SCHOOL OF GRADUATE STUDIES
DEPARTMENT OF ACCOUNTING AND FINANCE
ADVANCED FINANCIAL ACCOUNTING
Writing Essay about
Sustainability Accounting and Inflation Accounting
Aklesia Kefelegn (SGS/0095/2015, Sec-A)
Submitted to Asmamaw G. (Asst. Prof, ABD PhD in AcFN)
Addis Ababa, Ethiopia
Feb, 2023
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Table of Contents
1.
The concept of Sustainability Accounting ........................................................................................................... 2
2.
Historical overview of the development of Sustainability Accounting ............................................................... 4
3.
The Benefits of Sustainability Accounting .......................................................................................................... 5
4.
The Roles of the Major Actors in Sustainability Accounting .............................................................................. 6
5.
Practical Implementation and Methodology of Sustainability Accounting ......................................................... 7
6.
The Key Challenge for Sustainability Accounting .............................................................................................. 8
1.
Concepts of Inflation Accounting ...................................................................................................................... 11
2.
Inflation Accounting Methods ........................................................................................................................... 12
2.1.
Current Purchasing Power (CPP) Method ................................................................................................. 12
2.1.1.
Calculation of Conversion Factor ...................................................................................................... 13
2.1.2.
Distinction between Monetary and Non-monetary Accounts ............................................................ 13
2.1.3.
Gain Or Loss On Monetary items ...................................................................................................... 14
2.1.4.
Valuation of Cost of Sales and Inventories ........................................................................................ 14
2.1.5.
Ascertainment of Profit ...................................................................................................................... 15
2.1.6.
Restated Balance Sheet ...................................................................................................................... 15
2.2.
Current Cost Accounting (CCA) Method .................................................................................................. 16
3.
Merit and Demerits of Inflation Accounting...................................................................................................... 17
4.
Example of Inflation Accounting....................................................................................................................... 19
5.
Conclusion ......................................................................................................................................................... 19
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Sustainability Accounting
In recent years, the concept of sustainability accounting has gained traction in the business world as
organizations have begun to recognize the importance of managing their financial and environmental impacts.
This essay will explore the concept of sustainability accounting, its origin and historical development, benefits
of sustainability accounting for businesses, the role of major actors in promoting sustainability accounting,
and the professional guides and practical implementation and its challenges of associated with executing
sustainability accounting in the corporate environment. By exploring these topics, this essay will demonstrate
the potential of sustainability accounting to improve corporate responsibility.
1. The concept of Sustainability Accounting
The concept of sustainability accounting has emerged from developments in accounting. Sustainability
accounting is a subset of financial accounting that focuses on revealing non-financial information about a
company's performance to external stakeholders such as investors, creditors, and government authorities.
Sustainability accounting is concerned with the actions of a company that have a direct impact on society, the
environment, and its financial performance. Thus, it is the process of finding, measuring and managing of the
accounting practice that focuses on the environmental, social, and economic impacts of a company’s
operations. Therefore, it is a way of measuring and reporting the financial performance of a company in terms
of its environmental, social, and economic impacts so as to bring those key metrics into regular financial
statements for leaders to access key decision drivers and act on them.
Sustainability accounting differs from financial accounting in that it is used for internal decision making and
the development of new policies that will impact the organization's performance at the economic, ecological,
and social (known as the triple bottom line or Triple- P's; People, Planet, Profit) levels. Sustainability
accounting is regularly applied to produce value inside a firm and it is used by businesses to become more
ecologically responsible.
Sustainability accounting is a broad and complex topic that encompasses a variety of different areas. Here is a
list of topics related to sustainability accounting:
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
Environmental Accounting: This involves the measurement and reporting of environmental costs and
benefits associated with a company’s operations. It includes the identification and quantification of
environmental impacts, such as air and water pollution, waste management, and energy consumption.

Social Accounting: This involves the measurement and reporting of social costs and benefits
associated with a company’s operations. It includes the identification and quantification of social
impacts, such as labor practices, community engagement, and human rights.

Corporate Social Responsibility (CSR): This involves the measurement and reporting of a company’s
commitment to social and environmental responsibility. It includes the identification and
quantification of a company’s efforts to reduce its environmental footprint, promote ethical labor
practices, and engage with the local community.

Sustainable Supply Chain Management: This involves the measurement and reporting of a company’s
efforts to reduce its environmental footprint throughout its supply chain. It includes the identification
and quantification of a company’s efforts to reduce its energy consumption, reduce its waste, and
promote ethical labor practices throughout its supply chain.

Life Cycle Assessment (LCA): This involves the measurement and reporting of a product’s
environmental impacts throughout its life cycle. It includes the identification and quantification of a
product’s energy consumption, waste production, and other environmental impacts throughout its life
cycle.

Carbon Accounting: This involves the measurement and reporting of a company’s carbon emissions.
It includes the identification and quantification of a company’s carbon emissions from its operations,
its supply chain, and its products.

Water Accounting: This involves the measurement and reporting of a company’s water consumption
and wastewater discharge. It includes the identification and quantification of a company’s water
consumption and wastewater discharge from its operations, its supply chain, and its products.

Sustainable Investment: This involves the measurement and reporting of a company’s investments in
sustainable projects. It includes the identification and quantification of a company’s investments in
renewable energy, sustainable agriculture, and other sustainable projects.

Sustainable Reporting: This involves the measurement and reporting of a company’s sustainability
performance. It includes the identification and quantification of a company’s environmental, social,
and economic performance.
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2. Historical overview of the development of Sustainability Accounting
Sustainability accounting is a relatively new field of accounting that was originated about 20 years ago and
has been gaining popularity in recent years (Tilt, 2007).
But the foundation of its idea, sustainability, goes back to 1970s, when the United Nations Conference on the
Human Environment was held in Stockholm (Chasek, P.). At this conference, the concept of sustainable
development was introduced, which focused on the need to balance economic growth with environmental
protection.
This concept was further developed in the 1980s and 1990s, when the Brundtland Commission and the Rio
Earth Summit both highlighted the need for sustainable development (Are, F. O. F. S. D.). In the early 2000s,
the Global Reporting Initiative (GRI) was established to provide guidance on sustainability reporting. This
was followed by the International Integrated Reporting Council (IIRC) in 2013, which provided guidance on
integrated reporting. This was a major step forward in the development of sustainability accounting, as it
provided a framework for organizations to report on their sustainability performance.
In recent years, sustainability accounting has become increasingly important as organizations have become
more aware of the need to address environmental and social issues. This has led to the development of new
standards and frameworks, such as the Sustainability Accounting Standards Board (SASB) and the Task
Force on Climate-related Financial Disclosures (TCFD). These standards and frameworks provide guidance
on how organizations should report on their sustainability performance.
Companies are beginning to recognize the importance of sustainability accounting and are taking steps to
incorporate it into their operations. Sustainability accounting is still in its early stages, but it is becoming more
widely used. The number of companies that apply sustainability accounting is uncertain, as there is no single
definition of sustainability accounting and no single standard for reporting. But, it can be said that there are
considerable numbers of companies around the world have adopted some form of sustainability
accounting(…)..For example, many companies are now using sustainability accounting to track their carbon
emissions, water usage, and waste management. In addition, many companies are now using sustainability
accounting to measure their social and environmental impacts. This includes tracking their labor practices,
supply chain management, and community engagement. By tracking these metrics, companies can better
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understand their impacts and make more informed decisions about their operations. This includes large
multinational corporations, as well as smaller companies.
The Global Reporting Initiative (GRI) is one of the most widely used sustainability accounting standards. It is
used by over 1,000 companies in over 100 countries (_). In addition to the GRI, there are numbers of other
sustainability accounting standards that are used by companies around the world. These include the
International Integrated Reporting Council (IIRC), the Sustainability Accounting Standards Board (SASB),
and the Carbon Disclosure Project (CDP). Overall, it is clear that sustainability accounting is becoming
increasingly important for companies around the world. As more companies adopt sustainability accounting
standards, the exact number of companies that apply sustainability accounting will increase.
Overall, the development of sustainability accounting has been a long and ongoing process. It has evolved
from a concept introduced in the 1970s to a more formalized field of accounting with its own standards and
frameworks. As organizations become increasingly aware of the need to address environmental and social
issues, sustainability accounting is likely to become even more important in the future.
3. The Benefits of Sustainability Accounting
Sustainability accounting is an important tool for businesses to measure and manage their environmental and
social impacts. It is a way for businesses to assess their performance in terms of sustainability and to identify
areas for improvement. By using sustainability accounting, businesses can better understand their
environmental and social impacts, and make informed decisions about how to reduce their environmental
footprint and improve their social performance. The benefits of sustainability accounting for businesses are
numerous.
First, it helps businesses to identify and measure their environmental and social impacts, and to set goals for
reducing their environmental footprint and improving their social performance. This helps businesses to
become more efficient and to reduce their costs. Additionally, sustainability accounting can help businesses to
identify opportunities for innovation and to develop new products and services that are more sustainable.
Second, sustainability accounting can help businesses to better understand their stakeholders and to develop
strategies to engage with them. By understanding the needs and concerns of their stakeholders, businesses can
develop strategies to address them and to build relationships with them. This can help businesses to build trust
and loyalty with their stakeholders, which can lead to increased sales and profits.
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Third, sustainability accounting can help businesses to better understand their risks and to develop strategies
to manage them. By understanding the risks associated with their operations, businesses can develop
strategies to reduce them and to ensure that their operations are sustainable. This can help businesses to
protect their reputation and to ensure that their operations are compliant with environmental and social
regulations.
Finally, sustainability accounting can help businesses to better understand their competitive environment and
to develop strategies to remain competitive. By understanding the competitive landscape, businesses can
develop strategies to differentiate themselves from their competitors and to remain competitive. This can help
businesses to remain profitable and to ensure their long-term success.
Overall, sustainability accounting is an important tool for businesses to measure and manage their
environmental and social impacts. It can help businesses to identify and measure their environmental and
social impacts, to set goals for reducing their environmental footprint and improving their social performance,
to better understand their stakeholders, to manage their risks, and to remain competitive. By using
sustainability accounting, businesses can ensure their long-term success and remain profitable.
4. The Roles of the Major Actors in Sustainability Accounting
The major actors in sustainability accounting are the organization itself, its stakeholders, and the public. The
organization is responsible for developing and implementing a sustainability accounting system that meets its
needs and objectives. This includes setting goals and objectives, developing policies and procedures, and
monitoring and reporting on progress.
The organization should also ensure that its sustainability accounting system is transparent and accessible to
stakeholders and the public. Stakeholders are those individuals or groups who have an interest in the
organization’s activities and outcomes. They may include customers, suppliers, employees, investors, and
other interested parties. Stakeholders should be involved in the development and implementation of the
sustainability accounting system, as well as in the monitoring and reporting of progress. They should also be
provided with access to the information they need to make informed decisions.
The public is the broader community that is affected by the organization’s activities. This includes local
communities, governments, and other interested parties. The public should be informed about the
organization’s sustainability accounting system and its progress. The organization should also ensure that its
sustainability accounting system is transparent and accessible to the public.
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In summary, the major actors in sustainability accounting are the organization itself, its stakeholders, and the
public. Each of these actors has an important role to play in the development and implementation of a
sustainability accounting system, as well as in the monitoring and reporting of progress. The organization
should ensure that its sustainability accounting system is transparent and accessible to all stakeholders and the
public.
5. Practical Implementation and Methodology of Sustainability Accounting
The methodologies of sustainability accounting vary depending on the type of business and the goals of the
organization. Generally, sustainability accounting involves collecting and analyzing data related to three
pillars of a corporate sustainability strategy: the environmental, the socially responsible, and the economic.
They are referred to as pillars because, together, they support sustainable goals.
Every pillar focuses on different subsets. The environmental pillar includes energy, water, greenhouse gases,
emissions, hazardous waste, recycling, and packaging while the social pillars has subsets of community
investment, working conditions, human rights and fair trade, public policy, diversity, safety and
anticorruption. The third economic pillar encompasses accountability / transparency, corporate governance,
stakeholder value, economic performance and financial performance (Ernst and Young, 2011).
The practical implementation approach of sustainability accounting involves a number of steps.

First, companies must identify the sustainability issues that are most relevant to their operations. This
includes understanding the environmental, social, and economic impacts of their activities, and the
potential risks and opportunities associated with them. Companies should also consider the potential
impacts of their activities on stakeholders, such as customers, suppliers, and the local community.

Second, companies should develop a sustainability strategy that outlines their goals and objectives for
sustainability performance. This should include a plan for how the company will measure and report
on its sustainability performance, and how it will use the information to make decisions and take
action.

Third, companies should develop a sustainability reporting framework that outlines the metrics and
indicators they will use to measure and report on their sustainability performance. This should include
both quantitative and qualitative measures, such as energy and water use, waste generation, and
employee engagement. Fourth, companies should develop a system for collecting and analyzing data
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on their sustainability performance. This should include both internal and external data sources, such
as customer surveys, employee feedback, and industry benchmarks.

Fifth, companies should develop a system for communicating their sustainability performance to
stakeholders. This should include both internal and external communications, such as sustainability
reports, press releases, and stakeholder engagement activities.

Finally, companies should develop a system for monitoring and evaluating their sustainability
performance over time. This should include both short-term and long-term goals, and should be
regularly reviewed and updated to ensure that the company is making progress towards its
sustainability objectives.
By following these steps, companies can ensure that they are taking a practical approach to implementing
sustainability accounting. This will help them to measure and report on their sustainability performance,
identify areas for improvement, and take action to improve their sustainability performance over time.
6. The Key Challenge for Sustainability Accounting
The key challenge for sustainability accounting is to develop a comprehensive and consistent framework
for measuring and reporting the environmental, social, and economic impacts of an organization’s
activities.
This challenge is particularly difficult because sustainability accounting requires organizations to
consider a wide range of factors, including environmental, social, and economic impacts, and to develop
a comprehensive and consistent framework for measuring and reporting these impacts.
The ‘three pillars’ model is flawed because it implies that trade-offs can always be made between
environmental, social and economic dimensions of sustainability as if they are equivalent for the
existence of a given organization (Adams, 2006).
The challenge of sustainability accounting is further complicated by the fact that there is no single,
universally accepted definition of sustainability. Different organizations have different definitions of
sustainability, and this can make it difficult to develop a consistent framework for measuring and
reporting sustainability impacts (Adams, 2006).
Additionally, sustainability accounting requires organizations to consider a wide range of factors,
including environmental, social, and economic impacts, and to develop a comprehensive and consistent
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framework for measuring and reporting these impacts. In order to address this challenge, organizations
must develop a comprehensive and consistent framework for measuring and reporting sustainability
impacts. This framework should include a clear definition of sustainability, as well as a set of metrics and
indicators that can be used to measure and report sustainability impacts.
Additionally, organizations should develop a system for tracking and reporting sustainability impacts
over time, in order to ensure that sustainability goals are being met. Finally, organizations should ensure
that their sustainability accounting framework is transparent and accessible to stakeholders.
This will help to ensure that stakeholders are aware of the organization’s sustainability efforts and can
provide feedback on how the organization can improve its sustainability performance. Additionally,
transparency and accessibility will help to ensure that the organization’s sustainability efforts are credible
and reliable.
Another key challenge for sustainability accounting is balancing the need for accurate information with the
need for timely decision-making. Too much information can slow down decision-making processes, while too
little information can result in inaccurate decisions that harm the environment and society.
In conclusion, the key challenge for sustainability accounting is to develop a comprehensive and
consistent framework for measuring and reporting the environmental, social, and economic impacts of an
organization’s activities and in application of sustainability accounting in decision making.
To address this challenge, organizations must develop a clear definition of sustainability, as well as a set
of metrics and indicators that can be used to measure and report sustainability impacts. Additionally,
organizations should develop a system for tracking and reporting sustainability impacts over time, and
ensure that their sustainability accounting framework is transparent and accessible to stakeholders.
There are number of ways to tackle the challenges of huge size of information of sustainability accounting.
One approach is to use simulation models to create virtual scenarios that allow managers to explore different
options without actually making any changes to the real world.
Simulation models also allow organizations to compare different scenarios and see how each affects the
environment and society. Another approach is to use case studies to explore specific examples of how
sustainability accounting has been used in practice. This type of analysis can help managers understand how
different types of systems work and which ones are most effective for specific situations. Ultimately,
sustainability accounting is an important tool for organizations looking to improve their environmental
performance and protect both the environment and society. By using sound methodologies and data sources,
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businesses can ensure that their data is accurate and useful in making informed decisions about how best to
protect both resources and people.
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Inflation Accounting
Accounting's main role is to reflect what has occurred during a particular time through reporting. But
this approach is challenged since it does not paint a more accurate picture of how organizations and their
financial positions fare in inflationary or deflationary environments. Rising dissatisfaction with historical
cost accounting is observed among professionals as a means of presenting financial statements. Hence, it
is invariably suggested alternative supplementary financial statements, adjusted to show the effects of
changes in the purchasing power of the monetary unit, as a means of overcoming distortions in historical
accounting data resulting from the continuous inflation experienced in the world's major economic
nations (Tweedie & Whittington, 2009.).
This essay will explore the definition of inflation accounting, inflation accounting methodologies and
their advantages and disadvantages, as well as the benefits and drawbacks of inflation accounting.
1. Concepts of Inflation Accounting
Inflation is a recurrent issue in global economies. It is a concern since it depreciates money's purchasing
power, which can lead to decreased economic activity and even recession. Inflation may be measured in a
variety of methods, the most popular of which is through the Consumer Price Index (CPI).
Inflationary accounting use index prices to paint a more accurate picture of how organizations and their
financial positions fare in inflationary or deflationary environments. It contains more information than
simple cost accounting. It enables the business revenue and spending to be representative and compared
with other firms as well as previous data.
Inflation accounting is a method of accounting that takes into account the effects of inflation on the
financial statements of a company. It is used to adjust the financial statements to reflect the true economic
value of the company’s assets and liabilities. Inflation accounting is important because it allows
companies to accurately measure their financial performance over time.
Inflation accounting is based on the concept of purchasing power parity (PPP). This concept states that
the value of a currency is determined by the amount of goods and services it can purchase. As inflation
increases, the purchasing power of a currency decreases, and the value of assets and liabilities must be
adjusted to reflect this.
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Inflation accounting is used to adjust the financial statements of a company to reflect the true economic
value of its assets and liabilities. This is done by adjusting the values of assets and liabilities for the
effects of inflation. For example, if a company has a fixed asset such as a building, the value of the
building must be adjusted for inflation. This is done by calculating the present value of the asset, which is
the value of the asset in today’s birr.
Inflation accounting is also used to adjust the values of liabilities. For example, if a company has a loan,
the value of the loan must be adjusted for inflation. This is done by calculating the present value of the
loan, which is the value of the loan in today’s birr.
Inflation accounting is important because it allows companies to accurately measure their financial
performance over time. By adjusting the values of assets and liabilities for the effects of inflation,
companies can get a better understanding of their financial position and performance. This helps them
make better decisions about their investments and operations.
Inflation accounting is also important because it helps companies comply with accounting standards.
Many accounting standards require companies to adjust their financial statements for the effects of
inflation. This helps ensure that companies are providing accurate and reliable financial information to
investors and other stakeholders.
In conclusion, inflation accounting is an important tool for companies to accurately measure their
financial performance over time. It helps them adjust the values of assets and liabilities for the effects of
inflation, and it helps them comply with accounting standards. By using inflation accounting, companies
can get a better understanding of their financial position and performance, which can help them make
better decisions about their investments and operations.
2. Inflation Accounting Methods
There are several different methods of inflation accounting. The most common methods are the current
purchasing power (CPP) method and the current cost accounting (CCA) method.
2.1.
Current Purchasing Power (CPP) Method
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The CPP method adjusts the value of assets and liabilities to reflect the current purchasing power of
money. Under this method, financial statements prepared under historical cost accounting are re-stated by
using an approved price index. The following steps should be followed to prepare financial statements
under CPP method of accounting for price level changes.
2.1.1. Calculation of Conversion Factor
CPP method involves the re-statement of historical figures at current purchasing power. For this purpose,
historical figures must be multiplied by conversion factors. The formula for the calculation of conversion
factor is:
 Conversion factor = Price Index at the date of Conversion/Price Index at the date of item arose
 Conversion factor at the beginning = Price Index at the end/Price Index at the beginning
 Conversion factor at an average = Price Index at the end/Average Price Index
 Conversion factor at the end = Price Index at the end/Price Index at the end
 Average Price Index= Price Index at beginning + Price Index at the end/2
CPP Value = Historical value X Conversion factor
Notes:
* For the items taken from the beginning period (e.g assets, liabilities, taken from the operating balance
sheet), beginning conversion factor is used.
* For the items which occur throughout the year like sales, purchases, operating expenses etc., average
conversion factor is used.
* For the items which occur at the end of the year like tax, dividend etc. ending conversion is used.
2.1.2. Distinction between Monetary and Non-monetary Accounts
CPP method classifies all assets and liabilities into two group i.e. monetary items and non-monetary
items.
 Monetary Items: Monetary items are assets and liabilities, the amounts of which are receivable or
payable only at current monetary value. Monetary assets include cash, bank, bills receivables,
debtors, prepaid expenses, account receivables, investment in bond or debentures, accrued income
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etc. Monetary liabilities include creditors, account payable, bills payable, outstanding expenses,
notes payable, dividend payable, tax payable, bonds or debentures, loan, advance income,
preference share capital etc.
 Non-monetary Items: Those items which cannot be stated in ficed monetary value are called nonmonetary items. Such items denote assets and liabilities that do not represent specific monetary
claims. Non-monetary accounts include land, building, machinery, vehicles, furniture, inventory,
equity share capital, irredeemable preference share capital, accumulated depreciation etc. Nonmonetary items do not carry a fixed value like monetary items. Therefore, under CPP method, all
such items are to be restated to represent current general purchasing power.
2.1.3. Gain Or Loss On Monetary items
Monetary items are receivable or payable in fixed amount irrespective of changes in purchasing power of
money. The change in purchasing power of money has an effect on monetary assets and monetary
liabilities, Therefore, the holding of such items results gain or loss in terms of real purchasing power.
Such gain or loss is termed as general price level gain or loss. During the period of inflation, holding of
monetary assets results in loss and holding of monetary liabilities result in gain. Such gain or loss must be
taken into accounts when income statement is prepared under CPP method to arrive at the overall profit
or loss.
2.1.4. Valuation of Cost of Sales and Inventories
Cost of sales and inventory value vary according to cost flow assumptions i.e. first-in-first-out (FIFO) or
last-in-first-out (LIFO). Under FIFO, cost of sales comprises the entire opening stock and current
purchases less closing stock. And closing is entirely from current purchase. Under LIFO method, cost of
sales comprises current purchase only. However, if the current purchases are less than cost of sales, a part
of opening inventory may also become a part of cost of sales. And closing stock comprises purchases
made in previous year.
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2.1.5. Ascertainment of Profit
Under current purchasing power method, profit can be determined in two ways. They are:
 Re-statement Of Income Method
Under this method, historical income statement is re-stated in CPP terms. Following conversion factors
are used to restate the figures of historical cost statement.
* Sales and operating expenses are converted at the average rate application for the year.
* Cost of sales is converted as per cost flow assumption i.e. FIFO and LIFO.
* Depreciation is converted on the basis of indices prevailing on the dates when assets were purchased.
* Taxes and dividend paid are converted on the indices that were prevalent on the dates when they are
paid.
* Gain or loss on monetary items should be shown as separate item to arrive at the overall profit or loss.
 Net Change Method
This method is based on the normal accounting principle that profit is change in equity during an
accounting period. In order to determine profit, following steps are taken.
* Opening balance sheet prepared on historical cost accounting method is converted in CPP forms at the
end of the year. Monetary and non-monetary items are re-stated by using proper conversion factors.
Equity share capital is also converted. The difference in the balance sheet is taken as reserve.
Alternatively, the equity share capital may not be converted and the difference in balance sheet be taken
as equity.
* Closing balance sheet prepared under historical costing is also converted. Only non-monetary items are
re-stated. The difference in balance sheet is taken as reserve after converting equity capital. Alternatively,
the equity capital may not be restated in CPP terms and balance be taken as equity.
* Profit is equivalent to net change in reserve where equity capital has also been converted or net change
in equity where equity capital has not been re-stated.
2.1.6. Restated Balance Sheet
The historical balance sheet is prepared as per the historical income statement, so it can not represent the
revised or changed value of assets and liabilities. Under the price level change, the historical balance
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sheet should be revised to reflect the true picture of financial position of any organization. Inside the
historical balance sheet, both monetary and non-monetary items are listed. So, the monetary and nonmonetary items should be separated first of all. It is not necessary to change the monetary item
into CPP value because such items are already utilized while calculating the holding gain or loss. Only
the non-monetary items are to be adjusted to the CPP value by multiplying appropriate conversion
factors.
Inflation accounting methods are important for companies to use in order to accurately reflect the
financial performance of the company. Inflation can have a significant impact on the financial
performance of a company, and it is important for companies to adjust their financial statements for the
effects of inflation. This will help companies to make more informed decisions about their financial
performance and will help them to better understand the impact of inflation on their business.
2.2.
Current Cost Accounting (CCA) Method
The CCA method adjusts the value of assets and liabilities to reflect the current cost of goods and
services. The CCA system considers price changes that are relevant to a specific firm or industry rather
than the whole economy. It seeks to arrive at a profit figure that can be distributed safely in the form of a
dividend without impairing the firm’s operational capability.
The salient features of the CCA method are: - Fixed Assets are shown not at their depreciated original
cost but at their net replacement value - stocks are shown at their net replacement value - Depreciation is
calculated at the current value of assets - gains/losses due to the changes in the price level are shown in a
separate statement - inventory consumed is valued at the price at the date of consumption.
The CCA method is suitable when managers within an organization are committed to the industry, and
also when they are interested in replacing the present plant with a new one at the end of its useful life.
CCA is generally preferred over CPP technique of price level accounting. This is because it is a complete
system of inflation accounting.
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CCA systems can alleviate the need for a cost flow method and, in this way, solve the problem of having
either a realistic income statement or a realistic balance sheet, but not both.
3. Merit and Demerits of Inflation Accounting
The following are some of the benefits of inflation accounting.
 Observation of Fairness - Because the assets have been adjusted for inflation at their current
prices, the balance sheet provides an unbiased view of the firm's financial status.
 Adjusts Depreciation - When the assets' true worth is displayed, depreciation is based on face
value rather than past cost. This strategy permits a simple replacement for the firm since the exact
and fair worth of the business is determined and linked with inflation.
 Realistic Evaluation - By showing two years' worth of balance sheets and adjusting them for
inflation, one may compare the values after removing inflation quickly and easily. Because they
are current values, they are not dependent on past expenses, which is analogous in some ways to
the time value of money.
 Reflection of Real Value - Inflation accounting reflects earnings based on current prices and
always provides the true worth of a firm. As a result, current prices will be represented in the
financial accounts, taking inflation into account.
 No Overstatements - With this system, the profit and loss report would not overestimate the
company's income.
 Ensures Dividend Payment - Past costs imply that shareholders are likely to get larger
dividends. Unlike the cost technique, the inflation accounting method permits dividends and taxes
to be computed without distorted statistics.
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The following are some of the drawbacks of inflation accounting.
 It is an Infinite Process - Prices alter indefinitely when an economy undergoes inflation or
deflation. As a result, this process has no end.
 Complex Process - If there are too many computations, the process may become more difficult.
Regular folks may struggle to grasp all of the changes.
 Subjectivity is required because modifications to present values are not as easy as dynamic
adjustments. You may need to use discretionary judgments and subjectivity.
 Deflation Creates Exaggeration - As prices decline due to deflation, businesses may charge less
depreciation. As a result, it may overestimate the company's profitability, which is unquestionably
detrimental.
 It is simply a theoretical appeasement notion - Most economists see inflation accounting as a
theoretical appeasement concept. Because of the subjectivity involved, specific window
decorating may exist to fit particular whims and fancies.
 It is Expensive - Because this approach is pricey, most firms cannot afford it.
Historical cost-based financial statements, in general, do not correctly reflect an organization's current
condition of affairs. Because they are based on historical data, these financial statements do not reflect
current values. Historical cost accounting, on the other hand, provides the following benefits over other
accounting systems: Based on real-world events and data
 Everyone knows and utilizes it
 Comparing data over a given timeframe is simple
 Historical costs make it difficult to distort accounting records; and
 Inflation-adjusted financial statements are required for shareholders and other stakeholders.
Yet, there are various arguments against inflation accounting, including:
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 When the principle of objectivity is broken, financial statements lose credibility.
 Most tax authorities do not recognize the practice.
 Earnings derived from inflation accounting might be arbitrary at times.
As a result, no accounting method can satisfy everyone in terms of inflation accounting. As a result, a
strategy that adjusts for inflation while remaining objective and simple is being explored.
4. Example of Inflation Accounting
Example #1
A manufacturing company ABC purchased machinery for Birr 10,000 in 2001. In 2009, ABC Company
reinstated its financial records using inflation accounting. In 2001, the general price index was 400; in
2009, it was 600. Find the current cost of the machine purchased in 2001.
Therefore, the current price index is 600; the base price index is 400; the historical cost is Birr 10,000.
Thus, the current costs = 600/400 X 10,000 = Birr 15,000 which is the balance of the land that would be
shown on is the closing the balance sheet.
Example #2
The XYZ Company, involved in construction, purchased the land for Birr 5,000 in 1999. In 2000, the
XYZ company reinstated its financial records using inflation accounting. Based on a 200 general price
index in 1999 and a 300 general price index in 2000, calculate the current cost of a land parcel purchased
in 1999.
As a result, there is a current price index of 300; the base price index is 200; the historical cost is Birr
5,000. Hence, 300/200 X 5000 = Birr 7,500 is the current cost. The current price would be Birr 7,500,
and the closing balance of the land would be recorded as Birr 7,500 on the balance sheet.
5. Conclusion
Inflation accounting indicates a company's true worth, but it has various problems, such as nonacceptance by authorities and expensive systems and processes. The objective of a financial statement is
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to offer an accurate and fair value to a corporation. As a result, an income statement should reveal the
company's exact profit or loss for a given period, and a balance sheet should show the company's genuine
financial condition. Because currency and money fluctuate on a regular basis, a system such as inflation
accounting is required to show accurate and fair value in financial accounts. As a result, the firm will not
encounter major variances as a result of this strategy.
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