20 • 1

CHAPTER

20

ACCOUNTING FOR THE EFFECTS

OF INFLATION

Harold E. Wyman

Florida International University

CONTENTS

20.1 Inflation Undermines the Key
Accounting Principle of
Historical Cost 1
20.2 Inflation Around the World 1
20.3 Inflation, Hyperinflation, and
Highly Inflationary 2
20.4 Economic Causes of Inflation 3
20.5 Managerial Implications of
Inflation 4
(a) Strategic Planning 4
(b) Financial Projections 6
(c) Portfolio Analysis 6
(d) Financial Strategies 7
(e) Capital Expenditure
Evaluations 7
(f ) Operating Planning and
Budgeting 8
(g) Management Reporting and
Performance Evaluation 8
(h) Pricing 8

(i) Inventory Valuation 9

( j) Dividend Policy 9

20.6 Measurement Approaches to

Inflation Accounting 10

20.7 U.S. Inflation Adjustments 12

20.8 Inflation Adjustments in the

Netherlands 16

20.9 Brazilian Example of Inflation

Adjustments 18

20.10 Status of Accounting Standards

and Practices on Inflation in the

World and Major Countries 21

20.11 Inflation and Translation 23

20.12 Issues in Implementation and

Interpretation 24

20.13 The Future of Accounting for

Inflation 24

SOURCES AND SUGGESTED

REFERENCES 25

20.1 INFLATION UNDERMINES THE KEY ACCOUNTING PRINCIPLE OF HISTORICAL
COST. Existence of a high rate of inflation related to transactions recorded under
the historical cost principle undermines the economic validity of the basic account-
ing statements. Companies with multinational operations must be concerned with the
effects of inflation, even though their principal operations are in a country where in-
flation is not a significant problem. Failure to recognize the accounting distortions
that inflation causes can lead to a misunderstanding of reported financial results. This
causes problems in both financial accounting and managerial accounting.

20.2 INFLATION AROUND THE WORLD. According to statistics from the Interna-
tional Monetary Fund, a significant number of countries had inflation in 2000. In Ex-
hibit 20.1, inflation rates for various countries are presented. The more industrialized