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Wednesday, 2 May 2012

Accounting cannot and does not create real value out of nothing


Accounting cannot and does not create real value out of nothing




It must be clearly understood that accounting per se cannot and does not create real value out of nothing – out of thin air. Accounting cannot and does not create real value or wealth by simply passing some update or financial capital maintenance in units of constant purchasing power accounting entries when no real value actually exists. Constant real value non-monetary items first have to actually exist for the accounting model (CIPPA) to be able to automatically maintain the real values of those existing constant items constant for an indefinite period of time in all entities that at least break even in real value during inflation and deflation – ceteris paribus. This is achieved by continuously measuring financial capital maintenance in units of constant purchasing power as authorized in IFRS in terms of a daily index or other daily rate. Maintaining the constant purchasing power of capital constant is consequently a basic objective of financial reporting.





The IASB authorized very erosive financial capital maintenance in nominal monetary units (HCA) during inflation and deflation, as well as its real value maintaining remedy, financial capital maintenance in units of constant purchasing power (CIPPA), in one and the same sentence in 1989.





Obviously, at sustainable zero inflation constant items will maintain their real values constant in all companies that at least break even in real value during inflation and deflation – all else being equal- under both HCA and CIPPA. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.





The IASB confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 and in the original Framework (1989) that most companies´ primary financial reports are prepared based on the traditional Historical Cost Accounting model without taking changes in the general price level or specific price changes of assets into account, with the exception that investments, equipment, plant and properties (all variable real value non-monetary items) can be revalued. The IASB does not mention the other exception, namely, that salaries, wages, rentals, etc. (all constant real value non-monetary items) are generally measured in units of constant purchasing power on an annual basis.





The IASB does not mention the erosion of the real value of balance sheet constant items never maintained constant when the stable measuring unit assumption (a Generally Accepted Accounting Practice) is implemented during low inflationary periods in companies with insufficient revaluable fixed assets (revalued or not) because this process of erosion of the real value of constant items never maintained constant is not generally understood. The IASB, like the FASB and most others, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation, as specifically stated by the FASB. They also support the stable measuring unit assumption which is based on the fallacy that money is perfectly stable. They both authorized HCA based on the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation.





The erosion of the real value of constant items by the implementation of  the stable measuring unit assumption is very well understood and remedied by measuring  them in units of constant purchasing power by applying the annual CPI in the case of the income statement constant items salaries, wages, rentals, etc. The real value maintaining effect on balance sheet constant items is not understood of freely choosing to continuously measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved in IFRS in the original Framework (1989), Par 104 (a).





The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position.





The FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89.


‘Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.’


FAS 89, Par. 4, 1986


‘The integrity of the historical cost / nominal dollar system relies on a stable monetary system.’





FAS 33, 1979





The IASB never mentioned the stable measuring unit assumption in either IAS 6 Accounting Response to Changing Prices (approved in March, 1977 for publication in June, 1977) or IAS 15 (approved in June, 1981 for publication in November, 1981 and became effective on 1 January, 1983). IAS 15 completely superseded IAS 6. IAS 15 was withdrawn in December, 2003.


Nicolaas Smith


Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.