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Monday, 4 June 2012

Inflation accounting

Inflation accounting



Financial capital maintenance in units of constant purchasing power as authorized in the original Framework (1989), Par. 104 (a) as an alternative to financial capital maintenance in nominal monetary units during low inflation and deflation is not an inflation accounting model. The IASB´s inflation accounting model is specifically defined in IAS 29 Financial Reporting in Hyperinflationary Economies.



An inflation accounting model is generaly understood to be an accounting model specifically implemented only during very high inflation and hyperinflation. According to the IASB hyperinflation is cumulative inflation over three years approaching or exceeding 100 per cent, i.e., 26 per cent annual inflation for three years in a row. Under CIPPA financial capital maintenance in units of constant purchasing power is implemented at all levels of inflation and deflation, including during hyperinflation. Financial capital maintenance in units of constant purchasing power is the IASB-authorized alternative to financial capital maintenance in nominal monetary units at all non-hyperinflationary levels, i.e., the alternative to the traditional HCA model which is not an inflation accounting model.





The IASB´s inflation accounting model defined in IAS 29 is a failed inflation accounting model. The IASB even admitted that it was impossible to implement IAS 29 during the final severe hyperinflation in Zimbabwe. It was implemented during hyperinflation in Zimbabwe and had absolutely no effect on the economic conditions in that country during hyperinflation.



Brazil, on the other hand, very successfully implemented inflation accounting during 30 years from 1964 to 1994 by indexing non-monetary items in the economy in terms of a daily index supplied by the various governments during that period. This very successful use of inflation accounting in terms of a daily index was apparently completely ignored by the IASB in the formulation of IAS 29 in 1989. IAS 29 simply requires the restatement of HC or CC period-end financial statements in terms of the monthly published CPI.



Constant Purchasing Power Accounting (CPPA) is an inflation accounting model.



‘Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money.  It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index.’



(Whittington, 1983: )



The CIPPA model under which only constant items (not variable items) are measured in units of constant purchasing power by applying the Daily Consumer Price Index at all levels of inflation and deflation is not an inflation accounting model although it is also to be implemented during hyperinflation. Variable items are not simply indexed daily in terms of a Daily CPI during non-hyperinflationary periods under CIPPA. They are valued daily in terms of IFRS, excluding the stable measuring unit assumption, and only updated daily in terms of the Daily CPI when they are not valued daily in terms of IFRS.



Under the stable measuring unit assumption it is considered that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power – normally during low inflation and deflation.



Most entities in low inflationary and deflationary economies implement the Historical Cost Accounting model under which the stable measuring unit assumption is implemented. This means that all balance sheet constant items (e.g., owners´ equity, trade debtors, trade creditors, provisions, other non–monetary payables, other non–monetary receivables, etc.) and most (not all) income statement items are measured at their historical cost, i.e., financial capital maintenance is measured in nominal monetary units as authorized in IFRS. Some income statement items, e.g., salaries, wages, rentals, etc. are measured annually in units of constant purchasing power in terms of the annual CPI, but, are then paid on a monthly basis implementing the stable measuring unit assumption under HCA. It is impossible to maintain the real value of financial capital constant with financial capital maintenance in nominal monetary units per se during low and high inflation, deflation and hyperinflation. Financial capital maintenance in nominal monetary units during inflation and deflation, although authorized in IFRS, is still a popular accounting fallacy not yet extinct.



Valid inflation accounting, i.e., the use of an accounting model to automatically stop the erosion of real value in all non–monetary items (variable and constant items) in all entities that at least break even in real value during hyperinflation – ceteris paribus, is only possible with financial capital maintenance in units of constant purchasing power in terms of a daily non–monetary index or relatively stable daily hard currency parallel rate (not the monthly published CPI) to the valuation of (not the ‘restatement of’ period–end Historical Cost or Current Cost financial statements) all non–monetary items during hyperinflation.



This can be stated differently as follows: Only inflation accounting based on daily indexing of all non–monetary items in terms of a daily index or daily parallel rate automatically maintains the real value of all non–monetary items in all entities that at least break even in real value during hyperinflation – ceteris paribus; i.e., maintains the real or non–monetary economy stable during hyperinflation in the monetary unit.



The best example of successful inflation accounting was the use in Brazil of a daily government–supplied non–monetary index to index all non–monetary items daily during the 30 years of very high and hyperinflation in that country from 1964 to 1994.



The IFRS response to the erosion of real value in non–monetary items caused by the implementation of the HCA model, i.e., the implementation of the stable measuring unit assumption, during hyperinflation is IAS 29. IAS 29 requires entities operating in hyperinflationary economies, not to value or measure all non–monetary items in terms of a daily non–monetary index or a daily parallel rate, but to simply restate Historical Cost or Current Cost period–end financial statements in terms of the period–end monthly published CPI.



‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.’



(IAS 29, Par. 8)



PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:

‘Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting.’

(PricewaterhouseCoopers, 2006: 5)



The best example of the failure of the implementation of IAS 29 to have any effect at all on a hyperinflationary economy was its application, as required by the IASB, by listed companies on the Zimbabwean Stock Exchange during hyperinflation. The Zimbabwean real or non–monetary economy imploded in tandem with Zimbabwe´s monetary unit and monetary economy despite the implementation of IAS 29. The IASB actually officially admitted that it was impossible to implement IAS 29 during severe hyperinflation in Zimbabwe.



However, a daily relatively stable parallel rate was available till the last day of hyperinflation in Zimbabwe, which officially ended on 20 November 2008, when Gideon Gono, the governor of the Reserve Bank of Zimbabwe issued regulations that closed down the ZSE which stopped the daily Old Mutual Implied Rate (OMIR) being available in Zimbabwe. The (normally unofficial) parallel rate – usually the US Dollar parallel rate – is an excellent, not a perfect, substitute for a daily non–monetary index in a hyperinflationary economy. The US Dollar parallel rate was available 24/7, 365 days a year during Zimbabwe´s hyperinflation. Right at the end, during severe hyperinflation when the CPI was not being published any more and it was impossible to implement IAS 29, the OMIR was still available on a daily basis.



IAS 29 is fundamentally flawed by simply requiring the restatement of HC or CC period–end financial statements in terms of the period–end CPI instead of daily valuation / measurement of all non–monetary items in terms of a daily Brazilian–style Unidade Real de Valor index or parallel rate.


A number of entities are requesting a fundamental review of IAS 29 (2011). See  IFRS ´X’ Capital Maintenance in Units of Constant Purchasing Power.




Nicolaas Smith

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