INFLATION ACCOUNTNG

Financial Statements are prepared with a view to exhibit the true and fair fnancial
position of the concern. But in the real scenario of heavy infationary trends in the globe,
the position as shown by the fnancial statements becomes infated and hence does not
exhibit true and fair view.
Under the conditions of infation, the prices of all the factors and inputs of the
production are on a constant rise. he value of money declines in real term as the same
!uantity of goods is purchased at higher costs. he values attached to the di"erent
assets undergo big change with the changes in price levels and traditional Balance
Sheet fails to refect current economic position. here is distortion of fgures disclosed
by historical Balance Sheet fnally leading to the disclosure of inappropriate fnancial
position. hus, accounting based on historical cost concept infates profts and results in
erosion of capacity by way of dividend payment and tax liability.
Limitations of Historical costs-based Financial Statements:
#xaggerated fgures of profts especially because of undercharging depreciation $
higher value of inventories.
Unreliable results shown by fnancial statements leading to wrong decision ma%ing
by the users of fnancial accounting information.
&ayment of heavy dividends and taxes as the profts are infated and hence depletion
of fnancial resources as the proft is partly fctitious.
'nsu(cient funds for replacement of fxed assets after the end of useful life.
't adversely a"ects wor%ing capital position.
)omparison of fnancial fgures of di"erent position becomes di(cult and misleading.
*ains from the appreciation of assets are not accounted for.
+hat can be done to remove these limitations,
'n order to minimi-e or eliminate the impact of infation on maintenance of accounting
records $ to ensure appropriate treatment of various assets $ liabilities, the infation
accounting approach is developed.
'n the historical cost system of accounting the profts are infated, assets are
undervalued and losses and gains arise on holding of assets and liabilities, the infation
accounting system suggests that all the incomes, expenses, assets $ liabilities be
maintained at the current prices prevailing on the date of recording.
he fundamental ob.ective of infation accounting is to depict true $ fair value
observation in boo%s of accounts $ prevent the erosion of assets and business
resources.
MEITS OF INFLATION ACCOUNTING
he ob.ective of infation accounting is to embraces the true and fair value view of
accounts $ following are the merits of 'nfation accounting/
't enables the correlation of current cost with the current revenue leading to more
realistic proftability position of the business.
't prevents the payment of dividend from infated profts as shown by the historical
cost system.
0S in the infation accounting, the depreciation is charged on current values of the
assets, the capital is maintained intact.
't facilitates meaningful comparison of the records of the di"erent period.
0s the true profts 1instead of infated profts2 are shown, the tendency of
uncontrolled expenses by management and heavy demands by the employees is
curbed.
'nvestors and public get to %now the true proftability and fnancial position of the
business of organi-ation.
!EMEITS OF INFLATION ACCOUNTING
0lthough the basic main of infation accounting is to ensure the true $ fair value view of
accounting boo%s of an organi-ations, its implementation and follow up has many
obstacles in it. 'nfation accounting faces many limitations which are as under/
't involves fre!uent critical calculations as to ad.usting price level changes which
further ma%es fnancial statements more complicated.
3aluation at current prices ta%es di"erent views and brings further sub.ectivity
ultimately defeating the true $ fair view ob.ective of infation accounting.
'ncome tax department does not except the accounts prepared $ profts shown
under the infation accounting system.
4uring the period of defation it becomes more di(cult to maintain infation
accounting system as it leads to complex calculation $ sometimes controversial
situation.
)harging depreciation on current values leads to charging of the depreciation more
than the cost of the asset. his is not allowed by standard accounting principles.
METHO!S OF MAINTAINING INFLATION ACCOUNTING
here are two methods of maintaining the boo%s of accounts as per infation accounting.
)urrent &urchasing &ower method $ )urrent )ost 0ccounting method both the
approaches leads to the di"erent ways of calculating current values of various
accounting variables. hese two methods are briefy explained as under.
C"rrent #"rc$asin% #o&er 'C##(: Under ))& the historical costs are ad.usted with
the general price index. he items in the fnancial statement are ad.usted $ revalued at
the general price level. *eneral &rice 'ndex is considered as very good measure for
conversion of historical costs into e!uivalent current purchasing power.
For e.g. an asset purchased at 5s. 67888 in 69:6;:< has to have = value in <889;68.
his = value is found out by dividing purchase price of asset by general index value of
the year of purchase and then multiplying it with the general price index value of the
current year. *eneral &rice index value of 69:8 is 688 whereas its current year>s value is
776. So the value of asset in <889;68 is 67888?688 x 776 @ :<A78. he depreciation will
be charged on this current value of asset.
C"rrent Cost Acco"ntin% 'CCA(: he ))0 method is more realistic as it refects more
correct impact of infation by measuring the current cost of individual asset by applying
specifc index value instead of general index value. 't ta%es into account the individual
price index relating to particular asset of a concern. his method attempts to show the
assets at current cost instead of showing the changes in general purchasing power of
the money. Under this method each item in the fnancial statement is measured at its
current cost. his method has several merits such as the proft revealed is more realistic
and it is simple to implement this method.
he general practice of maintaining of fnancial accounting records, the infation
accounting methods are not incorporated by any business concern. 't is not acceptable
to the legal machinery of the country. 'nfation is a concurrent problem in any economy
and to deal with this problem while showing fnancial position and proftability of the
concern is a challenging tas%. 't re!uire further research for the development of more
accurate systems of incorporating infation accounting and eliminating impact of
infation on the various variables of the fnancial accounting information.