SA accountants value existing reported Retained Profits in SA companies at Historical Cost, i.e. in nominal monetary units. They assume that changes in the real value of the Rand are not sufficiently important for them to stop their destruction of the real value of existing reported Retained Profits as a result of their stable measuring unit assumption.
They make this assumption while inflation ranges from 0.01% to 25.99% per annum for 3 years in a row.
When inflation increases from 25.99% to 26% for three years in a row totalling 100% which would indicate that SA is in hyperinflation, they would immediately change their collective minds and agree that 26% inflation would result in them destroying 26% of all existing reported Retained Profits in SA companies – but not 25.99% inflation for 3 years in a row.
They would inflation-adjust all non-monetary items – variable and constant items – in SA when inflation is 26% per annum for 3 years in a row – but not at 25.99% for 3 years in a row.
They are currently unknowingly destroying 5.9% or about R200 billion of all existing reported Retained Profits and other constant items never maintained in SA companies. When inflation increases to 25.99% they would unknowingly destroy about R866 billion in this way per annum. They would assume the destruction of R866 billion per annum (at current prices) in this manner is not significantly important.
Kindest regards,
Nicolaas Smith
Wednesday, 25 November 2009
700 year old paradigm based on a single wrong assumption
SA companies´ Issued Share Capital and Share Premium Account values stay the same and so do other reported constant real value non-monetary items in audited financial reports, for example reported Retained Earnings and Capital Reserves under the Historical Cost paradigm in SA´s low inflationary economy. This all helps to reinforce the illusion that the Rand maintains its real value over time which is not true. It is an illusion, namely money illusion.
The SA low inflationary economy is locked into the HC paradigm by a single wrong assumption: the stable measuring unit assumption whereby SA accountants assume that changes in the Rand´s real value are not of sufficient importance to justify financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g., salaries, wages, rents, regulated prices, etc. and generally implement financial capital maintenance in nominal monetary units; i.e. they implement the real value destroying HCA model which includes the very destructive stable measuring unit assumption during low inflation.
The combination of HCA and low inflation plus money illusion blinds us to the continuous destruction of existing real value in reported balance sheet constant items in companies by SA accountants implementing the stable measuring unit assumption in our low inflationary economy. It is true that everything is done in accordance with IFRS or SA GAAP because the ongoing destruction of existing real value in existing reported balance sheet constant items in companies is an integral part of the current global HCA model in countries with low inflationary economies.
This is a direct result of accountants´ stable measuring unit assumption as authorized in the Framework, Par. 104 (a) where under they choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – the other option in Par. 104 (a) also compliant with IFRS. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they would knowingly stop the destruction of existing real value in reported balance sheet constant items in SA companies forever – all else being equal. They would also stop the creation of more real value in reported balance sheet constant items not updated (decreased in nominal value) in companies in deflationary economies forever – all else being equal.
Kindest regards,
Nicolaas Smith
The SA low inflationary economy is locked into the HC paradigm by a single wrong assumption: the stable measuring unit assumption whereby SA accountants assume that changes in the Rand´s real value are not of sufficient importance to justify financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g., salaries, wages, rents, regulated prices, etc. and generally implement financial capital maintenance in nominal monetary units; i.e. they implement the real value destroying HCA model which includes the very destructive stable measuring unit assumption during low inflation.
The combination of HCA and low inflation plus money illusion blinds us to the continuous destruction of existing real value in reported balance sheet constant items in companies by SA accountants implementing the stable measuring unit assumption in our low inflationary economy. It is true that everything is done in accordance with IFRS or SA GAAP because the ongoing destruction of existing real value in existing reported balance sheet constant items in companies is an integral part of the current global HCA model in countries with low inflationary economies.
This is a direct result of accountants´ stable measuring unit assumption as authorized in the Framework, Par. 104 (a) where under they choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – the other option in Par. 104 (a) also compliant with IFRS. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they would knowingly stop the destruction of existing real value in reported balance sheet constant items in SA companies forever – all else being equal. They would also stop the creation of more real value in reported balance sheet constant items not updated (decreased in nominal value) in companies in deflationary economies forever – all else being equal.
Kindest regards,
Nicolaas Smith
Tuesday, 24 November 2009
Trust me, I´m an accountant
Accountants unknowingly and unintentionally destroy at least R200 billion per annum in the real values of reported Retained Profits of most SA companies as well as in all SA companies that do not have 100% of Issued Share Capital and Share Premium Account values invested in revaluable fixed assets with their very destructive stable measuring unit assumption as part of the traditional Historical Cost Accounting model.
That is R200 billion per annum in Capital unknowingly destroyed by SA accountants assuming there is no such thing as inflation (value destruction) in the real value of the Rand when they value existing reported Retained Profits and other reported constant items never maintained during low inflation in nominal monetary units, i.e., at Historical Cost.
Inflation has no effect on reported Retained Profits, Issued Share Capital and Share Premium Account values which are all constant real value non-monetary items. Inflation can only destroy the real value of the Rand and other monetary items - nothing else. Inflation has on effect on the real value of non-monetary items.
SA accountants value the above items in nominal monetary units in terms of the SA Rand which is the monetary unit of account and functional currency in SA. They value them at their original Historical Costs over time in our low inflationary environment. These items´ nominal values thus stay the same because SA accountants simply assume there is no inflation in the Rand when they value them. They only make this assumption as far as balance sheet constant items and the majority of income statement items are concerned. Some income items they inflation-adjust, e.g. salaries, wages, rentals, etc.
SA accountants implement their infamous stable measuring unit assumption whereby they assume that changes in the purchasing power of the Rand is not sufficiently important to inflation-adjust these values. However, there is inflation in SA and their real values are thus being destroyed at a rate equal to the inflation rate because the Rand´s real value is, in fact, being destroyed by inflation.
SA accountants implement their very destructive stable measuring unit assumption because they refuse to measure them in units of constant purchasing power as they have been authorized to do 20 years ago by the IASB.
So, it is not inflation doing the destroying, but, SA accountants choosing the real value destroying Historical Cost Accounting model which includes the very destructive stable measuring unit assumption despite the fact that they have been authorized 20 years ago to stop this massive annual destruction by freely choosing to measure finacial capital maintenance in units of constant purchasing power - which they and all the boards of directors of alll JSE listed companies refuste to do.
Inflation can be whatever rate: 2% or 10% or 15% or 20% or 24% per annum - when SA accountants freely change over and choose to measure financial capital maintenance in units of constant purchasing power there will be no destruction at all in the real value of existing reported constant items.
So, it is very clear that it is not inflation doing the destroying, but, SA accountants unknowingly and unintentionally destroying about R200 billion per annum in existing reported constant items in SA companies simply because of the accounting model they choose; namely, the real value destroying traditional Historical Cost Accounting model which includes their very destructive stable measuring unit assumption.
The IASB authorized them 20 years ago to measure financial capital maintenance in units of constant purchasing power in the Framework, Par. 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
SA accountants and the boards of directors of all JSE listed companies refuse point blank to measure financial capital maintenance in units of constant purchasing power.
So, trust me, I´m an accountant: I´m destroying your company´s reported Retained Profits at the rate of inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
That is R200 billion per annum in Capital unknowingly destroyed by SA accountants assuming there is no such thing as inflation (value destruction) in the real value of the Rand when they value existing reported Retained Profits and other reported constant items never maintained during low inflation in nominal monetary units, i.e., at Historical Cost.
Inflation has no effect on reported Retained Profits, Issued Share Capital and Share Premium Account values which are all constant real value non-monetary items. Inflation can only destroy the real value of the Rand and other monetary items - nothing else. Inflation has on effect on the real value of non-monetary items.
SA accountants value the above items in nominal monetary units in terms of the SA Rand which is the monetary unit of account and functional currency in SA. They value them at their original Historical Costs over time in our low inflationary environment. These items´ nominal values thus stay the same because SA accountants simply assume there is no inflation in the Rand when they value them. They only make this assumption as far as balance sheet constant items and the majority of income statement items are concerned. Some income items they inflation-adjust, e.g. salaries, wages, rentals, etc.
SA accountants implement their infamous stable measuring unit assumption whereby they assume that changes in the purchasing power of the Rand is not sufficiently important to inflation-adjust these values. However, there is inflation in SA and their real values are thus being destroyed at a rate equal to the inflation rate because the Rand´s real value is, in fact, being destroyed by inflation.
SA accountants implement their very destructive stable measuring unit assumption because they refuse to measure them in units of constant purchasing power as they have been authorized to do 20 years ago by the IASB.
So, it is not inflation doing the destroying, but, SA accountants choosing the real value destroying Historical Cost Accounting model which includes the very destructive stable measuring unit assumption despite the fact that they have been authorized 20 years ago to stop this massive annual destruction by freely choosing to measure finacial capital maintenance in units of constant purchasing power - which they and all the boards of directors of alll JSE listed companies refuste to do.
Inflation can be whatever rate: 2% or 10% or 15% or 20% or 24% per annum - when SA accountants freely change over and choose to measure financial capital maintenance in units of constant purchasing power there will be no destruction at all in the real value of existing reported constant items.
So, it is very clear that it is not inflation doing the destroying, but, SA accountants unknowingly and unintentionally destroying about R200 billion per annum in existing reported constant items in SA companies simply because of the accounting model they choose; namely, the real value destroying traditional Historical Cost Accounting model which includes their very destructive stable measuring unit assumption.
The IASB authorized them 20 years ago to measure financial capital maintenance in units of constant purchasing power in the Framework, Par. 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
SA accountants and the boards of directors of all JSE listed companies refuse point blank to measure financial capital maintenance in units of constant purchasing power.
So, trust me, I´m an accountant: I´m destroying your company´s reported Retained Profits at the rate of inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Monday, 23 November 2009
Inflation-adjusting constant items during low inflation does affect the economy positively
Ask anyone receiving a wage or a salary and he or she will confirm that inflation-adjusting salaries does make a difference to the economy. It does affect the nature of the underlying resource – salary, wage, rent, reported Retained Profits, dividends receivable, etc – when a constant item value is determined in terms of units of constant purchasing power instead of in nominal monetary units over time during low inflation.
The choices SA accountants make do change those values and do affect the SA economy. All SA accountants who are members of the boards of directors of SA companies listed on the JSE choose between financial capital maintenance in nominal monetary units and units of constant purchasing power in terms of the Framework, Par. 104 (a). JSE listed companies have to do their accounts in terms of IFRS. All SA accountants on their boards of directors thus have to make that choice since they are the accounting experts on those boards of directors and have to advise the boards accordingly. Valuing existing reported constant items in units of constant purchasing power during low inflation do change those values and do affect the SA economy.
The statement that the choices accountants make won’t change those values and won’t affect the economy is dead wrong.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
The choices SA accountants make do change those values and do affect the SA economy. All SA accountants who are members of the boards of directors of SA companies listed on the JSE choose between financial capital maintenance in nominal monetary units and units of constant purchasing power in terms of the Framework, Par. 104 (a). JSE listed companies have to do their accounts in terms of IFRS. All SA accountants on their boards of directors thus have to make that choice since they are the accounting experts on those boards of directors and have to advise the boards accordingly. Valuing existing reported constant items in units of constant purchasing power during low inflation do change those values and do affect the SA economy.
The statement that the choices accountants make won’t change those values and won’t affect the economy is dead wrong.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
SA accountants are suckers for the stable measuring unit assumption
SA accountants unknowingly destroy the real value of existing reported constant items never maintained during low inflation when they implement their very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.
100% of the inflation-adjusted original real value of all contributions to Issued Share Capital and Share Premium Account values have to be invested in revaluable variable item fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) during low inflation in order for SA accountants not to destroy these item’s original real values at a rate equal to the rate of inflation under the real value destroying traditional HCA model when they implement their very destructive stable measuring unit assumption.
Very few companies in SA abide by the 100% of Issued Share Capital and Share Premium invested in fixed assets rule.
There is no unnecessary real value destruction by SA accountants in Issued Share Capital and Share Premium Account values not backed by 100% investment in revaluable fixed assets when they measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989: the constant real value of Issued Share Capital and Share Premium Account values would be maintained even with no fixed assets in SA companies - that always at least break even - when SA accountants measure financial capital maintenance in units of constant purchasing power; i.e. when they abandon their very destructive stable measuring unit assumption.
Kindest regards,
Nicolaas Smith
100% of the inflation-adjusted original real value of all contributions to Issued Share Capital and Share Premium Account values have to be invested in revaluable variable item fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) during low inflation in order for SA accountants not to destroy these item’s original real values at a rate equal to the rate of inflation under the real value destroying traditional HCA model when they implement their very destructive stable measuring unit assumption.
Very few companies in SA abide by the 100% of Issued Share Capital and Share Premium invested in fixed assets rule.
There is no unnecessary real value destruction by SA accountants in Issued Share Capital and Share Premium Account values not backed by 100% investment in revaluable fixed assets when they measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989: the constant real value of Issued Share Capital and Share Premium Account values would be maintained even with no fixed assets in SA companies - that always at least break even - when SA accountants measure financial capital maintenance in units of constant purchasing power; i.e. when they abandon their very destructive stable measuring unit assumption.
Kindest regards,
Nicolaas Smith
Friday, 20 November 2009
Constant items
The Framework, Par. 102 states that most companies choose a financial concept of capital to prepare their financial reports. An entity’s capital is the same as its equity or net assets when it adopts a financial concept of capital, for example invested purchasing power or invested money.
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) then states that:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The IASB clearly defines issued share capital, capital reserves, retained earnings, all other items in shareholders´ equity, all items in the income statement, provisions, etc as non-monetary items. Since these real value non-monetary items can be measured in units of constant purchasing power in terms of the Framework, Par. 104 (a), to implement a financial capital maintenance concept in units of constant purchasing power, they are obviously constant real value non-monetary items with constant real non-monetary values expressed in terms of a monetary unit of account over time in a low inflationary or deflationary economy.
Logic would thus imply and it is a fact that real value non-monetary items that are not measured in units of constant purchasing power during low inflation or deflation on a primary valuation basis but are valued in terms of specific IFRS at, for example, market value, fair value, recoverable value, net realisable value, present value, etc are not constant but variable real value non-monetary items, e.g. property, plant, equipment, shares, inventory, foreign exchange, etc.
Examples of constant items
All income statement items once they are accounted
Revenue
Cost of sales
Gross Profit
Investment revenues
Other gains and losses
Net monetary gains and losses
Share of profits of associates
Changes in inventories of finished goods and work in progress
Raw materials and consumables used
Depreciation and amortisation expense
Employee benefits expense
Distribution expenses
Marketing expenses
Occupancy expenses
Administration expenses
Finance costs
Consulting expense
Royalities
Other expenses
Profit before tax
Income tax expense
Profit for the year from continuing operations
Profit for the year from discontinued operations
Profit for the year
All balance sheet constant items
Deferred tax assets
Finance lease receivables
Trade and other non-monetary debtors
Provision for doubtful debts
Current tax assets
Issued share capital
Share premium
Share discount
Capital reserves
General reserve
Properties revaluation reserve
Investments revaluation reserve
Equity-settled employee benefits reserve
Hedging reserve
Foreign currency translation reserve
Retained earnings
Retirement benefit obligation
Deferred tax liabilities
Provisions
Employee benefits provision
Provision for rectification work
Provision for warranties
Onerous lease contract provision
Restructuring and termination costs provision
Decommissioning costs provision
Deferred Revenue
Trade and other non-monetary creditors
Current tax liabilities
The IASB only recognizes monetary and non-monetary items in the economy. The Board manages to side-step the split between variable and constant items with the stable measuring unit assumption which it accepts as part of HCA. Constant items are valued in nominal monetary units under HCA implementing the stable measuring unit assumption.
HCA makes no difference between variable real value non-monetary items and constant real value non-monetary items. Both variable and constant items are grouped together as simply non-monetary items as opposed to monetary items. Both variable items valued at HC (e.g. fixed property) and constant items valued at HC (Retained Earnings) are classified as simply non-monetary items under HCA.
Kindest regards,
Nicolaas Smit
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) then states that:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The IASB clearly defines issued share capital, capital reserves, retained earnings, all other items in shareholders´ equity, all items in the income statement, provisions, etc as non-monetary items. Since these real value non-monetary items can be measured in units of constant purchasing power in terms of the Framework, Par. 104 (a), to implement a financial capital maintenance concept in units of constant purchasing power, they are obviously constant real value non-monetary items with constant real non-monetary values expressed in terms of a monetary unit of account over time in a low inflationary or deflationary economy.
Logic would thus imply and it is a fact that real value non-monetary items that are not measured in units of constant purchasing power during low inflation or deflation on a primary valuation basis but are valued in terms of specific IFRS at, for example, market value, fair value, recoverable value, net realisable value, present value, etc are not constant but variable real value non-monetary items, e.g. property, plant, equipment, shares, inventory, foreign exchange, etc.
Examples of constant items
All income statement items once they are accounted
Revenue
Cost of sales
Gross Profit
Investment revenues
Other gains and losses
Net monetary gains and losses
Share of profits of associates
Changes in inventories of finished goods and work in progress
Raw materials and consumables used
Depreciation and amortisation expense
Employee benefits expense
Distribution expenses
Marketing expenses
Occupancy expenses
Administration expenses
Finance costs
Consulting expense
Royalities
Other expenses
Profit before tax
Income tax expense
Profit for the year from continuing operations
Profit for the year from discontinued operations
Profit for the year
All balance sheet constant items
Deferred tax assets
Finance lease receivables
Trade and other non-monetary debtors
Provision for doubtful debts
Current tax assets
Issued share capital
Share premium
Share discount
Capital reserves
General reserve
Properties revaluation reserve
Investments revaluation reserve
Equity-settled employee benefits reserve
Hedging reserve
Foreign currency translation reserve
Retained earnings
Retirement benefit obligation
Deferred tax liabilities
Provisions
Employee benefits provision
Provision for rectification work
Provision for warranties
Onerous lease contract provision
Restructuring and termination costs provision
Decommissioning costs provision
Deferred Revenue
Trade and other non-monetary creditors
Current tax liabilities
The IASB only recognizes monetary and non-monetary items in the economy. The Board manages to side-step the split between variable and constant items with the stable measuring unit assumption which it accepts as part of HCA. Constant items are valued in nominal monetary units under HCA implementing the stable measuring unit assumption.
HCA makes no difference between variable real value non-monetary items and constant real value non-monetary items. Both variable and constant items are grouped together as simply non-monetary items as opposed to monetary items. Both variable items valued at HC (e.g. fixed property) and constant items valued at HC (Retained Earnings) are classified as simply non-monetary items under HCA.
Kindest regards,
Nicolaas Smit
Thursday, 19 November 2009
Eskom price increase does not necessarily increase inflation
A price increase is paying more money for equivalent more real value.
Inflation is paying more money for the same real value.
In theory, an Eskom electricity price increase (25% or 45%) does not necessarily increase inflation. Everyone will just have less money for other things - all else being equal (the zero increase option).
That is theory.
All else do not stay equal.
Inflation comes about when unscrupulous business people abuse the electricity price increase for unjustified other price increases with no real value increase or no cost increase.
Is it unscrupulous or is it just the normal workings of the free market?
I think it is the normal workings of the free market. I will push my price up to see if I can make more profit. Imperfect market conditions may result in my inflationary actions not being corrected or counter-acted in the free market. They may flow through to the general price increase and may increase inflation: i.e., increase the destruction of the real value of the Rand and all other monetary items in the SA economy above the current 6.1% per annum real value destruction in the Rand.
Gill Marcus and her team at the SARB have to develop measures to combat my actions to simply look after my own self-interest.
Kindest regards,
Nicolaas Smith
Inflation is paying more money for the same real value.
In theory, an Eskom electricity price increase (25% or 45%) does not necessarily increase inflation. Everyone will just have less money for other things - all else being equal (the zero increase option).
That is theory.
All else do not stay equal.
Inflation comes about when unscrupulous business people abuse the electricity price increase for unjustified other price increases with no real value increase or no cost increase.
Is it unscrupulous or is it just the normal workings of the free market?
I think it is the normal workings of the free market. I will push my price up to see if I can make more profit. Imperfect market conditions may result in my inflationary actions not being corrected or counter-acted in the free market. They may flow through to the general price increase and may increase inflation: i.e., increase the destruction of the real value of the Rand and all other monetary items in the SA economy above the current 6.1% per annum real value destruction in the Rand.
Gill Marcus and her team at the SARB have to develop measures to combat my actions to simply look after my own self-interest.
Kindest regards,
Nicolaas Smith
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