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Friday, 23 July 2010

Valuing monetary items

Measurement of Monetary Items in the Financial Statements

Measurement is the process of determining the monetary amounts at which monetary items are to be recognised and carried in the financial reports. This involves the selection of the particular basis of measurement. The original nominal values of monetary items can only be measured in nominal monetary units during the current accounting period.

During low inflation

The real value of money and other monetary items can not be updated or indexed or inflation-adjusted or maintained during the current financial period under any accounting or economic model during low inflation. Inflation destroys the real value of money and other monetary items evenly throughout the SA monetary economy currently at 4.6% per annum (May 2010) or about R120 billion per annum. Money and other monetary items only maintain their real values perfectly stable under permanently sustainable zero per cent annual inflation. This has never been achieved over an extended period of time of more than a month or two.

"The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis." SARB

The SARB´s definition of price stability, in practice, is the destruction of the real value of the Rand at a rate of 6% or about R120 billion per annum because inflation normally rises to the top of the inflation targeting range. Real value is destroyed evenly in Rand bank notes and coins and other monetary items (loans, deposits, etc) throughout the SA monetary economy.

SA accountants value monetary items at their original nominal values – at their nominal historical cost – during the current financial period. It thus appears that it is correct when someone states that “financial reporting simply reports on what took place”. That is mistaken. Accountants value everything they account. There is no other way monetary items can be accounted and valued during the current financial period. It is an illusion that accountants only record what happened in the past: the “financial-reporting-simply-reports-on-what-took-place”-illusion as promoted by accounting professors.
SA accountants value monetary items at their current depreciated generally lower real values by accounting them during the current accounting period at their original nominal HC values during inflation. Their real values are destroyed by inflation over time. Being stated at their original nominal HC monetary values by accountants during inflation means that monetary items are automatically being valued by the continuous economic process of inflation over time.

This obviously means that monetary items are always correctly valued during the current financial period in any current account: at the current real value as determined by the current rate of inflation. In practice, money and other monetary items´ real values consequently generally decrease once per month – on the date the new CPI value is published by the statistics authorities – to a lower real value in low inflationary economies.

SA accountants do not destroy the about R120 billion in real value of the Rand and other monetary items in the SA monetary economy each year: 4.6% inflation does that. SA accountants value and account monetary items correctly in the SA monetary economy by stating them at their original nominal monetary HC values. They, however, fail to calculate and account the net monetary gains and losses from holding either net monetary liabilities or net monetary assets, as the case may be. This is a generally accepted accounting practice under HCA.

The only difference between accounting and valuing monetary items under the current HCA model and their accounting and valuation when measuring financial capital maintenance in real value maintaining units of constant purchasing power would be the calculation and accounting of net monetary gains and losses. These net monetary gains and losses are required by the IASB to be calculated and accounted in terms of IAS 29 during hyperinflation. These net monetary gains and losses are not calculated and accounted under the HCA model although it can be done. See Kapnick. No-one does that under HCA. Net monetary gains and losses are constant real value non-monetary items (income statement gains and losses) once they are accounted and have to be inflation-adjusted – measured in units of constant purchasing power - thereafter under the financial capital maintenance in units of constant purchasing power model or Constant ITEM Purchasing Power Accounting model as authorized by the IASB in the Framework, Par 104 (a) in 1989 as well as in terms of IAS 29 during hyperinflation.

Side note: The FASB and IASB have been working on their joint Conceptual Framework project for the last 6 years. However, they have not stated one word about valuing monetary items - or items like shareholders equity. It is called the Historical Cost mentalité - like there used to be the gold standard mentalité.
Copyright © 2010 Nicolaas J Smith