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Saturday, 16 August 2008

Abandoning the stable measuring unit assumption in South Africa

Here are some notes about abandoning the stable measuring unit assumption.

First of all, it is not the same as inflation accounting as can be found in many books and articles written about inflation accounting over the last 100 years.

That is why the term stable measuring unit assumption is not even mentioned in Geoffrey Whittington’s master work “Inflation Accounting – An introduction to the debate”.

The stable measuring unit assumption, as a Generally Accepted Accounting Practice, is, on the specific level, only applied in the valuing - by Chartered Accountants - of “non-monetary items which do not hold their value in terms of purchasing power.” Currently CAs specifically choose to value “non-monetary items which do not hold their value in terms of purchasing power” at historical cost when they apply the stable measuring unit assumption as part of the Historical Cost Accounting model.
Everyone first thinks that I want to implement 1970 style “inflation accounting” in South Africa. That is completely untrue.

I want SA to abandon the stable measuring unit assumption; that is, I want SA to update constant real value non-monetary items never updated (e.g. retained earnings) or not fully updated in the SA economy over time - at the rate of inflation under non-hyperinflationary conditions and at the parallel rate if SA ever experiences hyperinflation.

I simply show, additionally, that it is actually the combination of inflation and the stable measuring unit assumption – a Generally Accepted Accounting Practice, as implemented by choice by Chartered Accountants – and not simply “inflation” - which destroys the real value of non-monetary items that do not hold their purchasing power over time – also called constant real value non-monetary items or constant items.

If we had only inflation in money and no accounting, then there would be no destruction of value in non-monetary items since inflation only destroys real value in non-monetary items that do not hold their purchasing power over time in combination with the stable measuring unit assumption; that is, in combination with a Generally Accepted Accounting Practice that is part of the Historical Cost Accounting model and that Chartered Accountants choose to implement since they are not required to use the HCA model by IASs, IFRSs, SA GAAPs or the SA Companies Act.

I do not say abandon all current accounting International Standards and SA GAAPs: I say simply abandon one assumption. I do not say abandon a fact. I say abandon an assumption: the stable measuring unit assumption.

CAs use the unit of measure in accounting to be the base money unit of the most relevant currency in SA, namely the Rand. CAs also assume the Rand is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.

Abandoning the stable measuring unit assumption changes the HCA to the Real Value Accounting model.

Real Value Accounting is based on all current IFRSs, IASs, SA GAAPs and the SA Companies Act - excluding the stable measuring unit assumption, the definition of monetary items in IAS 21 and excluding the whole of IAS 29. IAS 29 is not required under Real Value Accounting when the stable measuring unit assumption is revoked.

CAs unknowingly / unintentionally / unwittingly destroy the real value of constant items never updated, e.g. retained earnings, or not fully updated over time in the SA economy at the inflation rate. This amounts to R57.983 billion in the case of those 169 JSE listed companies I have analyzed so far. I estimate that CAs unknowingly destroy a total of about R 200 billion each and every year in the SA real economy as a result of their application of the stable measuring unit assumption.

This destruction is an integral part of the HCA model. It is a Generally Accepted Accounting Practice under the current Historical Cost paradigm.

However, the stable measuring unit assumption is not required for the basic double entry accounting model. Real Value Accounting is also a double entry accounting model. The stable measuring unit assumption does not form part of the Real Value Accounting model.

Chartered Accountants´ unintentional destruction of the real value of constant items never or not fully updated is an indispensable part only of the HCA model. It is, fortunately, not a part of the basic double entry accounting model. It came about as a result of unavoidable historical circumstances, namely the lack of an index value to adjust constant items for inflation in the past.

This does not diminish the fact that CAs´ unwitting killing of the real economy is an integral part of generally accepted current economic activity in SA under the Historical Cost paradigm. Fortunately it is easy to stop CAs killing the real economy. Just stop the stable measuring unit assumption which is the next step in our fundamental model of accounting.

No-one stops CAs from abandoning the stable measuring unit assumption. Neither the SA Companies Act nor IASB Standards nor SA GAAPs require the HCA model.

This destruction by CAs is completely eliminated and is physically and mathematically impossible under the Real Value Accounting model which revokes the stable measuring unit assumption.

To the IASB all non-monetary items are the same. The stable measuring unit assumption allows them to do that. They have IASs and IFRSs to value non-monetary items with variable real values and they solve the problem of inflation by simply assuming there is no inflation in the valuing of constant items. They, like SA CAs, value them at historical cost and thus destroy their real value over time at the rate of inflation.

We can derive almost all of the basic theory of CIPPA from the statement that inflation destroys value in “non-monetary items which do not hold their value in terms of purchasing power”.

Then we can complete the basic theory of CIPPA from the statement in the opening post in this thread: “Even then, the adjusted figures have little meaning, since by the time they see the light of day they are already out of touch with reality.”

Real Value Accounting is so much in line with what everybody already knows but no-one implements, that we can take that statement and your statement and derive almost all of Real Value Accounting from those two statements.

What are non-monetary items?

Non-monetary items are all items that are not monetary items.

Non-monetary items are subdivided into:

1. Variable real value non-monetary items; and
2. Constant real value non-monetary items.
What is not realized is that by agreeing that inflation destroys the real value of not only monetary items – as we all know – but, also “non-monetary items which do not hold their value in terms of purchasing power” implies that he agrees that the combination of inflation and the stable measuring unit assumption as implemented by Chartered Accountants as a GAAP under HCA destroys constant real value non-monetary items never or not fully updated.

How else does inflation destroy “non-monetary items which do not hold their value in terms of purchasing power”?

Inflation destroys the real value of money as a result of the very nature of money: we could have inflation in money even if we do not have any accounting. Neither the basic double entry accounting model nor the HCA model has anything to do with the causes of inflation - the destruction of the real value of money.

The statement that inflation destroys the value of “non-monetary items which do not hold their value in terms of purchasing power” is only possible and inflation can only do that not because of the double entry accounting model per se, but because of the implementation of the stable measuring unit assumption as part of the HCA model.

Constant items only came about with the introduction of the double entry accounting model.

There is no destruction of value by inflation in variable real value non-monetary items.

Variable items in South Africa are valued at fair value or the lower of cost or net realizable value or recoverable value or market value or present value in terms of International Financial Reporting Standards (IFRSs), International Accounting Standards (IASs) and South African Generally Accepted Accounting Practice (SA GAAP). “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

Variable items in SA are adequately valued in terms of International Standards and GAAP - at the balance sheet date. Originally all variable items were valued at historical cost.


The debate today is about whether the Historical Cost Accounting model creates and destroys value.

It does destroy value. It also creates value. Without the double entry accounting model there are no constant items – only variable items.

CAs create value by implementing the double entry accounting model. They put in motion the process that creates constant items.

CAs do not destroy value by implementing the double entry accounting model per se.

Cas unknowingly destroy value when they implement the stable measuring unit assumption in conjunction with the double entry accounting model, that is, when they implement the HCA model.

When CAs abandon the stable measuring unit assumption they will maintain the real value of all constant items in SA for an unlimited period of time. They will maintain hundreds of billions of Rand in constant item real value year in year out. They will be responsible for reducing the destruction of real value in constant items in the real economy to zero percent for an unlimited period of time. I estimate that value to be about R200 billion per annum.

CAs will be responsible for protecting the SA real economy from real value destruction in constant items never or not fully updated by the combination of inflation and the stable measuring unit assumption.

We will still have inflation in monetary items in the SA monetary economy, but we will have 0% destruction of real value in the real economy.

If CAs carry on with the stable measuring unit assumption they will carry on unknowingly destroying all constant items never updated (e.g. retained earnings in all SA companies) at the annual rate of inflation as they are doing at the moment - albeit unintentionally. Constant items not fully updated will be destroyed at a lower rate than the annual rate of inflation.

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