Inflation accounting refers to the process of adjusting the financial statements of a company to show the real financial position of the company during inflationary period.
It is a special accounting technique that is used during the period of high inflation. It requires adjustments in financial statements of a company according to current price index prevalent in the economy. The technique of inflation accounting has been developed to the correct problems arising from historical cost accounting in presence of inflation.
Inflation Accounting involves recording of business transactions at current value, to analyze the impact of changes in price or business transactions on costs and revenues, assets and liabilities of a company.
Techniques of Inflation Accounting
(1) Current Purchasing Power Method – It involves adjustment of financial accounts to price changes. A general price index is used to convert the values of various items. It takes into account the purchasing power of money and ignores the rise and fall in the price of an item. It involves adjustment of historical figures at current purchasing power which id done through multiplication of the historical figures by a conversion factor.
Conversion factor can be calculated using the formula below –
Conversion factor = Price Index at time of conversion / Price Index at the date of conversion
CPP Value = Conversion Amount or Historical Value x Conversion Factor
(2) Current Cost Accounting – Under this method assets are shown at current costs and profits are determined on the basis of costs at the date of sale rather than the actual cost.
(3) Current Value – Under this method all assets and liabilities are measured at current value at which they could be sold or settled at the current date.
(4) Replacement Cost Accounting – Under this method all assets and liabilities are recorded on a balance sheet according to the cost of replacing them rather than their historical costs.