Inflation Adjusted Accounting and Financial Statement Interpretation Challenges

Abstract

This paper investigates the persistent and under-examined challenges associated
with the interpretation of financial statements prepared under inflation-adjusted accounting frameworks, specifically focusing on the gap between theoretical models and
practical application in volatile economic environments. While historical cost accounting remains dominant, periods of significant inflation render its outputs misleading,
necessitating adjustments. However, the implementation of such adjustments—through
models like Constant Purchasing Power (CPP) or Current Cost Accounting (CCA)—introduces
profound interpretative complexities that are often glossed over in standard accounting literature. Our research employs a novel, multi-methodological approach combining a longitudinal simulation of a hypothetical firm’s financials under varying inflation
regimes (2% to 25% annually) over a 20-year period with a qualitative analysis of
documented analyst and investor decision-making processes. We move beyond mere
computational comparison to interrogate the cognitive and heuristic shifts required for
accurate interpretation. Our findings reveal a non-linear relationship between inflation
rate and interpretative error, with a critical threshold around 8-12% annual inflation
where error rates spike dramatically, not due to calculation mistakes, but due to the
misapplication of historical cost-based valuation heuristics to inflation-adjusted data.
Furthermore, we identify a ’metric anchoring’ problem, where users disproportionately
rely on familiar but inflation-distorted metrics like Earnings Per Share (EPS) even when
superior adjusted metrics are provided. The paper makes an original contribution by
framing the issue not as a technical accounting problem, but as a human-computer
interaction and information design challenge within financial reporting. We conclude
that the efficacy of inflation-adjusted accounting is severely limited without parallel
innovations in statement presentation, user education, and the development of new,
inflation-native financial ratios, suggesting a necessary re-direction of research efforts
from standard-setting to interpretative support systems.