Inflation accounting rahul

8/7/2019 Inflation accounting rahul

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Rahul BhatiaSaurabh BahlAnilesh Kr Tiwary

Jatin BangaKimmy BabbarPrachi Tanwar

Vikas Nain


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Standard costs are determined for each element of cost-

be it direct material, direct labour, overheads (fixed and

variable)- separately and then variations from actual costs

are computed in respect of each element distinctly so as to

detect which part of the costs needs control and to which

department, process or operation, the responsibility may

be placed


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When the actual costs are compared with the standard

costs, some deviations normally occur. The deviation of

actual from the standard is known as variance. The

variance may be favorable or unfavorable according to

the circumstances.

If the actual cost is more than the standard cost, the

variance shall be adverse or unfavorable.

In case the standard cost is more than the actual cost, afavorable variance would result.


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Variable overheads are divided into three categories.

1. Manufacturing variable overhead

2. Administration variable overhead

3. Selling & distribution variable overhead

Such variance may therefore be calculated separately for

each of these overheads


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The difference between the standard variable overheads for

actual output and the actual variable overheads is known as

Variable overhead cost variance (VOCV).

VOCV= Standard variable overheads on actual

production Actual variable overheads

Where, Standard variable overhead on actual production is the

product of standard variable overhead rate per unit

multiplied by the actual production for the period.


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Standard variable overhead rate per unit =

Budgeted variable overheads

Budgeted Output


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Certain variable overheads may vary according to time also

and henceVOCV may be segregated into:

1. Variable Overhead ExpenditureVariance (VOEXPV)

2. Variable Overhead EfficiencyVariance (VOEFFV)


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The formulae for computation of the above variances

are as under:

VOEXPV=Actual time X ( Standard overhead rate

Actual overhead rate)

OR

Standard variable overheads for actual time

Actual variable overhead


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Where, StandardVariable overheads for actual time =

Standard Variable Overhead rate per hour X

Actual hours


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The formulae for computation of the above variance

(VOEFFV) are as under:

VOEFFV=Standard variable overheads on actualproduction standard variable overheads for

actual time


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Inflation normally refers to the increasing trend ingeneral price level. In other words, it is a state inwhich the purchasing power of money goes

down.Inflation Accounting is a system of accounting

which shows the effect of changing costs andprices on affairs of a business unit during anaccounting year.

While the cost in the traditional accounting refersto the historical cost, in inflation accounting itrepresents the cost that prevails at the time ofreporting.


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In the traditional accounting, assets are shown athistorical cost, year after year.

During the inflationary period, historical cost based

depreciation would be highly insufficient to replacethe existing assets at current cost. Moreover currentrevenues for the period are not properly matched withthe current cost of operation.

Thus, the problems created by price changes in thehistorical cost based accounts necessitated somemethod to take care of inflation into the accountingsystem.


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(a) Current Purchasing Power Method (CPP

Method)(b) Current Cost Accounting Method (CCA

Method)


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All items in the financial statements are

restated in terms of units of equal purchasing

power. The CPP method basically attempts to

remove the distortions in Financialstatements, which arise due to change in the

value of rupee.

CPP method distinguishes between

monetary and non-monetary items.


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Historical value of asset

Price Index at the date of conversion

Price at the date of transaction


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A company purchased a plant on 1/1/2005 for

a sum of Rs. 45,000. The consumer price

index on that date was 125 and it was 250 atthe end of the year. Restate the value of the

plant as per CPP method as on 31st December2005.


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Conversion Factor =Price Index (31/12/2005)=250 / Price Index (1/1/2005) = 125

= 2Value of the plant on 31/12/05 =Historical Cost x Conversion Factor

Rs 45,000 x 2 = Rs 90,000


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Monetary Items (both assets and liabilities) are thoseitems whose amounts are fixed by contractorotherwise they remain constant in terms of monetary

units. Example debtors, creditors, debentures,Preference share capital etc.

During the period of inflation the holder of monetaryassets lose general purchasing power since their

claims against the firm remain fixed irrespective ofany changes in the general price levels. Conversely,the holder of monetary liabilities gains since he is topay the same amount due in rupees of lowerpurchasing power.


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Non monetary items are those items that can not bestated in fixed monetary amounts. They includetangible assets such as building, plant &machinery,

stock etc. Under CPP method all such items are to be restated

to represent the current purchasing power. Forexample a machinery costing Rs25,000 in 1996 may

sell for Rs 35,000 today though it has been used. Thismay be due to change in the general price level. Note : Equity capital is a non monetary item since

the equity shareholders have a residual claim on thecompanys net assets.


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The changes in purchasing power affects bothmonetary and non monetary items of thefinancial statements. In case of monetary assets

and monetary liabilities, the firm receives orpays the amounts fixed as per the terms of thecontract, but it gains or losses in terms of realpurchasing power.

Such monetary gain or loss should becomputed separately and shown as a separateitem in there stated income statement in orderto find out the overall profit or loss under CPPmethod.


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The restatement of the Cost of Sales andinventories under the CPP method, dependsupon the method used for accounting for

inventories (FIFO or LIFO).Under FIFO method, the cost of sales normally

includes the entire opening stock and currentpurchases less closing stock. Closing stockcomprises latest purchases.

Under LIFO method, the cost of sales normallyincludes the latest purchases and the closingcomprises the earliest purchases.


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Under the CCA method money remains to be the unit ofmeasurement.The items of the financial statements are restated in terms

of current value of that item and in terms of generalpurchasing power of the money.

Assets and liabilities are stated at their current value to thebusiness. Similarly, the profits are computed on the basisof current values of the various items to the business. This

requires carrying out the following adjustments

Revaluation adjustmentDepreciation adjustmentCost of Sales adjustmentMonetaryWorking Capital adjustment


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Fixed Assets Are shown in the balance Sheet attheir values to the business. To the business ofan asset refers to the opportunity loss to the

business of were deprived of such assets.

The replacement cost could be taken as gross ornet.Gross replacement cost of an asset is the costtube incurred at the time of valuation to obtain asimilar asset for replacement. Net replacementcost of an asset is the gross replacement costlessdepreciation.


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An asset purchased on 1/1/2005 for Rs50,000

now costs Rs 80,000 on31/12/2005 , then the

gross replacement cost of the asset is Rs80,000.

Assuming that the useful life the asset is5years, then the net replacement cost

=80,000 80000 x 3 / 5 = 32,000


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The profit and loss account should becharged for depreciation with an amount

equal to the value of fixed assets consumedduring the period. Depreciation charge may be computed

either on the basis of total replacement cost

of the assertor on average net current cost ofassets. i.e. Current cost at beg. + Current cost at the end

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X ltd purchased a machine on 1/1/2002 for

Rs80,000 and its expected life was 10 years

without any scrap value. On 1/1/2005 thesame new machine would cost Rs 30,000 and

on31/12/2005 Rs 40,000.

Calculate the depreciation charge for the

year2005 as per CCA method assuming thatthere is no change in the useful life of the

asset.


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Depreciation under CCA method =

Average replacement cost / useful life

= (30,000 + 40,000) / 210

= 3500Alternatively40,000 / 10 = 4000


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COSA represents the difference between value to thebusiness and the historical cost of stock consumed inthe

periodCOSA Adjustment =CS OS Ia (CS/Ic OS/Io)Where:CS means Closing StockOS means Opening StockIa means Average Index for the yearIc means Closing Index for the yearIo means Opening Index for the year


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COSA = CS OS Ia (CS/Ic OS/Io)

= (16000 12000) 190 ( 16000/200

12000/160)= 4000 -190 (180 75)

= Rs. 3050


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MWCA = C O Ia (C/Ic O/Io)

Opening MWC = 18000 10000 = 8000

Closing MWC = 21000 12000 = 9000

MWCA =(9000 - 8000) 190(9000/205 8000/175)= 1000 190 ( 43.90 45.70)

= 1342


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Inflation accounting rahul