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Sunday, 29 November 2009

Accounting model maintains value - Part 2

Capital - as a variable real value non-monetary item (as traded or untraded shares in a company) - would have emerged even without double-entry accounting.

It is clear, however, that the real value of capital - as a constant real value non-monetary item - i.e. being all the items in shareholders´ equity (issued share capital, reported retained profits, share premium account, capital reserves, etc), can only be maintained constant during inflation with double entry accounting implementing not traditional Historical Cost Accounting (the stable measuring unit assumption) but financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is compliant with IFRS.

Double entry accounting can maintain the real value of existing constant items (issued share capital, reported retained profits, etc.) even in companies with no fixed assets as long as they at least break even for an unlimited period of time during indefinite inflation, but, only with financial capital maintenance in units of constant purchasing power - not with the traditional 700 year old Historical Cost Accounting model implementing the very destructive stable measuring unit assumption during low inflation.

Thus, instead of saying that the accounting model creates value we can say the accounting model maintains value - qualified as above.

Kindest regards,

Nicolaas Smith