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Wednesday, 4 April 2012

Financial capital maintenance in nominal monetary units per se is a very popular accounting fallacy


Financial capital maintenance in nominal monetary units per se is a very popular accounting fallacy

 Capital is a constant real value non-monetary item.

Maintaining the constant purchasing power of capital is a fundamental objective of financial reporting.

Financial capital maintenance in nominal monetary units per se as implemented under traditional Historical Cost Accounting is a very popular accounting fallacy because it is impossible to maintain the constant purchasing power of capital in nominal monetary units per se during inflation.

 It is only possible per se in entities that at least break even in real value – ceteris paribus – during indefinite zero inflation which has never been achieved in the past and is not soon to be achieved in the future.

 It is only possible to maintain the constant purchasing power of capital in nominal monetary units during inflation in entities that it least break even in real value – ceteris paribus – when they continuously invest 100 per cent of the constant purchasing power of all to contributions to capital in revaluable net assets (revalued or not) with an equivalent fair value, i.e., when the constant purchasing power of capital is always equal to the real value of net assets.

 It is possible to maintain the real value of capital with financial capital maintenance in nominal monetary units in entities that at least break even in real value – ceteris paribus – during indefinite deflation because the real value of capital would increase continuously during deflation as qualified.

 The constant purchasing power of capital would thus not be kept constant (which is what is required) in real value during deflation under financial capital maintenance in nominal monetary units.

Capital would be maintained constant in real value in all entities which at least break even in real value – ceteris paribus – in terms of a Daily CPI or other daily rate per se at all levels of inflation and deflation under financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) as authorized in the original Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)] which states:

‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

It is most probably safe to state that very few companies in the world economy would be able to claim with 100 per cent certainty that they have maintained the constant purchasing power of their owners´ equity over the lifetime of the company. It is most probably safe to state that hardly any company knows whether it has or has not. It is also most probably safe to state that very few companies in the world economy are 100 per cent sure that they are currently (2012) maintaining the constant purchasing power of their owners´ equity in nominal monetary units under traditional Historical Cost Accounting.

 All companies that would at least break even in real value – ceteris paribus – implementing financial capital maintenance in units of constant purchasing in terms of a Daily CPI or other daily rate (CIPPA) would be able to claim that at all levels of inflation and deflation.

Nicolaas Smith

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