Inflation AccountingInflation AccountingInflation AccountingInflation Accounting

Inflation: DefinitionsInflation: DefinitionsInflation: DefinitionsInflation: Definitions Decrease in purchasing power of money due to an Decrease in purchasing power of money due to an

increase in the general price levelincrease in the general price level ““A process of steadily rising prices resulting in A process of steadily rising prices resulting in

diminishing purchasing power of a given nominal diminishing purchasing power of a given nominal sum of money”sum of money”

The Penguin Dictionary of EconomicsThe Penguin Dictionary of Economics ““Rise in prices brought about by the expansion of Rise in prices brought about by the expansion of

the supply of bank money, credit, etc.”the supply of bank money, credit, etc.”

Oxford Advanced Learner’s Dictionary of Current Oxford Advanced Learner’s Dictionary of Current EnglishEnglish

Some Aspects on Inflation Some Aspects on Inflation AccountingAccounting

Problems:Problems: SubjectivitySubjectivity Often complicated calculationsOften complicated calculations Benefits:Benefits: maintaining production capacitymaintaining production capacity shows the internal logic of accountingshows the internal logic of accounting

Change in the price level is Change in the price level is described by indexesdescribed by indexes

Change in the price level is Change in the price level is described by indexesdescribed by indexes

General indexesGeneral indexes– Price Index of Gross Domestic ProductPrice Index of Gross Domestic Product– Cost-of-living IndexCost-of-living Index– Consumer Price IndexConsumer Price Index– Wholesale Price IndexWholesale Price Index– Production Price IndexProduction Price Index

Special indexesSpecial indexes– Industry indexesIndustry indexes– Commodity group indexesCommodity group indexes– Commodity indexesCommodity indexes

Finnish Wholesale Price IndexFinnish Wholesale Price Index1960-19941960-1994

Finnish Wholesale Price IndexFinnish Wholesale Price Index1960-19941960-1994

0

200

400

600

800

1000

1200

1400

1600

1800

1960 1965 1970 1975 1980 1985 1990Source: Statistical Yearbook of Finland 1995

Yearly Change (%) in the Finnish Yearly Change (%) in the Finnish Wholesale Price IndexWholesale Price Index

Yearly Change (%) in the Finnish Yearly Change (%) in the Finnish Wholesale Price IndexWholesale Price Index

-10

-5

0

5

10

15

20

25

30

1960 1965 1970 1975 1980 1985 1990

Source: Statistical Yearbook of Finland 1995

Inflation Accounting MethodsInflation Accounting MethodsInflation Accounting MethodsInflation Accounting Methods CPP - Current Purchasing PowerCPP - Current Purchasing Power CCA - Current Cost AccountingCCA - Current Cost Accounting The Finnish AHI-Method (Aktivoitujen The Finnish AHI-Method (Aktivoitujen

Hankintamenojen Indeksointisovellutus)Hankintamenojen Indeksointisovellutus)

Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP) Retains historic cost accounting conventionsRetains historic cost accounting conventions In U.S. General Purchasing Power (GPP)In U.S. General Purchasing Power (GPP) Expresses accounts in terms of “purchasing units”Expresses accounts in terms of “purchasing units” The purchase power of money at the end of the The purchase power of money at the end of the

accounting period as the baseaccounting period as the base Maintains the general purchasing power of the Maintains the general purchasing power of the

invested capitalinvested capital The original purchasing costs are corrected by The original purchasing costs are corrected by

correction coefficients applying some general index, correction coefficients applying some general index, for example Retail Price Indexfor example Retail Price Index

Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP)

Monetary items - financial assets and liabilities - Monetary items - financial assets and liabilities - remain unchangedremain unchanged

Inventories: FIFO purchase cost is corrected by a Inventories: FIFO purchase cost is corrected by a suitable correction coefficient to correspond the suitable correction coefficient to correspond the purchase power of the end of accounting periodpurchase power of the end of accounting period

Fixed assets: Fixed assets: – The purchase cost is corrected to correspond the purchase The purchase cost is corrected to correspond the purchase

power of the end of the accounting periodpower of the end of the accounting period– The balance value of the fixed assets is the same The balance value of the fixed assets is the same

percentage of the corrected purchase cost as the book percentage of the corrected purchase cost as the book value is of the original purchase costvalue is of the original purchase cost

Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP)Current Purchasing Power (CPP) Equity is defined as Assets - LiabilitiesEquity is defined as Assets - Liabilities Shareholders’ point of viewShareholders’ point of view Unsuitable for financing decisionsUnsuitable for financing decisions Work intensive methodWork intensive method

Nominal Statement of IncomeNominal Statement of Income

TO - VC= GP - FC= OP - IC - D= NP

TO = TurnoverVC = Variable CostsGP = Gross ProfitFC = Fixed CostsOP = Operating ProfitIC = Interest CostsD = DepreciationNP = Net ProfitBelow we also need:[ NG = Net Gain from Liabilities TP = Total Profit ]

Nominal Balance SheetNominal Balance Sheet

FAInv

FixAssAssets

Debt Eq

FA = Financial AssetsInv = InventoriesFixAss = Fixed AssetsAssets = Total Assets

Debt = LiabilitiesEq = Owners’ Equity

CPP - Statement of IncomeCPP - Statement of Income

TOCPP

- VCCPP

= GPCPP

- FCCPP

= OPCPP

- ICCPP

- DCPP

= NPCPP

+/- NG =TPCPP

,6

,12CPP

CPI

CPI*TOTO

t

ttt

CPP,12

,

,12

1,

CPP1,12

CPP

InvCPI

CPI*Purch

InvVC

tkt

tK

kkt

tt

t,6

t,12t

CPPt CPI

CPI*FCFC

t,6

t,12t

CPPt CPI

CPI*ICIC

CPP - Statement of IncomeCPP - Statement of Income

TOCPP

- VCCPP

= GPCPP

- FCCPP

= OPCPP

- ICCPP

- DCPP

= NPCPP

+/- NG =TPCPP

,6

,12

1,12

,121,121,12

,6

,12

1,121,12

,121,12

CPI

CPI*ΔFAΔFA

CPI

CPI*FAFA

ΔLiabCPI

CPI*ΔLiab

LiabCPI

CPI*LiabNG

t

ttt

t

ttt

tt

tt

tt

tt

CPP - Balance SheetCPP - Balance Sheet

FACPP

InvCPP

FixAssCPP

AssetsCPP

DebtCPP

EqCPP

K

k k

tkt

1

,12CPP

CPI

CPI*PurchInv

N

i p

ttit

1

,12,

CPP

CPI

CPI*FixAssFixAss

tt FAFA CPP

tt DebtDebtCPP

ttt DebtAssetsEq CPPCPP

Current Cost Accounting (CCA)Current Cost Accounting (CCA)Current Cost Accounting (CCA)Current Cost Accounting (CCA) Maintaining the production level of the Maintaining the production level of the

companycompany Main focus on replacement of production Main focus on replacement of production

capacity capacity Money is retained as the unit of measurementMoney is retained as the unit of measurement Different special indexes are applied to Different special indexes are applied to

different itemsdifferent items Work intensiveWork intensive

The Finnish AHI-Method The Finnish AHI-Method The Finnish AHI-Method The Finnish AHI-Method A combination of the CPP and CCA-methodsA combination of the CPP and CCA-methods Specially developed for firm analysisSpecially developed for firm analysis Calculations simpleCalculations simple Little extra information neededLittle extra information needed Change in the general price level is described by Change in the general price level is described by

the the wholesale price indexwholesale price index Adjustments are made on a yearly basisAdjustments are made on a yearly basis

– the price level at the middle of the accounting period the price level at the middle of the accounting period as the base as the base

AHI-Statement of IncomeAHI-Statement of IncomeAHI-Statement of IncomeAHI-Statement of Income Adjustments on Adjustments on

– Variable CostsVariable Costs– DepreciationDepreciation

Other posts remain unchangedOther posts remain unchanged

Adjustment on variable costs is computed by Adjustment on variable costs is computed by multiplying the multiplying the opening inventory valueopening inventory value by the by the relative change in the indexrelative change in the index

Adjustment on depreciation is the difference between Adjustment on depreciation is the difference between AHI-depreciation and the depreciation in the income AHI-depreciation and the depreciation in the income statementstatement

AHI - Statement of IncomeAHI - Statement of Income

TOAHI

- VCAHI

= GPAHI

- FCAHI

= OPAHI

- ICAHI

- DAHI

= NPAHI

ttTOTOAHI

1-1-

1-

AHI InvInvWPI

WPIVCVC

tt

t

t

tt *

ttFCFCAHI

ttICICAHI

ii

p

asset

date, purchase

*

ipip

tti

N

itit

EconLifeFixAssWPI

WPID

DD

,AHI,

1

AHI,

AHI

Adjustments to the Balance Adjustments to the Balance Sheet - AssetsSheet - Assets

Adjustments to the Balance Adjustments to the Balance Sheet - AssetsSheet - Assets

Financial Assets and Inventories (FIFO) remain unchangedFinancial Assets and Inventories (FIFO) remain unchanged Fixed Assets - first AHI-yearFixed Assets - first AHI-year

– The original purchase cost is revaluated to the price level of the current yearThe original purchase cost is revaluated to the price level of the current year– Depreciation/year is computed according to the economic lifetime of the Depreciation/year is computed according to the economic lifetime of the

assetasset– The depreciations up to the current year are subtracted from the revaluated The depreciations up to the current year are subtracted from the revaluated

purchase costpurchase cost

Fixed Assets - after the first yearFixed Assets - after the first year– The AHI-balance value of the previous year is revaluated to the current yearThe AHI-balance value of the previous year is revaluated to the current year

– New depreciation is computed based on the remaining economic New depreciation is computed based on the remaining economic lifetime lifetime

Adjustments to the Balance Adjustments to the Balance Sheet - Equity and LiabilitiesSheet - Equity and LiabilitiesAdjustments to the Balance Adjustments to the Balance Sheet - Equity and LiabilitiesSheet - Equity and Liabilities

EquityEquity– The accounting result is replaced by the AHI-The accounting result is replaced by the AHI-

resultresult

LiabilitiesLiabilities– Liabilities remain unchangedLiabilities remain unchanged

Inflation ReservesInflation Reserves– Correspond to the adjustments made in the Correspond to the adjustments made in the

Statement of Income and the Balance Sheet Statement of Income and the Balance Sheet

AHI - Balance SheetAHI - Balance Sheet

FAAHI

InvAHI

FixAssAHI

AssetsAHI

DebtAHI

EqAHI

InflResAHI

ttInvInvAHI

N

i ti

p

t

pit 1

AHI

,,

AHI DWPI

WPI*FixAssFixAss *1pt

ttFAFA AHI

ttDebtDebtAHI

AHIAHI

1-

AHI NPEqEqttt

AHI - Balance SheetAHI - Balance Sheet

FAAHI

InvAHI

FixAssAHI

AssetsAHI

DebtAHI

EqAHI

InflResAHI

t

jttjjt

1

AHIAHIAHI FixAssFixAssDDFixAssRes

tttt

VCVCInvResInvRes AHIAHI

1-

AHI

AHIAHIAHI FixAssResInvResIflResttt

Numerical ExampleNumerical ExampleNumerical ExampleNumerical Example

Correcting annual reports for a company over Correcting annual reports for a company over years 1975-1976 using the AHI-method. A years 1975-1976 using the AHI-method. A period of high inflation rate.period of high inflation rate.

Wholesale Price IndexWholesale Price Index19721972 338338

19731973 398398

19741974 495495

19751975 562562

19761976 626626 0

100

200

300

400

500

600

700

1972 1973 1974 1975 1976

Wholesale Price Index and its Wholesale Price Index and its Relative Change 1960-1994Relative Change 1960-1994

Wholesale Price Index and its Wholesale Price Index and its Relative Change 1960-1994Relative Change 1960-1994

-10

-5

0

5

10

15

20

25

30

1960 1965 1970 1975 1980 1985 1990

0

200

400

600

800

1000

1200

1400

1600

1800

1960 1965 1970 1975 1980 1985 1990

Learn More AtLearn More AtLearn More AtLearn More At

http://www.svtuition.orghttp://www.svtuition.org