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Friday, 10 August 2012

What to do with the world´s accumulated Historical Cost Accounting loss


What to do with the world´s accumulated Historical Cost Accounting loss



Entities preparing their financial statements based on the historical cost basis generally do not know whether they have maintained the constant purchasing power of their equity constant over time.



The test would be to measure every item in current equity in units of constant purchasing power as from the date each item was contributed or came about over the entity´s lifetime and then to compare that total value with the company´s current net asset value measured in real value, i.e. no item in current net assets to be stated at historical cost, but at fair value.



This would be required to be done by an entity adopting financial capital maintenance in unit of constant purchasing power as authorized in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) instead of financial capital maintenance in units of nominal monetary units, the traditional HCA model.



In most entities this would result in an enormous accumulated Historical Cost Accounting loss to be accounted as part of equity.



The net effect would be an enomous increase in the nominal value of equity (measured in units of constant purchasing power over the entity´s lifetime to date) together with and enormous accumulated Historical Cost Accounting loss, but resulting in the same current net equity real value being equal to the current real value of net assets before and after the above calcultions are made.



It is thus advisable to rather simply value current net assets in real value and state that as the constant real value of current equity to be maintained constant as from here on foreward by means of financial capital maintenance in units of constant purchasing power.



It is very doubtful that tax authorities would accept the sudden calculation of enormous accumulated Historical Cost Accounting losses which would represent the erosion of equity by the stable measuring unit assumption (HCA) over the lifetime of the entity to date under the Historical Cost paradigm.



In countries which allow the write-off of profits against accumulated losses over five years, for example, it would mean that no taxes would be paid by entities over the next five years in the case of an entire country adopting financial capital maintenance in units of constant purchasing power as from the same date. No country would accept not receiving any taxes from the corporate sector for five years.



This could be overcome in two ways:



  1. The accumulated HCA loss not being allowed for tax purposes. It would thus remain on entities´ balance sheets over many years till it is written off against future profits. The net constant real value of equity would be correct and be maintained constant correctly by means of financial capital maintenance in units of constant purchasing power. This option would be costly in terms of accounting time spent on the calculations. It would reveal the real cost today of having implemented HCA over the lifetime of an entity.
  2. Do not value past additions to equity in units of constant purchasing power and do not calculate the current HCA accumualted loss. Value current equity at the real value of current net assets and implement financial capital maintenance in units of constant purchasing as from the current date foreward. This option would have no extra costs, but would hide the accumulated cost of having implemented the HCA model over the lifetime of the entiy.



The second option is obviously the better choice.



So, the answer to the question: what to do about the world´s accumulated HCA loss is: just ignore it J in time-honoured accounting fashion.



However, it is actually required to stop the hundreds of billions of US Dollars (2012) in real value eroded each and every year by the implementation of the stable measuring unit assumption (HCA) in the world´s constant item economy during inflation and hyperinflation.



I do realize that may only happen a hunderd or more years from now (2012). Individual companies (even countries) are free to start anytime they like. It was authorized in IFRS in 1989.







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