Today I’m publishing the first guest post in The Summa‘s history. Written by Robert (Bob) Jensen, Trinity University Emeritus Jesse H. Jones Professor of Accounting, it was originally sent out on the AECM listserv. Given that the AECM policy is that anything sent out is in the public domain, and given that Bob frequently captures e-mail postings and puts them on his own web site, I’m just going to publish his letter.
by Robert (Bob) Jensen
Trinity University Emeritus Jesse H. Jones Professor of Accounting
Before I begin, I would like to mention an old theory case that I taught years ago that for students concisely explains the difference between financial statements prepared under historical costs, price-level adjustments, replacement costs, and exit values — www.cs.trinity.edu/~rjensen/temp/wtdcase2a.xls. It was almost always considered one of the best take aways from my theory course even though students worked on it the first day of the course.
Now on to: “Is Inflation a Problem for Accounting?” by David Albrecht, The Summa, September 25, 2011.
Firstly, I would like to thank David for making both a timely and scholarly blog posting. I agree with David’s criticisms of the FASB and IASB for not requiring price-level adjusted (PLA) statements at lower trigger points for inflation.
I don’t think David’s reference to the defunct FAS 33 has much bearing other than to point out that price level adjustments (general or current cost) are not worth much if they are poorly done to save the cost of generating more accurate numbers. So much leeway for error was allowed in FAS 33 that I’m in sympathy with analysts who purportedly ignored the supplementary FAS 133 statements in annual reports (see my discussion at http://www.trinity.edu/rjensen/Theory02.htm#FairValue).
Consideration must also be given to the fact that in nations having higher inflation contracts are generally written/indexed to make inflation no longer such a big risk in terms of the contracts themselves. Of course changes in inflation rates might indirectly affect business revenues and costs apart from the inflation adjustments in contracts. For example, inflation rates can affect export and imports even if they do not affect demand deposits in banks.
And students should definitely keep in mind that neither general PLA adjustments nor replacement cost adjustments are surrogates for “value” accounting. Both are simply adjustments to historical costs to allow for changes in either general purchasing power or relative price changes in different economic sectors.
The real economic problem becomes when longer-term contracts are not indexed to inflation as often happens when inflation is considered relatively modest (as in the U.S.) rather than extreme (as in Israel). Present FASB accounting standards are not doing a good job in isolating monetary-item gains and losses.
Don’t forget to take a look at www.cs.trinity.edu/~rjensen/temp/wtdcase2a.xls.
Thanks very much, Bob.
Debit and credit – – David Albrecht