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Saturday, 19 February 2011

Accounting per se can not and does not create real value out of nothing

It must be clearly understood, however, that accounting per se can not and does not create real value out of thin air – out of nothing. Accountants can not and do not create real value or wealth by simply passing some update or inflation-adjustment accounting entries when no real value actually exists. Constant real value non-monetary items, e.g. Issued Share Capital, Share Premium, Retained Profits, Capital Reserves, other items in Shareholders´ Equity, Trade Debtors, Trade Creditors, Provisions, Taxes Payable, Taxes Receivable, etc first have to actually exist for accountants to be able to maintain the real values of those existing constant real value non-monetary items constant by continuously measuring financial capital maintenance in units of constant purchasing power as authorized by the IASB and by continuously valuing income statement constant items in terms of units of constant purchasing power in order to determine profit or loss in units of constant purchasing power during low inflation and deflation.
The IASB has, amazingly, authorized the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation as well as its only and perfect remedy during inflation and deflation in one and the same statement in 1989. The remedy is perfect during inflation and deflation; the values may not be perfect as a result of the way the CPI is calculated.

Obviously, at sustainable zero inflation constant real value non-monetary items will maintain their real values constant in all companies that at least break even. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.

The IASB confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 and in the Framework that companies´ primary financial reports are prepared in most economies based on the traditional Historical Cost Accounting model without taking changes in the general level of prices or specific price changes of assets into account, with the exception that investments, equipment, plant and properties can be revalued. The IASB does not mention the erosion of the real value of balance sheet constant real value non-monetary items never maintained constant when accountants implement the stable measuring unit assumption during low inflationary periods because this process of erosion of the real value of constant real value non-monetary items never maintained is not generally understood. The IASB, like the FASB and most accountants, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation as specifically stated by the FASB and IASB. They all also support the stable measuring unit assumption which is based on the fallacy that money is perfectly stable as well as the fallacy of financial capital maintenance in nominal monetary units during low inflation and deflation. The erosion of real value of constant real value non-monetary items by implementation of the stable measuring unit assumption is very well understood - and compensated for by updating them by applying the annual CPI - in the case of the income statement constant real value non-monetary items salaries, wages, rentals, etc. Neither is the real value maintaining effect on balance sheet constant items understood of freely choosing to continuously measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved by the IASB in the Framework, Par 104 (a).

The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position. Whereas the FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89, the IASB never mentioned it in either IAS 6 Accounting Response to Changing Prices or IAS 15. IAS 15 completely superseded IAS 6. IAS 15 was eventually withdrawn.

“Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.” FAS 89, Par 4, 1986


“The integrity of the historical cost/nominal dollar system relies on a stable monetary system.” FAS 33, 1979

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