Capital Maintenance In A Period Of Inflation

Project and Seminar Material for Accountancy / Accounting

Project and Seminar Material for Accountancy / Accounting

Chapter One

1.0. Introduction

The word inflation is not new phenomenon; it has been experienced by most countries in the world at some stage in their history. Mere looking at this statement ones mind will really, run to developing countries. But it is in history that even the UNITED KINGDOM in 1974 when they could no longer sit back and watch inflation run them set up “The inflation Accounting committee” with Francis Sandilands as chairman to look into the problem. Even the Almighty UNITED STATES OF AMERICA went through it sometime in the sixties before they come to they present economic stability. So, one will not be surprised when countries like ours and some other like the Asian countries and even Latin American Countries are mentioned as suffering from this CANKER WORM called inflation.

There are so many definitions. Solow (1979) for instance, sees inflation as going on when one needs more and more money to buy some representative bundle of goods and services, or a sustained fall in the purchasing power of money. It is a sustained rising trend in the general price level or put in another way, it is a high and persistent rise in the price level.

Inflation is a rise in the general level (or average level of prices) of all goods and services. The general price level thus varies inversely with the purchasing power of a unit of money (such as the naira). For example, if prices double, purchasing power decreases by one-half. If prices halve, purchasing power doubles. Therefore, inflation is also a reduction in the purchasing power of a unit of money. The opposite of inflation is deflation.

Types Of Inflation

  1. Demand – pull inflation: This types of inflation take place when aggregate demand is rising while the available supply of goods is becoming increasingly limited. It is induced by excessive demand not matched with increase in supply.
  2. Cots – push inflation: This occurs when prices increase because factor payments to one or more groups of resource owners rise faster than productivity or technical efficiency. Typical forms of cost – push inflationi are “wage-push” “profit-push”, and “commodity”.
  3. Hyper – inflation: Hyper-inflation occurs when the price level rises at a very rapid rate.
Causes And Control Of Inflation In Nigeria Causes:

There are several causes of inflation in Nigeria.

  1. Excessive money supply caused by ineffective monetary and fiscal policy.
  2. Fall in the supply of goods and services, especially agricultural product causing demand to rise and price to rise as well.
  3. Budget deficit or government expenditure programmers is a major cause of inflation in developing nations. Too much expenditure by government can cause inflation.
  4. Too much importation of goods and services can cause inflation especially in developing nations.
  5. An increase in population can put more pressure on the little goods and services thereby prices will rise.
  6. The activities of the middleman in the distribution of goods and services can also cause severe inflation in our economy.
  7. Excessive demand by consumers and higher production cost can also cause inflationi.
  8. Monopolistic practices with respect to production, importation and distribution of certain essential commodities can cause inflation.
  9. Increase in wages and salaries and competitive attempts by various economic and social groups to increase their share of the national cake, can also cause inflation.
  1. The setting of price control board by the government of fix maximum prices changed for certain commodities is one way of controlling inflation but experience shows that this system does not work.
  2. Monetary policy is another way to control inflationi. It involves the use of traditional monetary instruments to reduce the quantity of money in increase in the bank or discount rate, increase in the liquidity ratio, us of open market operation (OMO) special directives etc.
  3. Fiscal policy: This entails an increase in personal income tax reduction in government expenditure.
  4. Total ban on the importation of certain items may help to control inflation especially when such inflation is imported.
  5. The production of more goods and services in an economy may also help to control inflation.
  6. The control of wages increases or wage freeze will also help to control inflationi.
  7. There is need to overhaul the entire distribution networks to control inflationi in an economy.
Inflation In Nigeria

One of the major causes of inflation in Nigeria has been the various government policies to stimate a fast rate of economic growth and development since independence. In recent years, however, specific policies like SAP: external debt policies, policies on subsidies on petroleum product and fertilizer, policies of privatization and commercialization, policies on trade liberalization, and interest rate deregulation, and others are responsible for the inflationary trend in our economy.

Before the SAP, inflation in Nigerian was caused primarily by using world export price and price and falling output. These are major external factor Contributing to Nigeria inflation. Thereafter, domestic or internal causes like increasing government expenditure, rising domestic credit creation and supply bottlenecks such as shortage of raw materials and spare parts worsened the situation. There is need, therefore, for monetary policy reform, exchange rate reform, effective price and wage policy and fiscal policy reform, to solve the problem of inflationi in Nigeria.

But for the purpose of this research, inflation according to Samuelso (1976) is a time of generally rising prices for goods and factors of production, rising prices for bread, cars, haircuts, rising wages, rents etc. Inflation has assumed a great deal of political social and economic significance that goes along with it. The political and social effect a part, the economic impact cannot be over emphasized. One of the most disturbing aspects of this to companies and their managers is its affect on capital maintenance. By companies we mean those publicly owned – those whose capital must have been sources through the money market.

CAPITAL!!! This one name that has failed to agree with the word INFLATION right from the world go. While the managers are busy managing and trying their best to maintain the capital entrusted in them, the inflation on its part is busy disobeying and eroding the value of the capital being handled and sub squally increased by manager. What an opposition?

One school of thought has argued in fervor of inflation based on its benefits. But they were proved wrong based on the long run effect of such advantages. This could be illustrated thus:

Supposing a company with a capital base of N4 million incurs expenditure of say N200,000 to make a profit of N50,000 after tax. Again, supposing in the next two years more due to inflation their profit rose to N million surely, workers salaries will have to be increased or they would seek for the increase by force since every other factors of productions reward has increased. Like wise intense or dividends. The government will not be left out in their share of the “national cake” by the time the company tries to meet all these demands of all these interest groups.

They may be left with nothing to their credit. Meanwhile the asset, i.e. machines plants, buildings etc. have in one way or the other won out. And the company might not be able to replace them or even repair them despite the huge profit recorded. This is the handwork of inflation. At this juncture, if he manager involved does not take time, he might be in deep shit. And this is where the problem lies. No wonder Nikitin (1980) states that “most people regard inflation as being associated with undesirable effect and it has implications for all persons and institution who conduct their economic activities by means of monetary unit”.

The question of maintaining capital in a period of inflation in manufacturing companies has become relevant, mostly in the recent past. Capital may simply be defined as “money which is invested” from a lay mans point of view. But in the real sense, it encompassed the working capital, real assets like building machines plants, and even vehicles used in the business. It is still embarrassing that even the accountancy profession have not postulated up till now. Hence the researcher has to investigate capital maintenance in a period of Inflation with “NIGERIA BOTTLING COMPANY PLC OWERRI” makers of COCA-COLA and other soft drinks. The researcher is interested in finding out how this multinational company which is highly equipped and mechanized has been able to remain at the top through out all this inflation any period from the 1970s, and at the same time maintaining its capital (Nigerian situation being as critical as it is with the value of Naira deprecating everyday, now at the rate of about N100.00 to $1.00 as against some 85-7 pence to $1.00 it used to be in the 60s)

For convenience, this research is organize into five major chapters: chapter one deals with general over vied of the study, chapter two centers on literature review it the work of previous authors on the subject matter of inflation and capital maintenance, chapter three treats the research procedures adopter four is devoted to sources of data and analysis as well as the hypothesis testing.

Finally, chapter five deals with summary of the work, conclusion and recommendation.

1.1. Statement Of The Problem

Capital being the life wire of an organization has been defined by many authors from the perspective of their discipline, but a business profit making organization (manufacturing concern in this case), it includes their working the liquid cash, manufacturing. And official buildings, machines, reserves, loan capital and even share capital equity. Growth of this chapter should be the ultimate aim of both the managers and the owners of the business, and even the creditors and investors. But this aim is not easy to come by even in a small scale industry to talk of a multination manufacturing company like “Nigeria bottling company” especially during inflationi.

Sequel to the above statement, the outline problems of this research are:-

  1. Companies have difficulties in pooling the adequate volume of capital from different sources.
  2. During inflation, the companies also have difficulties in maintenance of real asset (machines, equipment’s buildings etc) in terms of problem of choosing an adequate depreciation method.
  3. Companies encounter some difficulties in measurement of profit and maintenance of profit and maintenance of reserve to the tune of inflation.
  4. The government taxation policies during inflation also have some adverse effect on the manufacturing companies.

1.2. Objective And Purpose Of Study

It is very pertinent and clear that no companies director’s and managers will pilot the affairs of their companies for a whole accounting period only to pay their debts and dividends from their capital. It is very unheard if at least the owners (share holders) will not find it funny. This fact therefore necessitates the importance and relevance of the subject matter.

The objective of this study therefore is to:

  1. Find out how manufacturing companies gather their required volume of capital from different sources during inflation (i.e. internal and external sources) and the impact of this inflation on the different cost of the different sources of capital.

Capital Maintenance In A Period Of Inflation

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