Inflation accounting
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The document discusses different methods for adjusting accounting figures for inflation, including the Current Purchasing Power method, Current Cost Accounting, and the Finnish AHI method. It provides details on how these methods adjust items like inventories, fixed assets, profits, and equity for changes in purchasing power due to inflation. The methods aim to retain the historic cost accounting approach while expressing accounts in terms of purchasing power at the end of the accounting period.
![TO
- VC
= GP
- FC
= OP
- IC
- D
= NP
TO = Turnover
VC = Variable Costs
GP = Gross Profit
FC = Fixed Costs
OP = Operating Profit
IC = Interest Costs
D = Depreciation
NP = Net Profit
Below we also need:
[ NG = Net Gain from
Liabilities
TP = Total Profit ]](https://image.slidesharecdn.com/inflationaccounting-uwsb-130703064045-phpapp01/85/Inflation-accounting-10-320.jpg)
Inflation accounting
- 3. Decrease in purchasing power of money due to an increase in the general price level “A process of steadily rising prices resulting in diminishing purchasing power of a given nominal sum of money” The Penguin Dictionary of Economics “Rise in prices brought about by the expansion of the supply of bank money, credit, etc.” Oxford Advanced Learner’s Dictionary of Current English
- 4. Problems: Subjectivity Often complicated calculations Benefits: maintaining production capacity shows the internal logic of accounting
- 5. General indexes ◦ Price Index of Gross Domestic Product ◦ Cost-of-living Index ◦ Consumer Price Index ◦ Wholesale Price Index ◦ Production Price Index Special indexes ◦ Industry indexes ◦ Commodity group indexes ◦ Commodity indexes
- 6. CPP - Current Purchasing Power CCA - Current Cost Accounting The Finnish AHI-Method (Aktivoitujen Hankintamenojen Indeksointisovellutus)
- 7. Retains historic cost accounting conventions In U.S. General Purchasing Power (GPP) Expresses accounts in terms of “purchasing units” The purchase power of money at the end of the accounting period as the base Maintains the general purchasing power of the invested capital The original purchasing costs are corrected by correction coefficients applying some general index, for example Retail Price Index
- 8. Monetary items - financial assets and liabilities - remain unchanged Inventories: FIFO purchase cost is corrected by a suitable correction coefficient to correspond the purchase power of the end of accounting period Fixed assets: ◦ The purchase cost is corrected to correspond the purchase power of the end of the accounting period ◦ The balance value of the fixed assets is the same percentage of the corrected purchase cost as the book value is of the original purchase cost
- 9. Equity is defined as Assets - Liabilities Shareholders’ point of view Unsuitable for financing decisions Work intensive method
- 10. TO - VC = GP - FC = OP - IC - D = NP TO = Turnover VC = Variable Costs GP = Gross Profit FC = Fixed Costs OP = Operating Profit IC = Interest Costs D = Depreciation NP = Net Profit Below we also need: [ NG = Net Gain from Liabilities TP = Total Profit ]
- 11. FA Inv FixAss Assets Debt Eq FA = Financial Assets Inv = Inventories FixAss = Fixed Assets Assets = Total Assets Debt = Liabilities Eq = Owners’ Equity
- 12. TOCPP - VCCPP = GPCPP - FCCPP = OPCPP - ICCPP - DCPP = NPCPP +/- NG =TPCPP ,6 ,12CPP CPI CPI *TOTO t t tt = CPP ,12 , ,12 1 , CPP 1,12 CPP Inv CPI CPI *Purch InvVC t kt t K k kt tt −+ = ∑= − t,6 t,12 t CPP t CPI CPI *FCFC = t,6 t,12 t CPP t CPI CPI *ICIC =
- 13. TOCPP - VCCPP = GPCPP - FCCPP = OPCPP - ICCPP - DCPP = NPCPP +/- NG =TPCPP CPP , 1 , ,CPP FixAss* FixAss D D it N i it it t ∑= = ,6 ,12 1,12 ,12 1,121,12 ,6 ,12 1,12 1,12 ,12 1,12 CPI CPI *ΔFAΔFA CPI CPI *FAFA ΔLiab CPI CPI *ΔLiab Liab CPI CPI *LiabNG t t tt t t tt t t t t t t t t −+ −+ −+ −= − −− − − −
- 14. FACPP InvCPP FixAssCPP AssetsCPP DebtCPP EqCPP ∑= = K k k t kt 1 ,12CPP CPI CPI *PurchInv ∑= = N i p t tit 1 ,12 , CPP CPI CPI *FixAssFixAss tt FAFACPP = tt DebtDebtCPP = ttt DebtAssetsEq CPPCPP −=
- 15. Maintaining the production level of the company Main focus on replacement of production capacity Money is retained as the unit of measurement Different special indexes are applied to different items Work intensive
- 16. A combination of the CPP and CCA-methods Specially developed for firm analysis Calculations simple Little extra information needed Change in the general price level is described by the wholesale price index Adjustments are made on a yearly basis ◦ the price level at the middle of the accounting period as the base
- 17. Adjustments on ◦ Variable Costs ◦ Depreciation Other posts remain unchanged Adjustment on variable costs is computed by multiplying the opening inventory value by the relative change in the index Adjustment on depreciation is the difference between AHI- depreciation and the depreciation in the income statement
- 18. TOAHI - VCAHI = GPAHI - FCAHI = OPAHI - ICAHI - DAHI = NPAHI tt TOTOAHI = 1-1- 1- AHI InvInv WPI WPI VCVC tt t t tt −+= * tt FCFCAHI = tt ICICAHI = ii p asset date,purchase * = = = = ∑ = ipi p t ti N i tit EconLifeFixAss WPI WPI D DD , AHI , 1 AHI , AHI
- 20. FAAHI InvAHI FixAssAHI AssetsAHI DebtAHI EqAHI InflResAHI ( ) ( )∑ −+−= = t j ttjjt 1 AHIAHIAHI FixAssFixAssDDFixAssRes ( )tttt VCVCInvResInvRes AHIAHI 1- AHI −+= AHIAHIAHI FixAssResInvResIflRes ttt +=
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