This document discusses inflation accounting and its need. Traditional historical cost accounting fails to accurately match current revenues and costs during inflation as historical costs are much lower than current costs. It also fails to realistically report profits. The document describes two methods of inflation accounting: current purchasing power method and current value systems method. Both methods aim to express financial statement figures in terms of their current purchasing power to provide a more accurate picture during inflationary periods.

1. Chapter Nine -- Inflation Accounting
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.

2. Chapter Nine -- Inflation Accounting
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

3. Chapter Nine -- Inflation Accounting
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

4. Chapter Nine -- Inflation Accounting
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.

5. Chapter Nine -- Inflation Accounting
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

6. Chapter Nine -- Inflation Accounting
Chapter Nine Inflation Accounting
Methods of Inflation Accounting
Є Current Purchasing Power (CPP)
Є Current Value Systems

7. Chapter Nine -- Inflation Accounting
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.

8. Chapter Nine -- Inflation Accounting
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.

9. Chapter Nine -- Inflation Accounting
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.

10. Chapter Nine -- Inflation Accounting
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.

11. Chapter Nine -- Inflation Accounting
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.

12. Chapter Nine -- Inflation Accounting
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.

13. Chapter Nine -- Inflation Accounting
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.

14. Chapter Nine -- Inflation Accounting
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.