SAICA mistakenly blames inflation

Missive Nº 318

Hi,

What SAICA, SA accountants and accounting lecturers at SA universities do not understand is that accountants unknowingly destroy massive amounts of real value in SA companies doing normal accounting during low inflation. This unknowing and unintentional destruction amounts to about R200 billion per annum in the existing real values of existing constant items in SA companies. It is existing real value that is being destroyed. It is not a matter of making more money to update capital.

The IASB authorized them 20 years ago to change that and to stop accountants unknowingly destroying value, but, because they mistakenly think it is inflation doing the destroying, they do nothing about it and say it is up to Gill Marcus and her team at the South African Reserve Bank to bring down inflation.

The crux of the matter is their blind belief that it is inflation doing the destroying and not accountants with normal accounting. They simply cannot contemplate even considering the possibility that measuring financial capital maintenance in units of constant purchasing power during low inflation as the IASB authorized them 20 years ago in the Framework, Par. 104 (a), which states

"Financial capital maintenance can be measured in nominal monetary units or in units of constant purchasing power"

would stop accountants from this unknowing and unintentional destruction during low inflation while they all accept it as absolutely essential during hyperinflation as it is required in IAS 29 Financial Reporting in Hyperinflationary Economies.

This is what SAICA stated on their website:

Submitted by: SAICA
Date Submitted: 27 August 2008

[2] We have noted what Mr Nicolaas Smith is saying and strongly disagree with his accusations that accountants are destroying value.

We recognise that inflation influences reported results, but this is a matter of economic policy and economic growth.

Remeasuring reported results would be undesirable in South Africa where the monetary authorities are seeking to contain inflation.

It would make no sense for SAICA or the Accounting Practices Board to consider making any changes to the accounting standards as we committed to and support IFRS as issued by the IASB.

We do not concur with the suggestion that the standards should reject the stable unit measuring assumption.

SAICA will make no further response to Mr. Smith's missives as we have clearly outlined our views.

SAICA


It is clear they mistakenly think accountants have absolutely nothing to do with it. They are completely wrong.

Summary

SAICA does admit that "inflation influences reported results" doing Historical Cost Accounting during low inflation. They blame inflation resulting from the ANC´s and the SARB´s economic policy. The Institute apparently does not know that the stable measuring unit assumption is rejected outright in IAS 29 and as an option in the Framework, Par. 104 (a). They refuse to reject the stable measuring unit assumption under any circumstance. They totally disagree that accountants destroy value in any way.

Kindest regards,

Nicolaas Smith

SAICA loves the stable measuring unit assumption

Missive Nº 317

Hi,

Gill Marcus, the Governor of the SA Reserve Bank is the enemy of inflation.

No-one in SA is the enemy of the stable measuring unit assumption because no-one understands how it operates. In fact, SAICA is totally against rejecting the stable measuring unit assumption. The Institute stated on its web site on 27th August, 2008:

“We committed to and support IFRS as issued by the IASB”

and

“We do not concur with the suggestion that the standards should reject the stable unit measuring assumption”

SAICA inexplicably forgets that IFRS reject the stable measuring unit assumption in two instances:

(1) In IAS 29 Financial Reporting in Hyperinflationary Economies and

(2) The IASB approved its rejection during low inflation as an option in the Framework, Par. 104 (a) in 1989 which states:

"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

SAICA went so far as to state:

"Ultimately, inflation-adjusted accounts in a low inflation environment insult the user." SAICA website: 12 August, 2008

Fact: Most countries, including SA, inflation-adjust salaries, wages, rentals, etc. during low inflation.

Our dear friends at SAICA seem to be a little bit confused.

Kindest regards,

Nicolaas Smith

Two economic enemies

Missive Nº 317

Hi,

There are two processes of systemic real value destruction in the SA economy. The first process is by the well known enemy inflation. This economic enemy manifests itself in the Rand´s store of value function and only operates in the SA monetary economy since inflation can only destroy the real value of the Rand and other monetary items. Inflation has no effect on the real value of variable or constant real value non-monetary items.

The second economic enemy is the very destructive stable measuring unit assumption as applied by SA accountants when they implement the traditional Historical Cost Accounting model in all SA companies during low inflation. This second process of systemic real value destruction in the SA economy manifests itself in the Rand´s unit of account function in combination with the stable measuring unit assumption only in the constant item part of the SA real economy.

This second enemy is a stealth enemy since the way it operates is not understood by SA accountants, SAICA and accounting lecturers at SA universities. If they understood it, they would have stopped it by now as they have been authorized by the IASB 20 years ago in the Framework, Par. 104 (a) which states"

"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

Kindest regards,

Nicolaas Smith

Sufficient unreported hidden holding gains can maintain un-updated capital

Missive Nº 315

Hi,

The real value of Issued Share Capital and Share Premium Account can be maintained even if they are not updated over 100´s of years with unreported and hidden holding gains ONLY if 100% of the original updated real values of all contributions to these accounts are invested in sufficient revaluable variable item fixed assets (revalued via the Revaluation Reserve account or not). But, only in the case of these two items. All other reported constant real value non-monetary items´ real values never maintained are unknowingly destroyed by accountants choosing the HCA model during low inflation.

Very, very few companies have 100% of the original real values of Issued Share Capital and Share Premium Account invested in revaluable fixed assets. Only hotel groups and other property companies.

Hidden and unreported holding gains can not and are not applied to maintaining the real values of other items in Shareholders´ Equity. The reported Retained Profits of all companies are thus being unknowingly destroyed by HC accountants at a rate equal to the inflation rate in all low inflationary economies as they always have been in the past and as it is happening right now and as it will carry on as long as they keep choosing the HCA model - or as long as we do not have sustainable zero inflation.

With financial capital maintenance in units of constant purchasing power the real value of companies´ shareholders equity will be maintained for an unlimited period of time even without any fixed assets at all - as long as these companies at least break even for an unlimited period of time - all else being equal.

Kindest regards,

Nicolaas Smith

Accountants and inflation destroy value

Missive Nº 314

Hi,

Inflation destroys the real value of money and other monetary items over time. This fact is generally accepted and appears in Wikipedia stated as "inflation erodes or decreases or reduces the real value of money" and in IFRS as "general forces may result in changes in the general level of prices and therefore in the general purchasing power of money" (IAS29.5).

HC accountants destroy the real value of reported constant real value non-monetary items never maintained, e.g. reported retained profits, when they choose to value them in nominal monetary units during low inflation. This fact is not generally accepted.

This destruction of reported Retained Profit real value is generally attributed to inflation when, in fact, it is the result of accountants´ free choice of the traditional Historical Cost Accounting model whereunder they implement the stable measuring unit assumption, i.e. they simply assume that changes in the real value of the money (inflation) is not sufficiently important during low inflation for them to choose the alternate basic accounting model of financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, Par. 104 (a) in 1989 which would stop this destruction.

It is thus HC accountants´ free choice of accounting model and not inflation that is doing the destroying in the real value of reported Retained Profits. HC accountants would stop this destuction when they reject the stable measuring unit assumption and with it traditional Historical Cost Accounting and measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989.

This destruction (by HC accountants) generally incorrectly attributed to inflation is generally accepted by accountants and economists and expressed in Wikipedia in phrases such as:

Inflation results in the overstatement of margins and the overpayment of dividends which results in the erosion of companies´ capital that is paid away in overstated dividends.

Example: R2.4 billion of real value is destroyed by HC accountants in the real value of R40 billion reported Retained Profits during a year in the South African real economy at 6% per annum (a rate equal to the rate of inflation) when inflation is 6% because they value reported Retained Profist in Rand monetary unit terms and the real value of the Rand is being destroyed by inflation at 6% per annum. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.

HC accountants implement their very destructive stable measuring unit assumption at inflation rates ranging from 0.01% per annum to 25.99% per annum continuous inflation for 3 years in a row; i.e. they assume the destruction of 25.99% of the real value of reported Retained Profits and all other existing constant real value non-monetary items never maintained (eg. all items in shareholders equity, provisions, etc) is not sufficiently important for them to freely decide to stop this destruction by implementing financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is complaint with IFRS.

26% annual inflation for 3 years in a row totalling 100% cumulative inflation over 3 years would define an economy as being an hyperinflationary economy. IAS 29 requires accountants in hyperinflationary economies to value all non-monetary items (variable and constant items) in units of constant purchasing power. Accountants thus agree that 26% annual inflation for 3 years in a row is sufficiently important for them to stop destroying the real values of all reported constant items never maintained, but, not 25.99% annual inflation for 3 years in a row or inflation approaching 26% annual inflation for 3 years in a row.

This is obviously not true and correct. It results in HC accountants unknowingly and unintentionally destroying hunderds of billions of US Dollars of real value annually in existing reported constant items never maintained.

What in reality happens is that accountants do not know that they are doing this because HCA has been the traditional accounting model for the last 700 years.

They unknowingly evade fixing their massive annual destruction in companies´ reported constant real value non-monetary items never maintained by ascribing this destruction in real value to inflation when it is a fact that inflation can only destroy the real value of money and other monetary items - nothing else. It is impossible for inflation to destroy the real value of non-monetary items. Inflation can only destroy the real value of money and monetary items. As Milton Friedman so eloquently stated: inflation is always and everywhere a monetary phenomenon.

Kindest regards,

Nicolaas Smith

Accounting model maintains value - Part 2

Missive Nº 313

Hi,

Capital - as a variable real value non-monetary item (as traded or untraded shares in a company) - would have emerged even without double-entry accounting.

It is clear, however, that the real value of capital - as a constant real value non-monetary item - i.e. being all the items in shareholders´ equity (issued share capital, reported retained profits, share premium account, capital reserves, etc), can only be maintained constant during inflation with double entry accounting implementing not traditional Historical Cost Accounting (the stable measuring unit assumption) but financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is compliant with IFRS.

Double entry accounting can maintain the real value of existing constant items (issued share capital, reported retained profits, etc.) even in companies with no fixed assets as long as they at least break even for an unlimited period of time during indefinite inflation, but, only with financial capital maintenance in units of constant purchasing power - not with the traditional 700 year old Historical Cost Accounting model implementing the very destructive stable measuring unit assumption during low inflation.

Thus, instead of saying that the accounting model creates value we can say the accounting model maintains value - qualified as above.

Kindest regards,

Nicolaas Smith

Accounting model maintains value - Part 1

Missive Nº 312

Hi,

“What advantages does the Merchant derive from Book-keeping by double-entry? It is amongst the finest inventions of the human mind.” Goethe

Capital as we know it today only exists as a result of the double-entry accounting model.

Not the traditional Historical Cost Accounting model, but, simply the double entry accounting model. Measuring financial capital maintenance in units of constant purchasing power is also a double entry accounting model. So are Current Cost Accounting and various others.

Without double-entry accounting there would be no capital which is a constant real value non-monetary item. Without double-entry accounting there would only be monetary items and variable real value non-monetary items.

"The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double-entry bookkeeping.” Sombart 1953, p. 38.

Capitalism is based on double-entry accounting.

"Capitalism develops rationality and adds a new edge to it in two interconnected ways. First it exalts the monetary unit-not itself a creation of capitalism-into a unit of account. That is to say, capitalist practice turns the unit of money into a tool of rational cost-profit calculations, of which the towering monument is double-entry bookkeeping. . . . We will notice that, primarily a product of the evolution of economic rationality, the cost-profit calculus in turn reacts upon that rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise." Schumpeter 1950, p. 123.

http://www.dse.unive.it/summerschool/course2007/accounting%20and%20rationality.pdf

Kindest regards,

Nicolaas Smith