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Tuesday, 21 January 2014

PART 1: HOW TO MAINTAIN A COMPANY´S CAPITAL CONSTANT IN REAL VALUE IN A HIGH OR HYPERINFLATIONARY COUNTRY

A. Stop Historical Cost Accounting

1. The first thing to do is to stop Historical Cost Accounting (HCA) in the company´s business. Stop operating under the Historical Cost paradigm. Stop trying the generally impossible. It is generally impossible to maintain the real value (constant purchasing power) of capital (equity) constant in NOMINAL monetary units during low inflation, high inflation, hyperinflation and deflation. The stable measuring unit assumption (not inflation) erodes / destroys the real value (constant purchasing power) of that portion of capital (equity) never maintained constant during inflation.


Pass a board resolution to that effect and inform all third parties of the change and the date of the change which would be the date of the board resolution. Inform the auditors too. Nothing can be done retrospectively.

2. Pass a board resolution transferring all Retained Income and other transferable Capital Reserves at the end of this last financial period under HCA to Capital. This is necessary to avoid simply deleting these hard-earned (over many years) constant real non-monetary values as required in terms of fundamental financial reporting concepts (to be discussed further) for the opening balance sheet under CMUCPP in terms of a Daily Index.

3. Prepare final HCA financial reports as at the day before the date of the change-over to CMUCPP in terms of a Daily Index.

B. Implement Capital Maintenance in Units of Constant Purchasing Power

Start implementing Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) in terms of an index that follows all (at least daily) changes in the general price level. Capital can generally only be maintained constant in real value my means of Capital Maintenance in Units of Constant Purchasing Power, but ONLY in terms of an index that follows all (at least daily) changes in the general price level. This is also done with a board resolution. Indicate this change in the company´s GENERAL CONDITIONS OF SALE on the back of every invoice / contract / credit note, etc. State that when any third party does any business with the company, the third party accepts the change in accounting model and agrees to be bound by the new legal consequences as from the date of the change-over.


This is a paradigm change. The company will NEVER go back to the Historical Cost paradigm even under very low inflation or deflation. This is a very important change for the company and the country when all entities change to using a DAILY INDEX, namely the DAILY CPI or the US Dollar daily parallel rate.
PART 3


D. Prepare the opening balance sheet under CMUCPP


PART 4


E. Inform third parties of new conditions of sale and payment terms

Specifically point out to third parties during at least the first year of the change-over:

1. The Daily Index the company is using and on which website it is available on a 24/7, 365 days per year basis.

2. Selling prices may be increased daily in terms of the Daily Index depending on specific marketing strategies adopted by the company on a case by case basis. It may also result in all selling prices being increased daily (or even more than once a day during severe hyperinflation) in terms of the Daily Index or the daily USD parallel rate if need be - depending on the rate of hyperinflation. 


Third parties will be informed beforehand if the Daily Index were to be changed and the date of the change under normal conditions. This is not applicable during severe hyperinflation when the rate may change hourly.

3. All prices will always be initially recognised as an initial spot monetary value at an initial Daily Index (or USD parallel rate) value at the initial date. This monetary value will change at least daily thereafter in terms of the Daily Index (USD parallel rate) subject to the provisions in 2 above. The real value will remain constant over time.

4. Trade debtors and all other non-monetary receivables will always be updated at least daily in terms of the Daily Index under all circumstances. They are not monetary items. They are constant real value non-monetary items. Their monetary values will change at least daily in terms of the Daily Index, but their real values will remain constant over time.

5. Trade creditors and all other non-monetary payables (which are also all constant real value non-monetary items) will be updated at least daily generally ONLY when a third party also uses CMUCPP in terms of the same Daily Index, otherwise they will be settled in nominal monetary units with third parties who implement HCA. By doing business with the company, third parties agree to these terms of payment.


The company will update trade creditors and all other non-monetary payables at least daily in terms of the Daily Index whenever such creditors are also debtors whose payables are updated at least daily in terms of the Daily Index - whether such creditors use CMUCPP in terms of a Daily Index or not.

PART 5

F. Update all constant items at least daily

1. The constant purchasing power (real value) of the company´s spot or cash sales / revenue is guaranteed over time at any level of low inflation, high inflation, hyperinflation or deflation once the company updates all selling prices at least daily (every time the general price level changes).

2. The constant purchasing power (real value) of the company´s payables is guaranteed over time at any level of low inflation, high inflation, hyperinflation or deflation once the company updates all trade debtors and all other non-monetary payables at least daily (every time the general price level changes).

3. The constant purchasing power (real value) of the company´s gross margins are guaranteed over time at any level of low inflation, high inflation, hyperinflation or deflation once the company implements 1 and 2 above.

4. The company can thus 100% safely update all costs and expenses at least on a daily basis (every time the general price level changes).

The company thus pays salaries, wages, rents, fees, etc in tems of units of constant purchasing power in terms of the Daily Index, i.e., update them at least daily.

5. The constant purchasing power (real value) of the company´s income before tax is thus guaranteed. The company thus updates taxes payable in units of constant purchasing power in terms of the Daily Index. The company updates taxes paid in terms of the Daily Index.

It is very obvious from the above that a country´s constant real value non-monetary economy would be stabilized over a very short period of time when all entities in a country were to do the above.

PART 6

G. Calculation of net monetary gain or loss (Details following)


H. Calculation of constant real value non-monetary gain or loss (Details following)



When all entities in a country implement CMUCPP in terms of a Daily Index the entire constant real value non-monetary economy will be stabilised during low inflation, high inflation, hyperinflation (like it was done in Brazil from 1964 to 1994) and deflation. This is not something new.

This should also be done during low inflation and deflation.
This is authorised in IFRS and US GAAP.

The above is far from a complete description of the CMUCPP in terms of a Daily Index model. See the following Parts coming up.


To be continued...


Nicolaas Smith 

Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.