Thursday, 14 January 2010

Two accounting fallacies authorized by the IASB

Constant real value non-monetary items

"Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction makes no sense and leads to results that are void of meaning. (Massone, 1981a. p.6)"

The Taxation of Income from Business and Capital in Colombia: Fiscal Reform in the Developing World, By Charles E. McLure, John Mutti, Victor Thuronyi, George R. Zodrow, Contributor Charles E. McLure, Published by Duke University Press, 1990, ISBN 0822309254, 9780822309253, Page 259

Constant items are non-monetary items with constant real values over time.

The double entry accounting model was first comprehensively codified by the Italian Franciscan monk, Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.

SA accountants use the Consumer Price Index to maintain the real values of certain – not all - income statement constant items, e.g. salaries, wages, rentals, etc constant during low inflationary periods. They value them in units of constant purchasing power while they generally implement the real value destroying Historical Cost Accounting model which is based on two IASB authorized accounting fallacies, namely, financial capital maintenance in nominal monetary units and the very destructive stable measuring unit assumption during inflation.

Accountants are required by the International Accounting Standards Board to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. They have to restate their HC or current cost financial statements by applying the CPI during hyperinflation. They have to value all non-monetary items (both variable and constant items) in units of constant purchasing power by applying the CPI at the period end date. Companies in a hyperinflationary economy can only use IAS 29 to maintain the real value of non-monetary times stable when their tax authorities accept the restated values for the calculation of taxes due.

“Regarding to tax regulation, I want to emphasize that tax regulation required restatement of assets and liabilities according to inflation (in terms of IAS 29) for the date of 31.12.2003 but taxes were not taken according to restated values in 2003. In 2004, financial statements were restated and taxes were taken based on restated values.”

Cemal KÜÇÜKSÖZEN, Ph.D, Head of Accounting Standards Department, Capital Markets Board of Turkey

Constant Purchasing Power inflation accounting as defined in IAS 29 is a complete price-level inflation accounting model where under ALL variable and constant real value non-monetary items are inflation-adjusted by means of the CPI during hyperinflation.

Only the Constant ITEM Purchasing Power Accounting model, as approved by the IASB in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a) in 1989, enables accountants to maintain the real values of all income statement and balance sheet constant items constant during inflation and deflation.

The IASB´s Framework, Par 104 (a) states:

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

The IASB thus, amazingly, authorized and approved the two very popular accounting fallacies and their only and perfect antidote in the exact same statement in 1989. The antidote – financial capital maintenance in units of constant purchasing power – is perfect during inflation, hyperinflation and deflation; the values may not be.

Kindest regards,

Nicolaas Smith