Chapter seven: Recent Developments In Accounting (Forensic And

Inflation Accounting)
CHAPTER OBJECTIVES
After completing this chapter you will able to:
 Describe inflationary accounting
 Account for effect of inflation on monetary and non-monetary assets using current
purchasing power method (CCP)
 Recognize the advantage and limitation of inflationary accounting
 Describe forensic accounting
 Differentiate forensic accounting and auditing
 Identify the Role of Forensic Accountant
 Identify techniques and procedures of forensic Accounting
 1. INFLATION ACCOUNTING
Financial statements are prepared on historical costs on the assumption that the unit of account (e.g., the
dollar) has a static value.
In reality, however, the value of money changes over time due to change in price level.

Changes in price may be attributable to inflation or deflation.

Inflation is the gradual decline of purchasing power of money due to price increases over time that may
resulted less availability/supply of goods& services or more/over money circulation in the economy.

Deflation is the general decline in prices for goods and services that may occurs when too many goods
are available or when there is not enough money circulating to purchase those goods. As a result, the
purchasing power of money will be increased.
•These changes in price necessitate effective inflation accounting due to the need to present accurate
financial statements.
 Inflation Accounting……
Small amounts of inflation are considered healthy for the economy & does not require
inflationary accounting.
However, When inflation (or deflation) becomes too great, often referred to as hyperinflation,
inflationary accounting becomes necessary.
Inflation accounting refers to the method used to report financial statements by factoring in
the impact of rising or dropping costs of various goods, which are adjusted according to price
indexes to present a clear picture of the firm’s financial position usually in times of inflationary
environments.
It is used to adjust accounting numbers and financial statements to reflect more accurate
representations of the costs and incomes at a given time.
It involves the recording of the income and expenditure of the business at the current prices
and reinstating financial statements of the company.
 Inflation Accounting……
Financial statements that are prepared based on historical costs suffer from several shortcomings in an
inflationary context. These shortcomings include:

1. Fixed assets are stated at historical costs in the balance sheet; they do not show the true current worth and
are often unrealistically low.

2. Depreciation is charged on the historical cost of the assets. As a result, depreciation expense charged is also
inadequate/low which results in high net income.

3. In the context of rising prices, there is a significant overstatement of profits since the cost of goods sold is
calculated on a historical cost basis and no allowance is made for the reduction in the purchasing power of
money.

To sum up, it is worth adding that an overstatement of profits results in heavy financial strain for the company
in terms of heavy dividends, heavy taxation, and so on.
 Inflation Accounting Methods
•Generally, there are two main methods of inflationary Accounting
1. The current purchasing power method (CCP) involves adjusting the financial statements
and associated numbers to the current price. It adjusts historical cost based on changes in the general
level of prices, as measured by the general price level index.
Under this method, the monetary and non-monetary items, are separated with monetary items
recording only a net gain or loss during adjustment, whereas the non-monetary items will be
updated into figures with a particular conversion factor that is equivalent to a certain price
index.
For non-monetary items, this is done by taking the historical figures and applying a specific
conversion rate based on a price index.
The conversion rate is found by dividing the index price at the end of the period by the index
price at the beginning of the period.
 Conversion Factor under CPP Method = Price at Current Period / Price at the Historical Period
 Inflation Accounting Methods….
The CPP method distinguishes between monetary items and non-monetary items.
Monetary items are those items which are fixed by contract or otherwise remain fixed
irrespective of any change in the general level of price.
Monetary items are those assets and liabilities that represent a claim to receive, or an
obligation to pay, a fixed amount of currency. Examples of monetary items include cash,
accounts payable, accounts receivable, and long-term debt.
During a period of rising prices, holding monetary assets results in a loss of purchasing power.
While, Holders of monetary liabilities gain general purchasing power during a period of
inflation.
Non-monetary items such as stocks, plants, and buildings increase in value in an inflationary
context.
 Inflation Accounting Methods….
• The CPP method suggests the computation of the purchasing power gain or loss made by an
enterprise on holding net monetary items.
• Purchasing Power gain or loss on monetary items can be calculated in two ways.
• One procedure calculates the purchasing power gain or loss associated with each monetary
asset and each monetary liability and then sums up the individual gains and losses to determine
the gain or loss.
• A second procedure calculates the gain or loss on holding all monetary items as if they were
maintained in a single account.
• Alternatively, under the second procedure, general purchasing power gain or loss can be
computed in terms of net monetary assets (monetary assets—monetary liabilities). for which
the following procedures may be used:
 Inflation Accounting Methods….
(i) Compute the net monetary asset position at the beginning of the period.
(ii) Restate net monetary asset position at the beginning of the period in terms of the purchasing power at the end of the
period using conversion factors.
(iii) Restate all the monetary receipts of the year to the year-end basis and add this to the restated net monetary position
at the beginning of the period as calculated in (ii).
 This result is added to restated net monetary assets as calculated in (ii) to arrive at a total restated net increase in
monetary items.
(iv) Restate all the monetary payments of the year to the year-end basis and deduct the result from the total restated net
increase in monetary items as calculated in (iii).
 This result is deducted from net increase in monetary assets as calculated in (iii) to arrive at the adjusted computed
net monetary assets at the end of the period.
(v) Deduct the actual net monetary assets at the end of the period from the adjusted net monetary asset at the end of the
period as found in (iv) to obtain the purchasing power gain/loss.
 Inflation Accounting Methods…….
Example1 non-monetary assets: A company is using inflation accounting to adjust its equipment value in 2020.
The equipment was purchased for $10,000 in 2005 when the price index was at 300. In 2020, the price index is
now 600. find the new value of equipment using the CPP method.
Solution:

So, the new value of the equipment in 2020 would be $20,000 based on the conversion factor of 2 (600/300).
This value would be recorded on the balance sheet as the closing equipment balance at the end of the period. But
this figure ignored depreciation of the assets. That also needs adjustment!
 Inflation Accounting Methods…….
• Example 2 non-monetary Assets: Robert purchased a land at a cost of $120,000 when the
price index was at 90. he anticipated that the land, could be sold later at a profit. Seven years
later with the price index at 150, he was offered $235,000 for the land.
Required:
(i) Adjust the cost of the land to a current price basis by index numbers. Does this amount agree
with the current value of the land?
(ii) How much of the gain or loss is a real gain or loss? How much of the difference is attributable
to a price level change/purchasing power gain?
 Inflation Accounting Methods…….
• Solution:
(i) Adjusted cost of land = $120,000 x 150/90 = $200,000
• Does this adjusted cost agree with the current value of land………….. No.
(ii) Total gain = $235,000 – $120,000 = $115,000
• Real gain = $235,000 – $200,000 = $35,000
• Purchasing power gain = $115,000 – $35,000 = $80,000 or, $200,000 – $120,000 = $80,000
Example 3 monetary items: calculate purchasing power gain/loss at the end from the following
data: Monetary Assets January 1, 2000 Consumer Price index
Cash Br.50,000 January 1, 2000 120
Account Payable Br.30,000 December 31, 2000 180
Sales during the period Br.40,000 Average for the year 150
Purchase and expenses Br.30,000  
 Inflation Accounting Methods….
• Solution:
1st Net Monetary assets at the beginning (NMAB) = Monetary Assets-Monetary Liabilities
NMAB = Br.50,000-Br.30,000 = Br.20,000
2nd Net monetary asset purchasing power at the end of the period = NMAB*conversion factors
Br.20,000*180/120 = Br.30,000
3rd Adjusted monetary receipt (year end balance of monetary receipt) = MRP*Conversion factors
NB. Use average Price Index 40,000*180/150 = Br.48,000 hence,
Total restated net increase in monetary items = 30,000 + 48,000 = Br. 78,000
4th Adjusted monetary payments at the end = MPP*Conversion factors
NB. Use average Price Index 30,000*180/150 = Br.36,000 hence,
Adjusted computed net monetary assets at the end of the period = Br.78,000-36,000 = Br.42,000
 Inflation Accounting Methods….
Monetary items purchasing power gain/loss = Adjusted net monetary assets at the end of the period- Actual net
monetary assets at the end of the period so, ANMAE = Br. 30,000 (20,000+40,000-30,000)
Therefore purchasing power loss on net monetary items is Br. 12,000,
Br.30,000-Br.42,000 = (Br.12,000)
Example 4: monetary assets: From the below-given data, compute the net monetary gain or loss as per the CPP
method.
Monetary Assets January 1, 2020 December 31, 2020
Cash Br.5000 Br.10,000
Account Receivable Br.20,000 Br.25,000
Account Payable Br.15,000 Br.20,000
Loan Br.20,000 Br.20,000
Consumer Price index  
January 1, 2020 200  
December 31, 2020 300  
Average for the year 240  
 Inflation Accounting Methods….
Solution:
Particulars Unadjusted Conversion factor Adjusted
Net monetary assets as of Jan1,2020 (-) Br.10000 1.5 (300/200) (br.15,000)
(25,000 -35000)
Add: increase in Monetary receipt (+) Br.10000 1.25 (300/240) (+) Br.12,500
(10,000-5000) + (25,000-20,000)
Total net increase in monetary assets nil - (-) br.2500
Less: increase in monetary payment or liabilities (-) br.5,000 1.25 (300/240) (-) Br.6,250
(35,000-40,000)
Net monetary assets or net monetary liabilities (-) br.5,000 - (-) br.8750
Purchasing power gain Br. 8750- br.5000 Br.3750

Note: The amount of adjusted/net monetary liabilities as of December 31, 2008 should be br. 8750
during inflation. However, such liabilities are only br.5000. Therefore, the company is making
purchasing power gain of Br. 3750.
Look for alternative solution for the same example in the next slide:
 Inflation Accounting Methods….
Purchasing power gain can be computed following another method, as shown below:
 
Monetary assets
a. Monetary assets as of Jan1,2020 should have gone up with    
increase in price index (1.5*25,000) Br.37,500  
b. Increase in monetary assets should have gone up with    
increase in price index (1.25*10,000) Br.12,500  
Adjusted monetary assets as of 31, December 2020 should be Br.50,000  
however, the actual monetary assets 31, December 2020 was Br.35,000  
so, purchasing power loss on holding monetary assets (-15,000)
Monetary Liabilities    
a. Monetary liabilities as of Jan1,2020 should have gone with increase in Br.52,500  
price index (1.5*35,000)    
b. Increase in monetary liabilities should have gone up with increase in Br.6,250  
price index (1.25*5,000) Br.58,750  
Adjusted monetary liabilities as of 31, December 2020 should be Br.40,000  
however, the actual monetary assets 31, December 2020 was  
so, purchasing power gain on holding monetary liabilities Br.18,750
Therefore, net gain from monetary items Br.3,750
 Inflation Accounting Methods….
•Notes: Conversion factors: For items as on 1st January, 2020: 300/200 = 1.5 but for items
arising during 2020 average pI is used: 300/240 = 1.25
Treatment of Purchasing Power Gain and Loss:
•It has been widely suggested that the purchasing power gain or loss should be included in
current income.
2.The current cost accounting method takes the fair market value (FMV) instead of the
historical cost. With this method, all monetary and non-monetary assets must be adjusted to their
current values. (Students reading Assignment!)
Exercise: Assume that a machinery was purchased for $200,000 on January 1, 2004 when the general price index
was 100. The estimated useful life of the asset was 10 years with no salvage value. If the general price level index
on December 31, 2008 is 150, how much the inflation adjusted amount of the machinery under CPP method?
Assume further, Straight line depreciation method is used.
 Benefits And Drawbacks

• Inflation accounting comes with both benefits and drawbacks.

• The main benefit comes from the adjusted numbers’ value to internal users, external users, and the government. It
allows for more realistic and comparable data relative to other companies and historical financial statements of
the same company.
• Contrary, inflation accounting can actually complicate the financial statements and make it harder for investors
and other users of the statements to understand what the numbers mean. Specifically see the following points:
Advantages
1. Fair View: Since the assets are shown after considering and adjusting for inflation, at their current values, the
balance sheet goes on to represent an unbiased view of the financial position of the firm.

2. True Value Reflection: Since inflation accounting would go on to show the current profit based on current
prices, it reflects the correct and updated value of any business.
 Benefits And Drawbacks..

3. Accurate Depreciation: When the true value of the assets is represented, depreciation is
calculated on the value of assets to the business and not on its historical cost.

Limitations

1. Never-Ending Process: The changes in prices continue for infinity as long as there is
inflation or deflation in an economy. Hence the process is never-ending.

2. The system makes the calculations complicated due to many conversions and calculations.

3. Though the method of inflation accounting may be of use to the firm, it is not necessarily so
for the income tax authorities as they refuse this method owing to low the reported net
income.
 2. FORENSIC ACCOUNTING
 “FORENSIC MEANS “suitable for use in court of law” relating to, used in, or appropriate
for courts of law or for public discussion or argumentation or debate.
 It also relating to the application of scientific methods and techniques to the investigation of crime.

 Forensic accounting is an investigative methodology to follow money or proceeds, conducted

under the premise that the results of the investigation may be used in a court of law.

 FORENSIC ACCOUNTING: is a specialty practice area where accounting, auditing and

investigative skills are used to analyze information that is suitable for use in a court of law.

 FORENSIC ACCOUNTING: is the specialty practice area of accounting that describes

engagement that result from actual or anticipated disputes or litigation.
 FORENSIC ACCOUNTING……
A forensic accountant investigates incidents of fraud, bribery, money laundering and
embezzlement by analyzing financial records and transactions, tracing assets, and more.

Forensic Accounting encompasses both “Litigation Support” and “Investigative

Accounting.”

Litigation Support provides assistance of an accounting nature in a matter involving existing

or pending litigation. It deals primarily with issues related to the quantification of economic
damages.

Investigative Accounting is often associated with investigations of criminal matters or

examination of fraud.
 FORENSIC ACCOUNTING……

But the work of forensic accounting professionals is not always crime-related.

Businesses also value their guidance when considering potential structural changes.
Their input during mergers or acquisitions. For example, can give all parties an
accurate assessment of an enterprise’s financial situation and value.
 THE ROLE OF FORENSIC ACCOUNTANTS
A Forensic Accountant is often engaged to analyze, interpret, summarize and present
complex financial and business related issues in a manner which is both understandable and
properly supported.

Forensic Accountants can be engaged in public practice or employed by insurance companies,

banks, police forces, government agencies and other organizations.

Specifically, A Forensic Accountant is often involved in the following:

o Investigating and analyzing financial evidence; (Business/Employee Fraud Investigations)

o Developing computerized applications to assist in the analysis and presentation of

financial evidence;
 THE ROLE OF FORENSIC ACCOUNTANTS….
o Assisting in legal proceedings, including testifying in court as an expert witness and preparing visual
aids to support trial evidence.
o Personal Injury Claims / Motor Vehicle Accidents

o Shareholders' and Partnership Disputes

o Business Interruption / Other Types of Insurance Claims
o Business Economic Losses
o Professional Negligence
o Mediation and Arbitration

NB. In order to properly perform these services a Forensic Accountant must be familiar with legal
concepts and procedures. In addition, a Forensic Accountant must be able to identify substance over
form when dealing with an issue.
 THE ROLE OF FORENSIC ACCOUNTANTS….

Substance over form is the concept that the financial statements and accompanying
disclosures of a business should reflect the underlying realities of accounting transactions.

Conversely, the information appearing in the financial statements should not merely comply
with the legal form in which they appear.

But also, the recordation of a transaction should not hide its true intent, which would mislead
the readers of a company's financial statements.
 Forensic Accounting vs. Auditing
Commonly, Fraud is committed against business or for business, hence the primary difference
between forensic accounting & auditing relies on the purpose these fraud audit :

Hence, forensic accounting assignment relates to fraud against business this may involve
employee fraud or dispute with vendor & customer. while auditing assignment relate to fraud for
business.

The second difference allied on the scope; an audit is general in nature while forensic accounting
is specific.

An audit is a certification that the financial statement represent the company financial position,
but that error and fraud may Exist beyond the audit procedures. An audit will not analyze every
single transaction, nor will it look for fraud specifically.
 Forensic Accounting vs. Auditing…..
• When it comes to forensic accountants, however, their remit is extremely specific. They are not
concerned with reaching a general consensus on a firm’s financial status as a whole.
• In a forensic accounting, you know there is a fraud. Your focus is to identify who do it, how
much was the loss and what was the scheme.

• The third main point when it comes to comparing forensic accounting vs auditing is the
process itself.

• Auditing will typically have a programme and plan from the start that does not diverge in any
shape or form.
• In contrast, a forensic accountant’s investigation is not linear at all, and may require several
pivots or new directions depending on the information that has been uncovered.
 Forensic Accounting vs. Auditing…..

•Other specific point of Differences includes:

Timing: Audits are planned events and occur on a regular basis. Forensic investigations are
non-recurring, reactive and unforeseen.

Appointment: As mentioned earlier, auditors are appointed by the shareholders of a business.

A forensic accountant is instructed by company owners, counsel, or third parties.

Predication: A forensic investigation begins with an allegation or suspicion of fraud. The

allegation or suspicion of fraud is not the basis of an audit.
 Forensic Accounting Investigation Techniques

• Forensic accounting techniques are not so much different from audit techniques.

• They also perform important procedures to obtain the evidence, including analytical reviews,
inquiries, observations, recalculations, inspection, etc.

• However, as said in preceding slide, The evidence gathered from forensic accounting is
normally used for legal purposes rather than the general purpose of auditing financial
statements.

• There are several different forensic accounting investigation techniques that are used
throughout every single procedure. These include:
 Forensic Accounting Investigation Techniques…

A. Document Reviews
• The first thing a forensic accountant will do is review all of the company’s documents that are readily available
• often starting with ones that are already in the public domain. This includes anything in the public database,
corporate records and anything that is legally available online.
B. Conducting Interviews
• This is an extremely useful forensic accounting investigation technique as it helps the investigator fully
understand all of the facts of the case.
C. Surveillance 
• This is one of the forensic accounting investigation techniques that is the most conventionally used. It mainly
consists of  monitoring and tracking all official emails and messages sent by people in the organization.
 Forensic Accounting Investigation Techniques…

D. Confirmation, Reconciliation and Testing of evidence

• Confirmation is a technique used to validate the correctness of the transactions.
• Reconciliation is a technique used to know the reason of differences in balances.
• Testing is a technique of selecting representative transactions out of whole accounting data to draw a
conclusion about all items.
E. Physical Examination
• Physical examination requires verification and confirmation of the physical existence of tangible assets as appears in the
Balance Sheet like cash in hand, land and building, plant and machinery, etc.
F. Analyzing Evidence 

• Thorough analysis of the evidence can point to the guilty party and also help investigators
understand the extent of the fraud that has taken place.
 The Forensic Accounting Investigation Process
When there’s a financial dispute, forensic accountants use a certain methodology to find the truths and
the transgressions hidden in the numbers.

There are typically three stages of the forensic accounting investigation process, which are:

A. Investigation

The forensic accounting investigation process starts with a client approaching an accountant to convey
their concerns about potential fraud within their business.

The accountant will also take note of why the client is worried so they can be sure to address the key
point of the case and fulfil the terms of their instruction. 

There is often some confusion as to what forensic accounting investigation steps actually take place
during an investigation.
 The Forensic Accounting Investigation Process….

Below are some steps that forensic accountants follow when investigating financial crimes or
issues.
1. Map/plan out the investigation.
•The first step involved in investigative stage is to create a master plan to help guide his or her
research and analysis.
•The investigative plan includes tasks like these: Meeting with the client to understand and capture
his/her view of the dispute, Probing deeper to understand all aspects of the dispute, Locating and organizing all
relevant financial documents, Identifying anomalies and inconsistencies etc.
2. Gather evidence to support the case.
 Evidence is the most important outcome of investigations. Forensic accountants have a specialized skill set
which allows them to analyze complex and opaque financial issues.
 The Forensic Accounting Investigation Process….
B. Reporting

Reporting is the second stage of the forensic accounting process that take place during an
investigation as well as after investigation.

Primarily, the accountants will report to their client about the progress of the case and any
evidence that has been uncovered.

Any conclusions made should be robust and able to withstand cross-examination and critical
analysis.

The reporting must also be proactive and suggest recommendations (supported by evidence) so
that future instances of fraud can be avoided.
 The Forensic Accounting Investigation Process….
 Commonly, a typical forensic accounting report provide answers to questions like these:
 Was there fraud or misconduct? If so, what type?
 When did the fraud or misconduct happen (or not happen)?
 How did the misconduct happen and how was it concealed?
 Who were the responsible parties?
 What were total loss and damages caused by the misconduct?
C. Litigation/Testify in court
• If the parties involved in the case fail to come to an agreement, the final stage of the forensic accounting investigation
process is litigation.
• A forensic accountant can act as an expert witness. An expert witness is quite different to any other witness in court
proceedings. Most witnesses are 'witnesses of fact', ie they can only provide evidence on what they saw, did or heard.
• Their expert testimony gives the report greater credibility and context because they can explain the data and findings
in clear, concise language.
 ILLUSTRATIVE CASES ON FORENSIC ACCOUNTING

Situation
A client was experiencing an unexplainable decline in profits. The Chief Financial Officer was suspected of
embezzling corporate funds, so the client hired forensic accountant and investigative team to look into the
situation.
Solution
By analyzing the company's financial statements and records and uncovered a large fraud scheme. From available
documents and records, and from interviews with key employees, a fraud report revealed that the CFO's
fraudulent activities. The primary suspect was interviewed and confessed. The client is assisted in filing an
employee dishonesty claim, and further assisted law enforcement in the prosecution process.

Results
- Chief financial officer gave a written confession and was then fired. The case was turned over to law
enforcement and charges were filed by the local prosecutor.
- New chief financial officer was hired.
- Company is experiencing increased profits.
End of The Chapter !! Any Questions?