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Saturday, 10 September 2011

Monetary items under CIPPA - Part 2

Monetary items under CIPPA - Part 2

The full cost of or gain from inflation – net monetary loss or gain – would be recognized by these entities in their operations. It would be calculated and accounted in financial reports prepared under CIPPA. Under partial inflation–adjustment of monetary items – e.g. in Chile, the US, UK, Canada and all countries issuing inflation–indexed bonds – the net monetary loss or gain would be calculated and accounted for the part not inflation–indexed. This is presently not being done in Chile, the US, UK, Canada, etc. because these countries implement the HCA model under which net monetary losses and gains are not calculated and accounted.

The calculation and accounting of net monetary losses and gains are required under CIPPA because the stable measuring unit assumption is never applied under financial capital maintenance in units of constant purchasing power during inflation and deflation.

The constant purchasing power of capital can automatically be maintained constant by the real value of net assets in entities that at least break even during inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not – only when they implement financial capital maintenance in units of constant purchasing power. Capital is equal to the real value of net assets.

Under HCA the cost of inflation in the monetary economy is not calculated and accounted because the books are not being balanced in real terms but in nominal monetary terms with the implementation of the very erosive stable measuring unit assumption under financial capital maintenance in nominal monetary units. The concept of capital being equal to net assets is also applied under HCA, but, in illusionary nominal monetary terms. Historical Cost illusion that it is possible to maintain the real value of capital in nominal monetary units per se during inflation and deflation makes Historical Cost Accounting a very erosive and in principle inappropriate accounting policy.

Entities, on the one hand, apply the stable measuring unit assumption under HCA in the valuation of their own shareholders´ equity in their own financial reports in nominal monetary units under which they may not take into account unreported hidden reserves for fixed assets not revalued when they apply the Historical Cost approach to the valuation of fixed assets in terms of IFRS. On the other hand, they always value third parties´ shareholders´ equity taking into account unreported hidden reserves for fixed assets not revalued, e.g. in the share price of listed companies which they value at market value in terms of IFRS, as well as in their valuations of unlisted companies.

This means that under HCA only entities with revaluable fixed assets (revalued or not) with an updated real value equal to 100% of the updated constant real value of shareholders´ equity maintain the real value of their capital under the concept of capital is equal to net assets measured in nominal monetary units during inflation and deflation. This may only be the case in property companies, hotel, hospital and other property–intensive entities. CIPPA maintains the constant purchasing power of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribuswhether they own any revaluable fixed assets or not. This requires the calculation and accounting of net monetary losses and gains as well as net constant item losses and gains (a new accounting term) because the books are being balanced in real terms; i.e. the stable measuring unit assumption is never applied.

This also means that, under HCA, the portion of shareholders´ equity never covered by sufficient revaluable fixed assets (revalued or not) has always been and is still currently  unnecessarily, unintentionally and unknowingly being eroded at a rate equal to the annual rate of inflation; not by inflation, but, by the implementation of the stable measuring unit assumption during inflation.

The erosion is equal to the annual rate of inflation because economic items are valued in terms of money which is the legal monetary unit of account and inflation erodes the real value of only money and other monetary items. Inflation has no effect on the real value of non–monetary items. Shareholders´ equity is a constant real value non–monetary item. This unnecessary erosion in constant item real value amounts to hundreds of billions of US Dollars per annum in the world´s constant item economy.

Financial capital maintenance in units of constant purchasing power (CIPPA) would stop that forever and would instead maintain hundreds of billions of US Dollars per annum in the world´s shareholders´ equity investment base for an unlimited period of time.

As the Deutsche Bundesbank stated:



The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.



Deutsche Bundesbank, 1996 Annual Report, P 83.


Nicolaas Smith

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