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Thursday, 10 May 2012

Net monetary gains and losses

Net monetary gains and losses

Entities with net monetary item assets (weighted average of monetary item assets greater than weighted average of monetary item liabilities) over a period of time will suffer a net monetary loss (less real monetary item value owned / more real monetary item value eroded) during inflation. Entities with net monetary item liabilities (weighted average of monetary item liabilities greater than the weighted average of monetary item assets) will experience a net monetary gain (less real monetary item value owed/more real monetary item liabilities eroded) during inflation. The opposite is true during deflation.

Net monetary gains and losses are accounted during hyperinflation as required by IAS 29 Financial Reporting in Hyperinflationary Economies. The accounting of net monetary gains and losses was also authorized in IFRS during low and high inflation and deflation, i.e., under the Constant Item Purchasing Power Accounting model with the approval of measurement of financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par. 104 (a). This is due to the fact that the stable measuring unit assumption is not implemented under financial capital maintenance in units of constant purchasing power (CIPPA).  Net monetary gains and losses are not required to be computed under the traditional Historical Cost Accounting model although it can be done according to Kapnick.

‘Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical–cost basis.’

(Kapnick, 1976: p 6)

Net monetary gains and losses are constant items once they are accounted in the income statement under CIPPA. All income statement items are constant items under CIPPA.

This omission under the Historical Cost paradigm to compute the gains and losses from holding monetary items is one of the consequences of the stable measuring unit assumption as implemented as part of the traditional Historical Cost Accounting model. Net monetary item gains and losses are not required to be accounted because the stable measuring unit assumption is implemented under HCA.

‘The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.’

(Walgenbach, Dittrich and Hanson, 1973: p 429)

An increase in the general price level (inflation) erodes the real value of unstable money and other unstable monetary items with an underlying monetary nature, e.g., the capital values of nominal bonds and loans. However, inflation has no effect on the real value of non-monetary items.

Constant items never measured in units of constant purchasing power (e.g., trade debtors and trade creditors) are effectively treated as monetary items when the stable measuring unit assumption is implemented as part of the HCA model during inflation. Implementing the HCA model unknowingly, unintentionally and unnecessarily erodes their real values at a rate equal to the annual rate of inflation because they are measured in nominal monetary units during inflation. Inflation only erodes the real value of money which is the nominal monetary unit of account in the economy and other monetary items. The erosion of the real value of constant items never maintained constant by the stable measuring unit assumption under HCA would stop when financial capital maintenance is measured in units of constant purchasing power during inflation, i.e., implementing the CIPPA model. There is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power (CIPPA). It is thus the implementation of the stable measuring unit assumption and not inflation that is doing the eroding.

The generally accepted measure of inflation is the annual inflation rate calculated from the annualized percentage change in a general price index – normally the Consumer Price Index – published on a monthly basis.  

Financial capital maintenance in units of constant purchasing power (CIPPA) requires daily measurement in terms of a Daily CPI or a monetized daily indexed unit of account during non-hyperinflationary periods.

The correct measure of hyperinflation is either (a) the change in a relatively stable foreign currency daily parallel rate, normally the US Dollar daily parallel rate or (b) the change in a Brazilian–style Unidade Real de Valor daily index almost entirely based on the daily USD rate. The CPI published a month and a half to two months after the hyperinflationary changes in the real value of the monetary unit actually occurred (as happened in Zimbabwe), is completely impractical and totally ineffective when the aim is to stabilize the real economy during hyperinflation as Brazil so effectively did with daily indexation during 30 years of high and hyperinflation.


Nicolaas Smith

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