What is Inflation Accounting? How is it Applied?

Have you ever wondered how accurately your financial statements reflect reality in a period where prices change every day? As inflation rises, the purchasing power of money decreases, and the figures in the books can mislead you. This is where inflation accounting comes into play. In this article on Papel Blog, we explain what inflation accounting is, when it is applied, how it is done, and how it reflects on the balance sheet with an example calculation.

What is inflation accounting?

Inflation accounting refers to the adjustments made to prevent changes in the purchasing power of money from distorting financial statements. In periods of high inflation, when assets and liabilities are recorded at their nominal values—that is, the visible values of money today—they do not reflect the real situation. Therefore, non-monetary assets and equity items are updated with certain coefficients, making financial statements more accurate.

Inflation accounting was first implemented in Turkey in 2003 with the regulations added to the Tax Procedure Law, but it was suspended after 2004–2005. However, as of 2023, with the reemergence of conditions, it has become mandatory again under the 555 VUK General Communiqué and the VUK-165/2024-3 Circular. In addition, the TMS 29 standard determines the principles to be applied internationally.

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When is inflation accounting applied?

For inflation accounting to be applied in Turkey, two main conditions specified in Article 298/A of the Tax Procedure Law (VUK) must occur simultaneously. The first condition is that the increase in the Domestic Producer Price Index (PPI) over the last 36 months, including the current fiscal period, exceeds 100%. The second condition is that the increase in the PPI for the one year of the current fiscal year is at least 10%.

However, for financial statements dated December 31, 2023, it was stipulated that inflation adjustment must be made regardless of whether the above-mentioned 100% and 10% conditions were met. As of this date, the financial statements of all taxpayers keeping books on the balance sheet basis were included in the adjustment scope.

From 2024 onwards, the application of inflation accounting has been made dependent on the occurrence of these inflation conditions set out in Article 298/A of the VUK. In other words, as of the end of the 2024 period and in subsequent years, the decision of whether to apply inflation adjustment will be based on the two criteria mentioned above.

In addition, there are also special regulations for provisional tax returns: for example, in the first, second, and third provisional tax periods of 2025, most taxpayers within the scope will not make inflation adjustments, but taxpayers engaged in continuous gold/silver transactions and similar activities will continue to be required to do so.

How is inflation accounting done?

In inflation accounting, the items in the financial statement are first separated into monetary and non-monetary. Non-monetary assets (such as inventories, fixed assets, and equity items) are subject to adjustment, while monetary items such as cash and liabilities remain at their nominal values.

The registration date of each item is taken as the basis, and PPI indices are used to calculate the “adjustment coefficient” by comparing it with the period-end index. In inventories, aggregated methods such as the simple average can also be used. In addition, the “non-real” portion of financing costs included in costs due to inflation is separated.

The values are updated with the adjustment coefficient, and the differences are tracked in “inflation adjustment accounts.” For depreciable assets, depreciation is recalculated on the new values. Finally, how these differences will be reflected in the tax base and tax returns is determined according to the relevant communiqués and circulars.

Example calculation of inflation accounting

Suppose a company’s balance sheet dated December 31, 2023, shows an “Inventories” account with a book value of 8,400,000 TL. Let’s perform the calculation using PPI indices:

• December 2023 PPI: 3,020.12

• September 2023 PPI: 2,749.98

1. Calculation of the average index
   (3,020.12 + 2,749.98) / 2 = 2,885.05
2. Finding the adjustment coefficient
   3,020.12 / 2,885.05 = 1.04682
3. Calculation of the adjusted value of inventories
   8,400,000 × 1.04682 ≈ 8,793,265 TL
4. Adjustment difference
   8,793,265 − 8,400,000 = 393,265 TL

Result:
Inventories will be shown on the balance sheet as 8,793,265 TL. The difference of 393,265 TL will also be tracked in a separate “Inflation Adjustment Difference” account.

 

Sources: 1, 2.  

 

This blog post contains general information, not legal, financial, or investment advice. The content is prepared for informational purposes only, and you are advised to seek professional advice for your specific circumstances. The expressions in this article do not carry any binding nature or responsibility and reflect only the author’s evaluation. All your decisions are your responsibility, and Papel Electronic Money and Payment Services Inc. accepts no liability for any consequences arising from them.