Breaking Bad and Good

How often is that corporates are fearful about the laws, regulations and all other policies that they should be aware of? It so does happen that their fears never come to a stop.

Some are advocates to the various laws that are passed by the government, but many are hesitant to adopt them. Inflation accounting is one great example which had its advocates as well as critiques.

The question often arises. Is there really a need for inflation accounting?

Let’s first look at how the advocates look at this issue. Surely, prices are not constant in nature. In words of Ford, inflation is public enemy number one.

When one talks about accounting, we tend to look at the traditional way of accounting with respect to the costs and revenues. Although these prices are changing, and money is economy’s medium of exchange, the main aim or objective to prepare such statements is to provide a fair and true perspective of a business. But if prices are changing, and you are to record them at historical cost, would that really make sense? Profit and Loss statements will not disclose the potential profits or losses and neither will the balance sheet talk about the true value of your assets and liabilities. This very practice of recording your prices assuming that prices are going to ‘remain stable’ is referred to as historical accounting.

Furthermore, the advocates state that its not always necessary that the prices are always rising, they might fall as well, which refers to deflation. When there is a period of deflation, the value of money goes up making us richer (hello economics). Reporting financial statements on a historical basis is not going to portray the reality of the business or the economy to be frank. But when inflation accounting is taken into consideration, profits or losses are not overstated or understated, neither are your assets and liabilities which help in providing a fair value of the business. Financial ratios will make much more sense and your shareholders are now happy.

But is that the end of the story? Critiques of inflation accounting have a lot to say too. The biggest argument put forward is that the income tax authorities do not accept this method.

One such typical giant that came out to be against this decision of implementing inflation accounting was General Motors who argued that this method of accounting is just so subjective and based on so many ‘estimates’ and mathematical calculations that it did not make any sense. Funny how that statement came from a car company that ate away its own profits like no other company.

But they did have a point. Adjusting prices is not an easy task. Prices keep going up and down so changing your reports every now and then was not something a company could afford to do. Plus, when price levels are falling accompanied with falling outputs, profits will be overstated and depreciation charged will be absolutely different from what one may typically charge.

So, now the real question arises. Should companies really consider such type of an accounting practice which will provide a true and valuable information? Or are they substituting practical importance by theoretical importance by using this so-called inflation accounting? Although there is no specific answer on what a business must go for, many of them usually adopt the traditional method of accounting so as to not make their financial statements complicated. When it comes to the corporate giants who want to portray a fair value of their business and also to impress shareholders, they make use of such accounting method to provide a realistic view.

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References

1. https://www.accountingnotes.net/inflation-accounting/inflation-accounting-need-merits-and-demerits-accounting/13144

2. https://www.playaccounting.com/exp-ca/inflation-accounting/merits-and-demerits-of-inflation-accounting/

3. https://www.yourarticlelibrary.com/accounting/price-level-accounting/price-level-accounting-advantages-and-disadvantages-financial-analysis/67436

4. https://www.investopedia.com/articles/06/gdpinflation.asp