Page 47 - DCOM409_CONTEMPORARY_ACCOUNTING

Contemporary Accounting

Notes 6. Investors, employees and the public at large are not misled by inflated book profits
because inflation accounting shows more realistic profits. Higher paper profits without
adjustment for price level changes cause resentment among workers and they demand
higher wages. Also, excessive profits attract new entrepreneurs to enter the business.
Inflation accounting helps in avoiding further competition from prospective entrepreneurs.
7. The financial statements prepared by a company adjusted to the price level changes also
improve its social image.

8. Inflation accounting also affects the investment market as it helps to establish a realistic
price for the shares of a company.

Notes Disadvantages of Inflation Accounting
Some people are of the opinion that inflation accounting may create more problems than
provide solution to them, because of the following inherent disadvantages of the accounting
system considering price level changes:
1. Adjusting accounts to price level changes is a never-ending process. It involves
constant changes and alterations in the financial statements.
2. Price level accounting involves many calculations and makes financial statements
so complicated and confusing, that it becomes very difficult for a individual of
ordinary prudence to understand, analyse and interpret them.
3. The concept of price level accounting appears to have more theoretical importance
than practical relevance, because adjusting the accounts to the changes in the price
levels may lead to window dressing the accounts due to the element of subjectivity
in it. People may adjust the accounts according to the values most suited to them,
thereby, making the financial statements inaccurate.
4. Depreciation charged on current values of fixed assets is not acceptable under the
Income-tax Act, 1961, and hence adjusting it to price level changes does not serve
any practical purposes.
5. During deflation, when the prices are falling, adjustments of accounts to price level
changes will mean charging lesser depreciation and overstatement of profits
indicating that dividends could be paid from even the capital.

Self Assessment

Fill in the blanks:
13. The immediate operating effect of inflation is upon the …………of the business entity.
14. Assets recorded at historical cost will have a lower real value as the purchasing power of
money falls with …………….
15. Depreciation charged on current values of fixed assets is not acceptable under the ………….

2.6 Summary

Price level accounting may be defined as that technique of accounting by which the financial
statements are restated to reflect changes in the general price level.
Inflation accounting is a term describing a range of accounting systems designed to correct
problems arising from historical cost accounting in the presence of inflation.

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