Pages

Thursday, 18 March 2010

The Historical Cost Mistake

Constant ITEM Purchasing Power Accounting, the financial capital maintenance in units of constant purchasing power model is, unfortunately, not chosen by a single SA accountant in SA to measure financial capital maintenance in real value maintaining units of constant purchasing power despite the fact that it is authorized in the IASB´s Framework, Par 104 (a) since 1989 as an alternative to the very destructive traditional HC model at all levels of low inflation and deflation. SA accountants value balance sheet constant real value non-monetary items using the traditional HC model in terms of which they implement the stable measuring unit assumption. SA accountants unknowingly destroy the real values of constant items never maintained at a rate equal to the rate of inflation because they, unfortunately, choose to measure financial capital maintenance in nominal monetary units when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. They unknowingly make the wrong choice. Since they all do it, since it is the traditional choice and since it is also authorized in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS, they unknowingly make the Historical Cost Mistake.

In the same breath, SA accountants do exactly the opposite: they acknowledge that inflation is destroying the real value of the depreciating Rand used as a depreciating monetary medium of exchange and they index or inflation-adjust by means of the CPI constant real value non-monetary income statement items like salaries, wages, rentals, etc by increasing their nominal values at a rate at least equal to the rate of inflation thus keeping their non-monetary real values constant over the time period in question.

On the one hand they acknowledge that the nominal values of income statement items like salaries and wages have to be indexed or inflation-adjusted by means of the CPI because inflation is destroying the real value of the Rand and on the other hand they assume - at exactly the same time and during exactly the same period - that the constantly depreciating Rand is perfectly stable, but, only for the valuation of balance sheet constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, provisions, other shareholder equity items, etc as well as for the other income statement items not inflation adjusted. SA accountants thus, unknowingly, destroy their real values at a rate equal to the rate of inflation to the amount of about R200 billion, year in year out, decade after decade 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