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Thursday, 27 September 2012

Managerial Accounting under Financial Capital Maintenance in Units of Constant Purchasing Power

Financial capital maintenance in units of constant purchasing power is the same as Constant Item Purchasing Power Accounting at all levels of inflation and deflation, including during hyperinflation.

It is a departure from Historical Cost Accounting. The fundamental difference is that the stable measuring unit is never implemented under financial capital maintenance in units of constant purchasing power. Everything is done at real value: in Managerial Accounting too. I equate Managerial Accounting to Cost and Management Accounting.

Simply take any item in Managerial Accounting and update it to its current real value, i.e. it´s value today at today´s Daily CPI.

First you will have to find the Daily CPI for your country. If your government issues government capital inflation-indexed bonds, then you already have a Daily CPI in your country. The Daily CPI for your country is the one or two month lagged daily interpolated index that is used in your country to price your government inflation-indexed bonds on a daily basis: these bonds are bought and sold on a daily basis in your country´s capital markets.

If your country, like Venezuela, does not issue government inflation-indexed bonds, then you have to calculate the Daily CPI in your country from your country´s monthly published CPI using the formula for the calculation of the Unidad de Fomento in Chile as described by Prof. Robert Shiller. It is detailed as follows:


‘The formula for computation of the UF on day t is:

UF t = UF t–1 × (1+ π) 1/d

where π is the inflation rate for the calendar month preceding the calendar month in which t falls if t is between day ten and the last day of the month (and d is the number of days in the calendar month in which t falls), and π is the inflation rate for the second calendar month before the calendar month in which t falls if t is between day one and day nine of the month (and d is the number of days in the calendar month before the calendar month in which t falls).’

Shiller 1998:3

The above formula applies to the UF in Chile where the CPI for the current calendar month used to be available on the tenth of the next calendar month. The general case formula for a UF–based Daily CPI is stated as follows:

On day t

DI t = DI t–1 X (1 + π) 1/d

where π is the monthly inflation rate for the second calendar month before the calendar month in which t falls if t is on or between day one and the day of publication of the CPI of the previous calendar month (and d is the number of days in the calendar month before the calendar month in which t falls), and π is the inflation rate for the calendar month preceding the calendar month in which t falls if t is on or between the day the CPI for the previous calendar month is published and the last day of the month (and d is the number of days in the calendar month in which t falls).
You have to use the general case formula.

All you do then is multiply any item in your Managerial Accounts by the update factor you derive from dividing the value of your Daily CPI today, with the value of the Daily CPI on the date the item was purchased / came about / was contributed / etc. Then you have its real value today.

Since the Daily CPI changes daily, all your Managerial Accounts (and financial accounting) values change daily in terms of the daily changing Daily CPI.

There you have it.

Obviously you have to abandon the Historical Cost Accounting model and change over to the Financial Capital Maintenance in Units of Constant Purchasing Power model (which is the same as Constant Item Purchasing Power Accounting) in your financial accounting.

This is authorised at all levels of inflation and deflation, including during hyperinflation, in The Conceptual Framework (2010), Par. 4.59 (a).

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Nicolaas Smith

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