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Saturday, 15 November 2008

Only Constant Item Purchasing Power Accounting maintains constant items´ real values



There are no constant real value non-monetary items without double entry accounting.

A fundamental attribute of the Constant Item Purchasing Power Accounting model is that it maintains the real values of constant items during inflation (increasing nominal values) and deflation (decreasing nominal values) as a result of the measurement of financial capital maintenance in units of constant purchasing power. A fundamental attribute of the traditional Historical Cost Accounting model is that it destroys the real values of constant items never or not fully updated (increased) during inflation and creates real value in constant items never or not fully updated (decreased) during deflation as a result of the stable measuring unit assumption.

CPPA maintains constant items´ real values while HCA destroys constant items´ real values. SA accountants unknowingly are responsible for maintaining or destroying constant items´ real values in the SA real economy depending on the choice they make in terms of the IASB´s Framework, Par. 104 (a) which forms part of IFRSs.

The fact that SA accountants value economic activity does not mean that they can create value out of nothing simply by accounting economic items using the double entry accounting model. They cannot and do not use the basic accounting model to create wealth out of thin air. It is not part of the wealth creating process. No accounting model can create real value out of nothing.

SA accountants can maintain the real value of constant items in the real economy, but, only when they choose to measure financial capital maintenance in units of constant purchasing power as provided for in the Framework, Par. 104 (a). They can not do that when they choose to measure financial capital maintenance in nominal monetary units; that is, when they choose the traditional HCA model, unfortunately also provided for in Par. 104 (a). In fact, accountants do exactly the opposite when they choose to measure financial capital maintenance in nominal monetary units: they unknowingly destroy the real values of constant items never or not fully updated under the HC model at the rate of inflation.

Framework, Par. 110:

“The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements”

Not a single SA Chartered Accountant chooses to measure financial capital maintenance in units of constant purchasing power in terms of the IASB´s Framework Par. 104 (a) for any SA company listed on the Johannesburg Stock Exchange. Not one CA chooses the Constant Purchasing Power Accounting model under which she or he would maintain the real values of all constant items in a JSE listed company.

All CAs in JSE listed companies choose to measure financial capital maintenance in nominal monetary units. All Financial Directors and Chief Financial Officers of JSE listed companies state in their notes to the balance sheet that their companies´ accounts have been prepared based on the Historical Cost model; that is, that they implement the stable measuring unit assumption. In so doing, they, as well as all other accountants in all unlisted SA companies, are unknowingly responsible for the destruction of the real value of all constant items never or not fully updated in their companies in the SA real economy at the current 13% rate of inflation. This amount to about R200 billion per annum in current values compounded into the future for as long as SA accountants choose to implement the stable measuring unit assumption as it forms part of the HCA model; that is, for as long as they make the Historical Cost Mistake.

The accountants in these companies are unknowingly and unintentionally responsible – because they choose to measure financial capital maintenance in nominal monetary units in terms of Par. 104 (a) - for the destruction of the real values of salaries, wages, rents, pensions, taxes, duties, fixed interest payments, all other Profit and Loss Account items, retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, all other shareholder’s equity items, provisions, trade debtors, trade creditors, other non-monetary debtors and creditors, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, etc never or not fully updated at the rate of inflation in SA.

Only Constant Purchasing Power Accounting models can maintain the real value of constant items over time in inflationary and deflationary economies. Real Value Accounting is a CPPA model presenting all items at today’s real value. The valuation of economic items, the measurement of financial capital maintenance in constant purchasing power units and the determination of profit are the same under CPPA models and the RVA model. Generally CPPA models present results calculated in units of constant purchasing power at the CPI rate prevailing at the period end date. Those results or real values are not updated every month in the future when the CPI changes. Historical CPP values are thus presented as HC values in the future when the CPI changes. They are thus calculated in units of CPP and then presented in the future at their HC values at the period end date. The RVA model measures financial capital maintenance in units of constant purchasing power – it is a CPPA model - and always presents all CPP calculated items updated at the latest CPI value in the future.

Copyright © 2008 Nicolaas Smith