Sunday, 12 January 2014

Financial reporting unknown known

Financial reporting unknown known

Capital erosion / destruction under financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) is beyond an "unknown known" during low and high inflation: an intractable fact regarding a fallacy we prefer to forget.

It is a fact that HCA destroys billions of USD per annum in the world´s capital investment base because it is generally a fallacy that the real value (constant purchasing power) of capital (equity) can be maintained constant with financial capital maintenance in nominal monetary units in that portion of equity never maintained constant with the real value of net assets during inflation and deflation.

Although IFRS state in the Conceptual Framework, Par. 4.59 (a) that "Financial capital maintenance can be measured in ...... nominal monetary units ......" it is generally impossible to maintain the real value (constant purchasing power) of capital constant during inflation and deflation in nominal monetary units.

‘It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.’

FAS 33 1979: 24

The term "financial capital maintenance" which implies that the real value of capital is being maintained (constant) during inflation and deflation is thus a fallacy.

The implementation of the stable measuring unit assumption (not inflation) under HCA during inflation results in the unnecessary destruction of hundreds of billions of USD per annum in the real value of the world economy´s investment capital base: in that portion of capital (equity) that is never backed by the real value of net assets.

Only Capital Maintenance in Units of Constant Purchasing Power in terms of an index that follows all (at least DAILY, e.g., the Daily CPI) changes in the general price level can generally maintain the constant purchasing power of capital constant only in entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation.

Nicolaas Smith 

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