A STUDY ON INFLATION ACCOUNTING PRACTICES AT ADITHYA AUTO ENGNEERING Pvt Ltd

INFLATION ACCOUNTING

INTRODUCTION TO INFLATION ACCOUNTING

Inflation Accounting is not a new field of study. Since the beginning of the
twentieth century efforts have been made to adjust the accounts to reflect changes in
price level. The approach taken by each country to inflation accounting is influenced
by a number of factors. The urgency of the need to find a solution to the problem
depends on the rate of inflation for an individual country. Thus, certain South
American Countries with a traditionally high rate of inflation have been making
adjustments to account for inflation while by contrast, in countries like Belgium and
Germany, where the inflation rate has been comparatively low in recent years, there is
little interest in inflation accounting. The sophistication of the regulatory environment
for company reporting also influences the amount of interest in inflation accounting.
Thus a number of proposals and recommendations have been issued in countries like
U.K. and U.S.A., whereas in Italy no requirement or recommendation has been issued
so far.

Inflation accounting is a special technique used to factor in the impact soaring or

plummeting costs of goods in some regions of the world have on the reported figures of
international companies. Financial statements are adjusted according to price indexes,
rather than relying solely on a cost accounting basis, to paint a clearer picture of a firm’s
financial position in inflationary environments. This method is also sometimes referred
to as price level accounting.

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DEFINITION OF INFLATION ACCOUNTING

According to Mohd Rizwan Ahmad Inflation is that state of affair when money in
circulation is more than the production of commodities and services and purchasing
power of money comes down and prices of commodities and services increases.
Accounting for changing prices (Inflation Accounting) has become synonymous with
accounting for inflation due to the unprecedented pressure of inflationary price rise in
most countries in recent decades. In periods of sustained price rise, historical costs lose
their relevance and may even become misleading as measurements of economic value.

Explanation :-

The price as experience says do not remain constant of products, it varies due to
economic, social and political reasons. The change in price may be due to inflation or
deflation. The change price level leads to an accurate presentation of financial statement
which are prepared to show the correct picture of financial discipline of the corporate.

The financial statements are prepared on historical costs on the assumption that the unit
of account i. e. Rupee in our country has a static value. In practical life, the value of
money changing from time to time, the period after world war second has shown an
upward trend of increasing prices.

Financial statements which are prepared on the basis of historical cost records suffer
from a number of shortcomings during a period of rising prices. They are:

1. Fixed assets are stated at historical costs in the balance sheet; they do not show
the true current worth and are often unrealistically low.
2. Depreciation is charged on the historical cost of the assets. As a result,
depreciation provision is also inadequate for financing the replacement cost of fixed
assets. The firm may, therefore, have to face serious problems because of the paucity of
funds.

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3. In a period of rising prices, there is a significant overstatement of profits since the

cost of goods sold is calculated on a historical cost basis and no allowance is made for
the reduction in the purchasing power of money. Also, overstatement in profits results in
a heavy financial strain for the company in terms of heavy dividend, heavy taxation, etc,

In June 1969, the APB of the AICPA recommended that supplementary statements
should be appended to the annual accounts of companies so as to disclose the effect of
general price level changes on the financial position. Inflation accounting seeks to
incorporate realism into financial statements by
adjusting them, so as to reflect in a true and fair manner the financial performance and
the position of an enterprise in a particular period.

The balance sheet prepared at a point of time includes some items such as cash, debtors,
etc., that are stated at current purchasing power; others such as inventory, are stated in
monetary units that reflect the purchasing power of the recent past; and still others such
as furniture, land, plant and equipment that are stated at historical cost.

When the general price level is rising rapidly, reported profits of a company which has a
major proportion of its assets which are stated at historical costs are overstated. If profits
are overstated, it follows that costs and expenses are under-stated, This may lead to
reporting illusory profits.

Thus, accountants use the concept of Inflation Accounting so as to convert monetary

units having varying purchasing power into a single monetary unit.

OBJECTIVES OF INFLATION ACCOUNTING

The objective of Inflation Accounting is to adjust historical cost figures for substantive
changes in the general level in the economy, The following are some of the objectives of
Inflation Accounting:

(i). To remove the various distortions with which financial statement based on historical
cost suffer.

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(ii). To provide for more meaningful inter-period comparison.

(iii). To improve the meaning and measurement of income and expenses in the face of
changing the purchasing power of money.
(iv). To improve decision making in the organization.
Further, Inflation-adjusted information helps decision-makers in the following ways:

1. Allocation of capital is achieved through the pricing mechanism in capital

markets. Prices based on financial information which is incomplete or misleading results
in poor pricing and allocation decision. As inflation rates vary from year to year, an
element of uncertainty is there in business activities. Further, even though management
is aware of the need to incorporate inflation in making the business decision, it is
hundred in doing so by the lack of systematic and explicit recognition of inflation’s
effect in financial reports.
The system of inflation accounting, if introduced, will help the various parties who have
an interest and stake in the business viz. shareholders, employees, external users,
management and government.

2. Management will be better equipped to tackle the problems caused by inflation

and in turn improve productivity in the long run.

3. Information about the specific price changes on individual enterprises and by

industry grouping will help the policymakers to analyze the impact of the differential
impact of inflation on each industry inflation accounting will also help in giving a
clearer disclosure and in turn help the government in making various policy decisions.

4. The public understanding of the business and the various effects of inflation goes
up. This helps business in being somewhat less critically viewed by the general public
helps them in their continuous exercise of mobilizing funds for expansion, new
investment and also to provide employment.

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IMPORTANCE OF INFLATION ACCOUNTING

When a company operates in a country where there is a significant amount of

price inflation or deflation, historical information on financial statements is no longer
relevant. To counter this issue, in certain cases companies are permitted to use inflation-
adjusted figures, restating numbers to reflect current economic values.

IAS 29 of International Financial Reporting Standards (IFRS) is the guide for entities
whose functional currency is the currency of a hyperinflationary economy. The IFRS
defines hyperinflation as prices, interest, and wages linked to a price index rising 100%
or more cumulatively over three years.

Companies that fall under this category may be required to update their statements
periodically in order to make them relevant to current economic and financial
conditions, supplementing cost-based financial statements with regular price-level
adjusted statements.

Requirements for inflation accounting differs between IFRS and U.S. General Accepted
Accounting Principles (GAAP). Both IFRS and GAAP are treating Argentina as
“hyperinflationary” because cumulative inflation there over the past three years has
exceeded 100%. However, the requirements they impose on companies operating in the
country vary.

IFRS permitted international businesses with subsidiaries in Argentina to continue using

the peso for their accounts, provided they restate them to adjust for inflation. In contrast,
US firms with activities in Argentina are being forced to use the dollar as their
functional currency, costing them millions in foreign exchange losses.

Insurance company Assurant Inc. (AIZ) warned in its annual report that the shift to using
the U.S. dollar for its Argentine operation meant “non-U.S. dollar denominated
monetary assets and liabilities were subject to re-measurement resulting in losses.”

If the effect of inflation is ignored, one will have an unrealistic and exaggerated view of
the profit earned or return on investment achieved.

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Hence, the need for “Inflation Accounting.”

To illustrate this point, let us consider the steel plants in India. The plants of various
steel companies were established at various points of time. TISCO’s plant was erected
earlier than even the First World War. The Indian Iron and Steel Company was
established in the pre-independence period. The various plants of HSL were established
in 1960’s.

If the performances of these plants are compared through ratio analysis, erroneous and
misleading results will be shown because of the following two reasons:—

The investment base of all the plants would be different. It is obvious that the plants
which were established earlier had a much lower capital cost — the same facilities
established by other firms at a later period would have a much higher cost.

The investment base of the later companies would be much higher than the investment
base of the companies established earlier. Therefore, companies which are established
later will show a lower rate of return on investment.

The return showed by the old companies would be unduly high. This is due to the fact
that the depreciation charge of such companies would be much lower than warranted by
the real present day value of the assets.

A point of great significance, apart from proper measurement and comparability, is that
if only historical costs are considered, the amounts collected by way of depreciation
charge will be totally inadequate to replace the fixed assets when their life is over. If
physical assets are to be maintained, as indeed must be the aim, inflation must be kept
fully in view.

It is, therefore, important that proper adjustments on account of price level changes are
made in the financial statements. A number of studies have been conducted, especially
in U.K., to devise a practical method to adjust accounts for price level changes. There
are basically two methods by which price level changes can be recognised.

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METHODS 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 is 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.

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ADVANTAGES OF INFLATION ACCOUNTING

The major merits of inflation accounting are as under :

1. Realistic view . Inflation accounting enables the company to present a realistic

view of its profitability as current revenues are matched current costs.

2. Basic of Depreciation. The correct amount of depreciation be when it is

charged on the current values (inflated values) and thus the replacement of assets
will be more reasonable.

3. Check on payment of dividend out of capital. Inflation accounting enables a

company to maintain its capital by checking payment of dividend and taxes out of
capital due to inflated profit calculated on the basis of historical cost accounting .

4. True and fair Balance-sheet. The financial position of the company as

shown by Balance sheet will be true and fair if it is by keeping a meaning balance
of various effects of inflation accounting in mind.

5. Reasonable comparison of Profitability. When financial statements : profits and

loss and Balance sheet are presented and adjusted to the inflation accounting the
profitability of two plants purchased on two different dates can be known
correctly as these are calculated on the basis of their current value and not on
their historical cost.

6. Check On Mis-leading Deeds. Inflation accounting checks the misleading

deeds of historical cost concepts which shows more profits and more taxes, more
salaries and wages demand by the employees keeping high profits in mind. When
proper adjustment is made keeping price level accounting in mind, such demand
will not arise nor more and more prospective entrepreneurs will not come for
opening their units and unwanted competition will be checked.

7. Wrong matching concepts. Assets purchased long back is depreciated on the

original cost or historical cost concept while all other revenues and expenses are
shown on current prices be against matching accounting concept.

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8. Safety of Owner’s Equity. Inflation accounting records fixed assets value

according to their current values thus owner’s capital valuation will reveal its
correct value.

DISADVANTAGES OF INFLATION ACCOUNTING

The following are the main demerits of Inflation

1. Depreciation. Depreciation is the downfall of value of fixed assets due to use and
expiry of time, it should be charged on original and not on current values.

2. Replacement of fixed Assets. The critic of inflation accounting says that

depreciation is charged for the replacement of fixed assets, the same assets are not
available for replacement due to change in model or invention or fashion the
same machine is not needed thus replacement of assets does not contribute much.

3. Situation in Deflation. During deflation prices always falls, adjustment to price

level change means charging lesser Depreciation and overstatement of profits
which is also bad from many angles.

4. Theoretical Concept. The concept of inflation accounting is more Theoretical as

it is only window dressing of accounting concept as per the suitability of
individuals.

5. Complicated System. The inflation accounting is not each approach it requires a

lot of calculation and unwanted adjustment which a common man cannot
understand more he can use them.

6. Expensive Technique. This technique is very expensive ordinary business unit

cannot afford this technique.

7. Subjectivity in the valuation process. Inflation level accounting technique

cannot be applied to know the real value of assets. Adjustments to current values
is not so simple.

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Financial statements prepared on the historical cost basis do not, as a rule, depict the real
state of affairs of the organization. The figures presented in the Financial Statement do
not reflect present-day values. Nevertheless, accounts prepared on the basis of historical
cost have the following advantages over other systems of accounting:

1. It is based on actual events and data.

2. It is widely used and understood by all.
3. Comparison of figures over a period of time can be made easily.
4. It forms the basis of tax assessments.
5. Manipulation of accounting records is difficult under historical costs.
Thus, there is an imperative need for inflation-adjusted financial statements to be
presented to the shareholders and other interested parties. Yet, there are a number of
objections to inflation accounting. They are:

(1) The financial statements lose their credibility as the objectivity concept is violated.
(2) The method is not acceptable to the tax authorities.
(3) Inflation accounting may sometimes result in arbitrary profits.
Thus, the main problem with Inflation Accounting is that the method has not been able
to come up with an accounting system that would satisfy all. The method has still a long
way to go and the search is on for a method that would take into account inflation and
still be objective and simple in its implementation.

Developments relating to ‘Inflation Accounting’ in different countries

Germany

Germany contemplated the problem of price level adjustment as early as the

1920s due to the high rates of inflation after the World Wars. Schmalenbach, a
distinguished German accounting theorist, commented on stabilized accounting in his
book ‘Dynamische Bilanz’. He pointed out that by 1920, managers (of firms
following a policy of being a net monetary liability) realized that they would incur
losses if there were occasional improvements in the inflationary situation. Therefore,

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they adopted ‘measures of internal equalisation’ whereby payments were made to

prevent becoming a net monetary debtor. In this process purchasing power losses
were compensated by purchasing power gains. Changes in working capital became
the central component of financial statements. The accounting systems of firms
became quite complicated.
By the end of 1923, the fall in the value of German mark reached great
proportions giving rise to a number of accounting problems. Some German
academicians suggested that replacement costs or adjustments based on individual
business price index should be incorporated into financial reporting. Although
replacement costs were used for day-to-day business, ‘balance sheet stabilization’ in
terms of the gold mark was used as a supplement to historical cost reporting. Each
entry in the historical cost balance sheet was restated in terms of gold mark, assumed
to have constant purchasing power and a change in its paper mark equivalent was
assumed to represent a change in the purchasing power of the paper currency.

An accounting law, the ‘Goldmarkbilanzgesetz’ of 1924 attempted to improve

the reliability of financial statements. However, with the introduction of the
‘Rentenmark’ towards the end of 1923 and the restoration of the gold mark in early
1924, the German economy eventually returned to a stable monetary unit and strict
adherence to historical costs as the basis of accounting has been followed.

The military defeat and the economic consequences of the second world war
led to a complete collapse of the German currency, the Reichsmark (RM). The
situation was corrected by a monetary reform, the introduction of the Deutsche Mark
(DM) in June 1948, the conversion ratio of RM for DM being 10:1, but it could not be
applied to historical costs which were meaningless. A new law, the ‘DM
Eroffnungsbilanzgesetz’ dated 21 August 1949 required all balances to be restated for
financial reporting, including income tax accounting. All companies were required to
prepare a Deutsche Mark opening balance-sheet on that date in order to provide a base
point for future financial statements. The relevant legislation made the upper limit to
valuation, 'Current Value’ at the date of the balance sheet, but understatement was
allowed. Depreciation was to be calculated on current values3. After 1948, the
Companies Act and the commercial code returned to historical costs and the German

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laws found new ways to control prices.

In August 1975, the major committee (HFA) of the West German Institute
(IDW) released its proposal, ‘Accounting for Capital Maintenance in the
Measurement of Company Profits’, known as HFA 2/1975. The Institute proposed
voluntary disclosure of estimated net amount of ‘inflationary profits’ (in a
supplementary note or statement) which are included in the net income reported in the
income statement.

In October 1975, a statement was issued by the committee of the German

Institute of Chartered Accountants (Institute for Wirtschafts Priifer). It recommended
that the effect of changing prices on profits shown in the annual reports, should be
indicated in supplementary notes, to produce a more realistic distributable profit
figure. However, it did not require disclosure of restated balance sheet information. It
may be pointed out that very few German concerns complied with the provisions.

France

The post 1919 inflation in France provided stimulus to a number of French

accountants to consider the problems created due to the instability of the monetary
unit. During the period 1919-27, the prices in France approximately doubled. The
balance sheet stabilization method was followed.

Between 1930 when poincare stabilized the value of the Franc and 1960, the
French currency changed its official value 18 times and the government allowed firms
to reflect these devaluations in their accounts. The taxation authorities took the first
initiative through special concessions, rules of computation permitting firms to deduct
something from their profits or composition of tax only on a part of profits or
exemption of fictitious gains arising from the depreciation of the currency, thus
permitting special reserves created to be capitalized.

A law passed in August 1945, authorized firms to revalue certain assets and its scope
was widened until the measure enacted in December 1959. The law adopted the ‘for
feitary method’ for revaluation by applying an index of industrial wholesale prices,

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which permitted rapid calculation but also created problems. At the beginning of 1959,
revaluation was still optional, could be partial and could not go further than the
coefficients published by the Ministry of Finance. Revaluation of fixed assets had to
be accompanied by a corresponding revaluation of provisions for depreciation.

A law passed in December 1959, laid down that revaluations were obligatory
for all businesses (public and private) having an annual turnover during the previous
three years of more than 500 million old francs and that they should be accomplished
by December 1962. It affected 5000 firms. Two substantially different indices were
used, one for fixed assets and depreciation and the other for stocks, shares and
obligations.

In 1976, the government sponsored committee recommended that companies

listed on the Stock Exchange should produce supplementary financial statements
based on CPP principles. The government, however, did not accept this
recommendation despite the legislation for revaluation of assets being operative in
1977 and 1978. The legislation which required revaluation of all long term assets at
their use value to the enterprise at the end of 1976 was mandatory for listed companies
but optional for all others. The revaluation law remained in force until 1979. Since
then, revaluations have been permitted because the resulting surplus is taxable.

The French accounting profession has been slow to consider the impact of
inflation upon accounts because the French have traditionally prepared financial
statements for tax purposes. The Government and the committee des operations de
Bourse (the French equivalent to the US Securities and Exchange Commission) started
taking an interest on the impact of inflation. Consequently in 1981, an Exposure Draft
was issued, suggesting an inflation accounting approach based on a general price
index has been developed.

South Africa

In January 1975, the National Council of Chartered Accountants in South

Africa issued a discussion paper entitled “Accounting for Inflation and other changes
in Price Level”. The recommendations were similar to the Current Purchasing Power

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Approach. In October 1975, a circular was issued that accountants should experiment
with various inflation accounting techniques.

Japan and other Asian Countries

L.G. Campbell in his article “Current Accounting Practices in Japan” has

discussed the practice followed by Japanese Companies in respect of some major
aspects of financial accounting and reporting. None of the companies surveyed gave
any form of inflation adjusted accounting information nor was there any legal or
professional requirement to publish such information. In fact, the Business Accounting
Deliberation Council of Japan regarded historical cost accounting preferable to any
form of inflation accounting. However, there is a requirement for disclosure of cash
flow information in supplementary schedules filed with the Ministry of Finance.

Other Asian countries like Indonesia, Korea etc. have started taking keen
interest in Inflation Accounting and introduced legislation which allows depreciation
to be based on inflation adjusted fixed asset values. However, no formal
pronouncements have been issued in these countries.

Israel

A study of 19 industrial firms listed on the Tel Aviv Stock Exchange was conducted
and their Annual Reports (1968-1974) were restated on the basis of recommendations
of the Institute of Certified Public Accountants, Israel, SSAP 7 and the AlCPA’s APB
Statement No. 3. An analysis of reported profits after tax incidence of corporate
income tax and dividend cover led to the conclusion that the adjusted income is less
than nominal earnings even after the inclusion of monetary gains and that taxes and
dividends are sometimes not covered by adjusted profits.

Brazil

Brazil experienced extremely high rates of inflation for many years. In 1964,
inflation accounting was introduced into tax laws by the government. A system of
monetary correction known as ‘indexing’ was adopted as the basis of financial
reporting.

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The nominal amounts of assets and liabilities were adjusted by the use of a
purchasing power index, interest being paid on the higher amount. The monetary
correction was tax free. Fixed assets were restated annually and depreciation was
calculated on the restated amounts, the increase in asset amount being credited to
capital. A provision for ‘maintenance of stockholders investment’ charged to the
income statement on all assets and liabilities (except fixed assets) was tax-deductable
and included the monetary correction adjustment. Inventories were treated as
monetary assets, because firms corrected the amount in accordance with purchasing
power changes.

The provisions of the Brazilian Corporation Law (Law No. 6404 of December
15,1976) to be effective for financial years beginning after January 1, 1978, set out a
different standard of accounting and financial reporting, although the generally
accepted accounting principles were maintained. Faced with double and triple digit
inflation, the Brazilian Corporation Law now requires two adjustments for reporting
and tax purposes. Fixed assets should be compulsorily adjusted at the end of each
financial year on the basis of changes in Government Wholesale Price Index and
depreciation should be based on the restated asset figures. Second adjustment, which
relates to working capital items requires an allowance for maintenance of the
purchasing power of stocks and net monetary items. The Brazilian Government
Treasury Bond Index (ORTN) is to be used as deflator and the stipulated adjustments
be made in the income statement and balance sheet. The revised profit figure is
accepted for tax purposes.

Argentina

The Argentina accounting profession has been actively involved in the

development of inflation accounting proposals. In 1972, the Argentina Federation of
Accountants issued a statement ‘Dictamen No. 2’ which recommended the
presentation of supplementary general purchasing power statements by business

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enterprises from 1972 onwards to eventually replace historical cost information. But
the rate of compliance was poor due to lack of government support.

The peron Government introduced the Social Contract in 1973, in which price
controls were the key component of the programme. In September 1980, the
Argentina Professional Council of Economic Sciences of the Federal District, which
regulates the public accounting profession in Beunos Aires declared that in future the
basic financial statements should disclose historical cost constant dollar figures in one
column and historical cost figures in another.

Chile

Due to the high rates of inflation, the accountancy profession tried to introduce
an inflation accounting system which found little government support. In 1975, chile
however became the first country to adopt a comprehensive General Purchasing
Power Accounting System for financial reporting and taxation purposes. Although
similar to
U.S. proposals on the subject, stocks were frequently valued at replacement costs.

Uruguay

In Uruguay, revaluation became a generally accepted accounting principle and

if a company did not revalue, the auditors commented on it in their report.

Official indices were published for revaluation and depreciation was

calculated on the revalued amounts for taxation purposes.

Australia

During the period 1950-70, several contributions to the theory of accounting

for changing prices were made by Australians. Noteworthy among them were
‘adjustments to exit values recommended by chambers, ‘replacement cost accounting’
favoured by Mathews and a ‘replacement cost approach’ using specific indices

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recommended by Gynther who identified assumptions and analysed alternatives.

In December 1974, a joint committee of the Institute of Chartered

Accountants in Australia (ICAA) and the Australian Society of Accountants (ASA),
i.e. the Australian Accounting Standards Committee (AASC) issued an exposure draft
entitled ‘A method of Accounting for Changes in the Purchasing Power of Money. Its
contents were similar to PSSAP 7 of U.K. (discussed later). In November 1974, the
government appointed an enquiry group called Mathews Committee to study the
effects of inflation primarily upon taxation. The Mathews report supported Current
Value Accounting but failed to recognise the gains arising from long term borrowing
during a period of inflation.

Impressed by the Sandilands Committee recommendations in UK, AASC

issued a Provisional Standard on ‘Current cost Accounting in "October 1976. Later
a steering Group was formed. It prepared a revised recommendation that current
cost of fixed assets, depreciation, inventories and cost of sales should be disclosed
in supplementary notes, to be effective from July, 1978. But the provisional
standard did not cover gains and losses on holding monetary items. As a result an
Exposure Draft: The Recognition of Gains and losses in Holding Monetary Items in
the context of Current Cost Accounting’ was issued in August 1979.

A proposed standard issued by the Australian Current Cost Accounting

Standards Committee of the Australian Accounting Research Foundation provided
that from 1983, all listed companies with total assets exceeding 20 million Australian
dollars should present supplementary income statement and balance sheet reflecting
current cost adjustments for depreciation, cost of sales and gains or losses on
monetary items instead of that it was observed that, inflation accounting has been
losing popularity in the last few years.

Two leading Australian Companies the Broven Hill proprietary (BHP) and the
CSR have abandoned inflation adjustments presented as supplementary information,
on the ground, that it is not relevant and is ignored by most analysts. A para in the
CSR’s published accounts read “The company will not play the game in future unless
everybody else does, especially the tax authorities”.

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New Zealand

The New Zealand Society of Accountants is the leading professional

accounting group in the country. In December 1974, it issued an Exposure Draft
‘Accounting for changes in the purchasing power of money, recommending the
general purchasing power approach which did not receive much support. In March
1975, another Exposure Draft, ED-10 was published by the society based on UK’s
PSSAP-7, but was later withdrawn.

The next exposure Draft, ED-14, published by the society, entitled

‘Accounting in terms of Current Cost and Values’ recommended a Current Cost
System similar to the recommendations of the Sandilands Committee but was later
withdrawn. In December 1975, the Government established a Committee of Enquiry
into Inflation Accounting under the chairmanship of I.L.M. Richardson, which
submitted its report in September 1976. The report recommended the adoption of
financial statements based on Current Cost Accounting instead of historical costs
based financial statements, valuation of assets at current costs to the enterprise,
profit to be measured according to operating capability concept of capital
maintenance and the adoption of gearing adjustment. In the later part of 1975, the
Department of Management Studies at the University of Waikato initiated an
Inflation Accounting Research Project (IARP). A Working Manual was published
under the IARP at the request of the New Zealand Society of Accountants.

After a comprehensive study of various proposals and discussions thereupon, a

final standard entitled ‘Current Cost Accounting- No. T was submitted to the Council
of the New Zealand Society of Accountants. The standard issued in March 1982 and
similar to standards in other commonwealth countries, requires listed companies to
present supplementary current cost information and stipulates three adjustments,
namely depreciation, cost of sales and monetary working capital adjustment to
historical cost based operating income to arrive at current operating profit.

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Canada

The Canadian accounting profession has been influenced by developments

in U.K. and U.S.A. The Canadian Institute of Chartered Accountants (CICA)
published a discussion paper ‘Current Value Accounting and Price Level
Restatements’, in 1971.
The paper recommended retention of historical costs in published accounts but stressed
the need to reflect price level changes in financial reports. Specific price changes were
preferred.

The Accounting Research Committee of CICA released in November 1974,

guidelines titled Accounting for the Effects of Changes in General Purchasing Power
of Money’. It suggested optional publication of supplementary general price level
adjusted statements. In July 1975, these guidelines were re-issued as an Exposure
Draft Accounting for Changes in the Purchasing Power of Money’. This was followed
by a detailed 96 page discussion paper drafted by the Accounting Research Committee
in August 1976 on ‘Current Value Accounting’. The paper recommended the use of
current replacement costs for fixed assets and inventory and valuation based on
discounted cash flow for monetary items24. Recommendation for disclosure of the
effects of inflation on business was also made by a committee appointed by the
province of Ontario in June 1977.

In December 1982, the CICA, issued the Canadian Accounting Standard

‘Reporting the Effects of Changing Prices in the supplementary information section
4510 of the CICA Handbook. The Standard bears resemblance and appears to be a
combination of SSAP 16 (U.K.) and FAS 33 (U.S.A). It requires large publicly held
companies having fixed assets and inventories worth 50 million Canadian dollars or
total assets worth at least 350 million Canadian dollars to disclose supplementary
current cost information on certain itmes (for which the effects of changing prices of
changing prices are likely to be significant) in their annual reports for years
commencing on or after January 1, 1983.

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The Standard requires the disclosure of

(a) The current cost of inventories and of property, plant and equipment at the end of
the reporting period,

(b) The current year’s increase or decrease in the current cost of inventories and of
property, plant and equipment,
(c) The net assets of the enterprise after restating inventories and property, plant and
equipment at the end of the reporting period;
(d) The amount of current cost income or loss after reflecting the cost of sales and
depreciation, depletion and amortisation of property, plant and equipment on a
current cost basis.
(e) The Standard enables users to compute the income attributable to shareholders under
the financial concept and operating capability concept of capital maintenance. The
implementation of the standard was to be monitored and a comprehensive review
was to be undertaken in 5 years time.

(f) The Canadian Business Corporation Act and other provincial Acts require that
financial statements should be prepared in accordance with the CICA handbook,
thus granting legitimacy to the standard. However, it was evident during the first
year of disclosure that companies were unwilling to accept the recommendations of
the Standard due to declining rate of inflation, lack of demand from investors and
difficulties in interpreting the information presented.

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