Inflation adjustments of financial statements: Implication to price index and performance

Abstract

This paper examines the critical role of inflation accounting in adjusting financial statements to accurately reflect the impact of inflation on the economy. The primary objectives are twofold: examine the process of restating balance sheets and income statements, emphasizing the limitations inherent in historical cost accounting; and investigate the practical usefulness of price indices in identifying complex changes in the value of monetary and non-monetary assets and liabilities. It uses a systematic analysis of the restatement process, delving into the application of the Constant Purchasing Power Accounting (CPPA) method. The study used Royal Dutch Airlines Company for the years 2018-2019 financial data, including varying different inflation levels. The results of the analysis reveal that indexing revenues under the CPPA method improves liquidity, profitability, and solvency ratios. This improvement is particularly evident in the cash flow statement analysis, where corrections are minimized compared to historical cost accounting. The CPPA method appears to be a powerful solution to the limitations imposed by historical costing in inflationary environments. It is worth noting that the research reveals differences in the practical application of inflation calculations between countries, depending on economic and regulatory factors. This paper calls for continued research efforts to delve deeper into the implications of inflation for different industries, economies and financial reporting frameworks.

Keywords

• inflation accounting
• constant purchasing power
• financial statements
• price index
• historical cost