What is inflation accounting?
Inflation accounting is an accounting practice in which values are adjusted for inflation. This is done to provide a more accurate picture of a financial situation. In some countries, this type of accounting is required for companies that make public financial reports if they are over a certain size, and smaller companies may also use inflation accounting. This technique requires careful accounting work because it is possible to obscure the financial picture with inflation accounting.
Over time, currencies experience inflation in value. A value expressed in a given currency in 1990, for example, has a different value in 2000. Inflation occurs over the course of a given year and can rise and fall depending on a number of economic factors. If the financial information were provided in actual amounts at the time, it could provide an accurate picture. For example, a company could decide that it gained a million monetary units in 2003 and a million monetary units in 2013. On the surface, it could appear that the company's income doubled, but due to inflation, this could not be the case. .
With inflation accounting, the accountant takes the actual value and adjusts it for inflation. This practice is also known as price level accounting and can be very revealing. For example, an accountant who prepared statements in 2008 showing that a company earned $100,000 in a specific division in 1990 could use inflation accounting to show that this would be $162,727 in 2008 dollars. That division is still earning $162,727 in 2008 dollars. 100,000 in 2008, I suggest it's not doing very well.
Adjustments for inflation are made with the help of tools such as the consumer price index and other indicators released by government agencies. Accountants are usually required to show their accounts when doing inflation accounting so that someone reviewing the accounts can see which index was used to calculate the inflated values. This reduces the risk of using variable ratios to make a more favorable financial report by massaging the numbers.
Inflation accounting is not just for large corporations. Some families also find it helpful to use inflation accounting when budgeting and thinking about job opportunities. Inflation affects consumer prices very quickly, and it can be helpful for people to think of past income and expenses in terms of inflation. Someone who earns the same salary for 10 years, for example, actually earns less each year because of inflation.