Inflation Accounting- Objectives, Importance, and Features

Meaning of Inflation Accounting

Definition- Inflation Accounting refers to Identify and incorporating the changes in prices of assets and liability of a company over a period of time.

In an economic sense, Inflation refers to a quantitative measure of the rate at which the average price level of goods and services is increasing. Inflation accounting refers to a state in which the purchasing power of money goes down for conversely. there is more money in circulation then is justified by goods and services the general weakness of traditional accounting system is that it falls to reflect the prices level change in the financial statement as it is based on historical cost.

Objectives and Importance of Inflation Accounting

  1. Exhibits true position: Inflation accounting exhibits true financial status of company by reflecting all books of accounts at current price. It adjusts all record in accordance with current price index for determining real profitability.
  2. Avoids profit overstatement: This branch of accounting keeps a check on financial statements of companies for avoiding any overstatements of profits. All expenses and income are mentioned at current values which prevents overstatement of business income.
  3. Calculate right depreciation: Inflation accounting charges correct amount of depreciation by calculating it on present value instead of historical value. Charging right depreciation facilitates business in easy replacement of assets. 
  4. Easy profit comparison: It enables firms in easy comparison of their inter-periods performance for determining their profitability. Inflation accounting adjust effects of prices changes on all expenses and incomes listed in financial statements that avoids distortion of historical data.
  5. Provides correct information: Inflation accounting provides correct information to shareholders and workers based on present price level. There may be a chance of higher dividend and higher wages being demanded by these people in absence of such information.

Features of Inflation Accounting

  1. Presents true condition: Inflation accounting presents true condition of company by adjusting all price level changes taking place in its financial statements. It depicts fair view of company’s financial position by reflecting all changes as per the current price index.
  2. Facilitates reasonable comparison: It facilitates a fair inter-period comparison of business profits by bringing all expenses and income to current value. All financial statements such as Balance sheet and Profit and loss account shows present values in place of historical values which makes comparison a reasonable task. 
  3. Remove distortions: This branch of accounting helps in removing all distortions arising due to historical data. It makes accounting records reliable by updating all the data and matching current revenues with current expenses.
  4. Check on Mis-leading deeds: Inflation accounting keep an eye over the misleading deeds of Historical cost concepts depicting higher profits and higher taxes, thereby resulting in more wages being demanded by workers seeing the high profits. When all adjustments as per the price level accounting is made, these kind of demand will not arise. 
  5. Improve decision making: It is an efficient tool with management which assist in efficient decision making. Inflation accounting provides reliable from of data that is adjusted to current price level. After adjustments, balance sheet exhibits fair position which helps managers in taking right decisions. 
  6. Inbuilt automatic mechanism: Inflation accounting has an inbuilt and automatic mechanism for making adjustments as per the price level changes in company’s book of accounts. It compares revenues and expenses at current cost for reflecting realistic position.