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Wednesday, 25 November 2009

700 year old paradigm based on a single wrong assumption

SA companies´ Issued Share Capital and Share Premium Account values stay the same and so do other reported constant real value non-monetary items in audited financial reports, for example reported Retained Earnings and Capital Reserves under the Historical Cost paradigm in SA´s low inflationary economy. This all helps to reinforce the illusion that the Rand maintains its real value over time which is not true. It is an illusion, namely money illusion.

The SA low inflationary economy is locked into the HC paradigm by a single wrong assumption: the stable measuring unit assumption whereby SA accountants assume that changes in the Rand´s real value are not of sufficient importance to justify financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g., salaries, wages, rents, regulated prices, etc. and generally implement financial capital maintenance in nominal monetary units; i.e. they implement the real value destroying HCA model which includes the very destructive stable measuring unit assumption during low inflation.

The combination of HCA and low inflation plus money illusion blinds us to the continuous destruction of existing real value in reported balance sheet constant items in companies by SA accountants implementing the stable measuring unit assumption in our low inflationary economy. It is true that everything is done in accordance with IFRS or SA GAAP because the ongoing destruction of existing real value in existing reported balance sheet constant items in companies is an integral part of the current global HCA model in countries with low inflationary economies.

This is a direct result of accountants´ stable measuring unit assumption as authorized in the Framework, Par. 104 (a) where under they choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – the other option in Par. 104 (a) also compliant with IFRS. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they would knowingly stop the destruction of existing real value in reported balance sheet constant items in SA companies forever – all else being equal. They would also stop the creation of more real value in reported balance sheet constant items not updated (decreased in nominal value) in companies in deflationary economies forever – all else being equal.

Kindest regards,

Nicolaas Smith