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Thursday, 17 May 2012

Correct definition of monetary items is critical

Correct definition of monetary items is critical

Updated on 4 July 2013

Definition: Monetary items constitute the money supply.

The correct definition of monetary items is critical for the correct classification of monetary and non–monetary items since the latter are defined as all items that are not monetary items. If the definition of monetary items is partly wrong – as it currently (2013) is in IFRS – then some constant items are incorrectly classified as monetary items. This happens mainly with the incorrect classification of trade debtors and trade creditors as monetary items under IFRS. This affects the correct valuation of these items, the accounting of the net monetary and constant item gain or loss and consequently the profit or loss for the reporting period which influences the correctness of the financial statements in terms of IAS 29 during hyperinflation. The accounting of the net monetary and constant item gain or loss is an essential part of the CIPPA model while these two items are not required under the HCA model during non-hyperinflationary periods. Only the accounting of the net monetary gain or loss is required in IAS 29 during hyperinflation.



The incorrect treatment of the constant items trade debtors and trade creditors and other non–monetary payables and receivables as monetary items is mainly due to the incorrect definition of monetary items in IFRS.



It is generally accepted and taught at university that there are only two distinct economic items in the economy, namely, monetary and non–monetary items and that the economy is divided in the monetary and non–monetary or real economy.

Monetary items are defined by the IASB in
IAS 21 The Effects of Changes in Foreign Exchange Rates, Par. 8.



‘Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.’



Monetary items are also defined in IAS 29 Financial Reporting in Hyperinflationary Economies, Par. 12.


Monetary items are money held and items to be received or paid in money.’


The FASB and PricewaterhouseCoopers also define trade debtors and trade creditors incorrectly as monetary items.


The second part of the IAS 29 definition is not correct. When a non–monetary item, e.g., a raw material item, is bought on credit, the trade debtor amount in the supplier’s accounts is not a monetary item just because it will
be paid in money or because it will be paid in a fixed or determinable number of units of currency. It can be paid in strawberries or diamonds too, if the supplier will accept strawberries or diamonds as a medium of payment. That will not make the non–monetary raw material a strawberry item or diamond item, just like payment in money does not, necessarily, make a non–monetary raw material item, a monetary item. Money or strawberries or diamonds are simply used as the mutually agreed medium of exchange. The constant real value non–monetary trade debtor amount relates to the sale of a non–monetary item, namely the non–monetary raw material. That is the fundamental factor: what is the underlying nature of the trade debtor or trade creditor? The trade debt for the payment of a raw material item has an underlying non–monetary nature. All items – monetary and non–monetary items – are normally received or paid in money.



The buyer did not decide or agree to borrow money – exactly equal to the amount of the trade debt – from the supplier of the raw material item the moment the buyer decided not to pay the purchase cash on delivery or even if it was beforehand agreed that the buyer would not pay cash on delivery, but would be granted credit. The supplier did not decide or agree to lend the buyer money– exactly equal to the amount of the trade debt – the moment the buyer did not pay the purchase cash on delivery. The trade debt relates to a non–monetary item: raw material. The trade debt is thus a constant real value non–monetary item the moment it comes about. The underlying non–monetary nature of the debt (raw material, furniture, vehicle, etc.) results in it being a constant real value non–monetary item the moment the debt comes about which has to be measured in units of constant purchasing power – over time – during inflation  and deflation. Street vendors in hyperinflationary economies – some of whom have never been to school – know this instinctively from plying their trade in the street.



When inflation erodes the real value of the monetary medium of exchange at two per cent per annum, two per cent more money has to be paid over a year to pay off the constant real value non–monetary item, the trade debtor amount.



Inflation is always and everywhere a monetary phenomenon per Milton Friedman. Money is only the monetary medium of exchange used for payment. Inflation can only erode the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non–monetary items. The debt is for the constant real non–monetary value of a non–monetary item mutually agreed and generally accepted to be paid in money: not for a monetary item. Money is simply the medium of exchange. No–one lent any money to anyone else. There is generally no money loans involved with trade creditors and trade debtors.


Nicolaas Smith

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