States has been running up have increased dollar balances abroad, which has an im-
pact on the world economy similar to an increase in the money supply, given the im-
portance of the U.S. dollar in world trade.^3 Also, domestic inflation in developing
countries leads to devaluation of their currency under the floating exchange rates in
effect since 1971. This makes the imports they need to develop their economies cost
more, which leads to further inflation—a vicious circle.
20.5 MANAGERIAL IMPLICATIONS OF INFLATION. The literature on the manage-
rial implications of inflation is significant. It includes two monographs by Alan Seed
III of Arthur D. Little. One was published by the Financial Executives Institute (FEI)
in 1978: Inflation: Its Impact on Financial Reporting and Decision Making. The
other was published by the National Association of Accountants in 1981: The Impact
of Inflation on Internal Planning and Control. The FEI also published Coping with
Inflation: Experiences of Financial Executives in the UK, West Germany and Brazil
in 1981. The Institute of Management Accountants (IMA) (formerly the (National
Association of Accountants (NAA)) also has available a monograph, Inflation and
Managerial Decision Making, by Denise Breden and Robert DeMichiel, which does
not show a publication date but, judging from the dates of citations, was issued after
1983.
Seed’s 1981 work devotes three chapters to “Management Accounting Issues and
Practices.” They are titled “Strategic Planning and Budgeting Issues,” “Management
Control Issues,” and “Planning and Control Practices.” The work by Breden and
DeMichiel for the IMA has a chapter titled “The Impact of Inflation on Managerial
Decision Making.” The chapter covers the following topics: Strategic Planning, Cap-
ital Budgeting, Budgets and Cost Management, Pricing, Inventory, Performance
Evaluation, Management Evaluation, and Dividend Policy. The following paragraphs
draw heavily on the previously cited works. (For an in-depth treatment of manage-
ment and control issues in a hyperinflationary environment, see Chapter 27.)
(a) Strategic Planning. Inflation must be considered in strategic planning because of
the changes in specific prices and uncertainty about the amount and timing of these
changes. This has an effect on business unit analysis, preparation of financial projec-
tions, portfolio analysis, the selection of financial strategies, and evaluation of capi-
tal expenditures. The long-term planning inherent in developing strategy exposes the
planner to a greater possibility of inflation than would a shorter time horizon.
Even such developed economies as the United States, which is not considered at
this time to have an inflation problem, have a significant decline in the purchasing
power of the monetary unit if the time span is long enough. For example, from 1985
to 2000 the cumulative inflation rate in the United States was 59.9% and the cumu-
lative loss in purchasing power was 37%, as shown in Exhibit 20.2. Notice that the
inflation per year varied from 5.3% to 1.6% in a very irregular manner. This is what
makes prediction of amount and timing of price changes difficult to forecast, even for
an economy with a relatively low rate of inflation.
Strategy is developed from a business unit analysis. Seed^4 gives the Arthur D. Lit-
tle format for this, as follows:
20 • 4 ACCOUNTING FOR THE EFFECTS OF INFLATION(^3) Seed, 1978, p. 7.
(^4) Seed, 1981, p. 68.