under the CPP method points towards
the efficiency of the management in fighting against inflation. Whatever view one takes, no one can deny that,
but inflation has taken its toll. The reason for overstatement of corporate profitability under HCB method may
be attributed to undervaluation of material cost and depreciation. The performance which otherwise appears to
be quite good, turned out to be very dismal, when adjustments for current purchasing power of rupee are made.
The CPP method adjustments have thus proved that historical profitability is a fairy story.

* * *

101

Impact of Inflation on Major Financial Ratios

6.1 INTRODUCTION
Traditionally, historical cost based accounting information about the operations of companies has ignored the
effects of inflation. But the users of financial information, such as current and potential investors, creditors,
lenders, suppliers, customers, employees, government authorities and public, need relevant and reliable
information about the financial position, performance and changes in the financial position of firms for making
economic decisions. Inflation, on the other hand, distorts financial information by creating an impact on the
firm's operational and financial results. In a hyperinflationary economy, reporting of operating results and
financial position without restatement is misleading and thus is not useful (International Accounting Standards
29, code 2). Therefore, it is necessary that financial statements must reflect the true picture and are free from
the negative effects of inflation. Even though inflation accounting has long been debated, a necessary attention
is not paid towards in providing effects of inflation on financial ratios of businesses. Under this backdrop, this
chapter attempts to find out the results of inflation on major financial ratios of sample companies by
considering 10 ratios categorized under three groups as presented in Table-6.1.
Table 6.1
Ratios Used in the Study
Liquidly Ratios Profitability Ratios
Current Ratio Gross Profit Margin
Quick Ratio Operating Profit Margin
Activity Turnover Ratios Net Profit Margin
Debtor Turnover Ratio Return on Investment
Creditor Turnover Ratio Dividend Payout Ratio
Inventory Turnover Ratio
The t-test is used to compare the values of the means from two groups. The t-test has been performed because
the variances of two groups are assumed to be unequal.
6.2 IMPACT OF INFLATION ON LIQUIDITY RATIOS
These ratios are calculated to comment upon the short-term paying capacity of a firm or a concerns ability to
meet its current obligation. The important liquidity ratios are current ratio and quick ratio. The Table -6.2
shows the Liquidity Ratios (current ratio and quick ratio) of sample companies from the year 2004-05 to 2008-
09 under both the methods: HCB and CPP Method.
Table 6.2
Liquidity Ratios
Year
Current Ratio Quick Ratio
HCB Method CPP Method HCB Method CPP Method
2004-05 1.26 1.32 1.03 1.03
2005-06 1.31 1.35 1.05 1.05
2006-07 1.36 1.39 1.13 1.13
2007-08 1.63 1.64 1.33 1.33
2008-09 1.31 1.31 1.10 1.10
Chapter
6
102

Current Ratio
Current ratio is a measure of general liquidity and is used to make the analysis of a short-term financial
position or liquidity of an organization. It represents the margin of safety. It is the relationship between the
current assets and current liabilities. The relationship has been computed by dividing current assets with the
current liabilities. A review on the above Table reveals that current ratio of sample companies has shown an
increasing trend in the entire study period except the last year i.e., 2008-09. The absolute value of this ratio
was 1.26 in 2004-05, which increased to 1.63 in 2007-08; but then declined to 1.31 in 2008-09 under HCB
Method. Under the CPP Method, the ratio has also shown the similar trend, it gone up from 1.32 in 2004-05 to
1.64 in 2007-08 and then came down to 1.31 in the last year. Hence, the current ratios of sample companies are
higher in case of CPP Method as compared to HCB Method in all the years except for the last year (2008-09),
when the ratio stood one and the same, (1.31:1) under both the methods. However, the improvement of current
ratio under CPP Method is very nominal, because inflation has affected non-monetary current assets and non-
monetary current liabilities in the same proportion. Only the inventory holding has registered a higher growth
than the inflation level. Hence it recorded an expansion under CPP Method.
Quick Ratio
Quick ratio is also known as Acid Test Ratio or Liquid Ratio. It is a fairly stringent measure of liquidity. It is
based on those current assets, which are highly liquid. It is the relationship between the quick assets and
current liabilities. It has been calculated by dividing quick assets by the current liabilities. Inventories are
excluded from the current assets to find out quick assets. Table-6.2 reveals that quick ratios of sample
companies remains unchanged under both the methods, HCB and CPP; for all the year of study i.e.; from
2004-05 to 2008-09. It is because of the fact that, the inflation has affected non-monetary current assets and
non-monetary current liabilities in the same proportion as the inventories have been excluded from current
assets to get quick assets.
Statistical Outcome of Liquidity Ratios
Table-6.3 summarizes the results of Liquidity Ratios under HCB method as well as CPP method from 2004-05
to 2008-09 by the help of descriptive statistics and t-test. Descriptive statistics and t-test for the current ratio
provide that mean of reported current ratio is less as compared to that of the inflated; leading to the conclusion
that liquidity position of sample companies is better under CPP method. On the contrary, lower standard
deviation for reported current ratio as compared to inflated current ratio clearly indicates that former is more
consistent than the latter. Even though value of kurtosis is found to be more than 3 under both the methods, it
is higher in CPP as compared to HCB method. Therefore it can be concluded that the inflated current ratio is
more peaked than that of the reported current ratio. Yet again, the correlation value is 0.9998 represents high
degree of positive correlation between both the methods. The p-value of 0.0188, which is less than 0.05,
indicates a significant difference in the value of current ratio between HCB and CPP methods at 5 percent level
of significance.
Table 6.3
Statistical Results of Liquidity Ratios
Particulars
Current Ratio Quick Ratio
HCB Method CPP Method HCB Method CPP Method
Mean 2.1681 2.2620 1.2038 1.2038
Standard Error 0.4737 0.5162 0.1117 0.1117
Standard Deviation 3.0700 3.3454 0.7239 0.7239
Sample Variance 9.4249 11.1917 0.5241 0.5241
Kurtosis 34.5451 35.3145 1.2978 1.2978
Skewness 5.6496 5.7361 1.2626 1.2626
Range 20.2625 22.1101 3.1082 3.1082
Minimum 0.4701 0.4846 0.3210 0.3210
Maximum 20.7325 22.5947 3.4292 3.4292
Sum 91.0582 95.0051 50.5592 50.5592
103

Count 42 42 42 42
Confidence Level (95.0%) 0.9567 1.0425 0.2256 0.2256
Pearson Correlation 0.9998 1.0000
Hypothesized Mean Difference 0.0000 0.0000
Df 40 40
t Stat -2.1502
Hence in the case of Current Ratio our Null Hypothesis (H
03
) is rejected as there is a significant difference
between two accounting methods. Consequently our Alternative Hypothesis (H
a3
) is accepted.
The Descriptive statistics and t-test analysis for the quick ratio in Table-6.3 reveals that the mean, standard
deviation, kurtosis, skewness and all other findings are the same under both the accounting methods (HCB and
CPP). It is because inventory is taken away from current assets for finding out the quick assets, the result
indicates the reported and inflated quick ratios are identical.
6.2 IMPACT OF INFLATION ON PROFITABILITY RATIOS
This group of ratios measures the overall performance and effectiveness of the firm. The main profitability
ratios include Gross Profit Margin, Operating Profit Margin, Net Profit Margin, Return on Investment and
Dividend Payout Ratio etc. The Table-6.4 shows the results profitability ratios under HCB method and CPP
method form 2004-05 to 2008-09.
Table 6.4
Profitability Ratios
Year
Gross Profit
Margin (%)
Operating Profit
Margin (%)
Net Profit
Margin (%)
Return on
Investment (%)
Dividend Payout
Ratio (%)
HCB CPP HCB CPP HCB CPP HCB CPP HCB CPP
2004-05 29.18 28.74 18.47 17.23 11.24 8.28 52.89 44.26 36.60 60.78
2005-06 22.99 22.64 15.62 14.36 9.80 7.61 45.16 36.31 37.54 54.63
2006-07 23.51 22.97 15.42 13.90 10.35 8.69 46.18 35.43 32.68 55.47
2007-08 23.60 23.25 15.24 13.62 9.61 8.62 38.49 29.56 32.24 70.47
2008-09 22.87 22.23 13.67 11.53 8.29 6.45 48.58 31.23 31.15 47.13
Gross Profit Margin
Gross profit margin measures the relationship of gross profit with sales and indicates the margin left after
meeting manufacturing costs. It is clear from the Table-6.4 that the gross profit margin of sample companies
for both the method i.e. HCB and CPP is fluctuating over the five years of study from 2004-05 to 2008-09. It
recorded a high of 29.18 percent and 28.74 percent in 2004-05 and a low of 22.87 percent and 22.23 percent in
2008-09 under HCB Method and CPP Method respectively. During the entire period of study, the Gross profit
margin under HCB Method has witnessed slightly higher trend as compared to CPP Method. Consequently the
inflation has brought down the production efficiency of the sample companies.
Operating Profit Margin
Operating Profit Margin shows the relationship between operating profit and sales. The above Table it evident
that under HCB method, the operating profit margin of sample companies showed a declining trend in the
period of study. The value of this ratio was 18.47 percent in 2004-05 and reduced to 13.67 percent in the last
year of study. Similarly, under the CPP method the ratio has gone down from 17.23 percent to 11.53 percent
over the same period. Furthermore, it is apparent from the Table that volume of Operating Profit Margin is
higher in HCB Method in all the years under study as compared to CPP Method without any exception. It
104

gives good reason to conclude that inflation has dwindled for the operating efficiency of the sample
companies.
Net Profit Margin
Net Profit Margin establishes a relationship between Net Profit (Profit after Tax) and Sales and indicates the
overall efficiency of the management in manufacturing, selling, administrative and other activities of the
organization. The Table-6.4 points out that net profit margin of sample companies has fallen down from 11.24
percent in 2004-05 to 8.29 percent in 2008-09 under HCB method, whereas in case of CPP method it dropped
from 8.28 percent to 6.45 percent during same period. It can also be observed that in all the years of study
there is a wide gap in net profit margin between the two methods. The variation between net profit margins
(between HCB and CPP) was highest (2.96 percent) in the year 2004-05 and lowest (0.99 percent) in the year
2007-08. Thus the inflation has badly damaged the overall profitability position of the sample companies
during the period of study.
Return on Investment
Return on Investment (ROI) is one of the most important ratios used for measuring the overall efficiency of the
organization, as the objective of organization is to maximize its earnings. From the Table it is apparent that
ROI has a declining trend in HCB method during the study period except the last year 2008-09. The value of
this ratio varies between 52.89 percent (2004-05) and 38.49 percent (2007-08). Similarly, ROI under CPP
method has a declining trend in all the years of study except the year 2008-09. The absolute figures of this
ratio decreased from 44.26 percent to 31.23 percent over the span of five years i.e. from 2004-05 to 2008-09
after recorded a low of 29.56 percent in 2007-08. While comparing the two accounting methods, it is clear that
ROI is much higher in case HCB, than CPP in all the years under study without any exception. The
discrepancy between two methods (HCB and CPP) is highest (17.35 percent) in the year 2008-09 and lowest
(8.63 percent) in the year 2004-05. Thus it can be concluded that ROI of the sample companies has been badly
affected by inflation during period under our study.
Dividend-Payout Ratio
It is the percentage of earnings paid to shareholders in dividends and provides an idea of how well earnings
support the dividend payments. More mature companies tend to have a higher payout ratio. It is observed from
the Table-6.4 that the dividend payout ratio in HCB Method has gone down from 36.60 percent to 31.15
percent during the study period i.e. 2004-05 to 2008-09. But in the case of CPP method the dividend payout
ratio fluctuated in between 70.47 percent (highest) and 47.13 percent (lowest) during the period of study.
Table-5.4 also reveals that HCB dividend payout ratio is lower than CPP dividend payout ratio throughout the
period of study to a large extent. It means the sample companies have kept less profit and distributed more to
the shareholders as dividend. It definitely affects the net worth of the sample companies.
Statistical Results of Profitability Ratios
Generally, profitability ratios measure the financial efficiency of firms in different ways. The descriptive
statistics as well as results of t-test of profitability ratios viz. gross profit margin, operating profit margin, net
profit margin and return on investment both under HCB and CPP methods from 2004-05 to 2008-09 is given
below in Table -6.5.
Table 6.5
Statistical Results of Profitability Ratio
Particulars
Gross Profit
Margin
Operating Profit
Margin
Net Profit
Margin
Return on
Investment
HCB CPP HCB CPP HCB CPP HCB CPP
Mean 0.3348 0.3232 0.1069 -0.0617 0.0618 0.0032 0.4169 0.1551
Standard Error 0.0404 0.0402 0.0190 0.0518 0.0159 0.0244 0.2019 0.0496
St. Deviation 0.2616 0.2606 0.1231 0.3359 0.1030 0.1581 1.3087 0.3215
Sample Variance 0.0684 0.0679 0.0152 0.1128 0.0106 0.0250 1.7127 0.1034
Kurtosis -0.8664 -0.8272 2.4558 2.4587 8.4900 18.0787 40.1024 14.1382
Skewness 0.4850 0.5277 0.0393 -1.7679 - -3.5369 6.2678 3.1014
105

1.8331
Range 0.9408 0.9449 0.7307 1.4418 0.6507 1.0989 8.7274 2.0866
Minimum -0.0928 -0.0995
-
0.2823
-0.9492
-
0.3915
-0.8194 -0.1196 -0.3532
Maximum 0.8480 0.8455 0.4484 0.4926 0.2593 0.2794 8.6078 1.7334
Sum 14.0618 13.573 4.4906 -2.5905 2.5941 0.1362 17.5090 6.5152
Count 42 42 42 42 42 42 42 42
Confidence Level (95.0%) 0.0815 0.0812 0.0384 0.1047 0.0321 0.0493 0.4078 0.1002
Pearson Correlation 0.9953 0.5010 0.9212 0.5676
Hypothesized Mean Difference 0.0000 0.0000 0.0000 0.0000
Df 40 40 40 40
T Stat 2.9901 3.7177 5.1103 3.4662
P(T<=t) one-tail 0.0024 0.0003 0.0000 0.0006
T Critical one-tail 1.6839 1.6839 1.6839 1.6839
P(T<=t) two-tail 0.0048 0.0006 0.0000 0.0013
T Critical two-tail 2.0211 2.0211 2.0211 2.0211
The above Table clearly shows that mean value of gross profit margin is higher in the reported (HCB) method
as compared to inflated (CPP) method for sample companies over the period of study (from 2004-05 to 2008-
09), meaning thereby reported gross profit margin has performed better than inflated gross profit margin. But
the HCB gross profit margin has more variation than that of the CPP, since both standard deviation as well as
variance shows higher value in HCB method than CPP method. Though, the distribution of gross profit margin
are found to be positively skewed in both the methods, the CPP gross profit margin is little bit higher skewed
than that of the HCB gross profit margin. These ratios are observed to be platykurtic by nature i.e. it is more
flat on HCB method. The p-value of 0.0024 in case of gross profit margin indicates significant difference in
the absolute value of gross profit margin between reported and inflated at 5% degree of significance.
In case of operating profit margin, the mean value under CPP method is less than the HCB method, disclosing
thereby operating profit margin has reported at a higher value in comparison to actual operating profit margin
adjusted to inflation. The standard deviation of reported operating profit margin is less than inflated which
reveals that there is less variation in reported operating profit margin in comparison to inflated. Skewness of
operating profit margin found to be positive in case of HCB method, where as it is negative in case of CPP
method. So HCB operating profit margin is positively skewed and for CPP it is negatively skewed. The p-
value shows a significant difference between reported and inflated with respect to operating profit margin. The
factors influencing the inflation were tested for the degree of relationship among them to find whether the
fluctuation in one factor affects the other factors. To identify the same, the factors were measured for bi-variate
correlation with respect to each other and their coefficients were given in the above Table. From the Table, it is
clear that there is a significant correlation existing between the factors of operating profit margin of reported
and inflated.
Similarly, the mean of net profit margin is higher in case of HCB method as compared to CPP method. The
variation of reported net profit margin is less than the inflated net profit margin as both standard deviation and
variance is found to be less in HCB method. Here too there is a significant difference between reported and
inflated net profit margin as the p-value is less than 0.05. However the skewness under both HCB and CPP
method was found to be negative. So it can be said that net profit margins are negatively skewed. Net profit
margins under both the methods experimented to be leptokurtic by nature i.e. they are peaked.
From the Table-6.5, it is evidenced that Return on Investment (ROI) has executed the same trend like that of
gross profit margin, operating profit margin and net profit margin. The mean value and the standard deviation
of Return on Investment (ROI) under HCB method is found higher than that of CPP method. Therefore there is
less consistency in case of reported return on investment. The value of p shows that there is a significant
difference between reported and inflated return on investment among the two accounting methods (HCB and
CPP) for the study period. While in the case of skewness both reported and inflated return on investment are
positively skewed and HCB return on investment is higher than the CPP return on investment. Both the
reported and inflated returns on investment are leptokurtic by nature. The HCB return on investment is more
peaked than the return on investment of CPP.
106

Table 6.5 shows the results of the profitability ratios, where it can be observed that the entire profitability
ratios have dropped significantly. This shows that inflation adjustment leads to impact upon the shareholders
funds. The 3rd hypothesis does suggest no significant difference between the ratios of two groups (HCB and
CPP). But the p-values of 0.0024, 0.0003, 0.0000 and 0.0006 respectively for gross profit margin, operating
profit margin, net profit margin and return on investment shows that there is significant difference between
reported and inflated profitability ratios. Therefore our Null Hypothesis (H
03
): there is no significant
difference in reported and inflated financial ratios is rejected accepting the alternative hypothesis (H
a3
).
6.3 IMPACT OF INFLATION ON ACTIVITY RATIOS
Activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed.
These ratios are also called turnover ratios because they indicate the speed at which the assets are being turned
over into sales.
Table 6.6
Activity Ratios
Year
Creditor
Turnover Ratio
Debtor
Turnover Ratio
Inventory
Turnover Ratio
HCB CPP HCB CPP HCB CPP
2004-05 3.40 4.23 21.57 26.61 12.51 12.18
2005-06 3.77 4.50 21.79 25.75 11.44 11.22
2006-07 3.85 4.34 24.08 26.69 12.12 11.74
2007-08 3.76 4.06 23.97 25.39 11.89 11.65
2008-09 3.90 3.93 26.40 25.87 13.97 13.37
The Table-6.6 elaborates the activity ratios; viz. Debtor Turnover Ratio, Creditor Turnover Ratio and
Inventory Turnover Ratio of sample companies of both under HCB Method as well as CPP Method for the
study period i.e. from 2004-05 to 2008-09. The trend of these ratios is discussed in the upcoming paragraphs.
Creditors Turnover Ratio
In the course of business operations, an organisation has to make credits purchases and incur short-term
liabilities. A supplier of goods i.e., creditors are naturally interested in finding out how much time the
organisation is likely to take to repay its trade creditors. Higher creditor turnover ratio is good because it
decreases the average payment period. It depicted from the Table that, HCB creditor turnover ratio of sample
companies has increased from 3.40 times to 3.90 times during 2004-05 to 2008-09, whereas CPP creditor
turnover ratio has turned down from 4.23 times to 3.93 times over the years after recording a high of 4.50
times in 2005-06. Over again while comparing this ratio under both the methods; it is revealed that CPP
creditors turnover ratios are higher than that of HCB for all the years except the year 2008-09. It indicates that
the suppliers have been treated in a better manner under CPP method as compared to HCB method.
Debtor Turnover Ratio
Debtor turnover ratio indicates the velocity of debt-collection of an organization. In simple words, it indicates
the number of times debtors (receivables) are turned over during a year. Generally a high turnover ratio is an
indicator of efficiency in management of debtors to sales. By looking into the Table, it can observed that in
case of HCB method the debtor turnover of sample companies has improved over the study period where as in
case of CPP method it was worse during the period. The debtor turnover ratio found 21.57, 21.79, 24.08, 23.97
and 26.40 times from 2004-05 to 2008-09 respectively in HCB method but, in the case of CPP method it is
26.61, 25.75, 26.69, 25.39 and 25.87 times correspondingly over the study period. Moreover by comparison, it
is found that HCB debtor turnover ratios are smaller as compared to that of CPP for all the years of study i.e.
2004-05 to 2008-09. That means the inflation has improved the efficiency in debtors management of sample
companies during the period of our study.
Inventory Turnover Ratio
An Organization has to maintain a minimum level of inventory so as to be able to meet requirements of the
business, but the level of inventory should neither too high nor too low. High inventory levels are unhealthy
because they represent an investment with a rate of return of zero. It also opens the company up to trouble
should prices begin to fall. By looking at the Table the inventory turnover ratio of sample companies in case of
107

HCB method has varied over the study period from 2004-05 to 2008-09 after recording a high of 13.97 times
in 2008-09 and low of 11.44 times in 2005-06. But in case of CPP inventory turnover ratio has come down
from 12.18 times during 2004-05 to 11.22 times during 2005-06 and finally it reached to 13.37 times in 2008-
09. In the assessment of HCB inventory turnover ratio and CPP inventory ratio, it is clearly observed that
inventory turnover ratios are higher in the case of HCB method as compared to CPP method for all the years of
study i.e. from 2004-05 to 2008-09. So it concluded that inventory turnover ratio of sample companies has
suffered in the inflationary condition.
Statistical Results of Activity Ratios
Activity ratio is a very important tool to measure the velocity of current assets of an organization and includes
generally Creditor Turnover Ratio, Debtor Turnover Ratio and Inventory Turnover Ratio. The details of
descriptive statistics and t-test of these ratios for sample companies under HCB method as well as CPP method
are given away in Table 6.7 for the period under study.
It is observed from the Table 6.7 that the creditor turnover ratio has performed better in the case of
CPP method as compared to HCB method, which indicates creditors are treated well in case of inflationary
condition. The standard deviation as a measure of variation is found to be higher in CPP creditor turnover ratio
than that of the HCB. Again, the creditor turnover ratio under both the methods is found to be positively
skewed, but it is more skewed under CPP method than the HCB method. The ratio is experiential to be
platykurtic by nature i.e. it is more flat in case of HCB method. As the p-value comes to 0.0000, so it is
concluded that there is significant difference in creditor turnover ratio under both the accounting methods
under discussion.
Table-6.7
Statistical Results of Activity Ratios
Particulars
Creditor
Turnover Ratio
Debtor
Turnover Ratio
Inventory
Turnover Ratio
HCB CPP HCB CPP HCB CPP
Mean 3.7426 4.0907 22.9793 25.1120 11.4766 11.1810
Standard Error 0.4393 0.4825 3.6672 3.9989 1.2040 1.1668
Standard Deviation 2.8469 3.1267 23.7664 25.9161 7.8027 7.5617
Sample Variance 8.1050 9.7761 564.8427 671.6457 60.8817 57.1790
Kurtosis -0.1930 -0.0783 5.3379 5.2297 3.1295 3.0977
Skewness 0.7862 0.8134 2.2205 2.2088 1.5887 1.5714
Range 10.4887 11.7801 109.8264 118.0484 37.5967 36.5980
Minimum 0.3097 0.3355 1.6000 1.7463 0.4390 0.4199
Maximum 10.7984 12.1156 111.4264 119.7948 38.0357 37.0179
Sum 157.1911 171.8101 965.1307 1054.7024 482.0173 469.6033
Count 42 42 42 42 42 42
Confidence Level (95%) 0.8872 0.9743 7.4061 8.0760 2.4315 2.3564
Pearson Correlation 0.9997 0.9998 0.9994
Hypothesized Mean
Difference
0.0000 0.0000 0.0000
Df 40 40 40
t Stat -7.5652 -6.0256 5.5831
P(T<=t) one-tail 0.0000 0.0000 0.0000
t Critical one-tail 1.6839 1.6839 1.6839
P(T<=t) two-tail 0.0000 0.0000 0.0000
t Critical two-tail 2.0211 2.0211 2.0211
Similarly, it is observed from the Table-6.7 that the mean value of debtor turnover ratio is superior under the
CPP method as compared to that of HCB method but having more variations (as the standard deviation is
found to be higher). Thus it can be said that inflation has favorable impact debtors of the sample companies
during the period of study. Yet again the ratio is found to be positively skewed and leptokurtic under both the
methods of accounting, but more skewed as well as more peaked under the HCB method than CPP. Like the
108

creditor turnover ratio, there is significant difference in values of this ratio under both the accounting methods
since value of p is found to zero.
On the contrary, The mean value, standard deviation as well as variance of inventory turnover ratio is found to
be higher in HCB method as compared to the CPP method implying that the production efficiency of sample
companies has suffered to greater extent due to inflation, but it is inconsistent during the period of study. Here
also, like other turnover ratios, we found the inventory turnover ratio is positively skewed under both the
methods and marginally more peaked under HCB method. There is also significant difference in values of
inventory turnover ratio under both the accounting methods as evidenced from the p-value.
As the p-values for all three activity ratios (Creditor Turnover Ratio, Debtor Turnover Ratio and Inventory
Turnover Ratio) are found to be equal (0.0000), there is a significant difference in between two accounting
methods. For this reason our Null Hypothesis (H
03
) for Activity Ratios is discarded and the Alternative
Hypothesis (H
a3
) is accepted.
6.4 SUMMARY
From the above discussion and interpretation of the descriptive statistics and t-test of key financial ratios,
undoubtedly it is observed that inflation has affected all the ratios under study except the quick ratio. With the
pressure of inflation the current ratio, creditor turnover ratio and debtor turnover ratio have changed and
performed better, but no change has occurred to the quick ratio. Nevertheless all the profitability ratios and
inventory turnover ratio have suffered badly due to the impact of inflation. The financial ratio analysis thus
confirms the findings recorded in previous chapter that historical accounts overstate profitability and
understate liquidity.

* * *

109

Impact of Inflation on Stakeholders

7.1 INTRODUCTION
In the previous two chapters, our analysis was restricted to assess the impact of inflation on corporate financial
performance and on major ratios, which were essentially from the corporate point of view. However, there are
various stakeholders associated with a business enterprise with different motives. It would be quite interesting
to analyze and know how they are affected by the inflation with respect to their suffering or gaining. The
various stakeholders identified for this purpose are the Customers, Suppliers, Employees, Financial
Institutions, Government, Shareholders and the Management.
7.2 IMPACT OF INFLATION ON CUSTOMERS
The stakeholder of first category for any business organization is its customers. They are considered as the
focal point of any organization. Customers interest lies in getting the best product or services at the lowest
rate. However, prices do rise with inflation. Under these circumstances, we are interested to analyze to what
extent the inflation is responsible for the price rise in the products or services manufactured by the sample
companies under the study. The Table-7.1 depicts the figures of sales and growth there of over the period of
analysis, as disclosed by Historical accounts as well as Inflation adjusted accounts.
Table 7.1
Analysis of impact of inflation on Customers
(Rs. in crores)
Year
HCB Method CPP Method
Sales
Annual
Growth (%)
Sales
Annual
Growth (%)
2004-05 206633.47 - 255013.83 -
2005-06 247732.99 19.89 292775.36 14.81
2006-07 297138.98 19.94 329413.50 12.51
2007-08 332303.96 11.83 351968.60 6.85
2008-09 392936.88 18.25 385140.51 9.42
Average 17.48 10.90
Overstatement in Growth 37.65
From the Table, it could be seen that average growth in sales during the period of analysis, in the case of HCB
method is 17.48 percent, while it is only 10.90 percent as per CPP method. It implies that the price-rise in the
sales in real terms has record less growth as compare to HCB method in the entire period of study. The
customers have, therefore, been in an advantageous position by purchasing the products at cheaper rates. The
HCB method has thus failed to disclose the correct facts and overstated the growth of sales to the extent of
37.65 percent. Thus what has been customers gain is the loss of the companies.
7.3 IMPACT OF INFLATION ON SUPPLIERS/CREDITORS
Suppliers desire to fetch the maximum price for their products/services. As has been mentioned above, price of
products/services has the tendency to rise during inflation and in this context; the Table-7.2 explains to what
extent the inflation has affected the suppliers/creditors during our period of study.
Table 7.2
Analysis of Impact of Inflation on Suppliers/Creditors
Chapter
7
110

(Rs. in crores)
Year
Raw Material
Purchased
Annual
Growth (%)
Raw Material
Purchased
Annual
Growth (%)
2004-05 133196.24 - 164382.29 -
2005-06 168909.51 26.81 199620.33 21.44
2006-07 198415.24 17.47 219966.63 10.19
2007-08 227318.75 14.57 240770.72 9.46
2008-09 267072.40 17.49 261773.34 8.72
Average 19.08 12.45
From the above Table, it could be seen that raw materials purchased by the sample companies has recorded an
average growth of 19.08 percent as per HCB method and 12.45 percent as per CPP method. The overstatement
in average growth as per HCB method has thus been to the extent of 34.75 percent during the study period. It
implies that the suppliers have suffered loss in real terms when compared with historical figures and their loss
has become gain to the companies.
7.4 IMPACT OF INFLATION ON EMPLOYEES
Always, the employees of an organization constitute most important in the stakeholders. Employees get
remuneration in lieu of their services. It is reasonably fair to expect a reward system which compensates for the
inflation over and above the increase in remuneration. However figures of Employee Cost presented in
Table-7.3 tells a different story.
Table 7.3
Analysis of Impact of Inflation on Employees
(Rs. in crores)
Year
Employee Cost
Annual
Growth (%)
Employee Cost
Annual
Growth (%)
2004-05 6599.01 - 8144.08 -
2005-06 7281.63 10.34 8605.56 5.67
2006-07 9762.71 34.07 10823.11 25.77
2007-08 14030.58 43.72 14860.86 37.31
2008-09 15917.70 13.45 15601.87 4.99
Average 25.40 18.43
HCB method reflects that average growth in employees cost over the period of analysis is 25.40 percent. But
as per CPP method it is only 18.43 percent. HCB method thus overstates the growth in employee cost as much
as by 27.42 percent. Here also the companies have experienced gain and employees have suffered on account
of inflation.
7.5 IMPACT OF INFLATION ON FINANCIAL INSTITUTIONS
Financial Institutions, apart from shareholders, provide finance for the business. It will be useful to see whether
they got the same return on their lending as is reflected by HCB method or not, and also whether they were
able to maintain the real value of their lending. The Table-7.4 showed the figures of interest earned and the
percentage change in earnings of interest by financial institutions. It may be mentioned here that for the
purpose of our analysis the term Financial Institutions has been used to denote all those institutions or
individuals, who have provided secured as well as unsecured loans as per the balance sheets.
Table 7.4
Analysis of Impact of Inflation on Financial Institutions
(Rs. in crores)
Year
Interest Annual Growth (%) Interest Annual Growth (%)
111

2004-05 5010.08 - 6183.12 -
2005-06 5171.62 3.22 6111.92 -1.15
2006-07 5580.27 7.90 6186.39 1.22
2007-08 7684.02 37.70 8138.74 31.56
2008-09 13655.17 77.71 13384.23 64.45
Average 31.63 24.02
The Table 7.4 makes the following revelations:
- Interest paid by sample companies under HCB method has gone up from Rs.5010.08 crores to
Rs.13655.17 crores registering a growth of 172.55 percent during the study period i.e., from 2004-05 to
2008-09. CPP method, however, reveals that the interest has increased from Rs.6183.12 crores to
Rs.13384.23 crores during the same period, indicating a growth of 116.12 percent. Thus there has been
overstatement in growth to the extent of 32.50 percent in the HCB accounts.
- Average growth in interest paid by sample companies during 2004-05 to 2008-09 is 31.63 percent as per
HCB method but merely 24.02 percent as per CPP method. The HCB accounts have thus overstated the
interest payment to the extent of 24.07 percent. Thus the financial institutions got lower return on their
lending in real terms.
The analysis makes clear that the financial institution were not able to maintain the real value of their lending.
In fact lending being a non-monetary current asset for the institutions (conversely non-monetary current
liability for the borrower companies), they suffered purchasing power loss on their lending which became the
gain to the companies under study.
7.6 IMPACT OF INFLATION ON GOVERNMENT
The Government (both state and the central) is one more important stakeholder of corporate all over the world.
The Government collects excise duty, sales tax and corporate tax from the body corporate, however we shall
limit our analysis to excise duty and corporate tax since the figures of sales tax are not disclosed by the
financial statements of the sample companies. Tables-7.5 exhibits the relevant figures.
Table 7.5A
Analysis of Impact of Inflation on Government
(in terms of Excise Duty Rs. in crores)
Year
Excise Duty
Annual
Growth (%)
Excise Duty
Annual
Growth (%)
2004-05 18501.49 - 22833.36 -
2005-06 26797.08 44.84 31669.28 38.70
2006-07 29659.79 10.68 32881.37 3.83
2007-08 32646.23 10.07 34578.13 5.16
2008-09 30331.38 -7.09 29729.57 -14.02
Average 14.62 8.42
It is apparent from the above Table that the sample companies have recorded average growth in excise duty of
14.62 percent under the period of the study as per HCB method, while the corresponding figures is 8.42
percent only as per CPP method.
The HCB method had, thus overstated the average growth to the extent of 42.46 percent in excise
duty. The sample companies recorded such an abnormally astounding overstatement in HCB method as
compare to CPP method. It could be seen that the Government has not been able to maintain the real value of
its excise collections. The variation in loss is due to variation in excise policy for the industries. However when
it comes to corporate taxes the Government has been a gainer.
112

Table 7.5B
Analysis of Impact of Inflation on Government
(in terms of Corporate Tax Rs. in crores)
Year
Corporate Tax Tax (%) Corporate Tax Tax (%)
2004-05 12146.10 34.01 15000.43 46.13
2005-06 12339.09 33.35 14417.01 42.14
2006-07 15124.38 32.49 16559.05 44.96
2007-08 17278.93 34.60 17563.36 53.63
2008-09 14778.17 30.74 14778.17 40.18
Average 14333.33 33.04 15663.60 45.41
The Table-7.5B shows the absolute figures of corporate tax and percentage of tax on profit before tax for the
sample companies under both the methods (HCB and CPP) for the study period i.e. 2004-05 to 2008-09. It is
clear from Table-7.5B that real average rate of corporate taxes has been 45.41 percent in the case of CPP
method, while it is 33.04 percent as per HCB method. Thus in real terms the Government has received more
corporate taxes as compared to HCB method. This is the area where the thrust of Inflation accounting lies and
calls for immediate action from the Government for providing relief to the corporate sectors.
7.7 IMPACT OF INFLATION ON SHAREHOLDERS
Shareholders are the real owners of their company. The entire business operations ultimately culminate into
gain or loss to the shareholders. They are interested in two things dividend and appreciation in the net worth of
their shares. Table-7.6 exhibits data in respect of dividend payment of sample companies.
Table 7.6
Analysis of impact of inflation on Shareholders
(Rs. in crores)
Year
Equity Dividend
Dividend Payout
(%)
Equity Dividend
Dividend Payout
(%)
2004-05 8623.03 36.60 10649.44 60.78
2005-06 9256.95 37.54 10815.83 54.63
2006-07 10271.06 32.68 11245.35 55.47
2007-08 10527.49 32.24 10700.78 70.47t
2008-09 10371.96 31.15 10371.96 47.13
Average 9810.10 34.04 10756.67 57.70
The Table-7.6 shows the absolute figures of dividend and dividend payout ratio in percentage for the sample
companies under both the methods (HCB and CPP) for the study period i.e. 2004-05 to 2008-09. An analysis
of the above Table reveals the followings:
- The sample companies have paid, on an average, dividend of 34.04 percent during the period of analysis
as per HCB method, whereas the figure works out to be 57.70 percent as per CPP method. To
compensate the shareholders, they should have paid lesser dividends, so as to maintain the balance in
dividend percentage.
- The finding reveals a conflicting picture: the sample companies have paid excess dividend to their
shareholders, which is even more than the profit available for the purpose. What more is that, they have
paid dividend even during the period of loss. This is due to the fact that profitability of the companies
has decreased in real terms, which resultant in book value of share must have declined.
- This analysis makes it clear that shareholders have been misleading by the historical accounts in respect
of the net worth of their shareholding. It may be mentioned in the prospectus or had they been informed
the real book value of the shares, it could have a bearing on the stock market quotations.
7.8 IMPACT OF INFLATION ON MANAGEMENT
113

The Managements objective is to optimize the use of scarce resources at its disposal within the constraints of
the environment it operates in. It is clear that the management has to strike a balance among the various other
stakeholders associated with the business, as mentioned above in such a way that the profitability and
prosperity of the enterprise managed enhances. However, the above analysis has made it clear that inflation
adjusted accounts pose a great challenge before the management. We have seen above that while some of the
stakeholders gains, the others suffer due to inflation vis--vis the enterprise. It has more implications for the
management than meets the eyes, let us analyze recognition of inflation adjusted accounts may call for changes
in the pricing policies both of the input and the output which may lead to unforeseen consequences, employees
may raise demands for increasing their compensation so as to nullify the impact of inflation the financial
institutions and the Government might raise the interest rates and excise duty respectively and similarly, the
shareholders may ask for the rise in the dividend rates. There may thus be great pulls and pressures on the
management which it may or may not be able to face and gear them up advantageously towards meeting its
objectives. The point being emphasized here is that adjustment of inflation in accounts poses a great challenge
before the management and its ability to come out of it successfully might be at stake.
It was seen from the above analysis that average growth of sales under HCB method was 17.48
percent, while the same was only 10.90 percent under CPP method. Thus, the customers have been in an
advantageous position, while the suppliers have suffered loss as evidenced from the fact that raw materials
purchased by the sample companies have recorded an average growth of 19.08 percent as per HCB method but
12.45 percent as per CPP method. The average growth in employees costs was recorded as 25.40 percent and
18.43 percent respectively under HCB and CPP methods. Thus companies have experienced gain and
employees have experienced loss on account of inflation. In the same way the growth in average excise duty
found to be 14.62 percent as per HCB method, but lowered up to 8.42 percent as per CPP method. Likewise,
average growth of interest paid has risen from 31.63 percent in HCB method to 24.02 percent in CPP method.
The sample companies have paid tax on an average of 33.04 percent which was in real terms found to be 45.41
percent. In the same way the average dividend paid by sample companies was 34.04 percent in HCB method
and 57.70 percent in CPP method. The finding reveals a conflicting picture: the sample companies have paid
excess dividend to their shareholders, which resulted in decline in book value of shares. Thus it is concluded
that different stakeholders were affected differently by inflation. While customers and the Government are the
real gainers in the inflationary conditions; the suppliers, employees and financial institutions are the loss-
bearers in real terms. The shareholders are affected in both ways: They are gainers as they get extra dividends
and losers as the book value of their shares comes down owing to declined retained earnings.
Therefore our fourth Null Hypothesis (H
04
): Inflation affects all the stakeholders uniformly is rejected and the
a4
) is accepted.
7.9 SUMMARY
From the above discussion, it is certain that inflation has affected different stakeholders in different manner.
While customers and the Government are the gainers; the suppliers, employees and financial institutions are
the losers in real terms. However, the shareholders were affected in both ways; they are gainers in the sense
that they get additional dividend; losers because the book value of shares come down by the impact inflation.

* * *

114

Adjusting Effects of Inflation

8.1INTRODUCTION
The inflation is a common phenomenon and introduces entirely new deformation into financial performance of
companies. It occurs because revenues and cash costs are measured at current prices, while the investment cost
and depreciation charges are measured at historical prices used to acquire the assets. This results in overstating
the firms income. At the same time, the firms investment is understated, because most of
firms assets were acquired in previous years at lower price levels than those currently prevailing. The
combination of overstated net income and understated investment seriously affects financial performance. For
example, the Return on Investment (ROI) appears to be much higher than its actual figure, which is not a
signal of higher profitability. This is mainly due to a failure to adjust for inflationary effects. Unless some
adjustments are made to eliminate such inflationary effects, managers will be reluctant to make new
investments because of the negative impact on their financial performance. Moreover, the deflated return
serves as the criterion of management's success in facing the effects of inflation. This approach yields
unsatisfactory results since it is based on the erroneous assumptions that inflation affects all the components of
a firm's income in the same way and that real income alone constitutes the only success/failure criterion of
management's anti-inflationary performance.
Under the above backdrop, a model is used in this chapter for assessment of a firm's performance
under conditions of high inflation rates but with limited financial disclosure. It is based on an adjustment
mechanism (model) which is both concise and unambiguous. The new mechanism utilizes a number of ratios
in adjusting historical-cost data to general price-level increase. This model has already been applied to a
number of firms operating in Greece, a country of high inflation rates like India.
3
The relevant findings
demonstrate the significance of the new method to stakeholders in assessing the impact of inflation on their
command over resources, and its limitations in evaluating inflation-related performance on Sector-wide basis.
8.2 APPLICATION OF MODEL
In general, Purchasing power gain is the standard unit for measuring management's success or failure in facing
the effect of inflation. Gains, in purchasing power means, a success; while a loss, in it means failure in
protecting investors command over resources. A gain (loss) in general purchasing power is observed
whenever a firm reports (a) real, not inflationary, operating income (loss), and (b) purchasing power gain (loss)
on monetary items.
A gain (loss) is also observed in cases where the sum of real income and gains (losses) on monetary
items is positive (negative). The application of the General Price Level Adjustment (GPLA) model on
historical cost accounting data yields information on the purchasing power firms gain or lose by operating
under conditions of high inflation. Under this model, conventional balance sheet and income statement items
are restated for changes in the general price level. The resulting GPLA income represents the amount of wealth

3
Antonios A. P., (1986) The Impact of Inflation on Business Performance under conditions of Limited Financial Disclosure:
the case of firms Operating in Greece, SPOUDAI, University of Piraeus, p 25-42

Chapter
8
115

Gt = S
t
(B
t
+ P
t
- E
t
) ........ (1)
Where:
S
t
= Sales of year (t)
B
t
= Beginning inventory for year (t)
P
t
= Purchases of year (t)
E
t
= End inventory for year (t)

that can be disposed of during an inflationary period while leaving intact the entity's level of general
purchasing power.
Employment of other methods, besides that of GPLA model, is not possible conditions of limited financial
disclosure. For example, the application of current cost method depends on the availability of data on the price
changes of certain balance sheet items. Such data are not usually available to investors. But the adjustment
model presented in this chapter is substantially different from the GPLA model that appears in accounting
literature. Although both models employ the same success/failure criterion, their adjustment procedures are
significantly different. The GPLA model requires the restatement of the balance sheet items for changes in the
general price level, while the proposed model calls for the isolation of the inflationary factor contained in each
component of the conventional income.
The two models differ also in terms of their information requirements. The proposed model is operative under
conditions of limited financial disclosure, while the GPLA model requires more extensive disclosure. Data on
sales, cost of sales, breakdown of costs and revenue are not usually available in countries with unsatisfactory
level of accounting sophistication [Price Waterhouse, (1984, p. 6)].
4

The new model, applied on historical-cost data, yields information essential for the assessment of a firm's
performance in terms of protecting the purchasing power of investors' cash flows. Investors' purchasing power
is actually protected in cases where the purchasing power of the firm's capital is maintained. This takes place
whenever the firm experiences real net operating incomes and gains on monetary items.
8.3 ASSUMPTIONS FOR MODEL
The proposed model is based on a number of assumptions that refer to the entity's economic activities and
concern the application of the model. Specifically:
(a) Sales, purchases, cash expenses, and changes in monetary items occur evenly throughout the year
(inflation period).
(b) Beginning and ending inventories are purchased in the last two months of the prior and current year,
respectively.
(c) Cost of goods sold is determined on a FIFO basis, and
(d) Gross operating income is the top item in the income statement published.
These assumptions allow for the building of a model which is straight forward and corresponds to
requirements of Indian accounting practices. The model consists of a series of conversion ratios that express
relationships between (1) adjusted gross operating income and reported gross operating income, (2) adjusted
net operating income and reported net operating income, (3) purchasing power gain (loss) on monetary items
and (4) total gain/loss in General Purchasing Power. Each conversion ratio is determined, analyzed, and
interpreted in the following paragraphs.
8.4 THE MODEL
Gross Operating Income
Historical cost gross operating income at the end of year (t) is given by:

Equation (1) is rearranged into:

4
Price Waterhouse (1984): A Survey of International Accounting Practices, the Price Waterhouse Company.
116

G
t
a B
t
(b a) + E
t
(c a)
r = ........ (5)
Gt

Nr
t
= Gr
t
X
t
a D
t
e (6)
Where:
X
t
= Operating and Financial Cash Expenses For the Year (t),
D
t
= Depreciation and Other Non-Cash Expenses for the Year (t),

Year-end Price Index
e=
Previous Acquisition date Price Index
G
t
a B
t
(b - a) + E
t
(c a) ] X
t
a D
t
e (7)
k =
N
t

G
t
= (S
t
- P
t
) - (B
t
- E
t
)
The above equation, adjusted for changes in the general price level, becomes:
Grt = (St - Pt) a Btb +Etc (2)
Since (S
t
- P
t
) is equivalent to (G
t
+ B
t
- E
t
), equation (2) is rewritten as:
Gr
t
= G
t
a B
t
(b-a) + E
t
(c-a), (3)
Where:
Gr
t
= the gross income adjusted for changes in the general price level

The Gr is equal to the amount of the reported gross operating income net of the inflation effect. The inflation
component is given by the difference (G - Gr). If the difference is positive (negative), then inflation has eroded
(expanded) the purchasing power of the stated income by an amount equal to (G-Gr).
The relationship between G
t
and Gr
t
is expressed, also, as:

If G is positive and r is greater than 1, then a gain the purchasing power of the reported income is observed. If
r is less than 1, then a loss in purchasing power is experienced. A negative r implies that inflation has eroded
the purchasing power of the stated income to the extent that a real loss has emerged. The opposite conclusions
are drawn in case of negative G.
Net Operating Income
Once the adjusted gross income Gr
t
is given, the adjusted net operating income Nr
t
is derived as:

Equation (5) is rewritten as:
Nr
t
= [G
t
a B
t
(b - a) + E
t
(c a) ] X
t
a D
t
e ..(6)
[Since, Gr
t
= G
t
a B
t
(b-a) + E
t
(c-a) . from Eqn (3)]
The difference (N
t
- Nr
t
) is the inflation component of the reported net operating income. A positive (negative)
difference indicates an erosion (expansion) in the purchasing power of the income earned equal the (N
t
- Nr
t
)
amount.
The relationship between N
t
and Nr
t
can take the form:

c=
(Feb-Mar) Price Index
b=
Previous Year-end Price Index
a=
Average/Year Price Index
117

G
t
a B
t
(b - a) + E
t
(c-a) - X
t
a D
t
e + M
t
(b 1) + M
t
(a 1) (11)
s = N
t

In the case that N is positive and k is greater than 1, the real operating income exceeds the nominal income. If
k is positive and less than 1, then the real income is less than the stated, and a decrease in the level of
purchasing power is observed. A negative conversion ratio k implies that a real operating loss has occurred,
although Net operating income is reported. The reverse conclusions are reached in cases where (N) is negative.
Purchasing Power Gain /Loss on Monetary Items
The purchasing power a firm gains or losses from holding monetary items is the other determinant of the
purchasing power of an entitys capital. It is the result of the exposure of monetary items to inflation.
A purchasing power gain (loss) on monetary items is observed whenever the firm (1) maintains a net
monetary liability (asset) position during the period of inflation, and (2) enters into transactions that cause
either an increase in its net monetary liability (asset) position or a decrease in its net monetary asset (liability)
position.
The amount of purchasing power a firm gains or losses on monetary items is given by:
Im
t
= M
t
(b-1) + M
t
(a - 1) (8)
Where
M
t
= Net Monetary Position at the beginning of year (t)
M
t
= Change in Mt during the year (t)
(b-1) = Annual Inflation Rate for the year (t)
(a-1) = Average Inflation Rate for the year (t)
A negative (positive) Im suggests that a gain (loss) in purchasing power is experienced due to the net
monetary liability (asset) position maintained during the period of inflation. This gain (loss) can be expressed
as a percentage l of the reported net operating income N:

A positive N and a negative (positive) l suggest that a purchasing power gain (loss) on monetary items is
observed. Conversely, a negative N and a positive (negative) l imply the presence of a purchasing power gain
(loss) on monetary items.
Total Gain / Loss in General Purchasing Power
The sum of equations (6) and (8) represents the total amount of purchasing power a firm gains (losses) by
operating under conditions of persistent inflation. This is the total adjusted income Im
t
for the period t.
Ir
t
= Nr
t
+ Im
t
(10)
The adjusted income Ir
t
can be expressed as a function s of the reported net operating income:
Nr
t
+ Ir
t

s = N
t

Which is equivalent to:

Equation 11 represents the complete model.
Its components are the basic determinants of historical-cost gross income and the relevant inflation rates. This
model reflects the methodology proposed for the assessment of a firms inflation-related performance.
8.5 ADJUSTMENT OF IMPACT OF INFLATION ON FINANCIAL PERFORMANCE
Mt (b-1) + Mt (a - 1) (9)
l =
Nt
118

The sample companies financial statements are analyzed by applying the above model to sample companies to
assess their financial efficiency. In their financial statements, one major adjustment were considered essential
before applying the model i.e., the depreciation expense of all depreciable assets was adjusted to the 2000-01
price level.
For the calculation of the purchasing power gain or loss on monetary items, the balance sheet items
were separated into monetary and non-monetary. Such classification is possible by reference to the definition
of the relevant concepts and to a list of monetary and non-monetary items provided in Research Methodology
Chapter
The Wholesale Price Index employed here, measures changes in the general price level observed in
urban areas in India. The base year has taken for the study is 2004-05. The price indices (PI) utilized is based
on movements in wholesale price index. The details of PI have given in Table No. 3.1, Wholesale Price Index
in India [2000-09], in the Chapter Research Methodology.
The new model (conversion ratio- r, k, l, and s) applied on the financial statements of selected 42
sample companies capitulate useful information on the inflation-related performance. The relevant findings are
analyzed and interpreted in the following paragraphs.
8.6 ADJUSTMENT OF IMPACT OF INFLATION ON REAL OPERATING INCOME (ROI)
The Table-8.1 portrays the adjusted Gross and Net Operating Income in relation to that of reported ones of
sample companies for the study period. It is found from the Table that the absolute figures of the ratio r are
positive indicating thereby sample companies have realized real gross incomes in the entire study period.
However, the real gross income is found to be lower than the reported gross income and varies from a
minimum of 98.04 percent (2007-08) to a maximum of 99.48 percent (2008-09) of the reported (nominal)
income. The probable reason behind this superior ratio in the year 2008-09 is the ratio of average inventory to
total assets, which stood only 10.90 percent. Nevertheless, it can be observed from the Table that sample
companies in the year 2008-09 are holding smaller quantity of inventories in relation to their total assets as a
result of which they are less affected by inflation than years with larger inventory. Yet again in no single year
the amounts of these (inflated) incomes did not exceed the reported income and it is apparent from that
inflation does not equally affect all the sample companies in all the years of study.
Table 8.1
Adjusted Gross and Net Operating Income
from 2004-05 to 2008-09( in percentage)
Year
Ratio
r
Average Inventory to
Total Assets
Ratio
K
Net Fixed Assets to
Net Total Assets
Depreciation to
Gross Profit
2004-05 99.06 13.76 94.09 41.64 10.38
2005-06 98.63 15.00 88.73 38.81 14.33
2006-07 98.36 14.00 87.31 33.89 11.68
2007-08 98.04 12.67 79.05 29.14 12.04
2008-09 99.48 10.90 89.52 27.67 11.60
With reference to the capacity of sample companies to generate real net operating incomes, the positive values
of ratio k is determined and shown in the Table -8.1. From the Table it signified that sample companies
realized real net income in the entire study period. The net operating income varies in amount from a minimum
of 79.05 percent in the year 2007-08 to a maximum of 94.09 percent in the first year of study period. The
bigger percentage of the ratio k in 2004-05 is mainly due to high proportion of net fixed assets to net total
assets (41.64 percent). Secondly, the percentage of depreciation to gross profit in that year (2004-05) stood as
10.38 percent which is lowest during the period of study. Then again, the lesser percentage of net fixed assets
to net total assets (29.14 percent) and high proportion of depreciation to gross profit (12.04 percent) are
responsible for a smaller percentage of k in the year 2007-08.
Additionally, in no single year, the value of k was negative which indicates that the companies have
adequate reporting net incomes during the period of study. Further, the last but not least, the rate of variation in
the ratio k illustrates the significance of capital intensity upon the bearing of inflation on all sample companies
119

performance in the respective years. The values of the ratio of net fixed assets to net total assets reflect the
degree of capital intensity of all the sample companies in different years. Adjustment of historical-cost
depreciation expenses to rising prices always bears upon the level of the reported income and its inflation
component.
The adverse effect of adjusted depreciation on reported income depends upon the firms profitability.
The inverse relationship of depreciation expenses to gross profit measures the relative significance of sample
companies profitability. It found that, on an average, all sample companies generate real net incomes and their
reported incomes are sufficient enough to fully counteract the adverse effect of depreciation on their
profitability.
From the above analysis, it is found that the value of r and k are below 100 percent, meaning thereby
Inflated Gross and Net Operating Income is lower than the Reported Gross and Net Operating Income due to
inflation. Hence our Null Hypotheses (H
05
& H
06
) are rejected and their Alternative Hypotheses (H
a5
); There is
difference between reported and inflated gross operating income and H
a6
: There is difference between reported
and inflated net operating income) are accepted.
8.7 PURCHASING POWER LOSS DURING INFLATION
The amount of purchasing power loss (gain) on monetary items of sample companies from the year 2004-05 to
2008-09 is given in Table- 8.2, as percentage l of the reported net operating income. From the Table it clear
that, the sample companies have experienced purchasing power gains in the first four year of study i.e., 2004-
05 to 2007-08, when the ratio l varies from -3.28 percent to -2.77 percent of their reported income. But in the
last year of study i.e., 2008-09, the sample firms suffered a purchasing power loss of 0.43 percent. Over again
the purchasing power gain (ratio l) is radically different from that of the reported net income (ratio k). This
variation holds the principle that sample companies ability to generate gains on monetary items is not
influenced by its capacity to realize operating incomes.
Table 8.2
Purchasing Power Loss on Monetary Items
(from 2004-05 to 2008-09 in percentage)
Year
Ratio
l
Monetary
liabilities to
Monetary assets
Ratio
s
2004-05 -3.28 117.54 97.37
2005-06 -3.02 112.51 91.75
2006-07 -2.77 104.96 90.08
2007-08 -2.79 96.15 81.84
2008-09 0.43 95.54 89.09
The amount of monetary liabilities to monetary assets recorded as 117.54 percent (highest) in the first year of
the study i.e., 2004-05 and moderately decreasing to 95.54 percent (lowest) in the last year of the study (2008-
09). This component is showing a declining trend in the entire study period. Sample companies with net
monetary liabilities position gained from inflation in first three years, while in the last two years (2007-09),
sample companies with net monetary asset position, lost.
It brings a conclusion that, sample companies with limited liabilities position or extensive net
monetary asset position experienced either an insignificant gain or a substantial loss on their purchasing power
on monetary items. It also observed from the Table-8.2 that total sample companies having more monetary
liabilities as compare to monetary assets is responsible for purchasing power gain.
The value of ratio s, in the Table-8.2, indicates the overall performance of sample companies capacity
to maintain/improve the purchasing power in the period of study. The absolute value of ratio s varies from
81.84 percent in the year 2007-08 to 97.37 percent in 2004-05 which is the first year of the study period.
Therefore it has seen the sample companies has suffered more in the year 2007-08 and less in 2004-05.
However, it is observed that, sample companies have succeeded in increasing their general purchasing power
120

during the period of study. Moreover, it is also established that general purchasing power of sample companies
have increased by the sum of their gain on monetary items and the amount of their real operating income.
From the Table-9.2, it is observed that value of s is less than 100 percent in all the years of study. It
implies that the reported financial performance of sample companies is less than their of inflated financial
performance. Thus our Null Hypothesis (H
01
): There is no significant difference between reported and inflated
financial performance is rejected and its Alternative Hypothesis (H
a1
) is accepted.
8.8 SECTORAL ANALYSIS OF ADJUSTED GROSS AND NET OPERATING INCOME
Hitherto we are examining the impact of inflation on financial performance of corporate India at macro-level
representing various sectors of the economy. But it is very important on the part of a researcher to check
whether the impact inflation has been uniform across all the sectors or otherwise. For the purpose, sample
companies are divided into seven sectors: Automobile, Cement, Chemicals, Fertilizers, Food, Petroleum and
Steel. The results and interpretation are individually presented from Tables 8.3 to 8.8.
The Table- 8.3 shows Sector-wise adjusted gross and net operating income in relation to reported gross and net
operating income for the year 2008-09. The value of ratio r is positive for all seven Sectors indicating thereby
all Sectors had realized real gross income in 2008-09. But the real gross income is lower than the reported
gross income and varies from 98.09 percent (Food Sector) to 99.90 percent (Steel Sector) of the reported
income.
The ranking of the Sectors according to the amount of their real gross incomes reflects that inflation
does not equally affect all Sectors equally. Sectors with relatively low volume of inventory in relation to their
total assets are less affected by inflation than firms having more inventories. This clear from the Table-8.3,
where the average inventory to total assets is found to be 6.23 percent (lowest) in case of Steel Sector and
48.96 percent (the highest) in case of Food Sector.
Table 8.3
Sectoral Analysis of Adjusted Gross and Net Operating Income
(for the Year 2008-09)
Sector
Ratio
R (%)
Rank
Average
Inventory
to Total
Assets
Ratio
k (%)
Rank
Net Fixed
Assets to
Net Total
Assets
Depreciation
to
Gross Profit
(%)
Automobile 99.86 2 10.81 96.48 1 42.50 21.64
Cement 99.84 4 10.06 85.50 5 59.72 11.18
Chemical 99.85 3 10.25 89.84 3 34.71 8.93
Fertilizer 99.62 5 21.39 76.64 6 52.68 6.79
Food 98.09 7 48.96 75.29 7 35.09 3.37
Petroleum 99.32 6 12.41 89.38 4 24.44 12.28
Steel 99.90 1 6.23 94.11 2 21.80 8.03
With respect to the capacity of firms to generate real net operating income, the positive values of k indicates
that all seven Sectors have realized real net incomes during the period of our study. The percentage of k varies
from a minimum of 75.29 (Food Sector) to a maximum of 96.48 (Automobile Sector) of the corresponding
nominal net income in 2008-09. The ranking of the seven Sectors according to the proportion of their real
operating income (ratio k) demonstrates that Automobile Sector occupies the first position and the Food Sector
with very last as per their impact of inflation on the net operating income. These discrepancies in the ratio k
demonstrate the significance of inventory cost, capital intensity and depreciation upon the bearing of inflation
on a Sectors performance. Thus it can be said that inflation has affected the Automobile Sector marginally
(bigger percentage of the ratio k) mainly due to low proportion of average inventory to total assets (10.81
percent), even though there is a high proportion of depreciation to gross profit (21.64 percent). Conversely the
Food Sector that failed to generate real net incomes and experienced real losses (lower percentage of the ratio
k) is due to high proportion of average inventory to total assets (48.96 percent), even though there is a lower
proportion of depreciation to gross Profit (3.37 percent).
121

The values of the ratio net fixed assets to net total assets in Table-8.3 reflects the degree of the
Sectors capital intensity which varies from 21.80 percent (Steel Sector) to 59.72 percent (Cement Sector) in
the year 2008-09. The adverse effect of adjusted depreciation on reported income is offset either fully or
partially, depending upon the Sector's profitability. The reported incomes of Automobile Sector was not
adequate enough (high depreciation to gross profit ratio 21.64 percent) to fully counteract the adverse effect of
depreciation on their profitability.
8.8.1 Sectoral Analysis of Purchasing Power Loss
The amount of purchasing power lost (gained) on monetary items of each Sector in 2008-09 as a percentage of
the reported net operating income (l) is given in Table-8.4. From the Table, it is evident that the value of l is
positive in five Sectors out of seven. That means all the seven Sectors except Cement and Fertilizer have
suffered losses in their purchasing power in the year 2008-09 due to inflation. These two Sectors (Cement and
Fertilizer) have experienced gains, where l is recorded as -2.25 percent and -4.66 percent respectively, on
account of highest proportion of monetary liabilities to monetary assets. Thus it can be concluded that the
ability of Sectors, in relation to various Sectors, to generate gain on monetary items is not influenced by their
capacity to realize operating incomes.
Table 8.4
Sectoral Analysis of Purchasing Power Loss
(For the year 2008-09)
Sectors
Ratio
l (%)
Rank
Monetary liabilities to
Monetary assets (%)
Ratio
s (%)
Rank
Automobile 4.99 2 65.77 91.49 2
Cement -2.25 6 157.47 87.75 5
Chemical 0.76 4 93.37 89.08 4
Fertilizer -4.66 7 121.91 81.30 6
Food 7.04 1 75.20 68.25 7
Petroleum 0.07 5 99.65 89.31 3
Steel 2.11 3 83.60 92.00 1
The ratio s (the fifth column of Table-8.4), which is an indicator of overall performance of different Sectors in
terms of their capacity to maintain (even to improve) the purchasing power varies from 68.25 percent (Food) to
92.00 percent (Steel) in the year 2008-09. Thus the sample companies have succeeded in increasing their
general purchasing power in all Sectors in the year 2008-09.
8.8.2 Sectoral Analysis of Real and Reported Income
All positive values for the ratio r for the year 2007-08 (as presented in Table-8.5) clearly indicates that inflated
gross income is lower than reported income for all the seven Sectors. The value of this ratio varies in between
93.18 percent (Food) to 99.37 percent (Steel). The proportion average inventory to total assets, which is
responsible for such lower inflated income, varies in between 53.06 percent (Food) and 6.38 percent (Steel) in
2007-08.
Table 8.5
Sectoral Analysis of Real and Reported Income
[for the year 2007-08]
Sector
Ratio
r
Rank
Average
Inventory to
Total Assets
Ratio
K
Rank
Net Fixed
Assets to Net
Total Assets
Depreciation
to
Gross Profit
Automobile 99.20 2 11.51 86.76 1 39.37 29.63
Cement 99.12 3 10.66 74.45 4 49.77 10.74
Chemical 98.11 4 9.15 68.08 5 37.65 11.01
Fertilizer 98.04 5 21.08 42.57 6 51.16 7.08
Food 93.18 7 53.06 9.14 7 33.27 3.98
Petroleum 97.79 6 14.97 79.35 3 28.32 12.53
Steel 99.37 1 6.38 84.93 2 20.46 8.43
122

Similarly, the value of ratio k shows all positive figures for the year 2007-08 varying in between 9.14 percent
(Food) to 86.76 percent (Automobile). It indicates that all the Sectors have realized real net operating income
for the year 2007-08 although their degree varies. The Automobile Sector was able to generate sufficient net
operating income, even though it has highest percentage of depreciation to gross profit (29.63). On the other
hand, the Food Sector was incapable to generate sufficient net income (lowest k) mainly due to high proportion
of inventory to total assets, even though the percentage of depreciation to gross profit stood at its lowest level
(3.98).
8.8.3 Sectoral Analysis of Purchasing Power Loss
From the Table-8.6, it is evident that all Sectors of the sample companies have gained in their purchasing
power in 2007-08 varying between 12.04 percent (Fertilizer) to 1.71 percent (Petroleum) except
Automobile. The ranking of the seven Sectors according to purchasing power loss experienced (ratio l) is
significantly diverse as compared to reported net income (ratio k). This variation indicates that Sectors ability
to generate gains on monetary items is not influenced by its capacity to realize operating incomes. While
Sectors with highest ratio of monetary liabilities to monetary assets; viz. Cement (188.53 percent), Fertilizer
(121.96 percent) and Petroleum (102.18 percent) experienced significant gains, than the other Sectors with
limited net monetary liability position; viz. Automobile, Chemicals, Food and Steel experienced an
insignificant gain on their purchasing power in the year 2007-08.
Table 8.6
Sectoral Analysis of Purchasing Power Loss
[for the year 2007-08]
Sectors
Ratio
l
Rank
Monetary Liabilities to
Monetary Assets
Ratio
s
Rank
Automobile 20.89 1 68.23 65.87 5
Cement -7.42 3 188.53 81.87 2
Chemical -7.44 4 84.19 75.52 4
Fertilizer -12.04 7 121.96 54.61 6
Food -8.98 5 97.72 18.12 7
Petroleum -1.71 2 102.18 81.06 3
Steel -9.44 6 77.28 94.37 1
The value of ratio s in Table-8.6 (above) indicates the overall performance of each Sector in terms of their
capacity to maintain the purchasing power of their capital. The quantity of ratio s of Steel Sector ranked one
(94.37 percent) and Food Sector ranked seven (18.12 percent) in the year 2007-08. All Sectors thrived in
increasing their general purchasing power. By referring the Table-8.5 (ratio r and ratio k) all Sectors real
operating incomes absorbed losses on monetary assets. However, it can be concluded that in 2007-08, general
purchasing power of all Sectors had increased by the sum of the gain on monetary items and the amount of
their real operating income.
8.8.4 Adjusted Gross and Net Operating Income for different Sectors
As Adjusted Gross and Net Operating Income for different Sectors for the years 2006-07, 2005-06 and 2004-
05 shows a similar trend, a consolidated Table has been prepared for easy interpretation (Table-8.7). From the
Table, it is clear that value of ratio r varies from 93.87 percent to 99.54 percent for the above said period. The
Automobile Sector ranked first and the Food Sector ranked last during the entire period in terms of value of the
ratio r. The inflated gross income is lower than the reported gross income for the entire period. The average
inventory to total assets, which is responsible for such type of lower inflated gross income recorded as 53.29
percent, 48.75 percent and 57.64 percent for the Food Sector in the years 2006-07, 2005-06 and 2004-05
respectively. Alternatively, the same component was recorded as 12.46 percent, 14.68 percent and 13.58
percent in case of Automobile Sector in the respective years.
Table 8.7
Sectoral analysis of Adjusted Gross and Net Operating Income
(for the period 2004-07)
123

Sectors
Ratio
r
Rank
Average
Inventory to
Total Assets
Ratio
k
Rank
Net Fixed
Assets to
Net Total
Assets
Depreciation
to
Gross Profit
2006-07
Automobile 99.40% 1 12.46% 92.16% 1 40.17% 19.87%
Cement 99.33% 2 11.33% 81.68% 4 61.72% 11.45%
Chemical 98.37% 4 12.57% 80.10% 5 54.06% 11.41%
Fertilizer 97.95% 6 21.62% 70.96% 6 59.54% 10.45%
Food 95.10% 7 53.29% 46.53% 7 42.74% 4.56%
Petroleum 98.19% 5 14.76% 87.57% 3 28.77% 11.83%
Steel 98.58% 3 10.62% 89.99% 2 38.70% 9.53%
2005-06
Automobile 99.54% 1 14.68% 95.56% 1 38.67% 25.81%
Cement 99.28% 2 12.80% 60.15% 6 84.61% 11.60%
Chemical 98.62% 4 11.92% 85.22% 4 51.56% 12.15%
Fertilizer 98.06% 6 23.77% 68.79% 5 65.48% 11.20%
Food 95.92% 7 48.75% 41.27% 7 49.27% 4.85%
Petroleum 98.52% 5 14.63% 88.97% 3 30.58% 15.35%
Steel 98.80% 3 17.38% 91.21% 2 72.20% 10.17%
2004-05
Automobile 99.54% 1 13.58% 97.49% 1 46.12% 39.83%
Cement 99.41% 2 10.39% 36.96% 6 82.15% 13.52%
Chemical 99.00% 5 11.02% 89.34% 4 56.30% 10.80%
Fertilizer 98.16% 6 24.35% 77.13% 5 71.50% 11.31%
Food 93.87% 7 57.64% -6.56% 7 41.60% 3.85%
Petroleum 99.04% 4 13.23% 94.71% 6 32.52% 9.50%
Steel 99.27% 3 16.46% 95.77% 2 75.76% 7.89%
The percentage of ratio k in 2006-07 (92.16 percent), 2005-06 (95.56 percent) and 2004-05 (97.49 percent),
being the highest for the Automobile Sector among the various Sectors is ranked in first place. On the other
hand, the Food Sector stood seventh as it recorded the lowest k value, i.e., 46.53 percent in 2006-07, 41.27
percent in 2005-06 and -6.56 percent in 2004-05. It means all the Sectors realized real net income except Food
in 2004-05 (recorded 6.56 percent) and the Automobile Sector generate sufficient net operating income
irrespective of high percentage of depreciation to gross profit which was recorded as 19.87 percent, 25.81
percent and 39.83 percent in the three years under study. Further, the Food Sector is not able to generate
adequate net income irrespective of low percentage of depreciation to gross profit which was recorded as 4.56
percent, 4.85 percent and 3.85 percent respectively. The reason for lowest proportion of ratio k for the Food
Sector for above said period is mainly due to a higher proportion of average inventory to total assets which is
53.29 percent (2006-07), 48.75 percent (2005-06) and 57.64 percent (2004-05). The amount of net fixed assets
to net total assets ranges between 28.77 percent and 84.61 percent for three years, which had no clear cut
impact on creation of real operating income.
8.8.5 Sectoral Analysis of Purchasing Power Gain/Loss on Net Operating Income
From the Table-8.8, it is evident that, the all the industrial sectors experienced gain except Automobile in the
three years 2004-07. The value of ratio l varied in between 11.42 percent (Cement) to 2.22 percent
(Petroleum) of their reported net income in 2006-07, between - 36.15 (Cement) percent to 1.69 percent
(Petroleum) in 2005-06 and between 90.15 percent (Cement) -1.95 percent (Petroleum) in 2004-05.
Although, the Automobile Sector ranked first in all the three years of study, the ranking of the seven Sectors
according to purchasing power loss experienced (ratio l) a significant variation as compared to reported net
income (ratio k).
Table 8.8
Sectoral Analysis of Purchasing Power Gain/Loss on Net Operating Income
[for the period 2004-07]
124

Sectors
Ratio
l
Rank
Monetary liabilities to
Monetary assets
Ratio
s
Rank
2006-07
Automobile 19.11% 1 66.98% 73.05% 6
Cement -11.42% 2 202.02% 93.10% 2
Chemical -5.68% 6 104.45% 85.78% 4
Fertilizer -11.33% 3 129.01% 82.29% 5
Food -7.75% 4 111.50% 54.28% 7
Petroleum -2.22% 7 104.38% 89.79% 3
Steel -5.82% 5 109.57% 95.81% 1
2005-06
Automobile 7.61% 5 64.06% 87.95% 5
Cement -36.15% 1 318.92% 96.30% 2
Chemical -5.25% 6 117.84% 90.47% 4
Fertilizer -18.54% 3 135.98% 87.33% 6
Food -18.79% 2 118.37% 60.06% 7
Petroleum -1.69% 7 108.78% 90.66% 3
Steel -7.93% 4 159.79% 99.14% 1
2004-05
Automobile 5.79% 6 72.40% 91.70% 6
Cement -90.15% 1 332.93% 127.11% 1
Chemical -7.86% 4 122.63% 97.20% 4
Fertilizer -22.30% 3 161.85% 99.43% 3
Food -54.58% 2 132.20% 48.02% 7
Petroleum -1.95% 7 109.28% 96.66% 5
Steel -7.22% 5 208.23% 102.99% 2
This variation indicates that Sectors ability to generate gains on monetary items is not influenced by their
capacity to realize operating incomes. Sectors with the highest ratio of monetary liabilities to monetary assets
in 2006-07, 2005-06 and 2004-05 had experienced significant gain on their purchasing power on monetary
items like; Cement (202.02 percent, 318.92 percent and 332.93 percent), Fertilizer (129.01 percent, 135.98
percent and 161.85 percent) and Steel (109.57 percent, 159.79 percent and 208.23 percent).On the other hand,
the Automobile Sector having limited net monetary liability position experienced an insignificant gain on their
purchasing power on monetary items in the above three years.
The value of ratio s from the above Table indicates the overall performance of each Sector in terms of
their capacity to maintain the purchasing power of their capital for the years 2006-07, 2005-06 and 2004-05. In
terms of value of this ratio, the Steel Sector ranked first for the years 2006-07 (95.81 percent) and 2005-06
(99.14 percent), taking over the Cement Sector which occupied the position in the year 2004-05. Moreover, the
Food Sector ranked very last and recorded at 54.28 percent, 60.06 percent and 48.02 percent respectively in the
above said three years. From the above analysis, it can be concluded that in the years 2006-07, 2005-06 and
2004-05, inflation has affected overall profitability of all the Sectors under our study except Cement and Steel
for the year 2004-05.
The Table-8.3 to 8.8 indicates in all the years of study, the value of r, k and s is not equal to 100
percent, and their value varies from one sector to another depending upon degree of impact of inflation on a
particular sector. This sufficiently brings out the rejection of the following four Null Hypotheses:
H
01
: There is no significant difference between reported and inflated financial performance
H
02
: Inflation affects all the industrial sectors uniformly.
H
05
: There is no difference between reported and inflated gross operating income
H
06
: There is no difference between reported and inflated net operating income
Therefore their Alternative Hypotheses; H
a1,
H
a2,
H
a5
and H
a6
are accepted.
8.9 SUMMARY
125

As the Historical Cost Based Method of accounting system requires some adjustments with the changes in the
price level, a new methodology (model) was presented in the present chapter for the assessment of sample
firms performance under conditions of high inflation rates with limited financial disclosure. It is based on an
adjustment mechanism (model) which is both concise and unambiguous. This model shows the relationship
between the reported financial performance and inflated financial performance. From the analysis we found
that the financial performances of all sample companies have suffered due to inflation. The ratio r (relationship
between reported gross income and inflated gross income) was affected by inflation depending upon the factor
average inventory to total assets. In year/sector-wise comparison, it is found that year/sector with lesser
quantity of average inventory in relation to their total assets was less affected by inflation than year/sector with
greater quantity of average inventory. Similarly the ratio k, which represents the relationship between reported
net operating income and inflated net operating income, is less affected by inflation; when a year/sector has
high proportion of average inventory to total assets or high proportion of net fixed assets to net total assets and
vice-versa. The ratio l (representing relationship between monetary liabilities to monetary assets) shows the
purchasing power loss/gain on monetary items. The ratio l was found to be negative in almost all Sectors under
our study except Automobile. The ratio s, which represents overall inflated performances, was worst affected
in the year 2007-08 in comparison to different years. In the same way in Sector-wise comparison, inflation
affected the Food Sector most and the Steel Sector least throughout the study period.

* * *

126

Summary and Suggestions

9.1 INTRODUCTION
This chapter summarizes the entire study to reconfirm its significance and contribution. After analyzing the
financial performance of the sample companies and the different sectors in the light of ever increasing
inflation, we now proceed to conclude the findings of this study. This research has led to different main sets of
conclusions, a mixture of both theoretical and empirical reflecting a critical realistic approach to methodology.
9.2 SUMMARY OF THE THEORETICAL FINDINGS
Every person on this earth has been affected by inflation, some positively but a majority negatively because
Inflation leads to an erosion of general purchasing power. The inflation spares none and it equally influences
the businesses like it does to 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 Profit and Loss Account due to inflation and also it 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.
Different methods have been suggested to account for inflation; like Accounting for Current
Purchasing Power Method (CPP), Replacement Cost Accounting Method (RCA), Current Value Accounting
Method (CVA) and Current Cost Accounting Method (CCA). However, the Current Purchasing Power Method
(CPP) scores over other methods on account of its objectivity, verifiability and comparative simplicity. That
CPP is a better system, is also proved by the very fact that the International Accounting Standards Committee
(IASC) is also in favour of this to be adopted in hyper-inflationary economies. It is the only method which is in
force in Latin American countries, the countries where inflation accounting is being practiced mandatory.
The CPP method requires restatement of Historical Cost based accounts in terms of a general price
index that reflects changes in general purchasing power of rupee. In India there are two such major indices:
Consumer Price Index (CPI) and Wholesale Price Index (WPI). The WPI is better than CPI, as WPI is the most
updated price index and also more broad-based than CPI associated with industrial and non-consumer
transactions. Comparison of CPP financial performance and that of HCB reveals that the later highly overstates
the profitability. The extent of overstatement varies from company to company as well as from sector to sector.
CPP adjustments even turn the profits into losses. In short, HCB profits are illusory and misleading.
The major finding identified in the literature review is that, there are very few works conducted in
India till date in respect to impact of inflation in Indian Corporate sector, industry or group of industries,
financial ratios of corporate sectors and on corporate stakeholders.
9.3 SUMMARY OF THE EMPIRICAL FINDINGS
As mentioned earlier, the analytical part of study has been divided into four broader areas to study the impact
of inflation on corporate financial performance, on major financial ratios, and on stakeholders in addition to
study the impact of inflation through an adjustment model. The major findings are discussed in the following
paragraphs.
Due to inflation, all the revenue and expenses items of sample companies have been overstated for entire
period of study (2004-05 to 2007-08) except for the year 2007-08, leading to understatement of profits in CPP
Chapter
9
127

method as compared to HCB method for the entire period of study (2004-05 to 2008-09). There are three main
factors which are responsible for this overstatement: Materials cost, Depreciation and Purchasing Power Loss
on monetary items. In other words, HCB accounts underrate materials cost (since historical costs are matched
against current revenues) and depreciation (since it is not based on current value of the fixed assets). However,
in between materials cost and depreciation, it is the later which is undercharged more, and that too, many times
more. The CPP revenues have been overstated than HCB revenue up to 23.41 percent, 18.18 percent, 10.86
percent and 5.92 percent respectively from the year 2004-05 to 2007-08; but understated by 1.98 percent in the
last year of study (2008-09). Similarly the material cost was recorded higher under CPP method by 24.28
percent, 18.79 percent, 11.76 percent and 6.47 percent respectively, from 2004-05 to 2007-08 and lower by
1.09 percent in 2008-09 as compared to HCB method. During the year 2008-09 the total revenue and material
cost have been understated as the year-end WPI was lower as compared to average-year WPI. The depreciation
cost was overstated by 47.02 percent for all the five years of study, i.e. 2004-05 to 2008-09.
The Gross Value Added (GVA) is overstated under CPP Method in comparison to that of HCB Method during
the entire period of study except for the year 2008-09. However, its divergence in between two accounting
methods was gradually reduced from Rs.11436.70 crores to Rs.3568.13 crores during the period except for the
year 2008-09, where the GVA under the HCB method was found to be Rs.4195.17 crores more as compared to
that under CPP method. Thus inflation has affected the GVA of sample companies in all the years of study
either adversely or favorably, but one thing apparent from the study is that years with relatively high raw
material cost to sales are less affected by inflation as compared to years with relatively low raw material cost in
relation to sales.
Similarly Net Value Added (NVA) has been understated and shown a negative variation year after year from
Rs.8494.24 crores to Rs.2007.86 crores during 2004-05 to 2006-07. It was reversed and a positive variation
was observed in the last two years (Rs.873.48 crores and Rs.9094.85 crores respectively in 2007-08 and 2008-
09). Thus inflation has affected the NVA in the first three years of study unfavorably and reversed in the last
two years 2007-08 and 2008-09. It was also found that the years with high net fixed assets in relation to total
assets are more affected by inflation.
In year-wise comparison it was observed that Profit After Tax (PAT) of sample companies under CPP Method
were understated in all the years of study from 2004-05 to 2008-09 as compared to HCB method. It was
lowest (Rs.2310.92 crores) in the year 2007-08 and highest (Rs.8453.91 crores) in 2008-09. The reason of such
differences is mainly due to increase in material cost, depreciation and purchasing power loss on monetary
items. The year-wise deviations of PAT stuck between two accounting methods expressed in trend percentage
are found to be 10.35, 9.58, 8.95, 7.08 and 25.39 respectively from the year 2004-05 to 2008-09. Due to this,
the sample companies have paid more tax as well as more dividend and kept lesser amount as retained
earnings.
The purchasing power loss, which is the result of net monetary liabilities, has also affected the profitability for
the first three years of study (2004-05 to 2006-07), but in the years 2007-08 and 2008-09 the sample
companies have gained in their purchasing power. The purchasing power losses has come down from
Rs.5361.21 crores to 1719.35 crores and occur the purchasing power gain in the last two years Rs.131.98
crores and Rs.54.18 crores in 2007-08 and 2008-09 respectively. During rising inflation losses suffered by the
companies, on account of undercharge of materials cost and depreciation, are partly compensated by
purchasing power gain on net monetary liabilities during 2007-08 and 2008-09. The extent of compensation
varies from company to company and depends upon the share of net monetary liabilities in the financing
structure and the longevity for which these liabilities are held.
Inflation in accounts for tax purposes made the sample companies to pay excessive taxes in real terms. During
the period of study, they have paid additional tax of 7.52 percent, 5.92 percent, 4.17 percent, 2.06 percent and
6.56 percent in real terms from first year to last year bringing out clearly the hazardous impact of inflation on
their tax burden. Even they had paid taxes when they have suffered losses in real terms. The payment of
taxation on historical profits, without any regard to shrinkage in the purchasing power of rupee, virtually
amounts to a levy on capital.
Again due to inflation, the companies under study had distributed more dividends to their shareholders without
sufficient distributable profits. In the real terms, they had paid more dividend up to 5.33 percent, 4.44 percent,
2.83 percent, 1.26 percent, and 4.60 percent respectively from first year to last year during the study period
128

from 2004-05 to 2008-09 eventually leading to sharp decline in the Earning Per Share (EPS).
From the above it may be concluded that the financial performance of sample companies has changed with the
impact of inflation and the p value is 0.0349, it can be said that the impact of inflation on profitability of
sample companies has significant difference for all years under study. So the analyses clearly suggest that there
is a significant difference between reported and inflated financial performance. This makes clear our Null
Hypothesis (H
01
), that there is no significant difference between reported, and inflated financial performance is
rejected. Therefore Alternative Hypothesis (H
a1
) is accepted, that there is a significant difference between
reported and inflated financial performance.
The sector-wise comparative analysis of profit after tax revealed that profits have been understated in all the
Sectors except the Automobile due to inflation. Again it is found that impact of inflation on financial
performance of all Sectors is significant except the Automobile and Steel (as their p-value is 0.275 and 0.09,
which is more than 0.05). In sectors like; Cement, Chemicals, Fertilizers, Food and Petrochemicals, the impact
of inflation on financial performance is found to be significant as their p-values is less than 0.05. Thus our
second Null Hypothesis (H
02
)
:
Inflation affects all the industrial sectors uniformly is rejected and
consequently its Alternative Hypothesis (H
a2
) is accepted.
Even though inflation accounting has long been debated, a necessary attention is not paid to provide its effect
on key financial ratios. For the purpose, ten major ratios categorized under three groups: Liquidity, Activity
and Profitability are analyzed. The t-test was used to compare the values of the means from two groups.
For the analysis of liquidity, two important ratios viz. Current ratio and Quick ratio are studied. The current
ratio of sample companies is found to be higher in case of CPP Method as compared to HCB Method in all the
years except for the last year (2008-09), when the ratio stood one and the same, (1.31:1) under both the
methods. The Quick Ratio of sample companies remains unchanged under both the methods, HCB and CPP;
for the entire period of study because of the fact that, the inflation has affected non-monetary quick assets and
non-monetary current liabilities in the same proportion as the inventories have been excluded from current
assets to get quick assets. The statistical analysis of current ratio also reflects that current ratio of sample
companies is higher in case of CPP Method as compared to HCB Method and the p-value is 0.0188, which is
less than 0.05, indicates a significant difference in the value of current ratio between HCB and CPP methods at
5 percent level of significance. The Descriptive statistics and t-test analysis for the quick ratio reveals that the
mean, standard deviation, kurtosis, skewness and all other findings are the same under both the accounting
methods (HCB and CPP). It is because inventory is taken away from current assets for finding out the quick
assets, the result indicates the reported and inflated quick ratios are identical
For the analysis of profitability, four important ratios viz. Gross Profit Margin, Operating Profit Margin, Net
Profit Margin and Return on Investment in HCB method are found to be higher (33.48 percent, 10.69 percent,
6.18 percent and 41.69 percent) as compared to CPP Method (32.32 percent, -6.17 percent, 0.32 percent and
15.51 percent). Thus all profitability ratios of sample companies have suffered due to inflation during the
period under the study. The p-value recorded 0.0024, 0.0003, 0.0000 and 0.0006 respectively for gross profit
margin, operating profit margin, net profit margin and return on investment shows that there is significant
difference between reported and inflated profitability ratios from each other. This supports our earlier
conclusion that the financial performance of sample companies has dropped drastically due to inflation.
Activity ratios measure the efficiency at which the resources of a firm have been employed and they indicate
the pace at which the assets are being turned over into sales. The analysis of activity ratios under the two
accounting methods (HCB and CPP) reveals a wide gap. The mean of Inventory Turnover Ratio has decreased
from 11.4766 times to 11.1810 times under CPP method as compared to HCB method. On the other hand the
mean of Creditor Turnover Ratio has increased from 3.7426 times (HCB) to 4.0907 times (CPP). In the same
way the mean of Debtor Turnover Ratio has gone up to 25.1120 times in case of CPP from 22.9793 times as
per HCB. The inventory turnover ratio has performed better in inflationary condition, while creditor turnover
ratio and debtor turnover ratio has declined. The p-value for all these three ratios found to be 0.0000. Hence,
there is a significant difference between all reported and inflated activity ratios.
129

The mean value, standard deviation and variance of Inventory Turnover Ratio is found to be higher in HCB
method as compared to the CPP method meaning there by the production efficiency of sample companies has
suffered to greater extent due to inflation, although inconsistent during the period of study. Moreover better
performance of the Creditor Turnover Ratio under CPP method as compared to HCB method indicates that
creditors are benefited by inflationary condition at the cost of the firms. On the contrary, the mean value of
Debtors Turnover Ratio found to be higher under the CPP method indicates that inflation has favorable impact
on debtors of the sample companies during the period of study.
Hence our Null Hypothesis (H
03
) is rejected as there is a significance difference in financial ratios between two
accounting methods. From the findings it is also established that historical accounts overstate profitability and
understate financial position due to inflation.
There are various stakeholders associated with a business enterprise with different motives. We found it quite
interesting in analyzing as to how they are affected by the inflation. The various stakeholders identified for
analysis are the customers, suppliers, employees, financial institutions, Government, shareholders and the
management.
It was seen from the analysis that average growth of sales under HCB method was 17.48 percent, while the
same was only 10.90 percent under CPP method. Thus, the customers have been in an advantageous position
by purchasing the products at cheaper rates due to inflation during the period of our study. On the other hand,
the suppliers have suffered loss which is evidenced from the fact that raw materials purchased by the sample
companies have recorded an average growth of 19.08 percent as per HCB method but 12.45 percent as per
CPP method.
The average growth in employees costs has recorded 25.40 percent and 18.43 percent respectively under HCB
and CPP methods. Thus companies have experienced gain and employees have experienced loss on account of
inflation. In the same way the growth in average excise duty found to be 14.62 percent as per HCB method
which has been lowered up to 8.42 percent as per CPP method. The Government has not been able to maintain
the real value of its excise collections. Likewise, average growth of interest paid has also risen from 31.63
percent in HCB method to 24.02 percent in CPP method.
The sample companies have paid tax on an average of 33.04 percent which was in real terms found to be 45.41
percent. In the same way the average dividend paid by sample companies was 34.04 percent in HCB method
and 57.70 percent in CPP method. The finding reveals a conflicting picture: the sample companies have paid
excess dividend to their shareholders, which is even more than the profit available for the purpose. What more
is that, they have paid dividend even during the period of loss. This is due to the fact that profitability of the
companies has decreased in real terms, which resultant in book value of share must have declined. This
analysis makes it clear that shareholders have been misled by the historical accounts in respect of the net worth
of their shareholding.
From the above, it is concluded that different stakeholders were affected differently by inflation. While
customers and the Government are the real gainers in the inflationary conditions; the suppliers, employees and
financial institutions are the loss-bearers in real terms. The shareholders are affected in both ways: They are
gainers as they get extra dividends and loser as the book value of their shares comes down owing to declined
retained earnings. Therefore from the above it is clear that our fourth Null Hypothesis (H04): Inflation affects
all the stakeholders uniformly is rejected and the Alternative Hypothesis (Ha4) is accepted.
9.3.4 Adjustment of Impact of Inflation on Financial Efficiency through Model
As the HCB method of accounting requires some adjustments with the change in price level, the present study
has adopted a methodology (adjustment model) for the assessment of firms performance under conditions of
high inflation rates and limited financial disclosure. This model is based on an adjustment mechanism, which
is both concise and unambiguous. The model shows the relationship between the reported financial
performance and inflated financial performance.
The symbol r represents the relationship between reported and real gross income. The real (inflated) gross
income is found to be lower than the reported gross income and varies in between 98.04 per cent (2007-08) to
130

99.48 per cent (2008-09) of the reported income. This is mainly due to average inventory to total assets. In
sector-wise comparison, while the Automobile Sector was less affected for the first three years, the Steel
Sector has affected less in the last two years. The absolute value of ratio r of Food Sector had suffered more in
the entire study period. Again, it is found that the year/sector with smaller quantity of inventories in relation to
their total assets are less affected by inflation than years with larger inventory.
The symbol k is the relationship between reported net operating income and inflated net operating income. The
net operating income varies in between minimum 79.05 percent in the year 2007-08 to a maximum of 94.09
percent in the first year of study period. The ratio k is least affected in Automobile Sector and most in case of
Food Sector throughout study period. However it is less affected in the year/sector having high proportion of
average inventory to total assets or high proportion of net fixed assets to net total assets and vice-versa.
The symbol l indicating the relationship between monetary liabilities to monetary assets shows the purchasing
power loss/gain on monetary items. The value l found negative in almost all Sectors under study except
Automobile Sector. From the analysis it is clear that, the sample companies have experienced gains in the first
four years of study i.e., 2004-05 to 2007-08, when the ratio l varies from -3.28 percent to -2.77 percent of their
reported income. But in the last year of study i.e., 2008-09, the sample firms suffered a loss of 0.43 percent.
While the Cement Sector has achieved highest purchasing power gains in the first three years, the Fertilizer
Sector achieved the same in the last two years.
The value of ratio s indicating the overall performance of sample companies varies in between 81.84 percent
(2007-08) to 97.37 percent (2004-05). In Sector-wise comparison it is found that valueof s was most affected
in case of Food Sector and least for the Steel throughout the period of study.
From the above it clear that the value of r, k and s is not equal to 100 percent and their value varies from one
sector to another depending upon degree of impact of inflation on a particular sector for entire study period.
This sufficiently brings out the rejection of the Null Hypotheses H
01
, H
02
, H
05
, and H
06
, Therefore their
Alternative Hypotheses; H
a1
, H
a2
, H
a5
and H
a6
are accepted
9.4 CONCLUSION
From the above summary and findings, it is concluded that:
(a) The Profit/Loss Account under HCB method highly overstates the profitability in comparison to CPP
method. CPP adjustments even turn the profits into losses. However the extent of overstatement varies
from company to company. In short, HCB profits are illusory.
(b) There are mainly three factors which contribute to overstatement of profitability in HCB method:
Materials Cost, Depreciation and Purchasing Power Loss. In another words, HCB accounts
undercharge materials cost (since historical costs are matched against current revenue) and depreciation
(since it is not based on current value of the fixed assets). However, as between materials cost and
depreciation, it is the later which is undercharged more, and that too, many times more.
(c) Inflation affects different industrial-sectors differently.
(d) Different stakeholders are also affected differently by inflation. While customers and the Government
are the real gainers in the inflationary conditions; the suppliers, employees and financial institutions are
the loss-bearers in real terms. The shareholders are affected in both ways: gainers as they get extra
dividends and losers as the book value of their shares comes down owing to declined retained earnings.
9.5 SUGGESTIONS
Following are some of the suggestions for the implementation of an effective system of inflation accounting
derived from the study.
(i) For reliability in the financial statements (showing a true and fair view of the financial performance and
position), evading superfluous payment of tax as well as for avoiding over distribution of dividend
(which is adversely affecting the corporate growth due to erosion of profits), it is strongly recommended
that Accounting for Current Purchasing Power of Rupee (CPP) should be recognized by the Government
with Professional bodies and be adopted immediately in Corporate India.
(ii) For minimizing the personal biasness of accountants and to avoid manipulation of accounts, uniformity
131

in the identifying of monetary/non-monetary liabilities, methods of inventory valuation in inflationary
condition as well as methods of providing depreciation be introduced. Different methods of inventory
valuation result into different profits. Therefore, one and only one method should be allowed to be
followed. Since the LIFO method has emerged as the method which provides maximum coverage
against inflation, the same should be applied universally. Similarly, one and only one method of
depreciation, i.e. WDV Method should be recognized and prescribed to be universally followed in
preparing the financial statements.
(iii) The restatement of historical cost based accounts in terms of current purchasing power of rupee should
be done on the basis of wholesale price index (all commodities), because it is being more broad-based,
associated with whole-sale industrial and non-consumer transactions as well as superior to consumer
price index.
(iv) The inflation adjusted financial statements should be presented in the annual reports as supplemental to
HCB statements. This will enable the companies to disclose all other requirements of schedule VI to The
Companies Act in HCB terms, since some of them may not be amenable to restatement in CPP terms.
(v) The Direct Taxes Acts; viz. Income Tax Act and Wealth Tax Act, as well as The Companies Act
should be amended in a clear and unambiguous manner to incorporate the scheme of accounting for
inflation.
(vi) As required companies while making public issue and listing in the stock exchanges, all companies be
insisted to publish their half-yearly and quarterly results in national newspapers. It is suggested that the
Stock Exchanges should amend the listing agreement making it obligatory for the companies to publish
such results in inflation accounting terms also.
(vii) The Institute of Chartered Accountants of India (ICAI) has come out with changes and introduced
number of standards required for treatment of various items of accounting during changes in price level.
It is suggested that it should also amend its standards on Inventory Valuation and Depreciation.
(viii) There is a great need to educate the accountants and personnel related to the tax administration in the
subject of inflation accounting and its implication so that smooth implementation of accounting for
changes in price level and its counter check by the tax department to ensure that it is not being
manipulated to derive unintended advantages. The ICAI should start its programme to educate its
members and prospective members on the subject of inflation accounting without waiting for statutory
recognition to the system.
(ix) Initially the system of inflation for accounting should be implemented keeping in view the interest of
business and industry alone. Once the system is stabilized, continuous research should be undertaken to
strike a balance among the interests of various stakeholders associated with business and industry.
(x) Holding more and more monetary liabilities and reducing monetary assets provide cushion against
inflation in the shape of purchasing power gain. It is, therefore, suggested that the companies should
attempt to keep the balance of monetary items in favour of monetary liabilities.
(xi) The Chambers of Commerce must create awareness among the business and industry circles and educate
them extensively on the need of Accounting for Inflation.
9.6 PRACTICAL UTILITY OF THE STUDY
The impacts of inflation upon a business are distorting its profit performance and valuations of its capital. This
in turn affects the judgments and decisions of Management, Shareholders, Creditors, Employees, etc. Some
significant distorting facts that we have observed in the study are:
The assets that are stated in the balance sheet are reported at values that are much lower than their
current values. Due to the understatement of the values, the business is more vulnerable to take-over
bids and the shareholders may not realize a fair value for their shares at the time of such takeover.
The profits and return on investment under historical cost accounting are overstated as revenue is
recorded at increasing price levels and expenses such as; depreciation and cost of sales are charged off
at the historical cost.
132

Therefore accounts that havent adjusted the impact of inflation can prove vulnerable to the users of accounts.
In this context, the research presented in this thesis has the following practical utilities:
a) The corporate sector will be able to present more realistic view of its profitability because current
revenues are matched with current costs.
b) Depreciation charged on current values will further enable companies to show accounting profits more
closer to economic profits.
c) The corporate sector can maintain its real capital by avoiding payments of dividends and taxes out of its
capital due to inflated profits in historical accounting.
d) When financial statements are presented, with adjustments to the price level changes, it makes possible
to compare the profitability of two concerns set up at different times.
e) Investors, employees and the public at large cannot be misled by inflated book profits because inflation
accounting shows more realistic profits.
f) The financial statements prepared by a company adjusted to the price level changes also improve its
social image.
g) Investment market will show a realistic price for the shares of a company.
9.7 SCOPE FOR FURTHER RESEARCH
It is clearly identified in the literature review that there are very few works that have been conducted in India
till date in respect to impact of inflation in Indian Corporate sector. Therefore there are a range of potential
areas where further research can be undertaken in the Indian context as discussed below.
a) It would be very interesting to conduct another study within the same area of research, with the
incorporation of more industries, which will give more integrated result to the topic and better utility
to the stakeholders and management.
b) The study focuses on the impact of inflation with a limited financial disclosure. It would have been
better, if the study could have been conducted with more financial information collected directly from
individual sample companies.
c) This study concentrates only on manufacturing industries performances, while it could be of interest to
conduct a study on servicing industries as well. This will provide an idea of impact of inflation on
other sectors.
d) Lastly, this study is based on the financial performance of the selected companies for a period of five
years only. More honest results can be found, if the study period will be extended to ten years or more.

* * *

133

Bibliography

AAA (1966). A Statement of Basic Accounting Theory (ASOBAT) Evanston, Illinois, USA
Accounting Priniciples Board (1970), Statement of Accounting Principles, No.4: Basic Concepts and Accounting
Priniciples Underlying Financial Statements of Business Enterprises, AICPA, New York.
Ahmad Md. R., (2003) Inflation Accounting Practices in Indians Corporate Sectors Atlantic Publishers and
Distributors.
Akdoan N., Aktas R. and Unal S., (2009), Effect of Inflation Accounting on Financial Ratios: An Empirical
Analysis of Non-Financial Firm Listed on Istanbul Stock Exchange. The Icfai University Journal of
Accounting Research 2, p47-62
Al-Tassan, Mohammad Saleh (1983). Cash Flow Prediction A Comparison of Historical Costs and Constant
Dollar Accounting Information, Dissertation Abstracts International, Vol. 45 No. 2, August, 1984, p.
557-A. American Institute of Certified Public Accountants (PJCPA) in 1948.
Anonymous (2000). Framework for the Preparation and Presentation of Financial Statements, issued by the
Accounting Standards Board (ASB) of ICAI, p. 19-23
Anonymous (2006). Conceptual Framework for financial reporting: Preliminary Views, Financial Accounting
Standards Board (FASB) of the Financial Accounting Foundation, No. 1260-001.
Antonios A. P., (1986) Assessing the impact of inflation on business Performance under conditions of limited
Financial disclosure: the case of firms Operating in Greece, SPOUDAI, University of Piraeus, p 25-42
Baran A., Lakonishok J. and Ofer A. B., (1980) The Information Content of General Price Level Adjustment
Earnings: Some Empirical Evidence.
Barton, A. D. (1994). Expectations and Achievements in Income Theory. Accounting Review, 13, 65 71.
Baxter W. T., his book entitled Accounting Value and Inflation McGraw Hill U.K., 1975.
Baxter W.T., What Progress on Inflation Guidelines, Accountant: Sept. 29, 1977, p. 378.
Bhattar, M.M. (1995). Corporate Published Accounting Information and Investors, ISBN-81-900422-9-7, Books
Treasure Jodhpur, India, p.6
Bhuiyan, H.U. and Biswas P. K. (2007), Corporate Governance and Reporting: An Empirical Study of the Listed
Companies in Bangladesh. Dhaka University Journal of Business Studies 28 (1).
Boussard D., (1984), The Impact of the Definition of Inflation on the Effectiveness of Inflation Accounting
Adjustments, ABACUS p157-169
Bromwick, M. (1995). The general validity of certain current value asset valuation basis. Accounting Research,
5, 10 15.
Catsambas T., (1988), Budget Deficits, Inflation Accounting, and Macroeconomic Policy: A Skeptical Note,
Journal of Public Policy Vol.8, P49-60
Chahal, S.S. (1990). New Prespectives in Corporate Financial Reporting-Adequate Disclosure in Financial
Reporting, in M. Saeed (Ed.), Corporate Financial Reporting, ISBN 81-7041-348-6, Anmol Publications,
New Delhi, p. 22.
Chakraborti, Pronab Kumar (1990). Corporate Financial Reporting in India- New Perspectives, in M. Saeed
(Ed.). Corporate Financial Reporting, ISBN 81-7041-348- 6, p. 317-335, Limperg, T., "Industrial
economy, collected works posthumously published in 1964
Chander, Subhash (1992), Corporate Reporting Practices, ISBN 81-7100-411-5, Deep and Deep Publications,
New Delhi, p. 1-2.
Chandra, Gyan (1974). A Study of the Consensus on Disclosure among Public Accountants and Security
Analysts. The Accounting Review, p. 733-742.
Cooper, W.W., Ijiri and Yuji (1984.) Kohlers Dictionary for Accountants, Prentice Hall of India Pvt. Ltd., New
Delhi.
134

Cornelius J. C. and Michael J. S., (1981), Internal uses of accounting for inflation, Harvard Business Review
November-December 1981 P149-156
Daly D. J., (1982), Inflation, Inflation Aaccounting and its Effect, canadian Manufacturing 1966-82, York
University, Downsview, Ontario pp. 355-374.
Datta, Manipadma (1990). Corporate Financial Reporting in India-The Changing Prespective, in M. Saeed (Ed.)
Corporate Financial Reporting, Anmol Publications, New Delhi, p.75-92.
Davidson, S., Sticknay, C. P. & Weil, R. L. (1996). Inflation Accounting: A Guide for the accountant and
Financial Analysts. New York: McGraw Hill.
Dean, G. A. (1994), The Stock of Fixed Capital in United Kingdom in 1991. Journal of the Royal Statistical
Society, 127 (3), 142 - 146.
Devarajan, R. (2008). Financial Reporting. ISBN No. 978-81-8441-070-9.Vol. I, p. 3.3, A Book by Board of
Studies, Institute of Chartered Accountants of India.
Edgar O Edwards, in (1975), The State of Current Value Accounting" The Accounting Review, April p235-245
Edward V. M., (1982) Interaction Effects of Inflation Accounting Models and Accounting Techniques, The
Accounting Review. P 607
Elliot B. & Elliot J. (2004) Financial accounting and reporting, Prentice Hall, London 2004, p. 3,
FASB (1978). Statement of Financial Accounting Concepts No.1: Objectives of Financial Reporting by Business
enterprises, Financial Accounting Standards Board, in The Journal of Acountancy,Feb.1979, p. 90-98.
Fisher, John, Current Cost Accounting Some Basic Problems the accountant the JCAEW, London, May, 6 and
13, 1976, pp. 528-530 and 556-558.
Glautier, M. W. & Underdown, E. (1998). Accounting theory and practice (3rd edition). London: Pitman.
Graves, Oliver Finley (1985) Accounting for lnflation: German Theory of the 1920s, Dissertation Abstracts
International Vol.46 No.07 January, 1986, p. 202-A
Gupta A., (2000) Inflation Accounting: The Indian Context Kanishka Publishers and Distributors.
Gupta R. and Bhandari L. C., (1978) Impact of Inflation Accounting on Corporate Profits - A Study of 57 Indian
Companies, Institute of Management Ahmedabad, Research and Publication Department , working Paper
Series
Gupta R., (1978) Inflation Accounting in India - A Case Study of the Bharat Heavy Electricals Ltd. Institute of
Management Ahmedabad, Research and Publication Department, Working Paper Series.
Gupta S.P., Statistical Methods, 21
st
Edition, (1986), Sultan Chand and Sons, New Delhi
Gupta, N. Das (1977). Financial Reporting in India, Sultan Chand and Sons, New Delhi, p. 3.
Gupta, S.K. and Mehra, Arun (2002). Contemporary Issues in Accounting, ISBN- 81-272-0389-0, p.1.
Gynther R.S., Why use General Purchasing Power? Accounting and Business Research, Spring, 1974, op. cit.
Haggie, David (1984). The Annual Report as an Aid to Communication Accountancy, p. 66-67. 21
Hand Book on Statistics of the Indian Economy, Reverse Bank of India 2008-09
Hand Book on Statistics of the Indian Economy, Reverse Bank of India September 15, 2011.
Hendrickson E.S., Purchasing Power-Replacement Cost Concepts. Accounting Review July, 1963, pp. 483-
491
Hendrickson, E. S. & Brenda, M. F. (1992). Accounting Theory (5th edition). London: Richard Irwin.
Hingley w. and Osborn F., in London (1983) in their book entitled Financial Management Made Simple.
Hochman S. and Palmon O., (1985), The Impact of Inflation on The Aggregate Debt-Asset Ratio, The Journal of
Finance, Vol, Xl, No, 4 September 1985, P1116-1125
Hordia T. C. and Shivakumar L., (2005), Inflation Illusion and Post-Earnings-Announcement Drift, Journal of
Accounting Research, Vol. 43, p521-526
IASC (1989). International Accounting Standards Committee, Framework for the Preparation and Presentation of
Financial Statements, The Chartered Accountant, Aug. pp.124-132.
ICAI (1982) Treatment of Changing Price in Financial Statement discussion paper
IFRS - Framework for the Preparation and Presentation of Financial Statements, paragraph 100, IASC
135

Ijiri, Y. (1997). The foundations of accounting measurement. New Delhi: Prentice Hall.
Inflation Accounting, An Interim Recommendation, ASC, Nov. 1977, Accountant Vol. IV, 1977.
Inflation accountingthe interim period ASSC CCAB, January 1976.Institute of Chartered Accountants in
England and Wales, published in January, 1973.
International Financial Reporting Standards (2004). Financial reporting in hyper inflationary economy.
Washington DC: World Bank.
Jeffrey J. Archambault& Marie E. Archambault (1999), A cross-national test of determinants of inflation
accounting practices , The International Journal of Accounting, Vol.5, No.3. p189-207
Jennings R. &Maturana G. (2005) in their article The Usefulness Of Chilean Inflation Accounting, in the journal
ABANTE, p 85-118
Jiloka, S.K. and Verma S. (2006). Corporate Financial Disclosure. The Management Accountant, 41(11): 867-
871.
Jones, Ralph C., Price Level Changes and Financial Statements, Case Studies of four companies, AAA, 1955.
Kapur S. K. (1993), Elements of Practical Statistics, OXFORD and IBH Publishing Co. Private Limited.
Karapinar A. and Zaif F., (2005), The Effect of Inflation Accounting on Financial Statement Analysis,
YaklamDergisi 26, p4972.
Karapinar A., Zaif F. & Bayirli R., (2012) Impact of Inflation Accounting application on Key Financial
Ratios, Journal of Business Research, Turk, p44-57
Kaura M. N., (1982), Recent Development in Inflation Accounting: A Critique, ASCI Journal of Management
p133-144
Kistner, K. P. & Salmi, M. (1980). Holding gains and long-term liabilities. Accounting and Business Review, 21,
(2), 21-27.
Kohier E. L., op. cit., p. 136.
Kohler, E. L., A Dictionary of Accountants, 6th edition, Prentice Flail of India Pvt. Ltd., New Delhi, 1983, p.
111.
Kohli, Pooja (1998). Corporate Disclosure Practices- A comparative Study of the Indian and The U.S.
Companies., A Ph.D thesis submitted to the University Business School, Punjab University Chandigarh.
Konchitchki Y., (2011), Inflation and Nominal Financial Reporting: Implications for Performance and Stock
Prices, The Accounting Review, Volume 86 (3): 10451085.
Kothari C. R. (1997) Research Methodology Models and Techniques, Wishwa Prakashan,
Lacey K.C., Some implications of the first-in-first-out method of stock valuation, Economics, Feb., 1945, PP. 26-
30.
Lal, Jawahar (1985). Financial Reporting by Diversified Companies. Vision Books, Delhi, p. 7.
Lee, T.A. (1976). Company Financial Reporting-Issues and Analyses.Thomas Nelson and Sons. p. XV.
Levin R. I. and Rubin D.S., Statistics for Management, Sixth Edition (1994), Prentice-Hall of India (P) Limited,
New Delhi.
Mason, Perry, op. cit, and Hendrickson, E.S., op. cit.
Matolcsy Z. P., (1984), Evidence on the Joint and Marginal Information Content of Inflation-Adjusted
Accounting Income Numbers Journal of Accounting Research Vol. 22 No. 2, Autumn p555-566
Meena, D.D (1995), Corporate Reporting Practices in Public Enterprises, ISBN-81-7000-189-7, Ess Ess
Publications. P. 52.
Mehrotra, H. C. and Kulshrestha, D.K. (1990). Financial Reporting Practices in Public enterprises in India. In
M.Saeed (Ed), Corporate Financial Reporting, Anmol Publications, New Delhi, p. 7.
Middleditch, L., "Should Accounts Reflect the Changing Value of the Dollar?", The Journal of Accountancy,
February 1918, pp. 116-119.
Millichamp, A. H. (1989). Foundation accounting: An instructional manual for accounting students. London: The
Guarnsey Press.
Mueller, G. and C. Smith (ed.), Accounting: A Book of Reading, New York: Holt, Rinehart and Winston Inc.,
1970.
136

Narsimhan, M.S. (2001). Corporate Disclosure and Agency Problem Role of New International Accounting
Standards. The Chartered Accountant, December
N'cho-Oguee C., Blakley D. L., Murray L. W. & Smith M. B., (2 011), Econometric Analysis Of Functional
Relationship Between Inflation And Growth Of Firms In South Africa : Empirical Research Findings
Journal of Financial Management and Analysis, Om Sai Ram Centre for Financial Management Research
p1-19
Nigam R.S., Inflation Accounting and the Developing World: The Case of Trinidad and Tobago, Chartered
Secretary, July, 1983, pp. 517-520.
Norby W. C., (1981) The Interpretation of Inflation Accounting Information, The SAXE Lecture in Accounting.
P48-55
Nunley, Terry James, Can Disclosures of the Effects of Changing Pieces be audited? A Case Study Dissertation
Abstracts International Vol. 44 No. 8 February, 1984, p. 2504-A,
Okumus H. S., (2002) The effect of inflation on measures of profitability in Turkish Banking, YapKredi
Economic Review, 2002, vol.13, no. 2, pp. 3-18.
Oza, H.S. (1990). New Prespectives in Corporate Financial Reporting in India. In M. Saeed (Ed.) Corporate
Financial Reporting, Anmol Publications, New Delhi, p. 30.
Parker W. E., Accounting for Inflation, Accountancy, December, 1971.
Pasricha, J.S. (2000), Interim Reporting-A Device for Investors, The Chartered Accountant, March.
Paton, A. and R. Stevenson, Principles of Accounting, Ann Arbor: George Wahr, 1916.
Peterson, R. J. (1997). Impact of price-level accounting. The Accounting Review, 6 (1), 15 - 18.
Porwal L.S. and Mishra N., Corporate Practices in Inflation Accounting in India; Indian Journal of Accounting
Vol. XIII, June & December, 1983, Part II
Porwal, L.S. (1989). Accounting Theory-An Introduction. Tata Mc Graw-Hill, ISBN-0-07-463820-3, Third
Edition, p. 81 and 136-137.
Price Water House Coopers (May, 2006). Financial Reporting in hyperinflationary Environments: Understanding
IAS 29. Price Water House Coopers., page 3. Archived September 26, 2007 at the Way Back Machine.
Price Waterhouse (1984): A Survey of International Accounting Practices. The Price Waterhouse Company.p-6
Proposal Statement of SAP-ED-18-CCA-ASC, December, 1976.
Raghunathan V. and Rajib P., (2008) Stock Exchange Investments and Derivatives, Tata McGrawHill p27
Rehman, Abdur and Muttakin, Mohammed Badrul (2005). Corporate Environment Reporting Practices in
Bangladesh-A Study of some selected companies. The Cost and Management 33 (4): 13-21.
Report of Council of ICAEW on IASG-ED-18 CCAJournal of Accounting, Jan. 1977, PP. 72-75. Research,
10, 112-115.
Riaz, Uddin, Mausm, Iqbal and Syed, Maruf Reza (2006). Disclosure Practice: A Comparison of Commercial
Banks and Insurance Companies in Bangladesh. The Cost and Management 34 (1).
Rosen L. S., Current Value Accounting and Price Level Restatement, Toronto: The Canadian Institute of
Chartered Accountant, 1972.
Rosenfield, Paul, The Confusion Between General Price Level Restatement and Current Value Accounting,
Journal of Accounting October, 1972, PP. 65-69.
Rowles T, & Burrows G, (1997), 'The Inflation Accounting-Cycle: A British-Australian Comparative
Perspective', The 20th Annual Congress of the European Accounting Association, The European
Accounting Association, Graz, Austria, pp. 265-265
Saeed, M. (1990). The Theory of Corporate Disclosure and its Applications in Financial Reporting. In M. Saeed
(Ed.) Corporate Financial Reporting, Anmol Publications, New Delhi, p. 237.
Saha&Ashit B. Article on Accounting for price level changes: Evolution, Perspective and prospects published in
Commerce Journal, Gauhati University, Assam, India 1995, Vol. IV. p. 139.
Salvary, U. V. (2004), Measurement of portfolio performance under certainty. The American Economic Review,
15 (1), 12 17.
137

Sandilands, F.E.P., (Chairman), Report of Inflation Accounting Committee, London, Her Majestys stationery
office, Comn. 6225, September, 1975.
Schmalenbach, E., "Dynamic Accounting", 12th ed., translated by Murphy and K.S. Most, Gee and Co., London,
1959.
Schmidt, F., "The Importance of Replacement Value", The Accounting Review, Vb1.5, September 1930, pp.235-
242.
Sen, K., Inflation Accounting and Corporate Taxation, National Institute of Public Finance and Policy, New
Delhi, 1987, p. 11.
Sharma R. K and Gupta S. K.,(2003) A book on Management Accounting pp31.1-31.41
Shoven B., J., and Bulow I., J., (1976), Inflation Accounting and Nonfinancial Corporate Profits, Financial
Assets and Liabilities, pp.15-57 Brookings Papers on Economic Activity, 1:1976.
Shukla M.C., Grewal T.S., and Gupta S.C., Advanced Accounts, 13th Ed. S. Chand & Company Ltd. Ram
Nagar, New Delhi, 1997, pp. 31.2-31.4.
Singh, D. R. and Bhargava, S.K. (1978). Quality of Disclosure in the Public Sector Enterprises. Vikalpa 3(4):
257-264.
Singh, Kashmir (2005). Financial Reporting Practices of Banking Companies in India. A Ph.D. Thesis submitted
to H.N.B. Garhwal University, Srinagar.
Singh, Manjit (2009). Corporate Disclosure Practices in India-A Study of Large and Mid- Cap Companies. A
Ph.D. Thesis submitted to the Faculty of Business Studies of the Punjabi University, Patiala
Sinha S.L.N., Inflation and Company Finance, in Sinha (Ed.), Inflation in India, Vora& Co., 1974, pp. 276-
280.
Staubus, George J., Price Level Accounting: Some unfinished Business, Accounting and Business Research,
Winter 1975, P. 42.
Surgan C. J. and Mathur, N. D., (1994) The book entitled Accounting Theory and Practice edited by (Arihant
Publishing House), Jaipur.
Sweeney H.W. Stabilized Accounting, New York, Harpar and Brothers, 1936. Reissued.Holt, Rinchart and
Winston, 1964.
Sweeney, H., "Capital" The Accounting Review, Vol.8, September 1933, pp.185-199..
Swenson, Charles William (1984), Some Alternative Approaches to Mitigating Inflationary Effects on Corporate
Taxation Dissertation Abstracts International Vol. 45 No. 07 January, 1985, p. 3180-p
Table of Wholesale Price Index -All India, Economic Survey of Delhi, 2007-08 Month And Year Wise
Wholesale Price Index Numbers of All India P272-278
The book entitled Accounting Theory and Practice edited by Surgan C. Jam, N.D. Mathur in 1994 (Arihant
Publishing House), Jaipur.
The book of inflation accountingA Guide for the Accountant and the Financial Analyst written by Davidson
S., Stickney C. P. and Well R. L., in U.S.A. in 1976.
Tierney, C., "The Index Number Problem", in "Reporting the Financial Effects of Price z Level Changes",
Accounting Research Study No.6, New York: AICPA, 1963, pp.61-62.
Tugul Ai, Alexandru Jr. (2001), A New Model for Inflation Accounting, Working Paper Series
Tweedie, D. and G. Whittington, The Debate on Inflation Accounting, London: Cambridge University Press,
1984.
Ubha, Dharminder Singh (1999). Corporate Disclosure Practices in India. A Ph. D. Thesis submitted to Punjabi
University Patiala.
Vancil R., F., (1976) Inflation Accounting the Great Controversy, Harvard Business Review, P58-67
Vedpuriswar, A.V. and Subramanian, S. (2005). Corporate Disclosure ? You must be joking
,http://www.rediff.com/money/ June 30.
Vemonkam in 1990 his book entitled Accounting Theory they discussed.
Walter B. Meigs and Robert P. Meigs in 1983 in his book entitled Accountingthe basis for Business
Decisions.
138

Whittington G., Saporta V and Ajit Singh (1997) The Effects of Hyper-Inflation on Accounting Ratios.
Financing Corporate Growth in Industrial Economies Working paper series from The World Bank;
International Finance Corporation, IFC Technical Paper Number 3, p1-36
Wholesale price index, Office of the Economic Adviser to the Government of India, Ministry of Commerce and
Industry
www.fasb.org
www.icai.orgBaran, A. (1996). Empirical investigation of general purchasing power adjustments on earnings.
Journal of Accounting
www.sciedu.ca/ijfr International Journal of Financial Research Vol. 2, No. 1; March 2011, ISSN 1923-4023 E-
ISSN 1923-4031
Yang, David C, Vasarhelyi, et. AI (2005), An Empirical Study of Net Assets Disclosure: Inflation Accounting
Revisited, International Journal of Business.p403-421.

* * *

Inflation Accounting 4-2-2014

Transféré par

Informations du document

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Inflation Accounting 4-2-2014

Transféré par

Droits d'auteur :

Formats disponibles

1

Vous aimerez peut-être aussi