Inflation Accounting

Posted in Finance, Accounting and Economics Terms, Total Reads: 530
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Definition: Inflation Accounting

Inflation Accounting is a technique of accounting which helps to understand the financial position of a company or country when the country is experiencing a high inflation. High inflation causes a wrong projection and hence this technique is used.


Explanation:

Using this technique, a company's financial position can be evaluated even during a period of hyperinflation. The true profits should be shown in P&L along with the correct assets and liabilities in the balance sheet. Since inflation affects the costs of business, the overall picture is different and hence this technique has to be adopted.


Methods:

1. Current Purchasing Power (CPP) Method- The financial statements are converted into figures at current purchasing price. However the values of only the non-monetary items are converted.

Conversion Factor = Price index at the time of conversion / Price index at the date of transaction

2. Current Cost Accounting (CCA) Method- Each and every item under the financial statements is restated at its current value.

3. Hybrid Method- Mix of both CPP method and CCA method


Advantage:

By converting figures of financial statements at current prices the statements become more relevant to the current economic and financial conditions.


Disadvantage:

The price level is general price level and not for the individual items. Also the depreciation charged might not be adequate for replacing all types of assets.


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