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Tuesday, 9 February 2010

Accounting for Non-CA´s: Monetary items

For CA´s

“Monetary items have to be stated at their original nominal values because money cannot be updated. Inflation destroys the real value of money, but accountants ignore this real value destruction during low inflation, but, account it during hyperinflation. Obviously, if you account it under hyperinflation, you also have to account it under low inflation.”

For Non-CA´s

There are three fundamentally different basic economic items in the economy:

1. Monetary items
2. Variable real value non-monetary items
3. Constant real value non-monetary items

Monetary items

The R100 notes in your pocket do not magically change to R94 notes after a year of 6% inflation. They keep their nominal value of R100, but, they are only worth R94 in real value.

So, in your business, if you have R100 000 in your company bank account on 1st January and you keep the money in the bank for the whole year, then your accountant will state that R100 000 as R100 000 in your year end accounts. It is only worth R94 000 in real value, but, because the R100 note in your pocket cannot change, your accountant has to state the money as R100 000 in your accounts.

Compare this to stock: if you had R100 000 stock for resale in your company on 1st January and you have the same stock on 31st December and the stock´s net realizable value was only R94 000 your accountant will account it at R94 000 with R6 000 written off as a loss in your profit and loss account. But, he is not allowed to do that with the real value loss in money - not under low inflation. Under hyperinflation, yes, but not under low inflation. Crazy, isn´t it? This gets fixed under financial capital maintenance in units of constant purchasing power during low inflation which was authorized by the IASB in 1989 and which I promote for SA accountants. I am actually an unofficial agent for the IASB - doing what they should have been doing for the last 21 years - but, they don´t like me either because I state that accountants unknowingly destroy real value doing traditional historical cost accounting and they base International Financial Reporting Standards on fallacies - which is true.

Inflation, in very simple terms, means there are too many Rands in the economy in relation to the actual real value in the economy. Zero inflation would mean, for example, that there are R100 billion of real value in the economy and R100 billion of Rands in the economy and it stays like that over a year. What does actually happen is that there are R100 billion real value in the economy and R106 billion of Rands in the economy. Now there are too many Rands and every Rand, after a year, is only worth 100/106 = R0.94 in real value. So, the simple fact of having too many Rands in the economy destroyed the real value of each and every Rand by 6%: each and every Rand is now only worth 94 cents. This is inflation in simple terms. So, it is thus a fact that inflation always and everywhere destroys the real value of money and monetary items like bank loans over time.

The International Accounting Standards Board, the highest accounting authority in the world, forces companies do show this loss or cost of inflation as an actual business cost, but, only during hyperinflation. The IASB defines hyperinflation as 100% cumulative inflation over 3 years. 26% annual inflation for 3 years in a row will equal 100% cumulative inflation. So, the IASB forces companies to account the cost of inflation as a business cost being deducted from profits before tax, but, only during hyperinflation and not during low inflation. This is obviously wrong. If companies have to do it at 26% annual inflation for 3 years in a row they obviously have to do it at 20% annual inflation for 3 years in a row too and at 6% annual inflation and 2% annual inflation and 1% annual inflation, etc. A cost is a cost under all circumstances. But, not according to the IASB. That is obviously a mistake.

When SA accountants stop Historical Cost Accounting during low inflation, as I am promoting, they will change to financial capital maintenance in units of constant purchasing power and they will account the cost of inflation during low inflation as they are required by the IASB to do under hyperinflation. Financial capital maintenance in units of constant purchasing power has also been authorized by the IASB twenty-one years ago. So, it is fine for SA accountants to change over and do that.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith