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Saturday, 30 April 2011

Three popular accounting fallacies

Three popular accounting fallacies

Updated on 14-06-2016

The real values of many constant real value non–monetary items, for example, that portion of shareholders´ equity never maintained constant by sufficient revaluable fixed assets (revalued or not) under the HCA model, are not automatically maintained constant (as they are under Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI) in the world´s low inflation economies. This was clearly evident during the recent financial crisis that necessitated huge amounts of additional capital for under–capitalized banks and companies whose capital has been eroded by the stable measuring unit assumption (not inflation - as generally accepted) during low inflation. Inflation has no effect on the real value of non-monetary items. The constant real non–monetary values of their capital are still unnecessarily, unknowingly and unintentionally being eroded at a rate equal to the annual rate of inflation by the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional HCA model. HCA is based on the accounting fallacy that financial capital maintenance can be measured (implied: maintained)  in nominal monetary units per se during inflation and deflation as originally authorized in IFRS in the Framework (1989), Par 104 (a) as well as approved in the FASB´s Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (1984).

Many people see financial reporting as simply providing historic economic information. It is not realized that it is a basic objective of accounting (financial reporting) to automatically maintain the constant purchasing power of capital constant in all entities that at least break even in real value for an indefinite period of time by continuously measuring all constant real value non–monetary items in units of constant purchasing power in terms of the Daily CPI during inflation, deflation and hyperinflation.

The reasons for this are:

(1) The Three Popular Accounting Fallacies.

(a) The stable measuring unit assumption based on the fallacy that changes in the purchasing power of money (the montary unit of measure) are not sufficiently important to require the measurement of financial capital maintenance in units of constant purchasing power in terms of the Daily CPI during low inflation, deflation and hyperinflation originally authorized in IFRS in the Framework (1989), Par 104 (a) and in the FASB´s FA Concepts No. 5.

(b) Financial capital maintenance in nominal monetary units per se (the belief that the real value of financial capital can be maintained in nominal monetary units per se) during low inflation and deflation originally authorized in IFRS in the Framework (1989), Par 104 (a) and in the FASB´s FA Concepts No. 5.

(c) The generally accepted belief that the erosion of companies´ profits and capital is caused by inflation fully supported in IFRS and by the FASB.

(2) It is not realized (understood) that it is the stable measuring unit assumption and not inflation that erodes the real value of constant real value non–monetary items never maintained constant when financial capital maintenance in nominal monetary units (the traditional HCA model) is implemented during low inflationary and hyperinflationary periods. Reject the stable measuring unit assumption, i.e., implement financial capital maintenance in units of constant purchasing power in terms of the Daily CPI) and the real value of capital is automatically maintained constant in all entities that at least break even in real value, ceteris paribus.

(3) It is not realized (understood) that continuous measurement of financial capital maintenance in units of constant purchasing power (Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI) automatically remedies this erosion by the stable measuring unit assumption during low inflation and hyperinflation.

If the above were generally understood then the stable measuring unit assumption / financial capital maintenance in nominal monetary units, i.e. the HCA model, would have been stopped during low inflation, deflation and hyperinflation by now.

Although the principle of financial capital maintenance in units of constant purchasing power in terms of the Daily CPI during inflation and hyperinflation was authorized in IFRS in 1989, it has not been implemented generally during low inflations and hyperinflation because the eroding effect of the stable measuring unit assumption on the real value of constant items never maintained constant is not recognized (understood) as such. It is generally believed that it is inflation doing the eroding in, for example, companies´ invested capital and profits – as specifically stated in FAS 89 - when this erosion in constant item real value is, in fact, caused by the stable measuring unit assumption. Inflation has no effect on the real value of non–monetary items. Capital and profits are constant real value non–monetary items.

Nicolaas Smith

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