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Monday, 9 September 2013

IAS 29 needs to be implemented in terms of a DAILY INDEX

Hans Hoogervorst
Chairman
IASB

Dear Mr. Hoogervorst,

9-9-2013

CC: Michael Stewart, Kenichi Yoshimura, Rachel Knubley, Peter Clark, Wayne Upton, Sue Lloyd, Alan Teixeira, Joanne Perry, Fermin del Valle, Andrew Watchman, Scott A. Taub, Rafael Rodriguez Ramos, Guido Fladt, Bernd Hacker.





I did not know who to send this email to. You are thus the person of last resort. I suppose, being the Chairman, the buck stops with you.


I am a persona non grata at the IASB since I told a senior member of your staff that he had not stated something very correctly and I blogged about it on my blog. After that I was frozen out by the IASB staff of continuing working on this IFRIC Potential Agenda Item Request.


The same happened at the South African Institute of Chartered Accountants in 2008 when I stated on their public forum that accountants destroy value. I now use the term erode - and everybody is very satisfied with it. Erode is the same as destroy.


However, SAICA did not beat about the bush. They mocked me, told me to beat another drum, told me what I suggested was an insult to users of financial statements during low inflation, stated publicly on their website that they will not communicate with me regarding my suggestion that they should reject the stable measuring unit assumption, then banned me from leaving comments on their public forum and contaminated my alma mater to also refuse to communicate with me. The last item being the worst to me.


So, not being welcome at the IASB is not something new to me. It is very normal that this happens when one is the messenger that the 3000 year old Historical Cost paradigm is coming to an unavoidable and predictable end.


I know that financial capital maintenance in units of constant purchasing power in terms of a Daily Index at all levels of inflation and deflation is the future of global accounting. It was and is, however, very little understood.


It was very successfully used in Latin America from about the mid 1960´s to the mid 1990´s under the names of daily monetary correction, daily indexation and daily price level restatement - always in terms of a Daily Index. I am not aware that it was ever recognised as financial capital maintenance in units of constant purchasing power in terms of a Daily Index till I recognised it as such.


IAS 29 was authorised on 1 April 1989 requiring the restatement of HC or CC financial statements in terms of the measuring unit current at the end of the reporting period during hyperinflation. It has been implemented since 1990 in terms of the monthly published CPI.


On 16 January 2013 the IASB staff stated:





On 21 January 2013 is sent you an email in which I responded to Par. 10 above as follows:


[7] Incorrect: IAS 29 contains guidance on how to prepare financial statements in constant purchasing power units: many paragraphs in IAS 29 contain that guidance: they state which are monetary and non-monetary items, according to IAS 29, and how to measure items in units of constant purchasing power at the measuring unit current at the period-end date, but, IAS 29 does not result in “Financial capital maintenance ... in units of constant purchasing power” as defined in the CF, Par. 4.59 (a) because it is only possible to maintain a constant item constant when its constant real value is updated every time the URV-based Daily Index (or USD daily free-market rate) changes during hyperinflation. Values under IAS 29 are not continuously updated every time the URV-based Daily Index changes. The time variable (interval) should be: every time the URV-based Daily Index changes and not every time the monthly CPI changes. If IAS 29 were to be changed as such it would become “Financial capital maintenance ... in units of constant purchasing power” as defined in the Conceptual Framework, Par. 4.59 (a).



So, I informed the IASB for the first time on 21 January 2013.


In April 2013 the IASB issued a Draft Discussion Paper: Capital Maintenance in which the IASB stated:


Par. "9.48 The concepts of capital maintenance are used in IAS 29 Financial Reporting in Hyperinflationary Economies."


The IASB did not indicate which concept(s??) of capital maintenance are used in IAS 29.






On 3 September 2013 the IASB finally correctly confirmed that financial capital maintenance in units of constant purchasing power is required in IAS 29, 24 years after its authorization in 1989.


As can be seen from the above I personally also only realised it in January this year as a result of my work with the IASB on this Agenda Item Request.  


Why is financial capital maintenance in units of constant purchasing power in terms of a Daily Index so important?


1. When implemented correctly it results in automatically maintaining the constant purchasing power of capital constant in all entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation for an indefinite period of time.




When you personally eventually really understand it very well, you will realise that HCA at 2% inflation is almost equal to 98% financial capital maintenance in units of constant purchasing power in terms of a Daily Index (so in fact, it can almost be said that it is widely implemented on a “proxy” basis). However, erosion of 2% of the constant purchasing power of an economy´s corporate investment capital not maintained constant means that 51% of its real value is eroded (see I do not use the term destroy) over 35 years time: a very significant portion. No entity in the world (including the IFRS Foundation and SAICA) knows whether it has been and is maintaining the constant purchasing power of its capital constant over time. All entities maintain the nominal value of their capital constant: they all know how to balance the books. That is all HCA requires of them.


2. It has an at least 30 year record of success in Latin America, especially in Brazil - although it was and maybe still is not recognised as financial capital maintenance in units of constant purchasing power in terms of a Daily Index. The Brazilian experience as well as the 2% example above (for those who understand it) are proofs that it works. I also did it in the form of accounting dollarization in Angola in 1996. I am not now suggesting accounting dollarization.


3. The most important reason for the importance of financial capital maintenance in units of constant purchasing power in terms of a Daily Index is closely tied to the status, prestige, importance and international financial reporting standard setting power of the IASB.


The IASB has the power to REQUIRE financial capital maintenance in units of constant purchasing power in terms of a Daily Index in IAS 29.


What would happen when the IASB changes IAS 29 like that?


It would stabilise the constant real value non-monetary item economy in, for example, Venezuela, over a short period of time.


What does that mean?


It means the IASB has the power to stabilise the Venezuelan constant item economy over a short period of time with no intervention by the Venezuelan government.


Why?


Because Venezuela already implements IAS 29 since 2009.


So, when the IASB requires it, Venezuelan companies will have to start doing it: measuring salaries, wages, rents, transport costs, water costs electricity costs, trade debtors, trade creditors, all items in shareholders equity, all items in the income statement, all other non-monetary payables, all other non-monetary receivables in terms of the Daily CPI in Venezuela like Brazil did for 30 years from 1964 till 1994. As well as other LA countries.


What would happen when Venezuelan companies start doing that?


It would stabilise the Venezuelan constant item economy over a short period of time without the intervention of the Venezuelan government.


How could they update salaries, wages, rents, transport costs, etc. daily?


Because all selling prices would be updated daily since the stable measuring unit assumption is never implemented.


All trade debtors and trade creditors would be updated daily - so profits would be locked in. The stable measuring unit assumption would never be implemented: exactly like 160+ million Brazilians did for the 30 years from 1964 till 1994. They and millions of other Latin Americans in other South American countries.


This is not something new.


So, there the cat is out the bag: that is the power the IASB has.


Could I make that happen? No.


Could you make that happen? Yes.


Would you make it happen over the shortest period of time?


Only if you were motivated to do it. What would motivate you to do it? I don’t know. You may laugh at me - like SAICA did.


What has to happen at the IASB? IAS 29 has to be changed as soon as possible to REQUIRE financial capital maintenance in units of constant purchasing power IN TERMS OF A DAILY INDEX.


How to do it in the shortest period of time? Your staff at the IASB know the answer to that.


Unfortunately they are all very upset with me - just like everybody at SAICA and at the School of Accounting at the University of Port Elizabeth - where I first learnt the terms debit and credit.


So, would you take up the challenge? I sincerely hope you do. You would be a hero in Venezuela when you do. Maybe in Belarus too.


I am entirely at your disposal if you need my help. But be forewarned: if you do something completely wrong, I will tell you straight away.


I gain absolutely nothing financially from my interest in this subject. No-one understands the above, so no-one buys my book. But, I know too much about the subject to simply walk away from it. I got involved by chance when I went to work in Angola´s hyperinflationary economy from 1994 to 1997 and I stopped our fear of hyperinflation in the company where I worked after 15 months of living and working in a hyperinflationary economy with financial capital maintenance in units of constant purchasing power in terms of a Daily Index (the US Dollar daily parallel rate in our case in Angola).


Now to the current work at hand:


Since I cannot send it to any of your staff, I´m sending it to you.




1. Par. 6 states:


“On the basis of our discussions with the submitter, we understand that the main differences between financial statements prepared using IAS 29 and those prepared using the CMUCPP are:


(a) the scope of monetary items; for example, trade receivables and
payables. These are classified as monetary items under IAS 29 but are
classified as non-monetary items under the CMUCPP. This difference
gives rise to a difference in the amount of net monetary gain or loss.
This is because, under both the CMUCPP and IAS 29, non-monetary
items are restated with changes in the carrying amounts being recognised as monetary gain or loss while monetary items are not restated; and


The part in bold type and underlined is not correct.


Changes in the carrying amounts of non-monetary items are never recognised as monetary gain or loss under either the Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) model or IAS 29.


Changes in the real value (constant purchasing power) of monetary items - to the extent they are not linked to a general price level - during inflation and deflation are recognised as a net monetary gain or loss under both CMUCPP and IAS 29.


Both CMUCPP and IAS 29 implement financial capital maintenance in units of constant purchasing power as authorised in the Conceptual Framework, Par. 4.59 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.


The IASB staff in View 3 as stated in Par. 16 and 17 in Agenda Ref 12 correctly confirm for the first time that IAS 29 implements financial capital maintenance in units of constant purchasing power.  


The CMUCPP model implements financial capital maintenance in units of constant purchasing power in terms of a Daily Index (recognising all  changes in the general price level) which results in automatically maintaining the constant purchasing power (real value) of capital constant in all entities that at least break even in real value - ceteris paribus - for an indefinite period of time at all levels of inflation and deflation.


IAS 29 has been applied since 1990 implementing financial capital maintenance in units of constant purchasing power in terms of the 12 monthly published CPIs which ignores the at least 355 non-month-end daily changes in the general price level during hyperinflation (the general price level can change more than once a day during hyperinflation - (Hanke 2008)). This resulted over the last 24 years and currently results (e.g., in Venezuela and Belarus) in the erosion of the constant purchasing power (real value) - at the rate of hyperinflation - of that part of current year results and especially in the constant purchasing power (real value) of trade debtors, trade creditors, other non-monetary receivables and payables that are not maintained constant as a result of the mistaken use of the monthly published CPI under IAS 29 for the last 24 years.




This erosion of the constant purchasing power of constant real value non-monetary items not maintained constant with a Daily Index during hyperinflation was very evident during the last 8 years of Zimbabwe's hyperinflation - something the IASB steadfastly refuses to admit (speak to Michael Stewart) although it is very clear to all accountants worldwide (except those at the IASB) that IAS 29 had absolutely no positive effect in Zimbabwe. IAS 29 was implemented in terms of the monthly published CPI during those 8 years with absolutely no positive effect: the Zimbabwean economy imploded on 20 November 2008. If IAS 29 were to have been implemented in terms of a Daily Index, e.g., the Daily US Dollar parallel rate, or the Old Mutual Implied Rate that was available till 19 November 2008 during those 8 years, then the Zimbabwean economy would never have imploded.


Various Latin American countries implemented daily indexing or daily monetary correction or daily price level restatement which were all forms of financial capital maintenance in units of constant purchasing power in terms of a Daily Index with great success from 1964 till 1994. Brazil used their daily Unidade Real de Valor combined with their Real Plan to stop hyperinflation in April 1994. Brazil used daily indexation for 30 years from 1964 till 1994. This great Latin American success with daily indexation was completely ignored with the formulation of IAS 29 in 1989 because of a lack of understanding of capital maintenance in units of constant purchasing power in terms of a Daily Index. Another way to look at it would be to say it was because of the predominant influence of Historical Cost Accounting and the stable measuring unit assumption.


Changing IAS 29 as soon as possible to REQUIRE the use of a Daily Index would stabilise, for example, the Venezuelan constant real value non-monetary item economy over a short period of time.


2. Issue 1—whether an entity is permitted to use constant purchasing power units in a non-hyperinflationary situation


The Conceptual Framework invalidates View 1 (par. 12 and 13) namely that IFRSs provide an entity with no ability to use any model of the financial capital maintenance concept defined in constant purchasing power units.


The Conceptual Framework, Par. 4.59 (a) states:


“Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.


The fact that the selection of capital maintenance in units of constant purchasing power is a choice that is available within the Conceptual Framework that provides a fundamental basis of preparation of financial statements cannot simply be ignored when dealing with a submission.


3. The example in Par. 13 is irrelevant when the view expressed in Par. 12 is invalid.


4. The IASB staff state:


Staff’s view


“18. We note that when preparing IFRS financial statements, an entity is required to apply applicable IFRSs.”


Before an entity in a non-hyperinflationary economy can prepare IFRS financial statements, the board of directors has to decide which accounting model to use as part of its duty to decide on the accounting policies of the entity.


The applicable IFRS is IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors


IAS 8 states:


Selection and application of accounting policies


7 When an IFRS specifically applies to a transaction, other event or
condition, the accounting policy or policies applied to that item shall be
determined by applying the IFRS.


There are no applicable IFRSs regarding the accounting model to use in a non-hyperinflationary economy.


IAS 8 state:


10 In the absence of an IFRS that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy that results in information that is:


(a) relevant to the economic decision-making needs of users; and
(b) reliable, in that the financial statements:
(i) represent faithfully the financial position, financial
performance and cash flows of the entity;
(ii) reflect the economic substance of transactions, other events
and conditions, and not merely the legal form;
(iii) are neutral, ie free from bias;
(iv) are prudent; and
(v) are complete in all material respects.


11 In making the judgement described in paragraph 10, management shall refer to, and consider the applicability of, the following sources in
descending order:


(a) the requirements in IFRSs dealing with similar and related issues;
and
(b) the definitions, recognition criteria and measurement concepts
for assets, liabilities, income and expenses in the Framework.


In the absence of applicable IFRSs regarding the choice of the accounting model, i.e., the concept of capital maintenance to use in a non-hyperinflationary economy, the board of directors would then find the following in the Conceptual Framework as required in IAS 8, Par 11 (b):


4.65 The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements.


Par. 4.65 carries on:


Different accounting models exhibit different degrees of relevance and reliability and, as in other areas, management must seek a balance between relevance and reliability. This Conceptual Framework is applicable to a range of accounting models and provides guidance on preparing and presenting the financial statements constructed under the chosen model.


Par. 4.65 further states:


At the present time, it is not the intention of the Board to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy. This intention will, however, be reviewed in the light of world developments.


It would be clear to the board of directors that the IASB has no intention to prohibit or prescribe a particular accounting model in a non-hyperinflationary economy. The board is thus free to choose any accounting model in a non-hyperinflationary economy as long as it is authorised in IFRS.


The board of directors would then find the following in the Conceptual Framework:


Measurement of the elements of financial statements


4.55 A number of different measurement bases are employed to different degrees and in varying combinations in financial statements.


4.56 The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. This is usually combined with other measurement bases.


Concepts of capital and capital maintenance


Concepts of capital


4.57 A financial concept of capital is adopted by most entities in preparing their financial statements.


4.59 (a) Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.


The board of directors would thus note that financial capital maintenance in units of constant purchasing power is authorised in a non-hyperinflationary economy and that the IASB has no intention of prohibiting it in a non-hyperinflationary economy.


The board of directors would also note the following in IAS 8:


12 In making the judgement described in paragraph 10, management may
also consider the most recent pronouncements of other standard-setting
bodies that use a similar conceptual framework to develop accounting
standards, other accounting literature and accepted industry practices, to
the extent that these do not conflict with the sources in paragraph 11.


The board of directors would also note that the IASB and FASB have recently been on a Joint Conceptual Framework project.


The board of directors would also note the following in US GAAP:


Two major concepts of capital maintenance exist, both of which can be measured in units of either money or constant purchasing power: the financial capital concept and the physical capital concept.


US GAAP Concepts Statement Nº 6, Par. 71


It is thus clear that the board of directors can freely choose financial capital maintenance in units of constant purchasing power in a non-hyperinflationary economy.


In my opinion the board of directors would then agree with “View 3: The Conceptual Framework permits an entity to select the financial capital maintenance concept defined in constant purchasing power units if certain
conditions are met, but should apply IAS 29 by analogy” since IAS 29 deals with a similar condition.


However, implementing IAS 29 can also have absolutely no positive effect like what happened during its application during 8 years during Zimbabwe's hyperinflation.


The only way this can be corrected is for IAS 29 to be changed to REQUIRE the implementation of a DAILY INDEX that recognises all changes in the general price level, e.g., the Daily CPI in a non-hyperinflationary economy and a Unidade Real de Valor-based Daily Index or the daily parallel rate of a relatively stable foreign currency, e.g., the US Dollar, during hyperinflation.


IAS 29 also has to state that the stable measuring unit assumption is never to be implemented in the measurement of constant real value non-monetary items, e.g. salaries, wages, rents, all items in the income statement, all items in shareholders equity, provisions, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, etc.


IAS 29 also has to state that non-monetary items are divided in


(a) Variable real value non-monetary items, e.g., property, plant, equipment, inventories, finished goods, raw materials, foreign exchange, listed and unlisted shares, etc. measured on a daily basis in terms of IFRS excluding the stable measuring unit assumption, i.e., excluding nominal historical cost. Updated historical cost to be used. When these items are not measured on a daily basis in terms of IFRS - as qualified - then they are updated in terms of the Daily Index till they are again measured in terms of IFRS - as qualified.


(b) Constant real value non-monetary items are always and everywhere measured in terms of a Daily Index.


This split is necessary in order to know which items are to be measured in units of constant purchasing power, the new paradigm under this capital maintenance concept that is fundamentally different from the Historical Cost paradigm under which the stable measuring unit assumption is implemented. The stable measuring unit assumption is never implemented under the Constant Item Purchasing Power Paradigm.


The definitions of monetary items also have to be improved in IAS 29 and IAS 21.


Definition of monetary items


Monetary items constitute the money supply.


An item is not a monetary item if it does not form part of the money supply. For example, trade debtors and trade creditors do not form part of any money supply anywhere in the world. They are not monetary items.


I asked Gustavo Franco who was the Governor of the Central Bank of Brazil in 1994 when Brazil stopped hyperinflation with the Real Plan and the daily Unidade Real de Valor whether trade debtors and trade creditors were treated as monetary or non-monetary items during the 30 years of high and hyperinflation in Brazil.


He replied:


‘Two observations are in order. First, for spot transactions the existence of the URV is immaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enters the picture only when at least one leg of a commercial transaction is deferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs is to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.´


It is clear from his answer that trade debtors and trade creditors are not monetary items measured in fixed nominal monetary units during inflation.


Par. 22 states:


The Conceptual Framework does not override the requirements in
IFRSs (Introduction section of the Conceptual Framework).


See IAS 8, Par. 10 and 11 and my detailed explanation in my numbered Par. 4 above.


It was already stated in Staff Technical Analysis, Par. 12: “IFRSs are written from the perspective of an entity using the concept of financial capital maintenance that is defined in terms of nominal monetary units.”


That is correct: IFRSs (except IAS 29) are written based on the Historical Cost paradigm.


When an entity validly selects (see above) financial capital maintenance in units of constant purchasing power in a non-hyperinflationary economy the HC paradigm no longer applies.


It is very clear from my explanations based on IFRSs and the Conceptual Framework (see above) that an entity is authorised to implement financial capital maintenance at all levels of inflation and deflation.


Yours sincerely,


Nicolaas Smith




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