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Wednesday, 21 October 2009

Valuing monetary items during low inflation

Valuing monetary items during low inflation

Money and other monetary items can not be updated or indexed or inflation-adjusted or maintained during the current financial period under any accounting model under any economic mode that is not sustainable zero per cent annual inflation. Inflation destroys the real value of monetary items evenly throughout the SA monetary economy currently at 6.4% per annum (Aug 2009) or about R124 billion per annum. Monetary items only maintain their real values perfectly stable under sustainable zero per cent annual inflation. This has never been achieved before over an extended period of time.

The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. SARB

The SARB´s definition of price stability, in practice, is the destruction of the real value of the Rand at a rate of 6% or about R120 billion per annum because inflation normally increases to the top of the inflation targeting range. Real value is destroyed evenly in Rand bank notes and coins and other monetary items (loans, deposits, etc) throughout the SA monetary economy. Why destroying R120 billion per annum of the Rand´s real value in people’s pockets is supposedly good for the SA economy – supposedly good for economic growth and supposedly good for creating employment – is not well known in the SA economy.

SA accountants account monetary items at their original nominal values – at their historical cost – during the current financial period. It thus appears that it is correct when it is stated that “financial reporting simply reports on what took place”. That is dead wrong. Accountants value everything they account. There is no other way monetary items can be accounted and valued during the current financial period. It is an illusion that accountants only record what happened in the past: the “financial reporting simply reports on what took place” illusion as promoted by some SA accounting professors.

SA accountants value monetary items at their current depreciated generally lower real values by accounting them at their original nominal values during inflation. Their real values are destroyed by inflation over time. Being stated at their original nominal values by accountants during inflation means that monetary items are automatically being valued by the continuous economic process of inflation over time.

This obviously means that monetary items are always correctly valued during the current financial period in any current account: at the current real value as determined by the current rate of inflation. Money and other monetary items´ real values consequently generally decrease monthly to a lower real value in low inflationary economies.

SA accountants do not destroy the real value of monetary items in the SA monetary economy: inflation does that. SA accountants value and account monetary items correctly in the SA monetary economy by stating them at their original nominal values. They, however, fail to calculate and account the net monetary gains and losses from holding either net monetary liabilities or net monetary assets, as the case may be.

The only difference between accounting and valuing monetary items under the current real value destroying Historical Cost Accounting model and their accounting and valuation when measuring financial capital maintenance in real value maintaining units of constant purchasing power would be the calculation and accounting of net monetary gains and losses. These gains and losses are not calculated and accounted under the HCA model although it can be done. See Kapnick above. No-one does that under HCA. Net monetary gains and losses are constant real value non-monetary items (income statement gains and losses) once they are accounted and have to be inflation-adjusted thereafter under the Constant ITEM Purchasing Power Accounting model.

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