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Friday, 4 February 2011

Historical Cost Accounting is to blame

The real values of many constant real value non-monetary items, for example, retained earnings never maintained, are currently not being maintained constant in the world´s low inflation economies. To the contrary: they are unnecessarily, unknowingly and unintentionally being eroded at a rate equal to the annual rate of inflation by the implementation of the traditional HCA model where under accountants apply the very erosive stable measuring unit assumption when they measure financial capital maintenance in nominal monetary units – the accounting fallacy as authorized by the IASB in the Framework, Par 104 (a) in 1989 – during low inflation.


Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items constant during inflation and deflation is a basic objective of accounting.

This is the result of:

(1) the three popular accounting fallacies; namely,

(a) the stable measuring unit assumption based on the fallacy that changes in the purchasing power of the functional currently are not sufficiently important for accountants to measure financial capital maintenance in units of constant purchasing power during low inflation (authorized by the IASB) ,

(b) financial capital maintenance in nominal monetary units per se during low inflation (authorized by the IASB) and

(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB and the FASB);

(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very erosive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied, and

(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant real value non-monetary items of continuously measuring financial capital maintenance in units of constant purchasing power during inflation as approved by the IASB in the Framework, Par 104 (a).

If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units, i.e. the HCA model, during low inflation by now.

The accounting model accountants choose determines whether they unknowingly erode significant amounts annually in the real value of existing constant real value non-monetary items never maintained constant or knowingly would maintain significant amounts of real value every year in existing constant real value non-monetary items in the constant item economy depending on whether they choose the IASB-approved traditional HCA model when they apply the very erosive stable measuring unit assumption during low inflation or IASB-approved financial capital maintenance in units of constant purchasing power during inflationary and deflationary periods – both models amazingly approved in the Framework, Par 104 (a) in 1989. It is not inflation doing the eroding in real value of existing constant real value non-monetary items never maintained, e.g. in companies´ capital and profits, as the IASB, the FASB and most accountants believe. Implementing the HCA model is unnecessarily, unknowingly and unintentionally doing the eroding when accountants apply the stable measuring unit assumption during low inflation. Inflation has no effect on the real value of non-monetary items.

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