In the US, financial statements are not adjusted for inflation and report only historical cost amounts. As inflation is now north of 8%, it is important to consider the impact of inflation on financial reporting and investing. To illustrate, assume the cost of a business’s inventory is increasing at a rate of 8% a year (8% inflation). In this situation, cost of goods sold reported on the income statement (based off historical cost) will be less than the inventory’s replacement cost. Thus, in periods of inflation, using historical cost increases net income to a level that is greater than the true economic profit. This illusory profit happens with any expenses that are based off historical cost. One of the primary goals of the income statement is to aid investors in forecasting future income. In periods of inflation, using historical cost makes this difficult.

Do you think financial statements should be adjusted for inflation? Why or why not?