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Saturday, 23 April 2011

Capital is a variable or monetary item in the economy

Capital is a constant real value non-monetary item.

However, there is currently no constant real value capital in the world economy under HCA during low inflation and deflation. The portion of the original real value of all contributions to Shareholders´ Equity in companies covered by revaluable fixed assets is, in fact, treated as a variable real value non-monetary item under HCA during low inflation. This existing constant real non-monetary value is not maintained constant under the HCA model during low inflation and deflation. Its real value depends on the variable real non-monetary value of the fixed assets determined at fair value from time to time in terms of IFRS and US GAAP during low inflation since equity is equal to net assets under HCA with financial capital maintenance measured in nominal monetary units.

The portion of the original real value of all contributions to Shareholders´ Equity not covered by revaluable fixed assets is unknowingly, unnecessarily and unintentionally  being eroded by the stable measuring unit assumption (mistakenly believed to be inflation) at a rate equal to the annual rate of inflation as part of financial capital maintenance in nominal monetary units when the traditional HCA model is implemented during low inflation. This unknowing erosion by the stable measuring unit assumption amounts to about R200 billion in the SA constant real value non-monetary item economy and hundreds of billions of US Dollars in the world´s constant item economy each and every year.

When companies have no revaluable fixed assets at all under HCA, Capital is, in principle, treated the same as a monetary item (money or cash) and the stable measuring unit assumption erodes its real value at a rate equal to the annual rate of inflation in low inflationary economies.

Capital  will only – for the first time ever during low inflation and deflation - correctly be treated as a constant item and its existing constant value maintained constant in entities that at least break even for an unlimited period of time – ceteris paribus - when financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Conceptual Framework (2010), Par 4.59 (a) is freely chosen by entities. There is no other way during low inflation and deflation.

Financial capital maintenance in units of constant purchasing power during low inflation and deflation was originally authorized in the IASB´s Framework for the Preparation and Presentation of Financial Statements in 1989.

Nicolaas Smith

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