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Saturday, 7 March 2009

Accountants value economic activity

The debate of how to account for value has been around for decades.

Robert Kemp, CPA Professor, University of Virginia – CC http://www.glgroup.com/News/Fair-Value-Accounting---The-Good-And-Bad-Of-It-In-The-Real-World-27848.html


The three distinct economic items in the economy

1. variable items
2. monetary items and
3. constant items

are economic values. Each economic item is an economic value expressed in terms of money. SA accountants account economic transactions involving these three economic items in an organized manner when they implement a double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, items in the Profit and Loss Account, assets and liabilities in the Balance Sheet plus other financial, management and costing reports.

SA accountants value economic items when they account economic activity in the accounting records and prepare financial reports of SA economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

SA accountants do not simply record economic activity. Accounting is not just a scorekeeping or recordkeeping of economic events. Accountants value economic items when they account them. Subsequent accounting entries are part of continuous generally accepted accounting practice of valuation of the economic items originally valued and accounted over time as required by SA Generally Accepted Accounting Practice and IFRS implemented in conjunction with the IASB´s Framework.

The measurement basis SA accountants choose to value constant real value non-monetary items determines whether they maintain or destroy their real values. Inflation being a monetary phenomenon cannot destroy the real value of constant real value non-monetary items. When accountants value constant items at their HC nominal monetary values they unknowingly destroy their constant real non-monetary values at a rate equal to the rate of inflation because the depreciating monetary unit of account is the same as the depreciating monetary medium of exchange and inflation destroys the real value of the depreciating monetary medium of exchange. Only when they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power – as they can freely do in terms of the IASB´s Framework, Par. 104 (a) - do they maintain their real values over time.

Variable Items

SA accountants value variable real value non-monetary items in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

Monetary items

SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items can not be updated or indexed during the current financial period for the purpose of

1. accounting their values during the reporting period,
2. determining the profit or loss for the reporting period, and
3. measuring financial capital maintenance in either nominal monetary units or constant purchasing power units

during inflation or deflation.

Inflation – not SA accountants - destroys the real value of SA monetary items over time. The internal real value of the Rand is automatically adjusted downwards as it is being destroyed by the economic process of inflation in SA´s inflationary economy as indicated by the rate of change in the CPI. Inflation destroys the real value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors. The accounting model has no affect on the real value of monetary items during the reporting period.

Double entry accounting cannot maintain the real value of monetary items during the reporting period. It is not an attribute of double entry accounting to maintain the real value of monetary items during the reporting period. Inflation destroys the real value of monetary items no matter which accounting model is used. That is why low inflation is so critical for long term sustainable economic growth.

Low inflation is what long term sustainable economic growth is built on. Alan Greenspan.

Constant items

SA accountants can choose to measure financial capital maintenance in either nominal monetary units or in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a).

It is very obvious that how SA accountants choose to measure financial capital maintenance does make a big difference to the real value of constant items. There is no substance in the statement that economic resources´ values – per se - are independent of the way in which we value them – no matter how well respected and how important that person is in the SA accounting and academic circles. The accounting model SA accountants choose in terms of the Framework, Par. 104 (a) is of critical importance. When they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power they will maintain the real values of, for example, all SA banks´ and companies´ retained income values constant over time, all else being equal, instead of unknowingly destroying them as the currently do. The only way they can maintain the real value of constant real value non-monetary items during inflation and deflation is by choosing a Constant Purchasing Power Accounting model as per the IASB´s Framework, Par. 104 (a).

Not a single SA accountant in SA chooses to measure financial capital maintenance in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a). SA accountants, unfortunately, choose to measure financial capital maintenance in nominal monetary units and thereby, unknowingly, destroy the real values of constant items at a rate equal to the rate of inflation when they are never or not fully updated over time when they implement the very destructive stable measuring unit assumption as part of the HCA model. SA accountants are unknowingly killing the real economy at the rate of about R200 billion per annum – each and every year - as long as they carry on implementing the very destructive stable measuring unit assumption.

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