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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
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