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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 nations, this type of accounting is required for companies which make public financial reports if they are above a certain size and smaller companies may utilize inflation accounting as well. This technique requires some careful accounting work because it is possible to muddy the financial picture with inflation accounting.
Over time, currencies experience inflation in value. A set amount 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 wax and wane depending on a number of economic factors. If financial reporting was provided in the actual values at the time, it might provide in accurate picture. For example, a company could say that it earned one million currency units in 2003 and two million currency units in 2013. On the surface, it might look like the company's income had doubled, but because of inflation, this might not actually be the case.
With inflation accounting, the accountant takes the actual value and adjusts it for inflation. This practice may also be known as price level accounting, and it can be very revealing. For example, an accountant preparing statements in 2008 which showed that a company earned $100,000 United States Dollars (USD) in a particular division in 1990 could use inflation accounting to show that this would be $162,727 USD in 2008 dollars. If that division is still earning $100,000 USD in 2008, it would suggest that it is not doing very well.
Adjustments for inflation are done with the assistance of tools like the consumer price index and other indicators which are released by government agencies. Accountants are generally required to show their math when doing inflation accounting so that someone reviewing the accounts can see which index was used to calculate values with inflation. This reduces the risk of using varying indexes to make a financial report more favorable by massaging the numbers.
Inflation accounting isn't just for big corporations. Some households also find it helpful to use inflation accounting when making budgets and thinking about employment opportunities. Inflation affects consumer prices very rapidly, and it can be helpful for people to think about past income and expenditures in terms of inflation. Someone who earns the same salary for 10 years, for example, is actually earning less every year as a consequence of inflation.
@SZapper - You're right-if companies don't account for inflation, they aren't getting a very accurate picture of their profits.
I think people need to keep this in mind at their jobs too. If you are working somewhere that never gives you a raise, you're actually losing money every year! I would really consider looking for another job that at least gives cost of living raises.
I think inflation accounting makes a lot of sense, especially for businesses. I don't think you can get an accurate picture of the growth (or lack thereof) of a company without adjusting for inflation.
The example the article gave was really interesting-that if a company is making the same amount of profit it was ten years ago, it is actually making less profit! However, if the company didn't think to account for inflation, they would probably think they were doing fine. This could be misleading for the company and stockholders too.
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