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Inflation accounting

Methods of keeping a record of financial transactions and analysing them in a way which allows for changes in the pirchasing power of money over time. Until recently, historic cost accounting metohods have been used, that is to say accounts were derived more or less directly from book-keeping records of actual expenditures and receipts. Fixed assets, for example, such as buildings were recorded in the balance sheetat their actual (deprecitated) cost.

In period of rapidly rising prices the replacement cost of these assets is likely to be much higher than their recorded cost, and historic cost accounting, therefore may understate deprecitation and cost of real terms and overstate profits. Over a period of time this may lead to a situation where capital is not being maintained in real terms at all but distributed as ‘illusionary’ money profit in dividends and tax payments.

The problem of the effects of inflation on accounts has been under discussions since the 1930s. In the 1960s firms increasingly revalued their assets in a particular attemt to avoid overstating profits and later tax releif has been given on profits arasing from stock appreciation.

Various approaches to a more complete solution to the problem has been put forward. Some adopted for certain areas, others rejected. Among numerous solutions, the current cost accounting (C.C.A) has been adopted by most in recent years. Controversy continues, however, and both industry and the accounting profession remained divided on the new standard while both C.C.A and historic cost methods are being used in paralell.

Reference: The Penguin Dictionary of Economics, 3rd edt.