Clear your all doubts of Inflation Accounting

History of inflation accounting system

History of inflation accounting is as old as using the economics
term inflation. Since 1900, it became the system of accounting and theoretical researches were done in this field.


Inflation accounting in simple words:


International standard board accepted inflation accounting due to drawbacks of historical accounting system because company’s assets and liabilities value can never stable and in case if price are continually increasing. The value of money will be down. I can give simple example, If you go to market and purchases any thing, you will see the price of today will be more than 20 years ago what was giving for this, it means in every country's price are increasing that is inflation . At this time showing the assets on their historical cost does not represent actual cost business assets. Then under inflation accounting has to adjust all assets on their current price (shown in price index statical system of measuring changes in prices )

In usa this system is applied but from time to time, this system of accounting also rejected due to highly depression in 1930 and now in 2007-2008. In India, it is slowly but with progressive rate, this system of accounting is using in Indian corporate sector. Price in Indian market is increasing day by day, so this method is so important Indian corporate sector.

Definition

“Inflation accounting is a system of recording all transaction on their current market price which is calculated by price index. "


Methods of making financial statements under this system


(I ) Current purchasing power method :-

Under this method all value of assets are adjusted with current price index and then, it is shown in inflated balance sheet.
Suppose total assets of business is $ 10000 in 2000 and now in 2009 , enterprise wants to show his financial statement according inflation accounting system , then he can adopt or follow this method . Under this method 200 year’s price index = 100

2009’s index price = 150

And also adjust value of depreciation.



(II )Current cost method :-


Under this method all current and fixed assets are kept on market value basis and on the basis of comparison market value and cost value a revaluation account is created



Benefits of inflation accounting

1. Inflation accounting provides correct information of net profit because depreciation value is on current market value which will be more than historical cost method, because of inflation. It will decrease the value of profit and shareholder gets current amount of dividend.
2. Replacement is so easy :
   
   Because, depreciation is on fixed assets’ current market value, so it will decrease the value of net profit and company can easily create fund out of profit for purchasing new assets. In case, historical accounting system, it is most difficult to purchase new fixed asset at new market value, because depreciation is on historical cost and due to less charging of depreciation. It may possible that there will be less money in pocket of company for purchasing of new fixed asset. But in inflation accounting this problem will not arise.
3. Correct information to interested parties.-
   
   All economists believe that inflation decreases the level of new investment because customers start hoarding of material goods after fearing hyperinflation. At that time, if company makes his accounts on current purchase price and cost price basis, then all interested parties can get correct information about company’s financial and revenue position.
   a) They can also get information about inflation loss of company.
   b) They can also get information of gearing adjustments; it means what benefits are for shareholders in increasing price index in company.
4. Useful for managerial decision :-
   
   Manager studies financial statements before doing any managerial decisions. If company provides also financial statement on the basis of price level changing or inflation accounting system, managers can easily make their plans of new investment and also estimates new sale prices of their products.
5. UK has taken good steps in their tax laws which are now accepting financial statements which is made on the basis of inflation accounting system.