Accounting for Inflation—Recent Proposals and Their Effects

Abstract

A time-honoured convention in accounting has been that accounts should be based on historic cost, with all items being recorded in terms of the purchasing power of the pound at the date of each transaction. In a period of rapid inflation, accounts on the traditional basis become distorted and dangerously misleading. The authors describe the theory and practice of the proposals of the Accounting Standards Steering Committee for current purchasing power accounting and examine replacement cost accounting, comprehensively applied, as an alternative. They point out the advantages, despite somewhat greater practical difficulties, of current value accounting. A sample of large United Kingdom companies is analysed and the effect on their earnings of the A.S.S.C.'s proposals is estimated where these figures are not already published. Share price movements by different industry sectors over the last five years are examined in relation to changes in earnings on inflation accounting principles. It is stressed that gaining from inflation accounting is not the same as gaining from inflation, and that liquidity is a separate question. Problems of taxation (notably on stock appreciation) are discussed and practice in other countries is mentioned, as are the implications for price controls, trade unions, and indexation. The authors hope that the Sandilands Committee on Company Accounts and Inflation will find a convincing case for inflation-adjusted accounts to form the basis for taxation and price controls. They look forward to the gradual abandonment of historiccost accounts, regarding the proposals of the A.S.S.C. as a desirable but imperfect first step, and urge that meantime investors and creditors should make their own estimates of the impact of inflation on particular companies.