Pages

Tuesday, 3 July 2012

Valuing variable items at HC does not erode their real values

Valuing variable items at HC does not erode their real values

Buy the ebook for $2.99 or £1.53 or €2.68



The real values of variable items are not eroded by the stable measuring unit assumption when entities value these items at their original nominal HC values before the date that they are actually sold or exchanged during inflation and deflation. They would be valued at their current market values on the date of exchange or sale in an open economy. During hyperinflation all non–monetary items (variable and constant real value non–monetary items) are required to be restated in terms of IAS 29 to make these restated HC or Current Cost period–end financial reports – supposedly – more useful by applying the period–end monthly published CPI. A hard currency parallel rate – normally the US Dollar parallel rate – or a Brazilian–style URV daily index is applied on a daily basis when a country wishes to stabilize its real economy during hyperinflation.

Variable items´, e.g., land and buildings´, real values are not being unknowingly eroded by the HCA model as a result of the implementation of IFRS since they exist independently of how we value them. Entities can value land and buildings in the balance sheet at their historical cost 50 years ago, but, when these assets are sold in the market today they would be transacted at the current market price in an open market. The real values of variable items are also not being eroded uniformly at, e.g., a rate equal to the annual inflation rate because of valuing them at original nominal HC. Inflation has no effect on the real value of non–monetary items.

Where real losses are made in dealing with variable items in the economy, these losses are the result of supply and demand or business or private decisions, e.g., selling at a bad price, obsolescence, stock market crashes, credit crunches, other impairments, etc. They do not result from the implementation of the HC accounting model. These losses and impairments are treated in terms of IFRS.

A house is a variable real value non–monetary item. Let us assume a house in Port Elizabeth, South Africa is fairly valued in the PE market at say R 2 million on 1 January in year one. With no change in the market a year later but with annual inflation at 6 per cent in SA, the seller would increase his or her price to R2.12 million – all else being equal. The house’s real value remained the same. The depreciating monetary value of the house expressed in the depreciating Rand medium of exchange – all else being equal – was updated to compensate for the erosion of the real value of the depreciating Rand in the internal SA market by 6 per cent annual inflation. It is clear that inflation does not affect the house’s variable non–monetary real value – all else being equal.

However much inflation rises, it can only erode the SA Rind’s real value at a higher rate and over a shorter period of time. As inflation rises the price of the house would rise to keep pace with inflation or value erosion in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non–monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.

The house’s real value is not a constant real value non–monetary item. It is only assumed in this example that only inflation changes with all else being equal. This is not normally the case in the actual property market. The house is a variable real value non–monetary item.

When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 29 years (2010) since January, 1981 in the company’s balance sheet. When it is eventually sold in 2010 for R 1.4 million we can see that inflation did not erode the property’s variable real non–monetary value – all else being equal. Inflation only eroded the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 29 year period – all else being equal. This would be taken into account by the buyer and seller at the time of the sale in a free and open market. The selling price quoted in terms of the depreciating Rand would be increased to compensate for the erosion of the real value of the depreciating Rand by inflation. R1.4 million in 2010 was the same as R100 000 in January, 1981 – all else being equal.

As the two academics from Turkey state:

‘Purchasing power of non monetary items does not change in spite of variation in national currency value.

Guceneme and Arsoy 2005: 9

Buy the ebook for $2.99 or £1.53 or €2.68

Nicolaas Smith

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