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Wednesday, 9 November 2016

Capital would be maintained constant during deflation under CMUCPP

Contrary to how the inflation-conditioned mind would normally think, capital would be maintained constant under capital maintenance in units of constant purchasing power in terms of the Daily CPI during deflation.

In simple terms: capital would be decreased in nominal value but maintained constant in real value during deflation.  

It would thus promote financial and economic stability - during deflation.

Nick Smith Copyright (c) 2005-2016 Nick J Smith. All rights reserved. No reproduction without permission.

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Tuesday, 8 November 2016

Equity Equal to Net Assets Capital Maintenance Fallacy

Capital has never and is never and will never be maintained constant in real value by entities which prepare their financial statements on the nominal Historical Cost basis when it is taken into account that net monetary losses and gains are never accounted under this model and that sustainable zero inflation has never been achieved and will most likely never be achieved. It is also true that zero effect of inflation, hyperinflation and deflation is easily possible with daily indexing of all items in terms of the Daily CPI as used under Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI.

All nominal Historical Cost audit reports should start with the following standard statement:


"We confirm that the constant purchasing power (real value) of the entity's capital was not maintained during the last financial period as in its entire existence to date under the nominal Historical Cost basis because 


(1) the stable measuring unit assumption was implemented resulting in constant real value non-monetary items (e.g., shareholders´ equity, taxes, debtors, creditors, profits, losses, salaries, wages, etc.)  not being maintained in real value and 


(2) no account was taken of changes in the inflation/deflation rate with net monetary gains and losses not accounted for in the preparation of the financial reports.


The financial statements balance in nominal value but not in real value."


Current shareholders, creditors, employees, the authorities, prospective investors and all stakeholders should be made fully aware of the fact that it is impossible for the entity to maintain its capital under the nominal Historical Cost basis.


It is obvious that Historical Cost Accounting´s fundamental mistake - the stable measuring unit assumption - can be used in the Equity Equal to Net Assets Capital Maintenance Fallacy Proof.



‘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.


US FASB Financial Accounting Standard 33 (1979) Paragraph 24

[There is nothing like the above in IFRS. The Americans often seem to be just that little bit better. It is a good thing they have not adopted IFRS as is. :-) ]

The accounting profession generally argues that the fact that it is impossible to maintain the real value or constant purchasing power of capital under the nominal Historical Cost basis under non-zero inflationary conditions is not important since capital is always equal to net assets.

Yes, it is mathematically correct that nominal capital is always equal to net assets under the nominal Historical Cost basis - in nominal monetary units, that is all. However, that is not equal to capital maintenance (see FAS 33 above) as the profession - excluding the US contingent - so fraudulently implies.

Maintaining the constant purchasing power (real value) of capital always was, is and will always be impossible during non-zero inflationary conditions under the nominal Historical Cost basis.

Capital maintenance is impossible under the nominal Historical Cost basis. Period. State it openly in the financial statements and audit report.

The statement in the IFRS Conceptual Framework that "Financial capital maintenance can be measured in nominal monetary units" is thus completely dishonest, false, fake, misleading and fraudulent. That statement should at least state: "Only nominal financial capital maintenance can be measured in nominal monetary units" if IFRS were to be to be honest, true, real, not misleading and valid - in this respect.

Every past, present and future member of the IASB knows that generally no balance sheet prepared under the nominal Historical Cost basis has ever balanced, balances or ever will balance in real value during non-zero inflationary conditions.

Fortunately the IFRS Conceptual Framework also authorizes: "Financial capital maintenance can be measured in units of constant purchasing power".

However, it only works when it is done in terms of the Daily CPI. Using the monthly CPI does not result in real capital maintenance since it has to be done in terms of all changes in the general price level. The general price level does not change monthly as it appears as a result of the original (historical) monthly publication of the CPI figures. It changes daily in all economies. Economic transactions are executed every day of the month. The general price level can - and often does - change more than once a day in hyperinflationary economies.

The absolute proof that daily updating is required? All government inflation-indexed bonds are updated daily in terms of the Daily CPI because they trade daily on the trillion Dollar global sovereign inflation-indexed bond markets, for example US Treasury Inflation Protected Securities or TIPS. They need updated prices daily - not monthly. People and governments trade these inflation-indexed bonds daily, not monthly. The general price level changes at least daily. Daily CPI figures are thus generally available. See the examples on the right margin of this site.

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Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.