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Monday, 21 September 2009

Inconvenient Villains

Dictionary.com: villain - "Something/someone said to be the cause of particular trouble"

There are three basic economic items in the economy.

1. Monetary items
2. Variable items
3. Constant items

Accountants value everything they account. Every accounting entry accounts a debit value and a credit value.

1. Monetary items are items like money, bank account balances, car loans, housing loans, student loans, consumer loans, any loan in money, saving accounts, etc.

Accountants cannot value them wrongly: the only way accountants can value and account monetary items is at their original nominal values. Inflation destroys the real value of the Rand and monetary items. So, monetary items are always automatically kept at their always lower real values because inflation destroys their real values equally.

This loss in real value is, inexplicably required by accounting authorities to be calculated and accounted during hyperinflation, but not during low inflation. Why, no-one knows. The IASB authorized accounting in units of constant purchasing power during low inflation 20 years ago. Under this accounting model you have to calculate the real value loss in money during low inflation. But, not when you use the traditional Historical Cost Accounting model that the whole world uses. Why, no-one knows.

So, inflation and not accountants destroys the real value of your Rand balances you keep over time. So, don´t keep Rand balances and you will not lose any real value. Or if you keep Rands over time, you have to receive interest on that money at least equal to the inflation rate over that period. That is just to maintain the real value of your money. You still have not received and real interest. Just nominal interest if it is exactly equal to the inflation rate.

2. Variable items are things like fixed property, land, buildings, plant, machinery, equipment, computers, raw material stock, finished goods stock, etc.

Accountants again value all these items when they account them. They value them in terms of rules set forth in International Financial Reporting Standards or SA Generally Accepted Accounting Practice.

No value is destroyed here by accountants as long as they follow the rules correctly.

So here we have no problem.

3. Constant items are items like salaries, wages, rentals, companies´ capital, retained profits, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary receivables and all other non-monetary payables, etc.

Accountants value salaries, wages, rentals, etc in units of constant purchasing power. So, they inflation-adjust these items every year and thus keep their real values updated. You know that if your salary is not inflation-adjusted then its real value is destroyed – not by inflation (inflation can only destroy the real value of the Rand which is the medium of exchange used to pay the constant item salary) - but by the accountant that values your salary at Historical Cost. When the accountant values your salary in units of constant purchasing power or updates it in terms of inflation then you do not lose any real value in your salary. So, it is your accountant’s way of doing accounts that is maintaining the real value of your salary. It has nothing to do with inflation because it does not matter how high or how low inflation is, when your accountant inflation-adjust your salary you never lose real value.

Your accountant has to do the same with your company´s capital, retained profits if you keep profit behind in the company to grow the company, trade debtors, trade creditors, taxes payable, taxes receivable, etc. Not a single accountant in SA does that. By not updating these items in terms of inflation or not inflation-adjusting them, your accountant is unknowingly destroying their real values at a rate equal to the rate of inflation. It is not inflation doing the destroying because if your accountant values these items in units of constant purchasing power, that is, updates them in terms of inflation or simply inflation-adjust them, then your accounatant will maintain their real values constant forever – as long as your business at least breaks even.

The International Accounting Standards Board authorized your accountant to do that 20 years ago. Not a single accountant in SA does that because they do not understand and they are not taught that valuing these items at Historical Cost means they destroy their real values at a rate equal to the inflation rate. They also do not understand and they are not taught that when they inflation-adjust these items they maintain their real values constant forever as long as your business breaks even.

Kindest regards,

Nicolaas Smith