What is Inflation Accounting

Inflation accounting is a special accounting technique that can be used during periods of high inflation whereby financial statements are adjusted according to price indexes, rather than relying solely on a cost accounting basis. Companies operating in countries experiencing rapid and sustained levels of inflation or hyperinflation may be required to update their statements periodically in order to make them relevant to current economic and financial conditions.

Also known as price level accounting.

BREAKING DOWN Inflation Accounting

IAS 29 of International Financial Reporting Standards (IFRS) is the guide for entities whose functional currency is the currency of a hyperinflationary economy. The IFRS defines hyperinflation as prices, interest and wages linked to a price index rising 100% or more cumulatively over three years. Under IAS 29 rules, financial statements, including comparative (past) statements, must be expressed in the values of the currency current at the end of the reporting period, with changes tied to the general price index. Furthermore, the gain or loss on the net monetary position must be included in profit or loss for the period and must be separately disclosed.

Companies located in developed countries with relatively stable rates of inflation have no need to apply inflation accounting. In countries with high rates of inflation such as Venezuela, historical information on financial statements will not be relevant, forcing restatements to reflect current values.

Inflation Accounting Methods

There are two main methods — current purchasing power (CPP) and current cost accounting (CCA). Under the CPP method monetary items and nonmonetary items are separated. The accounting adjustment for monetary items is subject to recording of a net gain or loss. Nonmonetary items (those that do not carry a fixed value) are updated into figures with a conversion factor equivalent to price index at the end of the period divided by price index at the date of transaction. Under the CCA, both monetary and nonmonetary items are restated to current values.