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Thursday, 26 April 2012

Price-level accounting

Price-level accounting

Entities generally choose to measure financial capital maintenance in nominal monetary units and thus apply the very erosive stable measuring unit assumption as part of the traditional HCA model. They generally value all balance sheet constant items, e.g., owners´ equity, trade debtors, trade creditors, etc. as well as most income statement items, which are all constant items, at Historical Cost. They value them in nominal monetary units as a result of the fact that they assume that changes in the purchasing power of the unstable monetary unit are not sufficiently important to require financial  capital maintenance in units of constant purchasing power during low inflation and deflation.



Entities, in practice, assume unstable money is perfectly stable for this purpose. They, in practice, assume there has never been inflation or deflation in the past, there is no inflation and deflation in the present and there never will be inflation and deflation in the future as far as the valuation of most constant real value non-monetary items is concerned. They only value certain income statement constant items, e.g. salaries, wages, rentals, etc. in real value maintaining units of constant purchasing power annually by means of the annual CPI during low inflation. They then pay these items monthly in fixed nominal amounts, again implementing the stable measuring unit assumption.



IAS 29 Financial Reporting in Hyperinflationary Economies does not require the valuation of non–monetary items in units of constant purchasing power at the time of the transaction or event. IAS 29 simply requires the restatement of Historical Cost or Current Cost financial statements in terms of the period–end monthly published CPI in order to make them ‘more useful’ during hyperinflation. The non–monetary or real economy of a hyperinflationary economy can only be maintained relatively stable by applying the daily parallel US Dollar exchange rate or a Brazilian–style URV daily index to the valuation of all non–monetary items instead of simply restating HC or CC financial statement in terms of the period–end monthly published CPI as required by IAS 29.



The Framework is applicable



The concepts of capital, the capital maintenance concepts and the profit / loss determination concepts are not covered in IAS, IFRS or Interpretations. These concepts were covered in the original Framework for the Preparation and Presentation of Financial Statements (1989), now The Conceptual Framework for Financial Reporting (2010), Chapter 4: The Framework (1989): the remaining text. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, Par.11.



Deloitte states:

‘In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.’


IAS 8, Par. 11 states:

‘In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.’

The valuation of the constant items issued share capital, retained earnings, other items in owners´ equity and other constant  items was thus covered in IFRS in the original Framework (1989), Pa. 104 (a), now the Conceptual Framework (2010), Par. 4.59 (a).



Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:



‘Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price–level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.’



Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.


Nicolaas Smith

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