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Wednesday, 3 February 2010

Accounting can not and does not create real value out of thin air

It must be clearly understood, however, that accounting per se can not and does not create real value out of thin air – out of nothing.

Accountants can not and do not create real value or wealth by simply passing some update accounting entries when no real value already exists.

Constant real value non-monetary items, e.g. Issued Share Capital, Share Premium, Retained Profits, Capital Reserves, other items in Shareholders´ Equity, Trade Debtors, Trade Creditors, Taxes Payable, Taxes Receivable, etc first have to exist for accountants to be able to maintain the real values of those existing constant real value non-monetary items stable by continuously measuring financial capital maintenance in units of constant purchasing power as approved by the IASB and by continuously valuing income statement constant items in terms of units of constant purchasing power in order to determine profit or loss in units of constant purchasing power during low inflation and deflation.

Accountants can maintain the existing real values of existing balance sheet constant items, e.g. Issued Share capital, Retained Earnings, etc stable in companies at least breaking even for an unlimited period of time, ceteris paribus, when they choose to measure financial capital maintenance in units of constant purchasing power during low inflation and deflation as approved by the IASCB in the Framework, Par 104 (a) in 1989 and adopted by the IASB in 2001.

The Framework, Par 104 (a) states:

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

Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy. It is impossible to maintain the real value of capital stable in nominal monetary units per se during inflation and deflation. The only way to maintain the real value of capital constant during inflation and deflation per se in companies that at least break even - all else being even - is with financial capital maintenance in units of constant purchasing power.

The IASB has thus, amazingly, authorized the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation as well as its only and perfect antidote during inflation and deflation in one and the same statement in 1989. The antidote is perfect during inflation and deflation; the values may not be perfect as a result of the way the CPI is calculated.

Obviously, at sustainable zero inflation constant items will maintain their real values stable in all companies that at least break even. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith