Inflation Adjustment

1. Inflation Adjustment By R.Sivanesh Email: sivanesh@sivanesh.com Blog: http://www.sivanesh.com

2. Introduction: • Inflation is considered to be a rise in the general level of prices of goods and services in an economy over a period of time. • Inflation and Monetary unit / Currency are inseparable • Inflation is a depreciation in the purchasing power of any given currency • As inflation increases, money buys less and less goods and services.

3. Is Inflation always harmful? • Inflation though is a measure of price rise is not always harmful. • Inflations is not only unavoidable but also essential. • Economists favour a low but steady rate of inflation. • Inflation is very harmful when income levels don’t increase with Inflation

4. Limitation of purpose of Financial Statements: • Basic purpose of Financial Statements of any entity is to portray true and fair view of the operations and affairs of the entity. • Purpose not solved where the reporting currency is subject to hyperinflation.

5. Accounting for Inflation: • No Standard to account for inflation in India • IAS 29 Financial Reporting in Hyperinflationary Economies • ICAI has brought out Exposure Draft of AS- 34 which deals with this aspect • Inflation Accounting is Mandatory and not supplementary to regular accounting

6. When should we adjust for Inflation • When people prefer to keep their wealth in non-monetary assets or in a relatively stable foreign currency. • When start to transact not in terms of the local currency but in terms of a relatively stable foreign currency. • When credit sales and purchases take place at prices that compensate for the expected loss of purchasing power • When the interest rates, wages and prices are linked to a price index; and • When the cumulative inflation rate over three years is approaching, or exceeds 100%

7. Method of Adjusting for Inflation: • IAS 29 recognises the restatement approach for inflation adjustment. • the financial statements are required to be restated in terms of the measuring unit current at the end of the reporting period.

8. measuring unit current • Measuring unit current means the adjusted value of the reporting currency using a price index (PI). • E.g. • purchase value of asset = `1,00,000/- • PI on date of purchase = 250. • PI on reporting date = 350. • Value of asset as per measuring unit current = 1,00,000 X 350 = `1,40,000/- 250

9. Items not requiring Adjustment • Monetary items • Items linked to price index under an agreement • Items carried at fair value

10. Other non-monetary items: • To be adjusted using change in price index during initial recording and at the reporting date • If a price index not available, a rough estimate of a probable price index may be considered. • Revalued items should be adjusted from date of revaluation • Inflation Adjusted amount should not exceed Net Realisable Value

11. Gain or Loss on Inflation Adjustment: • If entity has more non-monetary assets there will a net loss. If there are more liabilities there will be net gain. • The net gain or loss arising from the restatement of non-monetary items need to be charged to the statement of Profit or Loss. • When the currency ceases to be hyperinflationary, the inflation adjusted carrying amounts need to be carried forward thereafter. • Historical figures should not be reverted one again

12. Components of Profit or Loss A/c: • All items of profit and loss also need to be adjusted • Change in price index from date of initial recording and the reporting date need to be considered

13. Disclosure Requirements: • The fact that the financial statements and the corresponding figures have been adjusted for inflation • The identity and level of the price index at the end of the reporting period and the movement in the index during the current and the previous reporting period. • To be given in Noted to Accounts

14. By R.Sivanesh Email: sivanesh@sivanesh.com Blog: http://www.sivanesh.com