Inflation is a state to inflation accounting

Inflation is a state to inflation accounting in which purchasing power of money goes down or conversely there is more money in circulation than is justified by goods and services. The effect of inflation is that prices of assets go up and the accounts prepared on the basis of conventional accounting system present much distorted figures to the users of accounts. Accountants prepare Profit and Loss Account and Balance sheet at historical costs. Profit is the difference between revenue and costs. Revenue reflects the current value whereas costs represent current as well as historical costs. Thus the profit is overstated measured in terms of money and the value of money is fluctuating due to inflation, any measurement with fluctuating scale is unreliable and would distort the true

financial position of the organization. In such cases to make the measurement perfect, the scale should be kept steady. If this is not possible, an alternative should be evolved to adjust the effects of fluctuating changes in money value and make the financial statements reflect current values in real terms. Management Accountant has responsibility towards shareholders and internal management of the organisation to appraise the true financial position of the organisation. Inflation Accounting devised to show the effect of changing cost and prices on affairs of a company during the course of relative accounting periods. It is also known as ‘Accounting for price level changes’.

Financial accounts are the basis on which the success of the business is measured and on which investors can find out whether or not their investment is safe and will produce a reasonable return for them. Financial accounts, therefore, have a significant effect on the business, and shareholders are particularly interested in them from the point of view of not only obtaining a good return on their investment but also of maintaining the value of that investment. But if this value is expressed in terms of historical costs, without allowing for the inspect of inflation, it could be illusory. Hence, the need for inflation accounting. The purpose of inflation adjusted accounting is to restore the principle of matching current revenues with current costs or current purchasing power to the Profit and Loss Account, thus removing the inflationary element from historic cost profit and/or allowing the concept of physical capital maintenance to be adopted. Inflation accounting is a system of accounting which regularly records all items in financial statements at their current values. The system recognizes the fact that the purchasing power of money is decreasing day-by-day during inflation and finds out profit or loss or states the financial position of the business on the basis of the current prices prevailing in the economy.