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Thursday, 2 June 2011

Benefits of automatic constant purchasing power capital maintenance not generally realized

Benefits of automatic constant purchasing power capital maintenance not generally realized


Continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA), despite being authorized in IFRS in the original Framework (1989), Par 104 (a), is not yet generally realized in low inflationary economies. This is the case despite the fact that CIPPA automatically maintains (as opposed to mostly being eroded under the HCA model) the existing constant real non-monetary values of all constant items in all entities that at least break even whether these entities own revaluable fixed assets or not and without the requirement of extra capital from capital providers in the form of extra money or additional retained profits simply to maintain the existing constant real value of existing Shareholders´ Equity constant for an unlimited period of time during low inflation and deflation. Comprehensive economy–wide continuous financial capital maintenance in units of constant purchasing power automatically stops the unknowing, unnecessary and unintentional eroding of hundreds of billions of US Dollars in the real value of constant real value non–monetary items never maintained constant in the world´s constant item economy each and every year. The implementation of CIPPA would result in accountants knowingly boosting the world´s real economy by hundreds of billions of US Dollars per annum for an unlimited period of time during indefinite low inflation – all else being equal.

The reason automatic financial capital maintenance in units of constant purchasing power is not generally implemented is because any price–level accounting model is generally viewed by almost everyone as a 1970–style failed and discredited inflation accounting model that required all non–monetary items (variable real value non–monetary items and constant real value non–monetary items) to be updated by means of the CPI during high inflation. They seem not to realize the substantial benefits of automatic constant purchasing power capital maintenance in all entities that at least break even.

If the enormous automatic real value maintaining benefits of financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized in the original Framework (1989), Par 104 (a) were generally realized, the Historical Cost paradigm would have already been abandoned.

The maintenance of the existing constant real non–monetary values of all existing constant real value non–monetary items (eg. companies´ and banks´ equity) for an unlimited period of time in all entities that at least break even would be automatic under the CIPPA model since it would be the result of the normal double-entry accounting model when the stable measuring unit assumption is abandoned and with it the traditional Historical Cost Accounting model under the current 3000 year old historical cost paradigm.

Deloitte, one of the Big Four accounting and auditing multi–nationals, also ignore the paragraphs in the original Framework (1989) that deal with the concepts of capital, capital maintenance and the determination of profit or loss in their presentation of the Framework on their site IAS Plus, Deloitte. Date: 11th March, 2011 http://www.iasplus.com/standard/framewk.htm

Deloitte do not even mention one word in their presentation of the Framework about the fact that entities have been authorized in IFRS since 1989 to measure financial capital maintenance in units of constant purchasing power during low inflation and deflation. This appears to be another example that it is generally not realized that an essential objective of accounting is automatic maintenance of the existing constant purchasing power of capital by continuously maintaining the real value of all constant real value non–monetary items constant in all entities that at least break even for an indefinite period of time at all levels of inflation and deflation. This can only be achieved automatically during low inflation and deflation with IASB–approved financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) as authorized in 1989 in the original Framework (1989), Par 104 (a) under which only constant real value non–monetary items (not variable real value non–monetary items) are continuously measured in units of constant purchasing power in terms of the monthly change in the annual CPI and IAS 29 with valuation of all non–monetary items at the daily parallel rate or a daily Brazilian-style non-monetary index only during hyperinflation.

Similarly the paragraphs in the original Framework (1989) dealing with the concepts of capital, the concepts of financial capital maintenance and units of constant purchasing power were also omitted from the presentation of the Framework in the Wikipedia article on IFRS till they were added very recently. Previously, the whole of the Framework was summarized in the Wikipedia article, except those paragraphs.

The IASB and FASB are jointly updating and converging their Frameworks. “The project's overall objective is to create a sound foundation for future accounting standards that are principles–based, internally consistent and internationally converged”, per the IASB. The joint Conceptual Framework project has eight phases, one of which is the Measurement phase.

The Boards held roundtable discussions on measurement during January and February 2007. No public Discussion Paper has yet been presented for comment.

All items in the IASB´s current Conceptual Framework (2010) are covered in this project, except the concepts of capital and capital maintenance. Reading the reports about the items discussed thus far in the Measurement Phase I noticed that the discussions are almost entirely about variable real value non–monetary items (property, plant, equipment, stock, shares, financial instruments, etc.) and almost nothing about monetary items and constant real value non–monetary items (all items in the income statement, all items in shareholders’ equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.).

I emailed Kevin McBeth, the FASB Project Manager responsible for the Measurement Phase in the joint project and asked him in which phase the Concepts of Capital and Capital Maintenance are going to be discussed.

He responded by email:

“I cannot speak for the Boards with respect to your query. I can only say that early on in the measurement phase the staff suggested that capital and capital maintenance be discussed in the measurement phase, as it was in the original FASB Conceptual Framework. However, to date the Boards have not taken a decision on where, or even whether, those topics will be included in the converged framework.” (my bold lettering).

I then put the same question to the US Financial Accounting Standards Board.

Ron Lott, the FASB director who is responsible for the joint FASB–IASB Conceptual Framework project responded by email:

“We are of course familiar with paragraphs 4.57 – 110 of the IASB Framework as well as paragraphs 45–48 of FASB Concepts Statement 5. Although not labelled as such, capital maintenance ideas have been raised at various points in the discussions of measurement concepts and will continue to be discussed until the board makes decisions about measurement concepts.


We do not know yet whether there will be a section in the yet–to–be–completed measurement concepts chapter labelled capital maintenance, but the concepts will almost certainly be discussed.”

Kevin McBeth stated the following by email:

“I believe that you may have misunderstood the discussions the FASB and IASB have had about measurement. Those discussions have used examples of various items, some of which you refer to as variable real value non–monetary items. That may have led you to believe that some of your concerns are being ignored. However, the scope of the measurement phase of the Conceptual Framework project does not exclude the items you refer to as constant real value non–monetary items. The Boards are concerned about the effects of selecting measurements on all elements of the financial statements.


Much remains to be done on this project. Although future discussions probably will not use the terminology and classification scheme that you are espousing, there is reason to expect that they will address the items of concern to you.”

The concepts of capital and capital maintenance will thus be discussed in the Measurement Phase.

Possible measurement methods have already been discussed by the FASB and the IASB for six years, but, although the Measurement Phase published material includes the following: “What should the measurement chapter accomplish—The measurement chapter should list and describe possible measurements”, it is quite strange that the term “measurement in units of constant purchasing power” has not yet appeared on the Measurement Phase site as one of “the set of possible measurement methods that are to be considered”.

The concept of automatic financial capital maintenance in units of constant purchasing power during low inflation and deflation seems to have been correctly treated by the IASC Board in 1989 (after proper due process) and then simply just ignored by everyone.

The IASB may be to blame for this by simply stating in the original Framework (1989), Par 104 (a) that financial capital maintenance can be measured in nominal monetary units without qualifying that statement. It is impossible to maintain the constant real value of capital constant with financial capital maintenance in nominal monetary units per se during inflation and deflation. Financial capital maintenance in nominal monetary units is only possible, per se, during sustained zero annual inflation. We have never had sustainable zero inflation on an annual basis in the past and we are not likely to have sustainable zero annual inflation any time soon in the future.

The missing qualification in IFRS is the following: Maintaining the constant real non-monetary value of financial capital constant with financial capital maintenance in nominal monetary units is only possible under the HCA model during low inflation in all entities that at least break even when an entity continuously invests 100% of the updated original real value of all contributions to Shareholders´ Equity in revaluable fixed assets (revalued or not) with an equivalent updated real value. All economic items are valued in accounting and the values are stated in terms of the monetary unit (money) as the unit of account. All functional currencies are unstable in real value: either their real values are being eroded by inflation or, in the case of Japan lately, the Yen’s real value is being increased internally by deflation. It is thus impossible to maintain the constant real non-monetary value of financial capital constant in nominal monetary units – per se – during low inflation and deflation – unless qualified as above.

IFRS did not authorize continuous financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par 104 (a) as an inflation accounting model. They did that with the CPP inflation accounting model in IAS 29 – also in 1989. Constant Item Purchasing Power Accounting as approved in IFRS by continuously measuring financial capital maintenance in units of constant purchasing power constitutes an IASB–authorized alternative to the Historical Cost financial capital concept, HC financial capital maintenance concept and HC profit or loss determination concept, namely a constant purchasing power financial capital concept, constant purchasing power financial capital maintenance concept and constant purchasing power profit or loss determination concept during low inflation and deflation. CIPPA as approved in the Framework only requires all constant real value non–monetary items to be valued in units of constant purchasing power. Variable real value non–monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS or GAAP.


Nicolaas Smith

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