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Tuesday, 16 March 2010

SA accountants are unknowingly doing the destroying - not inflation

We commonly find that SA companies state in their opening notes to their balance sheet that their financial reports have been prepared based on the traditional Historical Cost model. We normally find that they use different measurement bases to different degrees and in different combinations including constant items in the income statement that are indexed or inflation-adjusted or valued in units of constant purchasing power by applying the CPI in SA´s low inflationary economy: e.g. salaries, wages, rentals, utility fees, transport fees, etc. Indexation or inflation-adjustment or valuing in units of constant purchasing power is thus already a generally accepted accounting practice in SA´s low inflationary economy, but, only for some, not all, income statement items and not at all for balance sheet constant items. SA accountants generally choose financial capital maintenance in nominal monetary units implementing their very destructive stable measuring unit assumption unknowingly destroying about R200 billion per annum in the SA real economy.
The annual indexation or inflation-adjustment of salaries and wages in SA´s low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages during inflation. This involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating Rand payment values for constant real value non-monetary salaries and wages to maintain their purchasing power constant in the low inflationary SA economy where the real value of the Rand is continuously being destroyed by inflation of about 6% per annum which is the SARB´s definition of "price stability". The nominal values of constant real value non-monetary salaries and wages are thus increased or indexed or inflation-adjusted by means of the CPI to cover or compensate for at least the expected rate of destruction in the real value of the depreciating Rand which is the depreciating unstable monetary unit of account for accounting purposes as well as the depreciating unstable monetary medium of exchange for payment purposes in the SA economy. The period is normally for the year ahead. They normally agree on an additional percentage increase for increases in productivity or for social reasons.

Both parties to the salary and wage negotiations agree that constant real value non-monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very destructive stable measuring unit assumption whereby SA accountants simply assume that the depreciating Rand is perfectly stable in SA´s low inflationary economy. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated Rands whose real values are continuously being destroyed by inflation. They would not receive their full real values of their salaries and wages.

“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman.

Inflation can only destroy the real value of the depreciating unstable monetary medium of exchange (depreciating unstable money, i.e. the depreciating unstable functional currency inside an inflationary economy) - the depreciating unstable Rand in South Africa’s case - and other depreciating unstable monetary items.

Inflation has no effect on the real values of salaries and wages which are constant real value non-monetary items. Inflation can only destroy the real value of money and other monetary items. Accountants implementing the very destructive stable measuring unit assumption as part of the traditional HCA model unknowingly destroy the real value of salaries and wages when they do not inflation-adjust them by means of the CPI when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation; i.e. when they keep salaries fixed.

SA accountants are unknowingly doing the destroying - not inflation (as they so mistakenly believe) - and that inflation has no effect on the real value of any non-monetary item. Also inform them that SA accountants - with their full support - unknowingly destroy about R200 billion per annum in the SA constant item economy with financial capital maintenance in nominal monetary units per se - a complete fallacy - as authorized by the IASB in 1989. It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

Although, I am sure they realize that by now.
Copyright © 2010 Nicolaas J Smith