Discounted Cash Flows, Price Level Adjustments and Expectations.

Abstract This article considers the implications of using price-level adjusted financial data in situations where the inflation or price changes are both anticipated and unanticipated. It is a disconcerting fact that the application of price-level adjustment factors to the depreciated cost of an asset can lead to distorted value measures where the firm expected inflation to take place, and made its investment decisions based on this expectation. In a sense the adjustment for price level becomes a type of double counting. Even though the proponents of price-level adjustments do not claim that such adjustments will measure or report values, it is important to know the effect of the adjustments. Before the claim of more usefulness for price-level adjusted reports can be accepted, we have to consider the relationship of the resulting measures and the value of the investment. Price-level adjustments to be useful for decision making must consider the past expectations of decision makers since accountants must reconcile price-level adjustments to value accounting. It is not sufficient for the accountant to defend price-level adjusted cost as merely historical cost expressed in dollars of like purchasing power. If the criterion being applied is one of usefulness, the relationships of the measures being presented to value must be considered.