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Monday, 19 December 2011

Financial capital maintenance in units of constant purchasing power in terms of a daily rate or index is required

Financial capital maintenance in units of constant purchasing power in terms of a daily rate or index is required

I regard the requirement of financial capital maintenance in units of constant purchasing power in terms of a daily rate during high and hyperinflation in future review of IAS 29 as the most pressing financial reporting need for standard-setting action from the IASB. That would quickly lead to its implementation during low inflation in terms of a Daily Consumer Price Index. The Unidad de Fomento in Chile and all inflation-indexed bonds (they trade daily) in many countries currently use DCPIs. A Daily Consumer Price Index is a lagged daily interpolation of the CPI. The Unidad de Fomento is a monetized daily indexed unit of account un-rebased since 1967 and published daily since 1977. The Central Bank of Chile publishes it daily since 1990.

The current implementation of financial capital maintenance in nominal monetary units (HCA) during low inflation results in the unnecessary erosion of vast amounts of constant item real value in the world´s constant item economy each and every year. (See the deficiency in capital during the financial crisis.) It is very clear that it is not possible to maintain the real value of capital in nominal monetary units per se during low inflation.

Financial capital maintenance in units of constant purchasing power in terms of a daily rate or daily index would automatically stop this erosion in constant real value by the stable measuring unit assumption (not low inflation, high inflation or hyperinflation) for an indefinite period of time during low inflation, high inflation and hyperinflation. It would instead maintain vast amounts of constant item real value in the world´s constant item economy per annum at the current level of world inflation when the stable measuring unit assumption is finally rejected in the measurement of constant items, e.g. shareholders´ equity at all levels of inflation and deflation.

Although the IASB authorized financial capital maintenance in units of constant purchasing power at all levels of inflation, high inflation, hyperinflation and deflation in the original Framework (1989), Par 104 (a) – any individual company implementing IFRS can implement it right now during low inflation and deflation  and although the definitions of constant real value non-monetary items and variable real value non-monetary items are clearly implied in Par 104 (a), a definite requirement of only financial capital maintenance in units of constant purchasing power in terms of only a daily rate during high inflation and hyperinflation plus the actual definition of constant real value non-monetary items and variable real value non-monetary items in a revised IAS 29 would, in my opinion, quickly lead to the implementation of financial capital maintenance in units of constant purchasing power in terms of a Daily Consumer Price Index during low inflation and deflation.

Nicolaas Smith

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