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Inflation Accounting

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Inflation means an upward change in the prices of goods & services of general consumption. The basic details and need for inflation accounting is explained in this presentation, as a part of topic …

Inflation means an upward change in the prices of goods & services of general consumption. The basic details and need for inflation accounting is explained in this presentation, as a part of topic “Financial Accounting”.

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  • 1. Welingkar’s Distance Learning Division Financial Accounting CHAPTER-9. Inflation Accounting We Learn – A Continuous Learning Forum
  • 2. Chapter Nine - Inflation Accounting What is Inflation? Inflation means an upward change in the prices of goods & services of general consumption. is due to the fall in total supply of goods and services. imbalance in total supply of goods & services. changes in general prices of basic commodities.
  • 3. Chapter Nine - Inflation Accounting Need for Inflation Accounting? Traditional accounting based on historical cost fails to match current revenue against costs that are current costs of purchases or depreciation are shown at historical costs, and are much below current levels
  • 4. Chapter Nine - Inflation Accounting Need for Inflation Accounting? Traditional accounting based on historical cost fails to match current revenue against costs that are current state profit realistically as costs of purchases, depreciation are understated, reported profits are high
  • 5. Chapter Nine - Inflation Accounting Need for Inflation Accounting? Traditional accounting based on historical cost fails to - match current revenue against costs that are current - state profit realistically - provide adequate depreciation for replacement of assets depreciation is calculated on book value of assets that are way below their current market price.
  • 6. Chapter Nine - Inflation Accounting Need for Inflation Accounting? Traditional accounting based on historical cost fails to - match current revenue against costs that are current - state profit realistically - provide adequate depreciation for replacement of assets - show true and fair view in the financial statements
  • 7. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Є Current Value Systems
  • 8. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Step # 1 – Convert figures in the balance sheet as of beginning of the year into purchasing power of beginning of the year.
  • 9. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Step # 1 – Convert figures in the balance sheet as of beginning of the year into purchasing power of beginning of the year. Step #2 – Convert the figures derived above into purchasing power at the end of the year.
  • 10. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Step # 1 – Convert figures in the balance sheet as of beginning of the year into purchasing power of beginning of the year. Step #2 – Convert the figures derived above into purchasing power at the end of the year. Step #3 - Convert figures in the balance sheet as of end of the year into purchasing power of end of the year.
  • 11. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Step # 1 – Convert figures in the balance sheet as of beginning of the year into purchasing power of beginning of the year. Step #2 – Convert the figures derived above into purchasing power at the end of the year. Step #3 - Convert figures in the balance sheet as of end of the year into purchasing power of end of the year. Final Step – find out difference between equity at step two and step three to get profit for the year, expressed in terms of purchasing power at end of the year.
  • 12. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Є Current Value Systems Under this method, the current value of an individual asset is based on the present value of the future cash flows that are expected to result from the ownership of the asset.
  • 13. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Є Current Value Systems Under this method, the current value of an individual asset is based on the present value of the future cash flows that are expected to result from the ownership of the asset. Such present values are calculated from [a] the estimated cash amount of the future benefits [b] the timing of these benefits & [c] an appropriate discount factor.
  • 14. Chapter Nine - Inflation Accounting Methods of Inflation Accounting Є Current Purchasing Power (CPP) Є Current Value Systems Under this method, the current value of an individual asset is based on the present value of the future cash flows that are expected to result from the ownership of the asset. Such present values are calculated from [a] the estimated cash amount of the future benefits [b] the timing of these benefits & [c] an appropriate discount factor. This discount factor usually equals cost of capital to the company.
  • 15. Chapter Nine - Inflation Accounting Conclusion Methods of Inflation Accounting are criticized as They are subjective They are based on estimation They are not free from flaws Discussion on this subject gained momentum with the rise in the price levels and the tempo died down with the fall in inflation.

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