During periods of high inflation, companies' financial statements produce an illusion that isn't obvious at first glance. Revenue grows, profit expands, equity swells — yet how much of this increase reflects genuine growth in wealth, and how much simply reflects the shrinking unit of measurement, remains unclear. Inflation accounting is precisely the correction mechanism developed to resolve this uncertainty: it brings items recorded on different dates, in currency with different purchasing power, onto a common scale, making financial statements comparable again.
The root of the problem: a fixed, assumed unit of measurement
Traditional accounting rests on the historical cost principle. A machine purchased in 2019 remains recorded at the same figure in 2025. One of accounting's core assumptions — the "stability of the monetary unit" — creates no practical problem in low-inflation environments. But when the general price level rises at double-digit, or even triple-digit, annual rates, items appearing on the same financial statement come to represent entirely different levels of purchasing power.
This has concrete consequences:
- Depreciation becomes inadequate. Depreciation charged on outdated historical cost falls far short of an asset's replacement cost; the company effectively consumes its own capital while reporting a paper profit.
- Inventory "gains" become misleading. The difference between cheaply purchased inventory and its expensive sale price reflects price inflation rather than genuine performance.
- Ratio analysis breaks down. Comparing outdated balance-sheet assets against current-period income-statement figures renders indicators such as return on assets, return on equity, and turnover ratios meaningless.
- The tax base inflates unrealistically. Paying tax on fictitious profit effectively means the erosion of the business's own equity.
The literature discusses three main approaches to correcting these distortions: general price-level accounting (adjustment via indexation), current cost accounting (restating assets at current market/replacement value), and a hybrid method combining the two. The approach predominantly adopted in international standards is the first — using a general price index.
The international framework: IAS 29
The international regulation of this issue is IAS 29 – Financial Reporting in Hyperinflationary Economies, issued by the International Accounting Standards Committee in 1989 and taken over by the International Accounting Standards Board in 2001. In Turkey, the standard entered into force at the end of 2005, published in the Official Gazette as TMS 29. The standard applies to all primary financial statements — including consolidated statements — of entities whose functional currency is that of a hyperinflationary economy.
The standard is best known for its indicators used to determine a "hyperinflation" condition. These include the linking of prices, interest, and wages to a price index; the reflection in prices of expected purchasing-power loss over the term of deferred sales and purchases; and a cumulative three-year inflation rate approaching or exceeding 100%. These criteria function less as a mechanical threshold than as evidence to be weighed as a whole — the final determination is left to professional judgment.
The logic of the adjustment: monetary vs. non-monetary items
The standard's implementation mechanics rest on dividing balance-sheet items into two categories:
Monetary items are cash held and amounts to be collected or paid in money: cash, bank balances, trade receivables, loans, trade payables. Since these are already expressed in the measuring unit as of the reporting date, they are not indexed. However, during inflationary periods, the party holding a net monetary asset position loses purchasing power, while the party in a net monetary liability position gains. This effect is calculated as the "net monetary position gain or loss," included in the period's profit or loss, and disclosed separately. This is inflation accounting's most distinctive item — one that never appears in conventional statements, yet best captures the change in real wealth.
Non-monetary items are inventories, tangible and intangible fixed assets, prepaid expenses, capital, and other equity items. These are restated in line with the change shown by the price index over the period from their recording date to the reporting date. In this way, the entire statement comes to be expressed in the current unit of measurement as of the period end. Prior-period comparative statements are likewise restated into the current unit; otherwise, year-over-year comparison again becomes meaningless.
The entity must also disclose in its notes that the financial statements have been restated, which price index was used, and whether the statements are prepared on a historical cost or current cost basis.
Turkey's tax law dimension: Tax Procedure Law, repeated Article 298/A
In Turkey, the tax framework for inflation adjustment is set out in the (A) clause of repeated Article 298 of the Tax Procedure Law (Vergi Usul Kanunu, VUK). Under the law, income and corporate taxpayers who determine their earnings on a balance-sheet basis must apply inflation adjustment to their financial statements if the increase in the price index exceeds 100% over the last three accounting periods, including the current one, and exceeds 10% in the current accounting period. If both conditions are not met simultaneously, the practice is discontinued. The index used is the domestic producer price index (Yİ-ÜFE) published by Turkey's national statistical institute, TÜİK.
Two coefficients form the technical backbone of the application: the adjustment coefficient, found by dividing the index for the month to which the financial statement belongs by the index for the month containing the date used as the adjustment basis; and the average adjustment coefficient, used for items assumed to be evenly distributed over the period, based on the average of the period's opening and closing indices.
One of the framework's distinctive concepts is non-real financing cost (ROFM). For assets financed through borrowing, the amount found by applying the index increase for the period the loan was used to the loan amount represents the portion of financing cost attributable to inflation. This amount is separated out from the financing expenses added to the asset's cost and deducted from the value subject to adjustment; otherwise, the same inflation effect would be counted twice.
Amounts determined through the adjustment are treated as the opening values for the following period, regardless of whether adjustment is applied again in that period. If inflation difference accounts related to liability items are transferred to another account or withdrawn from the business, these amounts become subject to tax; conversely, inflation differences related to equity items may be offset against accumulated losses arising from the adjustment or added to capital by corporate taxpayers.
In Turkey, inflation adjustment under the Tax Procedure Law went largely unapplied for a long period after 2003–2004, returning to the agenda once the conditions were met again, starting with the financial statements dated 31 December 2023. Provisional Article 33 of the Tax Procedure Law forms the legal basis for this. The subject is also addressed in a separate section of the BOBİ FRS (Financial Reporting Standard for Large and Medium-Sized Enterprises) framework — meaning Turkey now has parallel frameworks under tax law, TFRS, and BOBİ FRS, whose details (the index used, the items subject to adjustment, transitional provisions) can differ from one another.
The limits of the practice and criticisms
Inflation accounting is not a magic wand. The method using a general price index is based on the economy's average price movement; yet the prices of the assets a particular business holds may move quite differently from that average. For this reason, adjusted figures are not "fair value" — they are simply historical cost homogenized in terms of purchasing power. The practice also imposes a significant technical burden, especially on small businesses, since it requires tracking accounting records item by item and by exact date.
By contrast, the alternative — making no adjustment at all — is far more costly: investors misprice assets, lenders misjudge risk, and businesses distribute profit they should not distribute. For this reason, inflation accounting is regarded not as a technical accounting detail, but as a financial discipline tool for preserving capital in high-inflation environments.