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Tuesday, 11 January 2011

IFRS should not be based on fallacies

The International Accounting Standards Board is a private, independent accounting standards board based in London. The mission of the IASB is to develop a single set of global accounting standards. The IASB cooperates with national accounting standard boards for international convergence of accounting standards.

The IASB should not authorize and approve International Financial Reporting Standards based on significantly erosive accounting fallacies, e.g. real value eroding financial capital maintenance in nominal monetary units per se and the very erosive stable measuring unit assumption during inflation which is based on a fallacy which costs the world economy hundreds of billions of USD per annum in real value unnecessarily, unknowingly and unintentionally eroded by the implementation of the traditional HCA model in the existing real value of constant real value non-monetary items (e.g. shareholders equity) never or not fully maintained. Currently the IASB is doing exactly that in the Framework, Par 104 (a) which states:

“Financial capital maintenance can be measured either in nominal monetary units or units of constant purchasing power.”

It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation since money is not perfectly stable in real value during inflationary and deflationary periods. However, accountants and financial statement users have been educated with the Historical Cost Accounting model of financial reporting which includes the stable measuring unit assumption as stated by the FASB in FAS 89. Financial capital maintenance in nominal monetary units per se is a fallacy during inflation and deflation while the stable measuring unit assumption is based on the fallacy that changes in the purchasing power of money are not sufficiently important to require continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation.

The real value of existing constant items never maintained constant is unknowingly, unnecessarily and unintentionally eroded as a result of the implementation of the HCA model with the very erosive stable measuring unit assumption during low inflation because accountants generally measure financial capital maintenance in banks and companies in nominal monetary units as part of traditional HC accounting based on those two very popular IASB-approved and authorized accounting fallacies.

Accountants who prepare their financial reports in terms of International Financial Reporting Standards generally choose to measure financial capital maintenance in nominal monetary units, the accounting fallacy as approved by the International Accounting Standards Board in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a) which they apply in the absence of specific IFRS relating to the concept of capital, the concept of capital maintenance, the concept of profit/loss determination and in the absence of specific IFRS for the valuation of specific constants items, e.g. Shareholders´ Equity items, etc.


Astonishingly, the IASB authorized both the HCA model stated in terms of the very popular accounting fallacy that financial capital maintenance can be measured in nominal monetary units as well as its only and perfect remedy (the remedy is perfect, not the resulting values) during inflation and deflation in one and the same statement in 1989. It is impossible to maintain the real value of financial capital stable by measuring it in nominal monetary units per se during inflation and deflation. The statement in the Framework, Par 104 (a) that financial capital maintenance can be measured in nominal monetary units is only true – per se – at sustainable zero inflation – a monetary environment never achieved over any significant period in the past and not soon to be achieved over a significant period in the future. The IASB statement that financial capital maintenance can be measured in nominal monetary units is a fallacy under all other economic environments: low inflation, hyperinflation and deflation. IFRS should not be based on fallacies as they currently are.

Accountants who prepare financial reports in terms of IFRS have to make the choice presented to them in the Framework, Par 104 (a). The boards of directors actually have to make the choice; their accountants being the accounting experts, obviously, advise them about the appropriate choice to make. Financial capital maintenance in nominal monetary units is a very popular accounting fallacy authorized by the IASB in the Framework, Par 104 (a) in 1989. It is, certainly, not an appropriate accounting policy for companies during inflation and deflation. Unfortunately most, if not all boards of directors choose financial capital maintenance in nominal monetary units as part of the traditional HCA model which includes the very erosive stable measuring unit assumption in the world economy. This results in the unnecessary, unknowing and unintentional eroding of hundreds billions of USD in the real value of existing constant items never or not fully maintained, e.g. retained profits, in the world´s real economy each and every year.

Accountants preparing financial reports of unlisted companies generally also choose to measure financial capital maintenance in nominal monetary units and implement the HCA model since it is the generally accepted traditional accounting model.

Copyright (c) 2005 - 2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.