Pages

Wednesday, 23 May 2012

Trade debtors and creditors are not monetary items

Trade debtors and creditors are not monetary items

Monetary items are defined incorrectly 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.’



The capital amounts of all capital inflation-indexed bonds are monetary items. However, they are non-monetary items according to the above definition because they are not to be paid or received in a fixed or determinable number of units of currency during inflation. No-one can determine the final nominal payback value of a capital inflation-indexed bond during inflation at the date of issue. TIPS and other sovereign inflation-indexed bonds with a guarantee of a capital payback at least equal to the original nominal principal value if it should be lower than the issuance amount due to deflation, are thus monetary items only during deflation according to the IASB´s definition in IAS 21, Par. 8. The capital amounts of inflation-linked bonds are obviously not non-monetary items during inflation no matter that they could be defined as such according to the IASB: they are always and everywhere monetary items because they are items with an underlying monetary nature. They are substitutes for local currency held during inflation and deflation.



Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se. Non–monetary items are often paid in a fixed or determinable number of units of currency. Fixed salary, wage and rental payments do not transform these constant real value non–monetary items into monetary items. Salaries, wages, rentals, etc. are constant real value non–monetary items. They are not monetary items. They are simply paid in money as the generally accepted mutually agreed medium of exchange. They are, however, sometimes paid in a fixed or determinable number of units of currency because they are measured in nominal monetary units under the current Historical Cost paradigm under which the stable measuring unit assumption is implemented during inflation and deflation (and often even during hyperinflation). This does not transform them into monetary items simply because they are paid in fixed nominal historical cost values. They remain constant real value non–monetary items.



Trade debtors and trade creditors are defined incorrectly by the FASB and by PricewaterhouseCoopers (amongst most probably all others except (1) in Chile, (2) during hyperinflation in Brazil and (3) during 1995-7 in Auto-Sueco (Angola) where I worked) to be monetary items. Trade debtors and trade creditors are items with an underlying non-monetary nature; e.g., finished goods, stock, raw materials, plant, equipment, services rendered, etc. They are constant real value non–monetary items.



I posed the question whether trade debtors and trade creditors are monetary or non-monetary items in 2007 to Dr Gustavo Franco, former governor of Brazil’s Central Bank in 1997-99. He was one of the architects of the Unidade Real de Valor by which Brazil finally conquered hyperinflation in 1994.



I asked him: ‘> Were trade debtors and trade creditors treated as monetary items under the URV and not updated or were they treated as non-monetary items an updated in terms of the URV?

>

> What are trade debtors and trade creditors in your opinion? Are they monetary or non-monetary items?’



He replied:



‘Two observations are in order. First, for spot transactions the existence of the URV is imaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enteres the picture only when at least one leg of a commercial transaction is defferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs are to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.



It was essentil, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denomiated obligation had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetized.’



(Franco, 2007)



It is clear from Dr Franco´s reply that trade debtors and trade creditors are non-monetary items that have to be measured in units of constant purchasing power during inflation.



In principle, all fixed payments over time under HCA are regarded as monetary items because of the implementation of stable measuring unit assumption. When it is assumed, in practice, that money is perfectly stable during low and high inflation and deflation, then the classification of an item between being a monetary or non-monetary item depends on whether it is paid or received in a fixed nominal amount over time or not. Fixed payments are then assumed to be monetary items under HCA. In reality they may not be.



The stable measuring unit assumption means that changes in the purchasing power of money are regarded as not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. In practice the stable measuring unit assumption means that the real value of money is assumed to be perfectly stable during low and high inflation and deflation. The stable measuring unit assumption is simply an economic and accounting assumption. It is not based on fact. The fact is that the real value of money is never perfectly stable under inflation and deflation. The stable measuring unit assumption is thus based on a fallacy, namely the fallacy that money is stable in real value during low inflation and deflation. A fact will always eventually prevail over an assumption regarding that fact.



Trade debtors and trade creditors are constant real value non–monetary items but are treated like monetary items under the Historical Cost paradigm. Brazil measured trade debtors and trade creditors in units of constant purchasing power in terms of a daily index value during 30 years of very high inflation and hyperinflation.



I measured all trade debtors in units of constant purchasing power in terms of the daily US Dollar parallel rate in Auto–Sueco (Angola) in 1996. All our trade debtors accepted that and paid the updated amounts in Angolan Kwanzas. They knew that the underlying nature of their debt to us was non-monetary, namely, the new spare parts that were installed in their trucks in our workshops and the services of our mechanics installing those parts and servicing their trucks.



Trade debtors and trade creditors are incorrectly treated as monetary items in practice in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. All calculations done since 1989 in terms of IAS 29 of net monetary losses and gains as well as profit / loss calculations are thus, in principle, wrong.


Nicolaas Smith

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