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Thursday, 15 August 2013

Automatic capital maintenance under CMUCPP

Automatic capital maintenance under CMUCPP

You do not maintain the real value (constant purchasing power) of your capital constant simply by measuring it in units of constant purchasing power by multiplying it by the rate of increase in inflation during the accounting period in isolation. You do it automatically by implementing Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily Index, for example, the Daily CPI during low inflation. 

This is possible because of double-entry accounting: for every credit (capital) there is an equivalent debit (e.g., trade debtor/inflation-adjusted monetary item/property). It is thus possible for capital maintenance to be automatic: it is automatic in NOMINAL (NOT REAL) VALUE under HCA and it is automatic IN REAL VALUE under CMUCPP, generally only in terms of a Daily Index

CMUCPP in terms of a Daily Index automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation. 

For example: When you have all your capital invested in a constant item, e.g., trade debtors, your capital is automatically maintained constant in real value over time during inflation and deflation because both the capital and the trade debtors are constant real value non-monetary items and both are always and everywhere measured in units of constant purchasing power in terms of a Daily Index. So it is automatic constant purchasing power capital maintenance.

When all your capital is invested in a variable real value non-monetary item, for example, a property in the middle of the financial district in London, then you would also have automatic constant purchasing power capital maintenance because you would measure your equity in units of constant purchasing power in terms of the Daily CPI in the UK (see link on the right side-bar) and the property would - generally - at least maintain its real value  in the always updated London property market. 

When all your capital is invested in a monetary item, for example, Treasury Inflation-Indexed Bonds (TIPS) in the American market, then the constant purchasing power of your capital would also automatically maintain its constant purchasing power over time. TIPS are inflation-adjusted daily in terms of the US Daily CPI (see link on the right side-bar). 

The requirement under CMUCPP in terms of a Daily Index that an entity has to break even in real value - ceteris paribus - ensures that capital maintenance is always automatic in real value (constant purchasing power) under this IFRS-authorized accounting model.

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