6 Effects of Inflation Accounting Infographic

Inflation affects us in many ways, some of which are quite obvious, such as the decrease in the value of money over time. However, it also has more subtle impacts beyond just end-user prices. For accountants, it can have significant consequences, including affecting the calculation of profits, expenses, and debts, as well as financial reporting, investing, and inventorying.

The following are six ways in which inflation can impact accounting:

1. Profits

Inflation results in higher costs for goods and services, leading to increased inventory and asset expenses. This, in turn, can result in higher income and profits.

If a business is unable or unwilling to immediately pass on price increases to the final price of their product, it could result in lower net income if the revenues do not keep up with production costs. Additionally, wage increases should also be taken into account.

2. Reporting and Evaluating

The value of money is affected by inflation, which means that comparing the cost of goods or services from different periods is not a straightforward process. For instance, when we think about how much cheaper gas used to be, we need to take into account the increase in wages over time. This complexity affects financial reporting, planning and budgeting. Moreover, if a company’s budget includes components that fluctuate at a different rate than general inflation, the accounting process becomes even more intricate.

During periods of inflation, using inflation accounting instead of pre-inflation pricing can lead to more accurate results. Experienced accountants rely on the proper price index to improve data reconciliation.

3. Investing

The stock market can become more volatile when prices go up, which can cause businesses to rethink their investment strategies. Investing in stocks can result in good returns, but it can also be risky if the market is about to correct itself. If a company invests at the wrong time, they may end up overpaying and seeing diminishing returns on their equity investments (ROE).

4. Debt

Inflation has a direct impact on interest rates, which can have a ripple effect on those who have variable interest rate loans. As interest rates on loans increase, a company’s debt also increases. Those who are affected by this situation may consider switching to fixed-rate loans or applying for additional credit to lock in lower rates before they rise any further. It’s always wise to reduce debt as it can be a good move in such circumstances.

5. Inventory

The methods used to determine inventory costs are not constant and can vary based on the type of method used, such as LIFO, FIFO, average overall, etc. Inflation can have an impact on the profits and valuation of inventory, which in turn, affects tax liabilities. To better manage the current market values and determine present costs, companies may need to shift their inventory accounting methods.

6. Expenses

Inflation leads to higher production costs and negatively impacts sales of non-essential goods and services. Companies must decide whether to pass on the cost to customers or accept reduced profit margins.

During times of inflation, businesses should monitor vendors and service providers closely, and keep an eye on long-term contracts and leases that may contain escalation clauses.

source: https://ohiocpa.com/getinvolved/news/2023/06/05/what-are-the-consequences-of-inflation-on-accounting


Download this infographic.

Embed Our Infographic On Your Site!