Accounting Rules

Just storing here some quotes from today's (that is, the April 11, 2011) deadtree edition of the Financial Times.

Page 19, Tony Jackson's "On Monday" column has the header, "Accounting rules covering inflation need consistency."

Pull quote, "International and US accounting standards specify that inflation must be used in subsidiaries with hyperflation." But hyperinflation for that purpose is 100% increase in price levels over a period of three years. Works out to 26% annual compounded.

"The only significant economy now qualifying is Venezuela," Jackson writes.

But I especially appreciated his analytical breakdown of the issues.

"There are basically three routes by which inflation affects the reported figures: depreciation, inventories and financial assets/liabilities.

"The first is obvious. If you depreciate a machine over its five-year life at cost and the price of a new one meanwhile doubles, your profit is overstated.

"Inventories ... are less obvious but arguably more important."

He proceeds to review the LIFO/FIFO distinction though without using those tags.

"In the mid-1970s, when UK consumer price inflation was 25 per cent-odd, industrial cost inflation was nearer 50 per cent. Companies were presented with large tax bills on non-existent profits, and the government hastily introduced stock appreciation relief to avert bankruptcies."

Final category of concern, financial balance sheet items. "Plainly, the net effect of inflation on debtors and creditors can go either way, depending on the balance sheet."

What about equity? "Companies need to be sure that in paying dividends, they are not in reality distributing capital. The obvious answer is to index that capital. But the question is what index to use."

If the IASB and the FASB get together on this, what would the new rules look like? "In 1970s Britain, the whole idea was so contentious that by the time an accounting standard was formulated, inflation had subsided."

Very well done.

Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see