Friday, 9 September 2011

Monetary items under CIPPA

Monetary items under CIPPA

Financial capital maintenance in units of constant purchasing power (CIPPA) never implementing the stable measuring unit assumption during inflation and deflation requires the following:

      All monetary items – historical and current period monetary items – are inflation–adjusted in terms of a Daily Consumer Price Index or monetized daily indexed unit of account like the Unidad de Fomento in Chile. This results in the complete elimination of the cost of inflation (not actual inflation in the monetary unit); i.e. there would be no net monetary loss or gain in the entire economy, only under complete coordination and with all money in the banking system which makes this only a theoretical assumption. There are always bank notes and coins outside the banking system even if all other monetary items in and outside the banking system were inflation–indexed as partially done in Chile since 1967 with the UF. There would thus always be net monetary losses and gains to be calculated and accounted only in the monetary economy. Inflation has no effect on the real value of non–monetary items.

Complete coordination in an economy would most probably not be that easy to achieve right from the start. Banks cannot be forced to inflation–adjust all monetary items in the banking system when entities do not yet understand all the benefits of financial capital maintenance in units of constant purchasing power. Chilean banks operate profitably with inflation–adjusting a portion (currently 20 to 25% of their broad M3 money supply) of deposits from clients since 1967. They inflation–index, for example, mortgages and car loans, which include their profit margins, to clients in terms of the UF.

However, entities may start financial capital maintenance in units of constant purchasing power, as authorized in IFRS, without any inflation–adjustment of monetary items at all. They may be motivated by the invisible hand of self–interest, shareholder pressure or more financial crises caused by continuously undercapitalized banks and companies. They may wish to immediately benefit from automatically maintaining the constant purchasing power of their own shareholders´ equity constant forever as long as they break even during inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not. (See CIPPA increases a company´s net asset value.) [Link this to the blog article.]

There is much to be gained from moving away from reporting on the basis of Financial Capital Maintenance in Nominal Monetary Units.

           Prof Rachel Baskerville, Associate Professor of Accounting at the School of Accounting and Commercial Law at the Victoria University of Wellington, New Zealand in her publication 100 Questions(and Answers) about IFRS,  Question 38, 2010 on the Social Science Research Network.

Nicolaas Smith

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