In our previous blog, we defined inflation accounting and the two methods of accounting to use when inflation occurs. Inflation accounting can help you understand the financial value of your business when a crisis happens and when the stakes are high.
However, while there are positive effects to come from this type of accounting, there are also setbacks that you should consider. In this blog, we go over the pros and cons of inflation accounting.
Here are a few of the pros associated with inflation accounting:
- The adjusted numbers are valuable to internal users, external users, and the government.
- Inflation accounting shows fair and realistic data. The adjustments are made by matching current revenues with a current cost.
- The data gives a reasonable comparison of profitability to other companies and their historical financial statements.
- Inflation accounting shows an accurate depreciation. It takes the current value and not the historical cost of the asset to calculate depreciation.
- There is no overstatement of financial statements. All adjustments are made using the current price index to show a more realistic statement.
- It keeps a check on dividend payments to the shareholders. Dividends and taxes are paid based on current adjusted profits and not on inflated profits in historical periods.
Here are a few of the cons of inflation accounting:
- Inflation accounting can complicate your financial statements. They may not be as clear to understand for your investors and other users of the financial statements. Simply put, other individuals may not know what the numbers mean, or there are too many calculations to decipher.
- If your investors don’t understand your inflation adjustments, it may mislead them and could be a moral hazard for your company.
- This confusion could cause you to create restatements or to constantly change your financial statements.
- You are constantly readjusting your statements due to the price changing.
- Inflation accounting is still a theoretical concept as the numbers have to be adjusted according to the suitability of individuals.
- Inflation accounting does not always work for small businesses because it is expensive to implement into their processes.
- If deflation occurs, you could have an overstatement of profits which leads to lesser depreciation and therefore causing a harmful exaggeration of profits.
At Assemblage LLC, we offer bookkeeping and accounting services to small and medium-sized businesses. We can assist you with your financial statements so you can better understand the numbers while getting ahead of the inflation rates!