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Monday, 14 March 2011

Salaries and wages inflation-adjusted during low inflation

The annual indexation or inflation-adjustment of salaries and wages in a low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages constant during inflation. This involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating monetary unit payment values for constant real value non-monetary salaries and wages to maintain their purchasing power constant in a low inflationary economy where the real value of the monetary unit of account is continuously being eroded by inflation. The nominal values of constant real value non-monetary salaries and wages are thus increased or indexed or inflation-adjusted by means of the CPI to cover or compensate for at least the expected rate of erosion in the real value of the depreciating monetary which is the depreciating unstable monetary unit of account for accounting purposes as well as the depreciating unstable monetary medium of exchange for payment purposes in the economy. The period is normally for the year ahead. They normally agree on an additional percentage increase for increases in productivity or for social reasons.
Both parties to the salary and wage negotiations agree that constant real value non-monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very erosive stable measuring unit assumption whereby accountants simply assume that the depreciating monetary unit is perfectly stable in a low inflationary economy. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated monetary units whose real values are continuously being eroded by inflation. They would not receive their full constant real non-monetary values of their salaries and wages.

“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman.

Inflation can only erode the real value of the depreciating unstable monetary medium of exchange (depreciating unstable money, i.e. the depreciating unstable functional currency inside an inflationary economy) - the depreciating unstable monetary unit - and other depreciating unstable monetary items.

Inflation has no effect on the real values of salaries and wages which are constant real value non-monetary items. Inflation can only erode the real value of money (the functional currency inside an economy) and other monetary items. Accountants implementing the very erosive stable measuring unit assumption as part of the traditional HCA model when they keep salaries and wages fixed over time, unknowingly, unintentionally and unnecessarily erode the real value of salaries and wages when they do not inflation-adjust them by means of the CPI when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Inflation cannot erode the real value of non-monetary items. Inflation can only erode the real value of the unstable monetary medium of exchange (the unstable functional currency - unstable money) used to transfer the constant real non-monetary values of salaries and wages from the employer to the employee.

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.

http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

The erosion at a rate equal to the annual rate of inflation of all constant real value non-monetary items never maintained constant during inflation stops the very moment the Boards of Directors of companies and accountants choose to implement the IASB-approved financial capital maintenance in units of constant purchasing power model (CIPPA) no matter what the level of inflation in the economy. The choice is theirs. The power to stop the erosion of real value in the real economy is in their hands - as authorized since 1989 in the IASB´s Framework (1989), Par 104 (a) which is applicable in the absence of specific IFRS. It is the choice of the accounting model and not inflation that maintains or erodes the existing constant real non-monetary value of constant real value non-monetary items in low inflationary economies.

The constant real non-monetary values of salaries and wages expressed in terms of the depreciating unstable monetary unit as the depreciating unstable monetary unit of account are presently being maintained constant in low inflationary economies when their nominal monetary values are indexed or inflation-adjusted by means of the CPI in low inflationary environments. This happens not because of a lowering of inflation, but because of accountants and trade unions valuing salaries and wages in units of constant purchasing power instead of the Historical Cost measurement basis for this particular purpose.

If the parties to the salary and wage determination process were to agree to value salaries and wages at fixed Historical Cost – like Iceland recently decided to freeze salaries because of their financial crisis - then their constant real non-monetary values would be eroded at a rate equal to the annual rate of inflation since constant real value non-monetary salaries and wages are expressed in term of the depreciating monetary unit of account, namely and are normally paid in depreciating monetary units. Salaries and wages are not depreciating monetary items. They are constant real value non-monetary items. They are, however, normally paid in depreciating monetary units which are depreciating monetary items during inflation.

“Income Statement


This standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date.” IAS 29, Par 26.

All items in the income statement are constant real value non-monetary items to be continuously inflation-adjusted by applying the monthly change in the annual CPI during low inflation and deflation. The real values of salaries and wages would thus not be eroded by inflation if they were valued in nominal monetary units (fixed salaries and wages), but by the choice of the measurement basis, namely, Historical Cost, i.e. in nominal monetary units, which means the implementation of the very erosive stable measuring unit assumption whereby accountants consider that the continuous erosion of the purchasing power of the monetary unit is not sufficiently important during low inflation in order to require the indexation or inflation-adjustment or measurement in units of constant purchasing power of the existing constant real values of constant real value non-monetary salaries and wages by means of the CPI in order to maintain their existing constant real non-monetary values constant. What accountants do, in essence, is they assume the constantly depreciating monetary unit of account – the depreciating monetary unit – is perfectly stable when they implement the stable measuring unit assumption. Accountants assume the depreciating monetary unit is perfectly stable, but, only for this particular purpose.

The financial capital maintenance in units of constant purchasing power model (CIPPA) is not yet generally chosen by accountants to measure financial capital maintenance in real value maintaining units of constant purchasing power during low inflation and deflation despite the fact that it is authorized in the IASB´s Framework (1989), Par 104 (a) since 1989 as an alternative to the very erosive traditional HC model at all levels of inflation and deflation. Accountants value balance sheet constant real value non-monetary items using the traditional HC model in terms of which they implement the very erosive stable measuring unit assumption. The HCA model unknowingly, unintentionally and unnecessarily erodes the real values of constant real value non-monetary items never maintained constant at a rate equal to the annual rate of inflation because accountants choose to measure financial capital maintenance in nominal monetary units when they implement the very erosive stable measuring unit assumption for an unlimited period of time during indefinite inflation. They unknowingly make the wrong choice. Since they all do it, since it is the traditional, generally accepted choice and since it is also authorized in the Framework (1989), Par 104 (a) which is applicable in the absence of specific IFRS, they unknowingly make the Historical Cost Mistake.

Accountants, on the other hand, do exactly the opposite: they acknowledge that inflation is eroding the real value of the depreciating monetary unit used as a depreciating monetary medium of exchange and they index or inflation-adjust or measure in units of constant purchasing power by means of the CPI some, not all, constant real value non-monetary income statement items like salaries, wages, rentals, etc by increasing their nominal values at a rate at least equal to the annual rate of inflation thus keeping their non-monetary real values constant over the time period in question.

On the one hand accountants currently acknowledge that the nominal values of some (not all) income statement items like salaries and wages have to be indexed or inflation-adjusted by means of the CPI because inflation is eroding the real value of the monetary unit and, on the other hand, they assume - at exactly the same time and during exactly the same period - that the constantly depreciating monetary unit is perfectly stable, but, only for the valuation of balance sheet constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, provisions, other shareholder equity items, etc as well as for the other income statement items not inflation adjusted. Accountants thus, unknowingly, unintentionally and unnecessarily erode their real values at a rate equal to the annual rate of inflation to the amount of hundreds of billions of US Dollars world-wide, year in year out, decade after decade when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Accountants at companies listed on stock exchanges comply with IFRS. If a country should enter into hyperinflation they would implement IAS 29. They would then apply the CPP inflation accounting model and index or inflation-adjust all income statement items plus balance sheet constant real value non-monetary items by means of the CPI. They would update, for example, Issued Share Capital and Retained Earnings for all listed companies and banks from the dates these items were contributed or came about and maintain their existing constant real non-monetary values constant, but, only for as long as the economy is in hyperinflation.

When the economy is not in hyperinflation any more they would stop the IAS 29 required real value maintaining CPP inflation accounting model and go back to the real value eroding HC model (as as Brazil did in 1994 and Turkey did in 2005) and again erode all these constant real value non-monetary items´ existing constant real non-monetary values at a rate equal to the annual rate of inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation. They could also choose to implement the real value maintaining Constant real value non-monetary item Purchasing Power Accounting model during low inflation and maintain the real values of only constant real value non-monetary items in units of constant purchasing power in terms of the IASB´s Framework (1989), Par 104 (a) while they would valuevariable real value non-monetary items in terms of IFRS.

Accountants can freely choose to change right now to the real value maintaining financial capital maintenance in units of constant purchasing power model (CIPPA) during low inflation and deflation in terms of the IASB´s Framework (1989), Par 104 (a). The choice is theirs since financial capital maintenance in units of constant purchasing power was authorized in the IASB´s Framework (1989), Par 104 (a) in1989 and is applicable in the absence of specific IFRS (see IAS8.11). No-one stops them from making that choice.

Auditors would certify that companies´ financial statements fairly present their businesses and comply with IFRS when boards of directors choose to continuously measure financial capital maintenance in units of constant purchasing power during low inflation and deflation in terms of the Framework (1989), Par 104 (a).

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