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Tuesday, 29 March 2011

Historical Cost Accounting is not an appropriate accounting policy

HCA is not an appropriate accounting policy


Auditors state in the audit report that the directors´ responsibility for the financial statements includes selecting and applying appropriate accounting policies. The audit report also normally states under the Auditors´ Responsibility that an audit includes evaluating the appropriateness of accounting policies used in a company. So, both the directors and the auditors have a responsibility with regards to appropriate accounting policies for a company.

The implementation of the stable measuring unit assumption which is based on a fallacy and financial capital maintenance in nominal monetary units per se which is a fallacy during inflation and deflation means that the use of the HCA model is not an appropriate accounting policy for companies during inflation and deflation. The IASB already agrees that the stable measuring unit assumption and financial capital maintenance in nominal monetary units per se are not appropriate accounting policies in hyperinflationary economies.

IAS 29 Financial Reporting in Hyperinflationary Economies states that:

“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2

When it can be clearly demonstrated that a company’s HC accounting policy selected by the board of directors eroded a significant percentage of the real value of the company´ Shareholders´ Equity as a result of the company’s implementation of the stable measuring unit assumption when the company assumes that it would be for an unlimited period of time during indefinite inflation when they know that financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework (1989), Par 104 (a), is an IFRS-compliant alternative freely available to the company and that it would stop the unknowing, unintentional and unnecessary erosion of existing constant non-monetary real value in existing constant real value non-monetary items never maintained constant by the implementation by the company´s board and accountants of financial capital maintenance in nominal monetary units during low inflation and deflation, then the traditional HCA model, in principle, is not an appropriate accounting policy.

The principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation has been subjected to a “thourough, open, participatory and transparent, due process” at the IASB before it was approved in the Framework (1989), Par 104 (a) twenty two years ago. The principle is thus generally accepted in the accounting and auditing professions. However, the practice of financial capital maintenance in unit of constant purchasing power during low inflation and deflation (CIPPA) is not yet generally accepted. Neither have accounting software packages been adapted for the implementation of CIPPA, nor have accountants and accounting personnel been trained to implement financial capital maintenance in units of constant purchasing power during low inflation and deflation, nor have audit procedures been adapted by auditors to audit companies implementing the Constant Item Purchasing Accounting model.

Currently financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is thus an appropriate accounting policy and HCA not an appropriate accounting policy, in principle, but, not in practice. The current implementation of the HCA model is thus still an appropriate accounting policy, in practice, although not in principle. However, as soon as the practical implementation of financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (CIPPA) has passed proper due process; accounting software packages have been adapted to CIPPA; accountants and accounting personnel have been trained to implement CIPPA and audit procedures have been adapted by audit firms to audit companies implementing CIPPA, then the HCA model will certainly not be an appropriate accounting policy - in principle and in practice.

This will not happen overnight. As was stated in US FAS 89 in 1986: “Mr. Mosso dissented to the issuance of Statement 33 and he dissents to its rescission, both for the same reason. He believes that accounting for the interrelated effects of general and specific price changes is the most critical set of issues that the Board will face in this century.”

and

“Relative to most changes in financial reporting, the changes required by Statement 33 were monumental. 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.”

Nicolaas Smith

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