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Wednesday, 11 April 2012

Valuation of constant items during hyperinflation


Valuation of constant items during hyperinflation



The stable measuring unit assumption is applied in the valuation of constant real value non–monetary items, e.g., salaries, wages, rentals, equity, trade debtors, trade creditors, taxes payable, etc. during hyperinflation when these items are not updated at all or not fully updated during hyperinflation; i.e., when the HCA model is implemented during hyperinflation as mistakenly approved in IAS 29 and mistakenly supported by Big Four accounting firms like PricewaterhouseCoopers.



PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:



Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting. IAS 29 seeks to overcome the limitations of historic cost financial reporting in hyperinflationary conditions.



Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, 2002, p 5.



IAS 29 states:



‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach shall be stated in terms of the measuring unit current at the end of the reporting period. ‘



IAS 29, Par 8.



It is absolutely clear from the above quotes that IFRS approve and PricewaterhouseCoopers support the implementation of the Historical Cost Accounting model and the very erosive stable measuring unit assumption during hyperinflation. That is a fundamental mistake during hyperinflation. HCA should be banned by law during hyperinflation.



Certain (not all) income statement items, e.g., salaries, wages, rentals, etc. are measured as a generally accepted accounting practice in units of constant purchasing power on an annual basis (they are updated annually – not monthly) as part of the traditional Historical Cost Accounting model during low inflation. The Framework states that various measurement bases are used in conjunction in the HCA model during inflation, hyperinflation and deflation.



A constant real value non–monetary item´s legal existence is determined by contract or statute (company law, commercial law, etc.). However, these constant real value non–monetary items are – in practice – treated as monetary items (cash) during the period that they are not measured in units of constant purchasing power in terms of the daily US Dollar or other daily hard currency parallel rate or a daily index rate during hyperinflation.



Salaries, wages, rentals, trade debtors, trade creditors, all other non–monetary payables, all other non–monetary receivables, etc. are not required in IAS 29 to be valued or measured or updated at the date of payment in terms of the period–end monthly published CPI. That is, obviously, not practically possible when the period–end monthly CPI is normally only available one or two months after the month to which it relates during hyperinflation. What is required in IAS 29 is that these constant real value non–monetary items´ nominal Historical Cost or Current Cost values – after payment or after the liability for the payment have been accounted – in HC or CC financial statements at the end of the accounting period be restated in terms of the period–end monthly CPI in order – simply – to make the HC or CC financial statements more useful during hyperinflation. The practical implementation of IAS 29 thus does not generally result in financial capital maintenance in units of constant purchasing power during hyperinflation. That clearly explains the failure of IAS 29, for example, when it was implemented during hyperinflation in Zimbabwe. It did not manage to keep the Zimbabwe real economy relatively stable like daily updating in terms of the daily index supplied by various governments during 30 years of very high and hyperinflation in Brazil did. The complete failure of IAS 29 in Zimbabwe seems to make absolutely no difference to the IASB´s confidence in this failed standard.



When there is no CPI published as happened towards the end of severe hyperinflation in Zimbabwe, constant real value non–monetary item values cannot be determined. It was impossible to implement IAS 29 during severe hyperinflation in Zimbabwe. See reference below. However, these constant items´ real legal or contractual values do not disappear even when they – temporarily – cannot be valued in the local currency. Their legal or contractual constant real non–monetary values still exist even after monetary meltdown of only the local currency. Constant real value non–monetary items are measured at fair value (in nominal monetary units or units of constant purchasing power depending on whether the entity chooses the HCA or CIPPA model) in the opening balance sheet after monetary meltdown in terms of IAS 1.



The IASB authorized an addition to IAS 1 in 2011 to allow for the fair value valuation of all non–monetary items (constant and variable items) in the opening balance sheet of companies applying IFRS after severe hyperinflation and a monetary meltdown. Inflation and hyperinflation have no effect on the real value of non–monetary items. All non–monetary items (constant and variable items) were still there to be fair–valued and included in the opening balance sheet of companies after the monetary meltdown in Zimbabwe in 2008.



No exchangeability with all relatively stable foreign currencies means no exchange rates which means no hyperinflation (no prices being set in the local currency) and vice versa: no exchange rate with any relatively stable foreign currency means no exchangeability which means no hyperinflation (no prices being set in the local currency). No prices being set in the local currency means monetary meltdown: the total money supply (all local currency money and other monetary items stated in the local currency) has no value.



Trade debtors and trade creditors are constant real value non–monetary items and not monetary items as incorrectly stated by the US Financial Accounting Standards Board, the International Accounting Standards Board, PricewaterhouseCoopers and most others except 180 million Brazilians and 10 million Angolans during hyperinflation.


Nicolaas Smith

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