Are Inflating our Balance Sheets a Bad Idea?

Are Inflating our Balance Sheets a Bad Idea?

Financial reports in today's economy do not take into account the rates of inflation. The federal government has for the history of our society been able to at will raise or lower the rates of inflation. The increase or depreciation of the US dollar is a decision that impacts all Americans. However, the ability to reflect these changes in strength or weakness of the US dollar has been unable to be translated into any of our corporation's balance sheets. The main question here to ponder is whether or not inflation restricts the usefulness of a balance sheet.

In past years as real estate was on the boom, many corporations would have been overjoyed to reflect the inflated value of their assets as a way to contribute to their overall bottom-line, but generally accepted account principles prohibit that practice. Now as we look back at the shambles of our economy, we have to ask ourselves if restricting inflation calculations into our balance sheets was a good idea. On the surface it appears that injecting inflation rates into our balance sheets would have merely compounded the problems we experienced, but, of course it goes deeper than that. Misguided calculations and inappropriate oversight certainly led us to where we are today.

If we look to the federal government for guidance, Former Federal Reserve Chairman, Alan Greenspan, had quite an opinion on this topic. Specifically, Chairman Greenspan had deep concerns over the extensive support that the government was providing into the economy in 2009. Chairman Greenspan warned that this support risked the economy into igniting a burst of inflation as a result. "You cannot afford to get behind the curve on reining in this extraordinary amount of liquidity because that will create an enormous inflation down the road," Greenspan said at a forum hosted by The Atlantic magazine, the Aspen Institute and the Newseum.

To understand how we got here, it is important to know where we started. In the mid-1970s, the Securities Exchange Commission (SEC) required large corporations to adapt the methodology of accounting called "replacement cost accounting." This edict impacted all publicly held companies with inventory and fixed assets exceeding $100 million. The goal was to disallow the practice of corporations from inflating their balance sheets. This accounting methodology led to fewer profits and more costs of operation for larger corporations. Corporations were cautioned against using a straight line approach of depreciation. Instead, by utilizing replacement cost accounting, a piece of machinery should be carried on the books for the amount it would cost to actually replace, which due to inflation could be quite large. In inflation accounting's defense, this practice has been used in other places in the world effectively. For example, the country of Brazil uses inflation accounting as a standard. In the 1974 Shell Oil Company annual report, financial results were offered in both "historic dollars" and "current dollars."

Where do we go from here? I think it is best we step back and really try to understand the goal of a company's balance sheet in the first place. At the end of the day, investors look to balance sheets to understand a company's economic health. Are they making a profit? Do they have the capacity to invest in themselves, others and their employees? Does the cash flow available line up with the needs of the financial landscape? On the flip side of keeping inflation off the books, as we sit in the financial world we do today, do we need to reevaluate due to the tremendous losses still being felt today?

Would changing principles in accounting assist struggling companies to accurately reflect their financial state of the union? For the tremendous losses being felt specifically in the real estate market, would a company benefit from reflecting that loss on the balance sheet. The real estate assets are arguably a company's most integral and substantial. It is fair to assume that the liquidation cost of these assets are plummeting significantly and continue to today.

Our society has become so very jaded over the past few years. We are unable or unwilling to trust our bankers or stockbrokers. We are looking over our proverbial shoulder at every financial transaction. Do we need to start to rebuild the trust that existed for so very long before this economic collapse? Is a step in that direction, reevaluating the standard practices in place for our balance sheet creation? In the end, the investors and the corporations want to exceed, but there must be clear communication for that success to be heard.' Perhaps taking a fresh look at how perform such an archaic task as balancing the books is just where we should start over.

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