MAFundamentals defines the foundation of Management Accounting from cost concept, classification and analysis. It provides general discussion on COST, VOLUME, PROFIT, VARIANCE and other information necessary for performance measurement, decision making and pricing.

Price Level Changes and Inflation

The two effects of changing price levels are:
  1. Inflation - an increase in the general price level
  2. Deflation - a decrease in the general price level
The general price level is inversely related to the purchasing power of money.

The Price Indices used in the calculation of price level changes are:
  1. Consumer Price Index (CPI) - measures the price level by a monthly pricing of a specific set of goods/services purchased by a typical urban consumer.
  2. Gross Domestic Product Price Index (GDP Deflator) - includes the prices of all goods and services produced in the country. It includes investment, government purchases, exports, as well as consumer goods and services.
  3. Producer Price Index - measures the prices of specified commodities at the time of their first commercial sale.
The impact of Inflation on Financial Management are:

  • Higher rates of inflation lead to higher interest rates which in turn discourage investments.
  • Inflation increases the price of resources, thus increasing the demand for capital.
  • If the tax structure is not indexed for inflation, taxpayers may be pushed to higher tax brackets even though real income has not increased.
  • Inflation distorts profit because of inadequate valuation of fixed assets and inventories.
  • The accuracy of predictions needed for business planning is reduced during periods of rapid inflation.
  • Inflation hurts creditors, fixed income groups, and savers, but benefits debtors because they pay back their debts in less valuable units of money.