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Monday, 23 April 2012

Basic objective of accounting not realized

Basic objective of accounting not realized

Many people still see financial reporting as simply providing historic economic information. It is not realized that it is a basic objective of general purpose financial reporting to maintain the constant purchasing power of capital.

The reasons for this are:

(1) The Three Popular Accounting Fallacies.

(a)   The stable measuring unit assumption based on the fallacy that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance inunits of constant purchasing power during low inflation and deflation. Changes in the purchasing power of unstable money logically require financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation in terms of a daily rate.

(b)   Financial capital maintenance in nominal monetary units per se during low inflation and deflation originally authorized in IFRS in the Framework (1989), Par 104 (a) and in the FASB´s Concepts Statement No. 5. It is impossible to maintain the real value of capital in nominal monetary units per se during inflation and deflation.

(c) The generally accepted belief that the erosion of companies´ profits and capital is caused by inflation fully supported in IFRS and specifically stated by the FASB. Inflation has no effect on the real value of non-monetary items. Companies´ profits and capital are constant real value non-monetary items. The implementation of the stable measuring unit assumption during inflation erodes the constant purchasing power of owners´ equity that is not being maintained constant by the real value of net assets.

(1)   It is not realized that the stable measuring unit assumption and not inflation erodes the real value of constant items never maintained constant when financial capital maintenance in nominal monetary units (the traditional HCA model) is implemented during low inflationary periods.

(2)   It is not realized that continuous measurement of financial capital maintenance in units of constant purchasing power (CIPPA) in terms of a daily index rate automatically remedies this erosion by the stable measuring unit assumption in all entities that at least break even in real value during low inflation – ceteris paribus- whether they own any revaluable fixed assets or not.

The stable measuring unit assumption as implemented under financial capital maintenance in nominal monetary units, i.e., the HCA model, would already have been stopped by now, if the above were realized.

(3)   Although the principle of financial capital maintenance in units of constant purchasing power during inflation and deflation was authorized in IFRS in 1989, it is not generally implemented during low inflation and deflation because the very erosive effect of the stable measuring unit assumption on the real value of constant items never maintained constant is not recognized as such. It is generally believed that it is inflation doing the eroding in, for example, companies´ invested capital and profits – as  specifically stated in FAS 89 – when this erosion in constant item real value is, in fact, caused by the stable measuring unit assumption. Inflation has no effect on the real value of non–monetary items. Capital and profits are constant real value non–monetary items.

Nicolaas Smith


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