Advice to Geoff Everingham: Abandon the stable measuring unit assumption

Re: Inflation Saturday, June 21, 2008 4:36 PM
From: "RealValueAccounting.Com™"
To: "Geoffrey Everingham"

Hi Geoff,

Thank you very much for your reply.

I note you have not answered the following from my previous email: Do you accept the fact that non-monetary items are sub-divided into:

Variable real value non-monetary items, and
Constant real value non-monetary items?

You state: "I see the ......... ... value of economic resources existing
independently of how we measure them"

It is important to note that although the IASB and the accounting and economic literature in general only recognise two economic items, namely, monetary and non-monetary items, there are in fact three distinct economic items:

1. Monetary items
2. Variable real value non-monetary items valued in terms of IASs, IFRSs and SA GAAP at fair value, market value, the lower of cost or realisable value, recoverable value or present value.
3. Constant real value non-monetary items that only have constant real values as a result of the double entry accounting model (e.g. retained income, issued share capital, other shareholder equity items, trade debtors, trade creditors, other non-monetary debtors, other non-monetary creditors, company taxes, personal taxes, value added taxes, deferred taxes, all items in the P&L, etc.).

Without the double entry accounting model, No 3 items would be variable items. Constant items only have constant real values because of the implementation of the double entry accounting model. I am not referring to the HCA model, but the double entry accounting model. Real Value Accounting is also a double entry accounting model.

There is no problem with the valuing of monetary items under all current accounting models. Inflation/hyperinflation values monetary items automatically day by day. We all know that monetary items´ real values are continuously being destroyed in inflationary and hyperinflationary economies at the rate of inflation or hyperinflation respectively. I will leave out deflation for now.

Your statement: "I see the ....... value of economic resources existing
independently of how we measure them" thus does not apply to monetary items as we all measure monetary items in the same way, namely at historical cost, or, their original nominal values. Monetary items´ real values are thus being destroyed at the rate of inflation or hyperinflation because it is impossible to update their orginal nominal values or historical costs in active accounts. I do not think there is any disagreement here.

I also agree with you that the value of variable items exist independently of how we measure them. A piece of land or a building may be valued in the balance sheet today at its original historical cost of say R50 000 first accounted 50 years ago, but, when it is actually sold today it may fetch R1 million. The real value of a variable item is not destroyed because it is temporarily/currently being valued at historical cost.

I agree with the valuing of all variable items in terms of IASs, IFRSs and SA GAAP, excluding the stable measuring unit assumption, the whole of IAS 29 and the definiton of monetary items in IAS 21.

It is really all about the recognition of constant real value non-monetary items and how they are valued, or, the abandoning of the stable measuring unit assumption in the valuing of constant items.

The values of constant items do depend on how we measure them.

Under HCA they are valued at historical cost as a result of the implementation of the stable measuring unit assumption. The stable measuring unit assumption is only used for this purpose by accountants and nothing else under the HCA model.

Since constant items, in fact, have constant real non-monetary values, their real values are constantly being destroyed at the rate of inflation or hyperinflation when they are valued at historical cost as a result of the implementation of the stable measuring unit assumption - exactly the same as in the case of monetary items.

I am sure you will agree with me that when you never update workers´ salaries in South Africa then the real value of their salaries are being destroyed at 11.1% per annum, the current inflation rate in SA. The real value of their salaries are being destroyed at the rate of inflation because of the implementation of the stable measuring unit assumption in the case of their salaries never being updated - which is the case with retained earnings.

All workers, trade unions and most people in South Africa know that. That is why SA government workers are going to get an across the board increase equal to the inflation rate plus 1%. I am sure you are aware of that.

It does matter how we value constant items.

That proves that the implementation of the stable measuring unit assumption as part of the Historical Cost Accounting model destroys the real value of salaries not updated in SA.

That also proves that the implementation of the stable measuring unit assumption as part of the Historical Cost Accounting model destroys the real value of retained earnings, issued share capital of all SA companies with no non-monetary items to revalue, other shareholder equity items, trade debtors, trade creditors, other non-monetary debtors, other non-monetary creditors, company taxes, personal taxes, value added taxes, deferred taxes, all items in the P&L, etc never or not fully updated.

This is a very important fact. Successive Brazilian governments updated all non-monetary items in their economy for 30 years: from 1964 to 1994 - according to the Brazilian Central Bank in an email to me. When they were in hyperinflation the government supplied a daily index value to update all non-monetary items (See Unidade Real de Valor in Wikipedia http://en.wikipedia.org/wiki/Unidade_Real_de_Valor .) In that way they maintained stability in their real economy, while they had high and hyperinflation in their monetary or cash economy.

Brazil’s 30 year updating - under various different governments - of all (under hyperinflation) non-monetary items is complete proof that what you stated in your letter to the Financial Mail, namely that “comprehensive CPI-based adjustment of the accounts themselves is not - and has nothing to do with the creation or destruction of value in the economy” and that “It is completely mistaken to accuse accountants of this” have no substance at all.

Please note that abandoning the stable measuring unit assumption in SA does not mean comprehensive CPI- based adjustment of the accounts, but only of constant real value non-monetary items never or not fully updated - e.g. retained earnings, issued share capital, other shareholder equity items, trade debtors, trade creditors, company taxes, personal taxes, value added taxes, deferred taxes, all items in the P&L, e.g. salaries, wages, rent, fees, royalties, etc.

Your and many other accountants´ initial denial is natural in a situation like this. The stable measuring unit assumption forms part of the Historical Cost Accounting model for the last 500 years. We cannot expect it to be abandoned from the one day to the next. But, when we actually sit down and calculate the real annual cost to our economy in the destruction of real value in constant items never or not fully updated because of CAs applying the stable measuring unit assumption, then the matter becomes very urgent – especially with inflation running at 11.1% and rising in SA.

You state: " the choice of the measuring unit does not affect their fundamental value," Brazil´s 30 years of updating non-monetary items is complete proof that your statement has no substance at all.

Gustavo Franco, the governor of the Brazilian Central Bank at the time of the Unidade Real de Valor stated the following to me in an email regarding this matter:

"The unit of account enteres the picture only when at least one leg of a commercial transaction is defferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs are to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.

It was essential, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denomiated obligation had to be treated as if they were obligations subject to monetary correction."

Gustavo Franco is a Brazilian central banker and does not use the same accounting jargon we use.

Your statement: "so we can use rands, rands of constant purchasing
power, ......, whatever we think best represents that value and will
make sense to whoever is using the information produced." has no substance at all.

Rands and rands of constant purchasing power are not the same. It is the same as stating that nominal and real interest are the same. That has no substance at all.

Your statements: "So its fine to represent value in terms of constant purchasing power & to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't
affect the nature of the underlying resources. The choices accountants make
won't change that value & won't affect the economy" are completely disproved by Brazil´s 30 year very successful history of updating non-monetary items whereby they stabilized their real or non-monetary economy and had real economic growth while they had cash hyperinflation in their monetary or cash economy.

This contrasts with Zimbabwe´s 14 years of total destruction of their real economy because their accountants continued and continue to apply the stable measuring unit assumption in the actual day to day accounting of constant real value non-monetary items.

Your statement that "The analogy of the bulldozer doesn't hold,, as there are real changes taking place as a result of its activity -whereas the scorekeeping analogy does hold as it is merely a recording/measuring process." has no substance at all as proved by Brazil´s 30 years of updating non-monetary items. They updated non-monetary items for 30 years to maintain the real values of their non-monetay items. Those were real changes taking place.

I am convinced that the stable measuring unit assumption will soon be abandoned in the SA economy. It will benefit all workers and all companies (including the companies on whose boards you are sitting) as well as the government and it will improve economic growth and job creation for an indefinite period of time. As the Deutsche Bundesbank stated in their 1996 annual report: “The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”

Abandoning the stable measuring unit assumption will result in 0% inflation (absolute price stability) only in the SA real economy – with concomitant benefits to workers, business and government. We will still have cash inflation in the monetary or cash economy.

Kind regards,

Nicolaas