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Monday, 26 October 2009

The IASB´s alternative to Historical Cost Accounting

The IASB´s alternative to Historical Cost Accounting


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Last updated on 17 April, 2012

Constant Purchasing Power Accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the International Accounting Standards Board´s inflation accounting model required to be implemented only during hyperinflation.

Constant ITEM Purchasing Power Accounting (CIPPA) is the IASB´s basic accounting alternative to traditional Historical Cost Accounting during low and high inflation and deflation. The stable measuring unit assumption is implemented under HCA. The stable measuring unit assumption is never implemented as a GAAP under CIPPA. HCA implements financial capital maintenance in nominal monetary units. CIPPA implements financial capital maintenance in units of constant purchasing power in terms of a daily index. CIPPA is fundamentally different from HCA. Financial capital maintenance in nominal monetary units is a fallacy because if is impossible to maintain the constant purchasing power (real value) of capital constant in nominal monetary units per se during inflation and deflation. CIPPA, on the other hand, automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation - ceteris paribus.

Both CPPA and CIPPA are price-level accounting models. IAS 29 simply requires the restatement of all non-monetary items (both variable and constant real value non-monetary items) in Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published Consumer Price Index during hyperinflation. IAS 29 is an extension to, not a departure from HCA per PricewaterhouseCoopers. IAS 29 had no effect during hyperinflation in Zimbabwe.

CIPPA as approved by the IASB in the original Framework for the Preparation and Presentation of Financial Statements (1989), Par. 104 (a) which states

'Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power'

requires the following:

(1) Daily inflation-adjustement of all historic and current period monetary items in terms of a Daily CPI or monetized daily indexed unit of account. The net monetary loss or gain is calculated and accounted when monetary items are not inflation-adjusted daily during the current accounting periõd. The net monetary loss or gain is a constant real value non-monetary item once accounted in the income statement.
(2) Daily valuation of variable real value non-monetary items in terms of IFRS excluding the stable measuring unit assumption. Historical variable items (e.g., valued yesterday) are updated daily in terms of the Daily CPI or monetized daily indexed unit of account when they are not valued daily in terms of IFRS during low and high inflation and deflation. Impairments are treated in terms of IFRS.

(3) Historic and current period constant items are always and everywhere measured in units of constant purchasing power in terms of the Daily CPI or monetized daily indexed unit of account during low and high inflation and deflation. The net constant item loss or gain is calculated and accounted when current period constant items are not measured daily in units of constant purchasing power.

In terms of the Framework, accountants can choose CIPPA to implement a financial capital concept of invested purchasing power instead of the traditional HC concept of invested money. They will thus implement a CPP financial capital maintenance concept by measuring financial capital maintenance in units of CPP instead of traditional HC nominal monetary units and they will implement a CPP profit/loss determination concept. Examples of constant items include issued share capital, retained income, shareholders´ equity, trade debtors, trade creditors, deferred tax assets and liabilities, salaries, wages, rentals, etc. Examples of variable item include property, plant, equipment, shares, inventory.

Monetary, variable and constant items are the three fundamentally different basic economic items in the economy.

CIPPA would maintain the real value of constant items including banks´ and companies´ capital base, for an unlimited period of time - all else being equal, as opposed to the traditional HCA model which unknowingly, unintentionally and unnecessarily erode the real value of constant items never maintained constant. CIPPA was authorized by the IASB in 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation in the Framework and is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of constant items.

CIPPA (not CPPA) during hyperinflation would be the same as in non-hyperinflationary economies. The only difference is that the daily rate would be a relatively stable foreign currency daily parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate. All non-monetary items (variable and constant items) would be measured in units of constant purchasing power on a daily basis as indicated above during hyperinflation.

Discredited 1970-style CPPA was a form of inflation accounting which tried unsuccessfully - by updating all non-monetary items (variable and constant items) equally by means of the CPI during high inflation - to allow for the effect of the stable measuring unit assumption in an attempt to make corporate accounts more informative when comparing current transactions with previous transactions.

Nevertheless, almost all accountants and accounting authorities - excluding the IASB - mistakenly regard CIPPA as the same as the discredited and failed 1970-style CPPA inflation accounting model. They ignore the CIPPA model's substantial benefits, for example, automatically maintaining banks´ and companies´ capital base when accountants choose to measure constant items in units of constant purchasing power by means of the Daily CPI thus maintaining instead of continuously eroding their real values at a rate equal to the rate of inflation while they value variable items daily in terms of IFRS or GAAP excluding the stable measuring unit assumption.

Certain income statement constant items, most notably salaries, wages and rentals, etc. are measured in units of constant purchasing power on an annual basis, but are paid in fixed monthly amounts again implementing the stable measuring unit assumption in most economies implementing the HCA model.

The IASB specifically requires the CPPA inflation accounting model to be used during hyperinflation as per IAS 29.


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Nicolaas Smith

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