Aurora Borealis
1 November 1980 Financial Analysts Journal Volume 36, Issue 6

The Indexation Issue in Inflation Accounting

  1. George Terborgh

Inflation is something that happens to the general purchasing power of money, not to its purchasing power over a particular item. Prior to the emergence of the inflation problem, accountants were happy with historical cost accounting. Yet historical cost entries seldom reflected current values accurately in those days and were often wide of the mark. If they were acceptable then, why are they unacceptable now?

One can at least adjust fixed assets — property, plant and equipment — for general purchasing power gains or losses. This is not true of replacement pricing, which derives the current value of a long-lived asset in partially depreciated condition indirectly from the cost of a reference asset. To the SEC, the appropriate reference asset is the one with the same productive capacity and the best current technology. To the FASB, it is a replica of the existing asset in new condition. In either case, it is virtually impossible to make the necessary allowances required to derive current value for specific plant. In practice, one resorts to published indexes of market values that cover groups of assets more or less similar to those being evaluated.

The specific index approach, applied as it must be by borrowed group indexes and stereotyped depreciation writeoffs, yields values that may be far removed from what assets are actually worth. The FASB should abandon its specific index requirement for fixed assets as soon as the SEC permits.

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