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Tuesday, 26 November 2013

Venezuela: best real-time economics lesson about HCA during hyperinflation in an oil-rich country

Venezuela: Historical  Cost Accounting 101 during hyperinflation in an oil-rich country


1. The real value of the Bolivar (a monetary item) is being destroyed by Historical Cost Accounting. Proof: If all monetary items (items expressed in Bolivars) in Venezuela were inflation-indexed DAILY there would be no loss of real value in these items. Like Brazil did with many monetary items (not all) from 1964 to 1994. There would, however, still be hyperinflation while the Central Bank of Venezuela keeps on creating too many Bolivars. But, there would be no destruction of real value over time in Bolivar monetary items in Venezuela. Prof Steve Hanke said this is an interesting idea. 

Who is to blame: The International Accounting Standards Board. 

Why? The IASB requires Venezuela to implement IAS 29 Financial Reporting in Hyperinflationary Economies in terms of the MONTHLY published CPI. It has been implemented in Venezuela since 2009. 

Solution: The IASB should change IAS 29 to require DAILY INDEXING instead of the use of the monthly published CPI. This was done very successfully in Brazil and other Latin American countries in the past. The IASB simply ignores that.

2. The real value of variable real value non-monetary items (e.g. electrical appliances) is being destroyed by Nicolas Maduro´s price fixing.

Who is to blame: Nicolas Maduro and his advisers.

Solution: These variable real value non-monetary items should be valued at the parallel rate and normal forces of competitive demand and supply should be allowed to rule in the market. There would - ceteris paribus - be no loss of real value in these items.

3. The real value of constant real value non-monetary items, e.g., salaries, wages, rents, trade debtors, trade creditors, etc. is being destroyed by Historical Cost Accounting. Proof: If they were measured in units of constant purchasing power in terms of a DAILY INDEX there would be no loss of real value in these items, i.e., no loss of real value in salaries, wages, rents, trade debtors, trade creditors, etc. Like Brazil did from 1964 to 1994.

Who is to blame: The International Accounting Standards Board. 

Why? The IASB requires Venezuela to implement IAS 29 Financial Reporting in Hyperinflationary Economies in terms of the MONTHLY published CPIIt has been implemented in Venezuela since 2009. 

Solution: The IASB should change IAS 29 to require DAILY INDEXING instead of the use of the monthly published CPI. This was done very successfully in Brazil and other Latin American countries in the past. The IASB simply ignores what happened in Brazil in the past.

Why does the IASB not change IAS 29 to require DAILY indexing? 

(i) The IASB does not understand financial capital maintenance in units of constant purchasing power in terms of a DAILY index. The IASB is too arrogant to spend the time to properly find out the benefits of Daily Indexing. Financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation was authorised by the IASB twenty four years ago in the original Framework (1989), Par. 104 (a) which states: "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power." 

(ii) According to Michael Stewart, the Director of Implementation Activities - the IASB´s view is that financial reporting has no effect on the economy. (That was an absolutely silly statement by Michael Stewart. It shows the low level of understanding of basic accounting and economic concepts at the IASB.)

(iii) The IASB is not responsible enough to take financial capital maintenance in units of constant purchasing power in terms of a DAILY INDEX seriously.

(iv) Venezuela and Belarus are relatively small economies and thus not important to the IASB. When the world economy was crippled during the 2008 financial crisis, the IASB had a special task force to deal with fair value accounting. The IASB has not even included research regarding Daily Indexing in Research projects on which preliminary work is not expected to commence until after the 2015 agenda consultation. After an agenda consultation, the IASB normally takes one year to come to conclusions regarding the consultation. They are very laid back at the IASB. The research project Financial Reporting in High Inflationary Economies is now included by the IASB in Research projects for which the timing of preliminary work has not yet been confirmed, i.e., perhaps in 2017 or later.

(v) According to Michael Stewart, the IASB is incapable of expressing a view regarding whether IAS 29 had a positive or negative effect on Zimbabwe´s hyperinflationary economy in the past since the Board has not yet had a special review of the problem while all other accountants in the world would generally agree that it is very, very obvious that IAS 29 had no positive effect  on Zimbabwe´s economy like it is currently not having a positive effect on the Venezuelan economy. The IASB cannot grasp that.

Nicolaas Smith 

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