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Wednesday, 3 March 2010

Generally accepted fact and fiction

The IASB approved Framework, Par 104 (a) which is applicable in the absence of specific IFRS relating to the concepts of capital, the capital maintenance concepts, the valuation of constant items, e.g. Issued Share Capital, Retained Earnings and other items in Shareholders´ Equity, etc during non-hyperinflationary periods, allows accountants to reject the stable measuring unit assumption during all levels of inflation and deflation when they choose to measure financial capital maintenance in units of constant purchasing power as an alternative to measurement in nominal monetary units as applied in the traditional HCA model.

It is not generally understood by SA accountants that they are unknowingly and unintentionally responsible for the unnecessary destruction of the real value of constant items never maintained with sufficient revaluable fixed assets when they implement the traditional HCA model: more specifically, their very destructive stable measuring unit assumption during periods of low inflation when they maintain it for an unlimited period of time during indefinite inflation. This lack of understanding also applies to economists, business people and the public in general.

It is also not generally understood by SA accountants that they can stop this destruction by selecting financial capital maintenance in units of constant purchasing power as authorized by the IASB 21 years ago in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS. If they understood it, they would have stopped the stable measuring unit assumption by now.

It is generally accepted and a fact that inflation destroys the real value of money (the internal functional currency) and other monetary items over time. It is also a fact that hyperinflation can destroy the real value of a country’s entire monetary base as happened in Zimbabwe recently. That was the result of a massive increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, with an equivalent extreme rate of destruction of the real value of the Zimbabwe Dollar since the massive nominal increase in the ZimDollar money supply was not in response to an equal increase in real value in the real or non-monetary economy of Zimbabwe. Gono was actually "printing money" in the popular belief that you can create wealth by simply printing pretty pictures on paper. When the German company from which he was buying the special bank note paper was pressurized to stop supplying him, he started printing the 100 trillion ZimDollar notes on normal A4 photostat paper.


“There is no subtler, no surer means of overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
The Economic Consequences of the Peace by John Maynard Keynes, 1919http://socserv2.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace

This certainly was true in the case of Zimbabwe.

It is generally accepted and a fact that inflation destroys the real value of money and the original real value of monetary savings and money lent over time. It is generally accepted, but not a fact, that inflation erodes, which is the same as destroys, the real value of constant real value non-monetary items with fixed nominal payments over time, e.g. fixed salary, wage, rental payments, etc.

The constant real non-monetary values of salaries, wages, rentals, etc are generally maintained, i.e. not destroyed, when accountants choose to measure the real value of these constant real value non-monetary items in units of constant purchasing power in terms of the CPI in most economies with payment in depreciating money during inflation.

It is not generally accepted, but a fact, that SA accountants unknowingly destroy the real value of constant items never maintained, e.g. Retained Earnings, of all SA companies and banks over time when they choose to measure financial capital maintenance in nominal monetary units in terms of the traditional HCA model during low inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith