International Journal of Information Technology & Computer Science ( IJITCS ) (ISSN No : 2091-1610 )
Volume 5 : Issue on September / October , 2012
IMPACT OF INFLATION ACCOUNTING ON FINANCIAL STATEMENTS AND
CHANGING
PRICES
IN SAIL
Hilda Shamsadini and M.R. Yavarzadeh
Islamic Azad University Bam Branch
Iran
ABSTRACT
Inflation is defined as a disproportionate and relatively sharp and sudden increase in the quantity of
money relative to the amount of exchange business which always results in a decline in the general purchasing
power. The inflation accounting which also known as price level accounting is a technique of accounting which
takes care of the impact of price level changes on accounts. The important aim of this research is to see the
difference between these two methods of preparing financial statements (historical & inflation) and assess the
impact of inflation on financial statements of Steel Authority of India Ltd (SAIL) for the period of 5 fiscal years
from 2006-07 to 2010-11. For this purpose the researcher has used CPP method for converting historical
figures to inflation accounting, and the also the WPI (wholesale price index) that has been published by Reserve
Bank of India. For analysis of data the researcher has used 6 ratios; NPR, OPR, ROI, ROE, CR and QR. The
result exhibited that there are significant differences between historical cost accounting and inflation
accounting, and there is a significant relationship between inflation accounting and performance measurement
in financial statements of SAIL.
Keywords: Sail, inflation accounting, historical accounting, financial statement, changing prices.
1. Introduction
Accounting is an information system and its ultimate objective is to report such information to the
users which may be helpful to them in their relevant decisions. The user's decision oriented approach to
corporate reporting has been widely advocated in literature. All these documents emphasis that corporate
financial reports should be designed in such a way so as to present the information which may be used by
various users' groups in their respective decisions. The objectives that prescribe statements of earnings and
financial position are based on the user’s need to predict, compare and evaluate earning power.
Under historical cost accounting (HCA) the amounts are recorded by business at the price at which
they are acquired and there will be no change in their values even if the market values of such assets change.
The most significant and persistent complaint about published financial statements in recent years has been that
they do not recognize the economic facts of life. In most countries, primary financial statements are prepared on
the historical cost basis of accounting without regard either to changes in the general level of prices or to
increase in specific prices of assets held, except to the extent that property, plant and equipment and investments
may be revalued.
Historical cost accounting is all right, if monetary unit is stable and there is no erosion in its value as a
result of inflation. Inflation refers to state of continuous rise in prices. It brings downwards changes in the
This Paper is presented on : International Conference on Information Integration and Computing Applications –
August 14-15, 2012 – Singapore ……………………………………… Page … 73
International Journal of Information Technology & Computer Science ( IJITCS ) (ISSN No : 2091-1610 )
Volume 5 : Issue on September / October , 2012
purchasing power of money unit. Thus, financial statements prepared without taking into account the change in
purchasing power of the monetary unit lose their significance.
Inflation accounting is a system of recording all transaction on their current market price which is
calculated by price index.” Inflation is a reality throughout the world. Yet its effects go unrecognized in
financial statements prepared in accordance with generally accepted accounting principles in most of the
countries.
Ignoring general price level changes in financial reporting creates distortions in financial statements
such as:
•
Reported profits may exceed the earnings that could be distributed to shareholders without
impairing the
company’s ongoing operations.
•
The asset values of inventory, equipment and plant do not reflect their economic value to the business.
•
Future earning is not easily projected from historical earnings.
•
The impact of price changes on monetary assets and liabilities is not clear.
•
Future capital needs are different to forecast and may lead to increased leverage, which increases the business’s
risk.
•
When real economic performance is distorted, these distorted lead to social and political consequences that
damage business.
Research Methodology
The researcher has selected the 5 years annual reports (balance sheet and profit and loss
account) of SAIL (steel authority of India limited) for the purpose of data collection. SAIL use historical cost
accounting for preparation of financial statements, therefore researcher have converted this figures to inflation
accounting basis .For this purpose she has chosen CPP(Current purchasing Power) method and use WPI
(Wholesale Price Index), then according to related formulas conversions have been done. CPP method seeks to
use general purchasing power price of money rather than specific price indices to convert the historical figures
into relevant figures of purchasing power for the end of the period in review. In simple term, the conversion of
historical figures into CPP figures is as follows:
Multiplying the historical cost figures by the price index at the end of the period, and divide by the
index which existed at the date of original transaction.
The conversion process is discussed below in following 3 sections:
a)
Balance sheet at the beginning of the year
b) Profit and loss account for the year and
c)
Balance sheet at the end of the year
And net gain or loss on monetary assets also should be calculated.
For data analyzing has used 6 ratios such as; NPR (net profit ratio), OPR (operating profit ratio), ROI
(return on investment), ROE (return on equity), CR (current ratio) and QR (quick ratio), then used the Karle
Pearson correlation coefficient between the variables, that NPR has chosen as an independent variable and other
This Paper is presented on : International Conference on Information Integration and Computing Applications –
August 14-15, 2012 – Singapore ……………………………………… Page … 74
International Journal of Information Technology & Computer Science ( IJITCS ) (ISSN No : 2091-1610 )
Volume 5 : Issue on September / October , 2012
ratios as dependent . Also for analyzing the differences between two methods T-test has been used from through
the mean of the variables.
Result and discussion
According to the result obtained in the study, in examining the correlation between ratios the results is
as under:
- Because the p-values between NPR with OPR, was lesser than 0.05, so correlation is significant at 5%
level. Therefore there is a positive relationship between NPR as an independent variable and OPR, ROI, ROE,
RC. So we can say there is significant relationship between inflation accounting and performance measurement.
- After calculating the mean of variables in two methods, the researcher shows that the mean and
standard deviation of NPR, OPR, ROI, ROE in inflation figures are smaller than the figures in historical and the
signals are less than 0.05,therefore in this ratios, the study is being approved with 95% confidence. But there is
no significant difference between CR (current ratio) as per historical and inflation method and about QR (Quick
Ratio) we can see that the figures in both methods are exactly same and no changes has happened.
This variation in performance, when measured on inflation and historical cost basis indicates that
inflation, which is a persistent phenomenon in the recent decades, has significant impact on the performance and
financial structure of an enterprise. The aim to tackling the impact of inflation on financial reporting is to
provide better information, in particular to help the users to assess prospective cash flow, to measure the
performance of the company and to provide more helpful data on the erosion of operating capability and
changes in general purchasing power.
Table (1): Ratios as per historical accounting
NPR
2006-07
2007-08
2008-09
2009-10
2010-11
MEAN
18.28
19.08
14.28
16.66
11.48
15.96
OPR
ROI
ROE
CR
QR
28.76
46.47
35.82
186.12
125.37
29.19
51.98
32.68
199.40
147.44
22.36
31.63
21.92
202.32
143.03
25.98
23.10
20.27
228.32
175.68
17.95
12.91
13.23
219.45
24.85
33.22
24.78
207.12
149.17
154.33
Table (2): Ratios as per inflation accounting
NPR
OPR
ROI
ROE
CR
QR
2006-07
15.19
24.21
33.48
27.76
180.8
125.37
2007-08
15.36
23.72
35.53
22.66
190.61
147.44
2008-09
10.02
18.88
15.98
12.61
193.33
143.03
2009-10
11.22
23.45
10.41
13.13
204.48
175.68
This Paper is presented on : International Conference on Information Integration and Computing Applications –
August 14-15, 2012 – Singapore ……………………………………… Page … 75
International Journal of Information Technology & Computer Science ( IJITCS ) (ISSN No : 2091-1610 )
Volume 5 : Issue on September / October , 2012
2010-11
7.53
15.86
1.72
5.89
207.25
154.33
MEAN
11.86
21.22
19.42
16.41
195.30
149.17
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August 14-15, 2012 – Singapore ……………………………………… Page … 76