Inflation Accounting

SIMSR | MFM | SEM - IV |

MFM Year 2000 10000 per anum
MFM Year 2010 60000 per anum
In 10 years 600% RISE

Milk Year 2000 10 per litter
Milk Year 2010 50 per litter
In 10 years 500% RISE

House (1 BHK Flat Mumbai - Goregaon)
1 BHK Flat Year 2000 Rs.15 Lakhs
1 BHK Flat Year 2010 Rs.70 Lakhs
In 10 years 500% RISE

Almost 50% rise year on year in most of the
essential commodities.

Overall Average Inflation is over 7% year on year
for last 30 years
What is
Inflation
This rise in overall prices for all goods
produced in the Economy is called Inflation.

On the other side we can say fall in value of
Money is due to Inflation.

Higher Inflation reduces the Purchasing
Power

Lower Inflation increases the Purchasing
Power.
Inflation
Effect
5. 2011 150% rise in Real
Estate Price accounted in
B.S. above.

6. This is how Inflation can
affect B.S.

1. India Bulls
2. 2005 BKC Commercial
Space acquired @ 20,000
p.s.f.
3. 2005 - Balance Sheet
Representation
Cost of BKC Commercial
Space = 20,000 X 5000 s.f.
= 1,00,000,00
2011 - Balance Sheet
Representation
Value of BKC Commercial
Space = 50,000 X 5000 s.f.
= 10,00,00,000

A
1
B
2
What Inflation Can Do to Corporate B.S.?
A term describing a range of
accounting systems designed to
correct problems arising from
historical cost accounting in
the presence of inflation.
Inflation Accounting

Incorporates such changes
over the period in cost of
different Assets, Products,
Raw Material to give True
representation of Real Values
as on Today or in Future.
What is Inflation A/c
1
Definition
2
Inflation Accounting
First was suggested in 1936 by Henry
Sweeny of USA through his book
Stabilized Accounting.

USA and England are the two countries that
made prominent inroads to Inflation
Accounting.
Inflation
Accounting
Origin
3. The objective of charging
depreciation is to spread the
cost of the asset over its
useful life and make reserve
for its replacement in
the future. But it does not
take into account the impact
of inflation over the
replacement cost which may
result into the inadequate
charge of depreciation.
4. Future earnings are not easily
projected from
historical earnings.
1. Historical accounts do not
consider unrealized holding
gains arising from rise in the
monetary value of the assets
due to inflation.
2. Under historical accounting,
inventories acquired a told
prices are matched against
revenues expressed at current
prices. In the period
of inflation, this may lead to
the overstatement of profits
due mixing up of holding gains
and operating gains.

Limitations of historical
Cost accounting
1 2
Inflation Accounting
ICAI realized the importance of Inflation
Accounting very late (Feb 1982).

Indian corporate sector does not follow this
method, as there is no fiscal law governing
the presentation of company accounts in
this basis.

Ashok Leyland Ltd., Carborandum Universal
Ltd. & Tube Investment of India Ltd. were
the first 3 companies who presented CPP
accounts in 1973-74 annual reports.
Inflation
Accounting
Indian
Scenario
BHEL and Tata Chemicals Ltd. are
considered to be the pioneers in the
presentation of inflation adjusted accounts.

But both discontinued after following for
long period.

NTPC, MMTC & OIL are still following
inflation accounting (CCA).
Inflation
Accounting
Indian
Scenario
Current Cost Accounting (CCA)
Method
Current Purchasing Power (CPP)
Method
1 2
Techniques
To measure the impact of inflation on
financial statements, following are
the techniques used.
This method takes into account
the changes in the general
purchasing power of money and
ignores the actual rise or fall in
the price of the given item.
All items in the
financial statements are restated
in terms of a constant unit of
money i.e. in terms of general
purchasing power.

For measuring changes in the
price level and incorporating the
changes in the financial
statements we use General Price
Index, which may be considered to
be a barometer meant for the
purpose.


Current Purchasing Power
(CPP) Method
1
Techniques
Value of asset as per CPP =

Historical Cost of Asset x
Conversion Factor

Conversion Factor =Price Index
at the date of conversion / Price
at the date of transaction
For converting historical value of
money into purchasing power
value as at the end of the period ,

Two index numbers are required :

1. Showing general price level at
the end of the Period and another

2. Showing general price level at
the date of the transaction
CPP Method
1
Techniques
The value of machinery as
on 31-12- 2006 by CPP method
will be calculated as under:

1,50,000*250/150 = Rs.2,50,000

Thus, Rs.2,50,000 being the new
cost of machinery represents
the current purchasing power at
the end of 2006 of Rs.1,50,000
paid out in the beginning of
2004.
X Ltd. purchased machinery on1st
Jan. 2003for Rs.1,50,000.

This machinery is to be expressed
in current purchasing power terms
at the end of 2006.

The approved general index has
increased from150 in Jan.2003 to
250 at the end of Dec. 2006.

CPP Method
1
Techniques
The CCA method matches current
revenues with the current cost of
the resources which are
consumed in earning them.

Under this method, asset are
valued at current cost which is the
cost at which asset can be
replaced as on a date.
Current Cost Accounting
(CCA) Method
2
Techniques
Change in the price level is a continuous
process.

This system makes the calculations a
tedious task because of too many
conversions and calculations.

This system has not been given preference
by tax authorities.
Inflation
Accounting

Limitations
1. CPA scores over CCA w. r. t.
Verifiability

2. Comparatively not simple to
use

3. International Accounting
Standards Committees not in
favor of CPP method to be
adopted in hyperinflationary
economies.

4. CCA is not the method, in
force in Latin American
countries, where inflation
accounting is mandatory.


1. Verifiability

2. Comparative simplicity

3. International Accounting
Standards Committees also in
favor of CPP method to be
adopted in hyperinflationary
economies.

4. CPP is the only method, in
force in Latin American
countries, where inflation
accounting is mandatory.

CPP Vs.
1
CCA
Techniques
2
Conclusion
Despite a right method of
presenting financial
statements, Inflation
Accounting is still not widely
prevalent due to certain
limitations
Despite a right method of
presenting financial
statements, Inflation
Accounting is still not widely
prevalent due to certain
limitations
Inflation Accounting by Group
Presented By :

Savargankar Vivek (49)
Sen Vikram (50)
Shukla Arun (51)
Tanna Dimple (52)
Tavade Mamata (53)
Tawde Manish (54)