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Monday 9 April 2012

Objectives of general purpose financial reporting

Objectives of general purpose financial reporting
It is clear from the above that the objectives of general purpose financial reporting are:

(a)                Maintaining the constant purchasing power of capital.

(b)                Provision of continuously updated decision–useful financial information about the reporting entity to capital providers and other users.

‘It is the overall objective of reporting for price changes to ensure the maintenance of the business as an entity.’

(Coenenberg and Macharzina, 1976)

‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’  

(Framework, 2010)

‘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)

Only existing constant real non-monetary value capital can be maintained. Double–entry accounting does not and cannot create real value out of nothing as a result of simply passing update entries when no real value actually exists.

Financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation (CIPPA) automatically maintains the constant purchasing power of (existing) capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus. Maintaining the constant purchasing power of capital at all levels of inflation and deflation is a basic objective of financial reporting.

An entity has maintained the existing constant purchasing power of its capital if it has as much equity – expressed in units of constant purchasing power – at the end of the reporting period as it had at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Consequently, a profit is earned only if the constant purchasing power of equity at the end of the period exceeds the constant purchasing power of equity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

The German economist Werner Sombart (1863–1941) wrote in Medieval and Modern Commercial Enterprise:

‘The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double entry bookkeeping.’

(Sombart, 1953)

The objectives of general purpose financial reporting are supposed to answer the question, what is financial reporting supposed to do? The only accounting model an entity can use to implement a capital concept is double–entry accounting. Every fundament concept of capital logically gives rise to its respective fundamental capital maintenance concept.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Thursday 5 April 2012

Stable measuring unit assumption based on a fallacy

Stable measuring unit assumption based on a fallacy

Under the stable measuring unit assumption it is assumed that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation.

In practice the stable measuring unit assumption means that the real value of money is assumed to be perfectly stable during low inflation and deflation.

The stable measuring unit assumption is an assumption made in economics and accounting. The fact is that the real value of money is never perfectly stable under inflation and deflation.

The stable measuring unit assumption is thus based on a fallacy, namely the fallacy that money is stable in real value during low inflation and deflation.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Wednesday 4 April 2012

Financial capital maintenance in nominal monetary units per se is a very popular accounting fallacy


Financial capital maintenance in nominal monetary units per se is a very popular accounting fallacy

 Capital is a constant real value non-monetary item.

Maintaining the constant purchasing power of capital is a fundamental objective of financial reporting.

Financial capital maintenance in nominal monetary units per se as implemented under traditional Historical Cost Accounting is a very popular accounting fallacy because it is impossible to maintain the constant purchasing power of capital in nominal monetary units per se during inflation.

 It is only possible per se in entities that at least break even in real value – ceteris paribus – during indefinite zero inflation which has never been achieved in the past and is not soon to be achieved in the future.

 It is only possible to maintain the constant purchasing power of capital in nominal monetary units during inflation in entities that it least break even in real value – ceteris paribus – when they continuously invest 100 per cent of the constant purchasing power of all to contributions to capital in revaluable net assets (revalued or not) with an equivalent fair value, i.e., when the constant purchasing power of capital is always equal to the real value of net assets.

 It is possible to maintain the real value of capital with financial capital maintenance in nominal monetary units in entities that at least break even in real value – ceteris paribus – during indefinite deflation because the real value of capital would increase continuously during deflation as qualified.

 The constant purchasing power of capital would thus not be kept constant (which is what is required) in real value during deflation under financial capital maintenance in nominal monetary units.

Capital would be maintained constant in real value in all entities which at least break even in real value – ceteris paribus – in terms of a Daily CPI or other daily rate per se at all levels of inflation and deflation under financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) as authorized in the original Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)] which states:

‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

It is most probably safe to state that very few companies in the world economy would be able to claim with 100 per cent certainty that they have maintained the constant purchasing power of their owners´ equity over the lifetime of the company. It is most probably safe to state that hardly any company knows whether it has or has not. It is also most probably safe to state that very few companies in the world economy are 100 per cent sure that they are currently (2012) maintaining the constant purchasing power of their owners´ equity in nominal monetary units under traditional Historical Cost Accounting.

 All companies that would at least break even in real value – ceteris paribus – implementing financial capital maintenance in units of constant purchasing in terms of a Daily CPI or other daily rate (CIPPA) would be able to claim that at all levels of inflation and deflation.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Tuesday 3 April 2012

Do you think Argentina should end Historical Cost Accounting?

Do you think Argentina should end Historical Cost Accounting?

Annual inflation in Argentina is currently (February, 2012) at 9.7 per cent. There are some people who think it is closer to 26 per cent per annum according to reports in the press. These people also think the official inflation numbers are being tampered with.

The Argentinean Accounting Federation submitted a research paper to the IASB in 2010 in the form of a proposed new IFRS named IFRS 'X' INFLATION in which they proposed that entities should perform restatements of their financial statements when:

(a) the cumulative inflation rate of its functional currency for the last 12 months
is higher or equal to 10%; or

(b) the cumulative inflation rate of its functional currency for the last 36 months
is higher or equal to 26%; or

(c) the preceding financial statements were restated and the cumulative inflation
rate of its functional currency has not been lower than 15% for the last 36
months.

The Argentinean Federation thus wants the IASB to do what the Federation thinks it cannot do on its own.

The IASB and the Argentinean Federation made the proposal available to me and I amended it (via an unsolicited comment letter to the IASB) to IFRS ‘X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER. The amended version would require an end to HCA: a fundamental change from HCA to financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) as originally authorized in IFRS in the Framework (1989), Par. 104 (a) at annual inflation equal to or higher than 10 per cent or cumulative inflation equal to or higher than 26 per cent over three years with no return to HCA afterwards at any level of inflation or deflation.

Afterwards I realized that all Argentinean companies could right now freely choose to implement financial capital maintenance in units of constant purchasing power because it was authorized in IFRS in 1989.

I then suggested to the Argentinean Accounting Federation (Federación Argentina de Consejos Profesionales de Ciencias Económicas) that they should simply authorize a national accounting standard in Argentina requiring Argentinean companies to implement financial capital maintenance in units of constant purchasing power in terms of their amended proposal at annual inflation equal to or greater than 10 per cent per annum or cumulative inflation equal to or greater than 26 per cent over three years with no future return to HCA.
Implementation is not required in IFRS, but it is authorized. Argentina should simple require it.

They would be requiring something that was authorized in IFRS in 1989.

In my opinion Argentina should end HCA in this manner when it is taken into account that financial capital maintenance in units of constant purchasing power would automatically maintain the constant purchasing power of capital constant for an indefinite period of time in all Argentinean entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus- whether they own any revaluable fixed assets or not.

What is your opinion?

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Monday 2 April 2012

Hurdles to financial capital maintenance in units of constant purchasing power

Hurdles to financial capital maintenance in units of constant purchasing power
Financial capital maintenance in units of constant purchasing power (CIPPA) which automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that break even in real value during inflation and deflation – ceteris paribus – is not yet generally accepted by companies for the following reasons:

1        The CIPPA due process is not yet complete in 2012; it is an on–going process although authorization of the principle of financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation in IFRS in 1989 was a major milestone.

2        It is still (2012) initially assumed that any price–level accounting model refers to either (a) the inflation accounting model authorized in IAS 29 to be used only during hyperinflation or (b)  to the CPPA inflation accounting model used during the high inflation 1970s and 80s.

3        It is not yet generally understood that the implementation of the traditional Historical Cost Accounting model – in general – unknowingly, unintentionally and unnecessarily  erodes real value on a significant scale (hundreds of billions of US Dollars per annum) in the world´s  constant item economy when  the stable measuring unit assumption is implemented and financial capital maintenance is measured in nominal monetary units during inflation in entities when the constant purchasing power of constant items is never maintained.

4        It is not yet generally understood that this massive annual erosion of existing constant real value in existing constant items never maintained constant can be stopped by simply selecting the alternative approved in IFRS in 1989.

5        The fallacy that financial capital maintenance can be measured in nominal monetary units (HCA) was also approved in IFRS in the original Framework (1989), Par. 104 (a).

6        The HCA model that includes the stable measuring unit assumption is implemented by most entities world–wide.

7        The fallacy that the erosion of business profits and invested capital is caused by inflation is still (2012) generally accepted.

8        The cost of the stable measuring unit assumption (the net constant item loss in constant items not maintained constant over time under HCA) is mistakenly still (2012) generally accepted to be the same as the cost of inflation (the net monetary loss from holding a net balance of monetary item assets over time) and needs to be limited by central banks´ monetary policies because it is not realized that it is the implementation of the stable measuring unit assumption and not inflation that is eroding the real value of constant items never maintained constant.

9        The concept of a constant item with a constant real non-monetary value to be maintained constant over time by means of financial capital maintenance in units of constant purchasing power in terms of a daily rate is still a very new accounting concept in 2012.


Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Friday 30 March 2012

Differences between CIPPA and CPPA (updated)


Differences between CIPPA and CPPA (updated)



‘Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money.  It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index.’



(Whittington, 1983)



It is very clear from the above that Prof. Whittington also consideredat that time – that ‘indexing accounts by means of a general index’ would ‘deal with the inflation problem’ and not the stable measuring unit assumption problem. The term ‘stable measuring unit assumption’ does not appear in his book at all.



CPPA is an inflation accounting model and is dealt with in this book as it is implemented in terms of IAS 29.



CIPPA implements financial capital maintenance in units of constant purchasing power in terms of a daily rate which automatically maintains the constant purchasing power of owners´ equity constant for an indefinite period of time in entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not. The net monetary loss or gain and the net constant item loss or gain are calculated and accounted in the income statement. CIPPA is a basic accounting model alternative to HCA at all levels of inflation and deflation including during hyperinflation. It is not only an inflation accounting model to be implemented during hyperinflation like CPPA. CIPPA is a price–level basic accounting alternative to HCA authorized in IFRS at all levels of inflation and deflation. The stable measuring unit assumption is never implemented under CIPPA.



Differences



CIPPA
CPPA



1                     When implemented


Implemented at all levels of inflation and deflation.                                             

Only implemented during hyperinflation as required by IAS 29.

                                                            

2                     Stable measuring unit assumption




The stable measuring unit assumption is never implemented.                            


The stable measuring unit assumption is implemented as part of a number of different measurement bases in the preparation of HC or CC financial reports which are then restated in terms of the period-end monthly published CPI only during hyperinflation.



3                     Non–monetary items


Non–monetary items are split in variable 
and constant real value non–monetary
items.

No split in non–monetary items.



4                     Capital concept




Constant item purchasing power financial    capital concept implemented.                         


Nominal financial capital concept implemented in HC or CC financial reports then restated in terms of the period–end monthly published CPI only during hyperinflation.



5                     Capital maintenance concept




Financial capital maintenance in units   
of constant purchasing power concept       
implemented; i.e., owners´ equity     
is measured in units of constant
purchasing power in terms of a daily rate at all levels of inflation and deflation.          


Nominal financial capital maintenance concept implemented; owners´ equity is measured in nominal monetary units in HC or CC financial reports during the accounting period which are then
restated in terms of the period–end monthly published CPI only during hyperinflation.



6                     Inflation–accounting model


A basic accounting model implemented 
at all levels of inflation and deflation
including during hyperinflation.                  

Only an inflation accounting model
implemented during hyperinflation.  

                                                                                                                       

7                     IFRS authorization


Originally authorized in IFRS in the Framework (1989), Par. 104 (a).                 

Authorized in IFRS in IAS 29 in 1989.



8                     Measurement


Daily measurement of all items in terms of a daily rate as detailed below.                 

Non-monetary items in HC or CC financial reports are restated at the end of the accounting period in terms of the period-end monthly published CPI.                                                   

                                  

9                     Measurement of monetary items


Historic and current period monetary   
items are inflation–adjusted daily in terms of a daily rate. When not inflation
 –adjusted daily during the current
 period, the net monetary loss or gain 
 is calculated and accounted.                                             

Current period monetary items are measured in nominal monetary units. They are not restated. Inflation-indexed items are adjusted in accordance with the contract in order to state the amount outstanding at the end of the reporting period. The net monetary loss or gain is calculated and accounted in terms of incorrectly defined monetary items.                                                                       

                                                                                    

10                 Measurement of variable items


Variable items are measured in terms of
IFRS excluding the stable measuring unit assumption and the definitions of monetary items (2011). They are updated daily in terms of a daily index when not measured daily.                                                         


Non–monetary items are not split in
variable and constant items. Variable items in HC or CC financial reports are restated in terms of the period–end monthly published CPI. The daily hard currency parallel rate is used for the valuation of some, not all, variable items at the time of purchase during hyperinflation. Most variable item selling prices are updated daily in terms of the daily parallel rate.



11                 Measurement of constant items


Historic and current period constant items are always and everywhere measured in units of constant purchasing power on a daily basis in terms of a daily rate at all levels of inflation and deflation.                                             


Non–monetary items are not split in
variable and constant items. Constant items, e.g., equity, is measured in nominal monetary units in HC or CC period-end financial statements during hyperinflation. All non–monetary items in these financial reports are restated in terms of the period–end monthly published CPI.    



12                 Net constant item loss or gain


Net constant item loss or gain calculated
and accounted. This is a new accounting
concept.                                                         

A net constant item loss or gain concept does not exist under HCA, CPPA, IFRS or US GAAP.



13                 Measurement of trade debtors and trade creditors


Constant real value non–monetary
payables and receivables (e.g., trade debtors and trade creditors) are measured in terms of a daily rate. The net constant item loss or gain is accounted where applicable.                                               

Trade debtors and trade creditors and other non-monetary payables and receivables are treated as monetary items and measured in nominal monetary units in HC or CC financial reports. They are not restated. The net real value loss or gain as a result of the implementation of the stable measuring unit assumption during hyperinflation is incorrectly accounted as a net monetary loss or gain in terms of IAS 29. It is a net constant item loss or gain.



14                 Consumer Price Index 


Daily Consumer Price Index or a monetized daily indexed unit of account used during low and high inflation and deflation. Daily US Dollar parallel or Brazilian-style URV daily index rate used during hyperinflation.         

Monthly Consumer Price Index used
during hyperinflation as per IAS 29.



15                 Parallel rate


Daily hard currency parallel rate used 
during hyperinflation in the absence of a Brazilian-style daily index for the daily valuation of variable and constant real value non-monetary items as well as the calculation and accounting of the net monetary gain or loss when monetary items are not inflation-adjusted daily in terms of the daily parallel rate as well as for the accounting of the net constant items loss or gain.
                                    

Daily hard currency parallel rate used for the valuation of some, not all, variable items at the time of purchase during hyperinflation. These values are then restated in HC or CC financial reports in terms of the period-end monthly published CPI. Not used for the daily measurement of constant items. Used for the daily updating of the selling prices of most variable items.              

16                Indexation


CIPPA is daily indexation at all levels of inflation and deflation.

Monthly indexation can be used only during hyperinflation.
              



17                 Monetized daily indexed unit of account


A monetized daily indexed unit of account
can be used at all levels of inflation and deflation.                                                               

A monetized daily indexed unit of account not used during hyperinflation.



18                Constant real value non-monetary item concept



The constant real non-monetary item concept, namely that there are non-monetary items with constant real non-monetary values over time, is a fundamental concept under CIPPA.
There is no concept of a constant real value non-monetary item under Historical Cost Accounting. CPPA is taken to be implemented in terms of IAS 29. IAS 29 requires the restatement of Historical Cost or CC financial statements.



19                Net assets



The real value of net assets is always equal to the real value of capital.
The nominal value of net assets is always equal to the nominal value of capital.



20 Fundamental value date



The fundamental value date is the current date, i.e., today. All items are always accessed, read and valued at the current, today´s, value or Daily CPI or other daily rate.
The fundamental value date is the date of the financial report. During hyperinflation financial reports can become meaningless the next day as a result of hyperinflation.


Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.