Current Purchasing Power and Its Utilisation on Annual Reports of the Companies (with Special Reference to Indian Steel Companies)

TLDR: In this paper, the use of inflation accounting by current purchasing power method and its effects on financial statements of steel companies in India have been investigated and the results show that a significant difference between adjusted cost based financial ratios and historical cost-based financial ratios occurs only for return on equity (ROE) and return on asset (ROA) and there is no significant change in operating profit ratio (OPR), current ratio (CR) and quick ratio (QR).

Abstract: This paper investigates the use of inflation accounting by current purchasing power method and its effects on financial statements of steel companies in India. Therefore the annual reports of 8 steel companies listed in Bombay Stock exchange, India has been collected. All the companies prepare the annual reports in historical cost method; therefore conversion to Current Purchasing Power (CPP) has been done. Then the ratios were calculated on both historical cost and CPP of financial statements to form two sets of ratios. An analysis of paired sample t test has been conducted on some financial ratios of these companies to see the differences between two methods. At the end the results show that a significant difference between adjusted cost based financial ratios and historical cost based financial ratios occurs only for return on equity (ROE) and return on asset (ROA) and there is no significant change in operating profit ratio (OPR), current ratio (CR) and quick ratio (QR).Keywords: inflation accounting, CPP, annual reports, Steel Companies.INTRODUCTION:Financial statements are usually reported in the traditional accounting framework commonly referred to as historical cost accounting, in which money is based as a unit of measures. In times of inflation the purchasing power of money is falling and thereby, this unit of measures does not have a constant value. As such, in accounts based on historical cost income, expenditure, assets and liabilities have a mixture of value depending on the date at which each item was originally brought into the accounts. During a period of rising prices, financial statements based on historical cost do not adequately portray financial position. There are three potentially serious problems:- An erosion of the equity base may not be clearly recognized;- The assets of the business will tend to be understated; and- Any gains and losses from holding monetary items will not be recognized.The distorting effects of inflation on the conventional financial statements can be severe. Even relatively low inflation rates can have a significant cumulative effect overtime. To combat the problem, various methods of accounting for inflation have been proposed and there has been much debate as to which should be adopted. At the heart of the debate lies the problem of equity maintenance and, in particular, how equity maintenance should be defined. By resolving this problem, other problems, such as the way in which profit is measured and how assets should be reported, can then be resolve financial transactions occurring at different dates will be expressed in terms of their purchasing power at a single, common date - the end of the accounting period. This is done by adjusting for the change in the price index between the date of the transaction and the end of the accounting period. Profit available for distribution will be derived by expressing both the revenue received and the cost of the goods sold for the period in terms of their current (end-of-accounting-period) purchasing power. The cost of assets acquired will also be expressed in terms of their current purchasing power.The sales revenue is already expressed in terms of current purchasing power as the sale of inventories took place on the last day of the accounting period. The cost of sales figure is adjusted as the inventories were acquired at an earlier date. Where there are lots of sales and purchases that accrue evenly over the period, an average index for the period is used.Cash has not been adjusted as it is a monetary item that stays fixed irrespective of changes in the purchasing power of the monetary items. (There is no loss on holding cash during the period as it was received at the end of the month.) The CPP approach is often commended for its reliability. The historic cost of items is normally used as the basis for making adjustments and the adjustments are made using an objective index. …