Skip to main content

How to calculate Cost of Inflation index?

What is Inflation?

Inflation is a rise in price of a goods and services in particular period of time. In inflation the purchasing power is decreases. 

Example: Suppose on 25 may 2021 Mr. Gupta pays Rs. 20 for one pencil set and now in 2022 those pencil set cost Rs. 50. The rise in price shows the inflation and you can also notice that the value of money is decreases because those pencils which Mr. Gupta bought in Rs. 20 is now increases by Rs. 30. The price of product is definitely increases but the value of product is decreases.

What is Capital gain?

 Capital gain is rises due to sale of capital assets. It can be short term or long term.

Formula: 

Indexed cost of acquisition = Cost of acquisition * cost of inflation indexed of  the year the asset is being transferred / cost of inflation indexed of  the year the asset was acquired or 2000-01 (whichever is later)

Indexed cost of improvement = Cost of improvement * cost of inflation indexed of  the year the asset is being transferred / cost of inflation indexed of  the year in which the expenses for improving the asset were incurred 

 Long term gain/ short term gain = value of consideration- indexed cost of acquisition –indexed cost of improvement – other expense

Cost of inflation index:

It measures the inflation rate in given period of time. Due to inflation the price of assets increases and it also increases the tax amount. To know the correct value of assets rate of inflation at the time of purchase is calculated. It helps to pay tax on capital gain. To know the short term or long term gain subtract the indexed cost of acquisition and indexed cost of improvement and other expenses from value of consideration.

Value of consideration is an amount which seller receives after selling the assets. If the assets purchased before 1st April 2000 then the fair market value amount is taken as cost of acquisition.  

Example: Suppose Mr. Mehta purchase a house for Rs. 5, 30,000 in May 2011. In June 2019 he sells the house for Rs. 7, 00,000. The cost of inflation index on 2011-12 was 184 and the cost of inflation index on 2019-20 is 289. Find out the cost of acquisition.

Solution:  Indexed cost of acquisition = Cost of acquisition * cost of inflation indexed of  the year the asset is being transferred / cost of inflation indexed of  the year the asset was acquired or 2000-01 (whichever is later)

= 5, 30,000*289/184

= Rs. 8, 32,445.65

Example: Mr. Verma purchases shares Rs. 2, 20,000 on April 2001 and in June 2020 he sells the shares for Rs.3, 60,000. The cost of inflation index on 2000-01 was 100 and the cost of inflation index on 2020-21 is 301. Find out the cost of acquisition.

Solution:  Indexed cost of acquisition = Cost of acquisition * cost of inflation indexed of  the year the asset is being transferred / cost of inflation indexed of  the year the asset was acquired or 2000-01 (whichever is later)

= 2, 20,000*301/100

= Rs. 6, 62,200

 

 

 


Comments

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of ...
88 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to b...
Post a Comment
Read more

Numericals with solutions of Net income Approach

Net income approach questions and answers:   Questions:  Find out the value of the firm with the help of given information: Particulars Amount Earnings before interest and tax 3, 50, 000 Cost of equity 10% Cost of debt 7.2% Debenture 1,00,000 Find out the overall cost of capital with the help of net income approach. (Assume tax rate-10%) Solution: Particulars Amount Earnings before interest and tax 3, 50, 000 Less: Interest @7.2% 7, 200 Earnings before tax 3, 42, 800 Less: Tax@10% 34, 280 Net income 3, 08, 520 Cost of equity 10% Market value of equity (S =net income/ cost of equity) 30, 85, 200 Market value of debt (B) 1, 00, 000 Value of the firm (S+B) 31, 85, 200 Questions:  Find out the overall cost of capital if the equity capitalisation rate is 12...
1 comment
Read more