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Tuesday, 5 July 2011

Legal tender

Legal tender


Money derives its nominal value from being declared by government to be legal tender. It does not mean economic entities will accept it as money. Zimbabwe declared 100 trillion Zimbabwe Dollar notes as legal tender, but the population in Zimbabwe refused to accept it as legal tender after a very short time because hyperinflation in the millions of per cent per annum made the notes almost worthless. The Zimbabwe Government withdrew the ZimDollar from circulation when they dollarized their economy with multi–currencies after the Reserve Bank of Zimbabwe wiped out all the real value represented by the Zimbabwe Dollar in their economy by printing excessive amounts of extremely high nominal value bank notes till the currency had no exchangeability with any other foreign currency.

Fiat money’s real value is determined by all the underlying value systems in the economy. Changes in money’s real value over time are indicated by the rate of annual inflation or deflation. Money has the legal backing of being legal tender. Legal tender is an offered payment that, by law, cannot be refused in settlement of a debt. Credit cards, personal cheques and similar non–cash methods of payment are not usually legal tender. The law does not relieve the debt until payment is accepted which explains the practice in some economies of making out receipts for most payments. Bank notes and coins are usually defined as legal tender.

Monetary items are defined incorrectly in IAS 21 The Effects of Changes in Foreign Exchange Rates, Par 8:

Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.

Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se. Non–monetary items are often paid in a fixed or determinable number of units of currency. Fixed salary, wage and rental payments do not transform these constant real value non–monetary items into monetary items. Salaries, wages, rentals, etc are constant real value non–monetary items. They are not monetary items. They are simply paid in money as the medium of exchange. They are sometimes paid in a fixed or determinable number of units of currency because they are measured in nominal monetary units under the current Historical Cost paradigm during low inflation and not in units of constant purchasing power. This does not transform them into monetary items simply because they are paid in fixed historical cost values. They remain constant real value non–monetary items.


Nicolaas Smith

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