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Monday, 9 August 2010

How would business be different in SA? - Part 1

Bertie: Nicholaas, how would business be different in SA if that value was not being destroyed? In practical terms. I now buy into your point. But blog for us on what difference the opposite approach would have for everyday business in SA. Would we be able to borrow more? Lend more? Produce more? Market more lavishly?

The opposite approach means a once-in-3000-year paradigm change. Everything used to be accounted at historical cost. It could also be seen as the last step in a 100 year process of changing this global 3000 year old Historical Cost paradigm.

Over the last 100 years or so, accountants have realized that variable real value non-monetary items, e.g. property, plant, equipment, shares, inventories, etc cannot be accounted/valued/measured at their 200 year old or 20 year old or 1 year old or any historic price that is not the price/fair value at the balance sheet date.

IFRS and US GAAP are really about defining rules for the measurement of the above mentioned variable items.

Both US GAAP and IFRS value constant real value non-monetary items, e.g. issued share capital, retained profits, capital reserves, equity and most items in the profit and loss account still at Historical Cost as they have been for the last 3000 years: they ASSUME there was no inflation, there is no inflation and there never will be inflation ONLY as far as these items are concerned: they, in principle, ASSUME all monetary units are perfectly stable during low inflation and deflation ONLY for this purpose.

By doing this SA accountants unknowingly, unnecessarily and unintentionally destroy about R167 billion per annum in the real value of SA companies´ equity never backed by sufficient revaluable fixed assets (revalued or not) as well as other constant items never maintained PER ANNUM under HCA as long as annual inflation stays at more or less 5%.

Luckily for workers, they do change their minds for the constant items salaries, wages, rentals, etc. They value them in units of constant purchasing power: i.e. they inflation-adjust them annually. But, ONLY for a selected few profit and loss account items: no balance sheet constant items at all.

Only IFRS, not US GAAP, authorized accountants 21 years ago already, to inflation-adjust all constant items: all profit and loss account and all balance sheet constant items during low inflation and deflation. SA accountants would knowingly maintain instead of destroy about R167 billion PER ANNUM in the real value of all constant items of all SA companies´ that at least break even whether they own any revaluable fixed assets or not – ceteris paribus – forever, when they freely change over to financial capital maintenance in units of constant purchasing power during low inflation: inflation-adjusting ONLY constant items (NOT variable items) during low inflation (this is not inflation-accounting required to be implemented only during hyperinflation).

No-one does it.

Why?

Because they all believe that inflation is doing the destroying because they have been taught like that and everyone “knows” that to be a “fact”. In SA someone stated that in so many words and someone else  confirmed that: accountants have no control over inflation; so, it has nothing to do with them: they can not fix it: they can not stop the destruction.

However, inflation is always and everywhere a monetary phenomenon: it is impossible for inflation per se to destroy the real value of any non-monetary item ever. All items in shareholders´ equity are constant real value non-monetary items: all accountants would confirm that. So, it is not inflation doing the destroying: it is accountants´ free choice of implementing the stable measuring unit assumption as part of traditional HCA. When they reject the stable measuring unit assumption and implement financial capital maintnenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago, the destruction stops - in all entities that at least break even.

How would business in SA be different when SA accountants implement financial capital maintenance in units of constant purchasing power during low inflation: inflation-adjusting ONLY constant items as authorized in IFRS in the Framework, Par 104 (a) in 1989: the opposite approach?

There are obviously two aspects to the change-over from the current Historical Cost paradigm to a units of constant purchasing power paradigm or Constant Purchasing Power (CPP) paradigm: (1) the actual change-over which would be a once-in-3000-year event and then (2) the actual effects of the change. Bertie´s questions are about Nº 2: the actual effects of the change-over. The US regards changing from US GAAP to IFRS as a once-in-a-100-year event. Imagine when they then have to change again in this once-in-a-3000-year event? Accounting, auditing and consulting companies are going to make billions in extra retraining fees.

In general

Everybody will have to get used to think in real terms or CPP terms instead of Historical Cost terms. Everybody in SA will have to get used to the fact that the value of the Rand changes once a month: that the Rand is not perfectly stable as all SA accountants ASSUME only for this ONE purpose and that all EXISTING constant items´ nominal values would be revalued/remeasured/updated correctly and automatically in businesses (in the whole real or non-monetary economy) to maintain their EXISTING CONSTANT real values constant forever in all entities that at least break even and that all financial statements would show this monthly - once all financial statements are updated automatically digitally on a montly basis: no real value would be destroyed any more by accountants simply in the way they do accounting. But, the EXISTING CONSTANT real value of EXISTING CONSTANT REAL VALUE ITEMS would be maintained automatically by the way accountants do accounting in a better way.

Hard copy printed financial statements would be correct only for the first month after the year-end or period-end – in general - and only if the first set of statements were produced within the first month after the year-end or period-end: during the month of the year-end or period-end CPI. Sometimes SA has two or even three months of zero MONTHLY inflation (I remember that): the CPI stays the same for two or even three months in a row. No change would be made to financial statements only during those zero MONTHLY inflation months. Otherwise all financial statements would change monthly: i.e. every time the CPI changes.

It would be best for companies to keep their financial statements only in digital form so they can be updated monthly with the change in the CPI. Companies would end up with a digital set of financial statements only in digital form that would automatically be updated monthly. Only the latest updated version would be correct. There will always only be one set of financial statements that are correct, namely, the latest ones updated at the latest CPI. No copies of statements at previous CPI levels will be kept - ever - because it is not possible for us to put our minds and thinking and evaluating processes back in time: it is impossible to do that - although that is how we have been doing accounting (wrongly) for the last 3000 years.

I will answer more of Bertie´s questions tomorrow. This blog is getting rather long.
Copyright © 2010 Nicolaas J Smith