# Inflation Accounting: Methods, Benefits, and Challenges Explained

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## What Is Inflation Accounting?

Inflation accounting, often termed price level accounting, is an essential method for adjusting [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) in [inflationary](https://www.investopedia.com/terms/i/inflation.asp) environments. It reflects true economic conditions by using price indexes instead of traditional [cost accounting](https://www.investopedia.com/terms/c/cost-accounting.asp), ensuring international companies report more accurate figures in fluctuating economic scenarios. This method is also sometimes referred to as [price level](https://www.investopedia.com/terms/p/price_level.asp) accounting.

### Key Takeaways

*   Inflation accounting adjusts financial statements to reflect current price indexes, providing a clearer picture of a company's financial status during inflationary periods.
*   Two main methods of inflation accounting are Current Purchasing Power (CPP) and Current Cost Accounting (CCA), each with its own approach to adjusting monetary and nonmonetary items.
*   IFRS and U.S. GAAP have different criteria and practices for implementing inflation accounting, particularly in countries experiencing hyperinflation like Argentina.
*   While inflation accounting can help match current revenues with current costs, it may also confuse investors and lead to frequent restatements of financial statements.
*   Inflation is calculated using the Consumer Price Index (CPI), showing the percentage increase in prices over a specified period.

## Understanding the Functioning of Inflation Accounting

In countries with significant inflation or [deflation](https://www.investopedia.com/terms/d/deflation.asp), historical financial data becomes irrelevant. To counter this issue, in certain cases, companies are permitted to use inflation-adjusted figures, [restating](https://www.investopedia.com/terms/r/restatement.asp) numbers to reflect current [economic values](https://www.investopedia.com/terms/e/economic-value.asp).

International Accounting Standard (IAS) 29 adopted by the [International Financial Reporting Standards (IFRS)](https://www.investopedia.com/terms/i/ifrs.asp) is the guide for entities whose [functional currency](https://www.investopedia.com/terms/f/functional-currency.asp) is the currency of a [hyperinflationary](https://www.investopedia.com/terms/h/hyperinflation.asp) economy. IFRS defines hyperinflation as prices, interest, and wages linked to a price index rising 100% or more cumulatively over three years.

Companies may need to regularly update statements to reflect current conditions, supplementing cost-based financials with price-level adjustments.

## Key Methods in Inflation Accounting

There are two main methods used in inflation accounting—current purchasing power (CPP) and current cost accounting (CCA).

### Current Purchasing Power (CPP)

Under the CPP method, [monetary items](https://www.investopedia.com/terms/m/monetary-item.asp) and nonmonetary items are separated. The accounting adjustment for monetary items is subject to the recording of a net gain or [loss](https://www.investopedia.com/terms/n/netloss.asp). Nonmonetary items (those that do not carry a fixed value) are updated into figures with an inflation conversion factor equivalent to the consumer price index (CPI) at the end of the period divided by CPI at the date of transaction.

### Current Cost Accounting (CCA)

The CCA approach values assets at their [fair market value](https://www.investopedia.com/terms/f/fairmarketvalue.asp) (FMV) rather than [historical cost](https://www.investopedia.com/terms/h/historical-cost.asp), the price incurred during the purchase of the fixed asset. Under the CCA method, both monetary and nonmonetary items are restated to current values.

## Important Considerations in Inflation Accounting

Requirements for inflation accounting differ between IFRS and U.S. [Generally Accepted Accounting Principles](https://www.investopedia.com/terms/g/gaap.asp) (GAAP). Both IFRS and GAAP have been treating Argentina as “hyperinflationary” since 2018 because cumulative inflation there over the prior three years has exceeded 100%. However, the requirements they impose on companies operating in the country vary.

IFRS permitted international businesses with subsidiaries in Argentina to continue using the peso for their accounts, provided they restate them to adjust for inflation. In contrast, U.S. firms with activities in Argentina are being forced to use the dollar as their functional currency, costing them in [foreign exchange](https://www.investopedia.com/terms/f/foreign-exchange.asp) losses.

Insurance company Assurant Inc. warned in its 2021 annual report that “management has classified Argentina’s economy as highly inflationary in accordance with GAAP accounting requirements and, as a result, the functional currency of our Argentina subsidiaries was changed from the local currency to U.S. dollars and their non-U.S. dollar denominated monetary assets and liabilities were subject to [remeasurement](https://www.investopedia.com/terms/r/remeasurement.asp) resulting in losses.”

## Weighing the Pros and Cons of Inflation Accounting

Inflation accounting's main benefit is matching current revenues with costs, offering a realistic view of profitability.

However, adjusted figures may confuse investors and allow companies to present misleadingly favorable numbers. Adjusting accounts for price changes can lead to constant restatements of financial statements.

## What Are CPP and CCA Short for in Inflation Accounting?

CPP stands for current purchasing power; CCA stands for current cost accounting. These are the two main methods used to adjust financial statement figures in inflation accounting.

## How Do You Calculate Inflation?

The percent inflation rate is calculated as the CPI at the end of the period divided by the CPI at the beginning of the period multiplied by 100.

For example, let's assume you wanted to calculate the inflation rate between January 2006 and January 2022. According to the Consumer Price Index table, January 2022 has a CPI of 281.148 and January 2006 has a CPI of 198.300. The formula to calculate the percent inflation rate is therefore 281.148 / 198.300 × 100 = 141.77%.

## What Does IFRS Define As Hyperinflation?

According to IFRS, hyperinflation is when prices, interest, and wages linked to a price index rise 100% or more cumulatively over three years.  

## The Bottom Line

Inflation accounting is vital in presenting a company's financial reality in hyperinflationary conditions by adjusting statements using price indexes. It employs the current purchasing power (CPP) and current cost accounting (CCA) methods to provide a more accurate reflection of financial health. However, differences between IFRS and U.S. GAAP highlight the challenges of applying these methods internationally. Investors and businesses must understand both the benefits and complexities of inflation accounting, like restating figures to match current economic conditions and addressing potential investor confusion.

> **Article Sources**
>
> 1.  IFRS Foundation. "[IAS 29 Financial Reporting in Hyperinflationary Economies](https://www.ifrs.org/issued-standards/list-of-standards/ias-29-financial-reporting-in-hyperinflationary-economies/)."
>     
> 2.  PwC. "[Hyperinflation in Argentina: Which Implications for Your Consolidated Financial Statements?](https://www.pwc.fr/fr/assets/files/pdf/2019/01/fr-pwc-hyperinflation-in-argentina-en.pdf)" Page 1.
>     
> 3.  PwC. "[Hyperinflation in Argentina: Which Implications for Your Consolidated Financial Statements?](https://www.pwc.fr/fr/assets/files/pdf/2019/01/fr-pwc-hyperinflation-in-argentina-en.pdf)" Page 2.
>     
> 4.  Grant Thornton. "[Argentina Hyperinflation May Trigger DASTM Rule](https://www.grantthornton.com/library/newsletters/tax/2020/hot-topics/apr-21/argentina-hyperinflation-trigger-DASTM-rule.aspx)."
>     
> 5.  Assurant. "[2021 Annual Report](https://s22.q4cdn.com/805855654/files/doc_financials/2021/ar/Assurant-2021-AR-FINAL-PDF-FOR-POSTING-3-16-22.pdf)," Page 50.
>     
> 6.  U.S. Bureau of Labor Statistics. "[Databases, Tables & Calculators by Subject](https://data.bls.gov/timeseries/CUUR0000SA0)."