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Thursday, 3 May 2012

Price–level accounting does not prevail


Price–level accounting does not prevail



Price–level accounting as Harvey Kapnick hoped for in 1976 clearly does not prevail for balance sheet constant real value non–monetary items (e.g., owners´ equity) and most income statement items during low inflation. Income statement items are all constant real value non–monetary items. Price–level accounting does prevail as far as the income statement constant items salaries, wages, rentals, etc. are concerned since they are generally measured annually in units of constant purchasing power in terms of the annual change in the Consumer Price Index, but, they are then paid monthly applying the stable measuring unit assumption.



In terms of the HCA model the stable measuring unit assumption is implemented under which balance sheet constant items are valued at historical cost, i.e., in nominal monetary units thus eroding the existing constant real value of these constant items when they are not maintained constant  during low inflation.



Price–level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when Brazil indexed all non–monetary items (variable and constant items) in their non–monetary or real economy with a daily index value supplied by the different governments during that period. Brazil stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They should have changed from daily indexation of all non–monetary items (variable and constant items) during hyperinflation to financial capital maintenance in units of constant purchasing power during low inflation by applying their Daily CPI.



William Paton noted:



‘the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.’



As quoted in FAS 33, p. 29.



There is no substance in the claim that the existence and value of economic resources, for example owners´ equity items, exist independently of how we measure them – and that the choice of the measuring unit does not affect their fundamental value, only how we choose to represent that value – and that we can use any monetary unit, US Dollars of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced.  See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit – but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices made in accounting will not change that value and will not affect the economy. Measuring constant real value non–monetary items in units of constant purchasing power over time does affect the economy. That is generally known and a fact.



The HCA model would have been rejected by now if it were generally understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional erosion of hundreds of billions of US Dollars of real value in constant items (e.g., banks´ and companies´ equity) never maintained in the world´s constant item economy year in year out.


Nicolaas Smith

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