Money

Money

Money is the greatest economic invention of all time. Money did not exist and was not discovered. Money was invented over a long period of time.

Money is not perfectly stable in real value during inflation and deflation. However, all Historical Cost Accounting world–wide is done assuming it is stable in real value when the stable measuring unit assumption is implemented for the valuation of most – not all – constant real value non-monetary items during  inflation and deflation. It is assumed, in practice, that money is perfectly stable when balance sheet constant items and all income statement items (excluding constant items like salaries, wages, rentals, etc., which are measured in units of constant purchasing power on an annual basis, but paid monthly implementing the stable measuring unit assumption) are valued in nominal monetary units when financial capital maintenance in nominal monetary units (HCA) is implemented during inflation and deflation as authorized in IFRS in the original Framework (1989), Par 104 (a).

Money is not the same as constant real value during inflation and deflation. Money would only have a constant real value over time during permanently sustainable zero annual inflation which has never been achieved in the past and is not likely soon to be achieved in the future.

The real values of monetary items (excluding bank notes and coins) would remain constant over time when the total money supply within an economy is inflation-indexed on a daily basis in terms of a Daily CPI or a monetized daily indexed unit of account with complete co-ordination. Chile (2011) inflation-adjusts 20 to 25 per cent of its broad M3 money supply on a daily basis in terms of the Unidad de Fomento which is a monetized daily indexed unit of account in use since 1967. Many countries issue capital inflation-indexed government bonds inflation-adjusted on a daily basis which protect investors against the erosion of the real value of their capital during inflation.

There would be no net monetary losses or gains and also no cost of inflation with complete daily inflation-adjustment of the total money supply with complete co-ordination. There would still be inflation, but it would have no effect in the economy.

Bank notes and coins are physical tokens of money. Unstable money is an unstable monetary item which is used as an unstable monetary medium of exchange. It serves at the same time as an unstable monetary store of value and as the unstable monetary unit of account for the accounting of economic activity in a country or a monetary union. All three basic economic items – monetary, variable and constant items – are valued in terms of unstable money within an economy.

An earlier form of money was commodity money, e.g., gold, silver and copper coins which had substantial real intrinsic value. Today unstable money is fiat money with an insignificant physical intrinsic value created by government fiat or decree.

Unstable money is an unstable medium of exchange which is its main function. Without that function it could never be money. The historical development of unstable money led it also to be used as an unstable store of value and as the unstable unit of measure to account the values of economic items.

Unstable money is the only generally accepted unit of measure that is not a stable value under all circumstances. All other units of measure are fundamentally stable units of measure, e.g., inch, centimetre, ounce, gram, kilogram, pound, etc.

Nicolaas Smith

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

Valuation of variable items

Valuation of variable items

Variable items are valued in terms of IFRS, excluding the stable measuring unit assumption, under financial capital maintenance in units of constant purchasing power (CIPPA). They are then updated daily in terms of the Daily CPI when they are not valued daily thereafter. They are valued / accounted in terms of the daily parallel rate or the daily index rate during hyperinflation.

Under financial capital maintenance in units of constant purchasing power (CIPPA) all accounting entries contain four elements:

21      An indication whether the item valued / accounted is

a.      A monetary item (m),

b.      A constant item (c) or

c.           A variable item (v).

22      The value of the item expressed in terms of the functional currency.

23      The date of the accounting entry.

24      The Daily CPI or monetized daily indexed unit of account at the date of the accounting entry during low and high inflation and deflation or the daily parallel or other index rate during hyperinflation.

         Variable items valued in terms of IFRS at Historical Cost as well as all other historical variable item IFRS valuations are updated in ledger accounts and in financial reports and publications in whatever format in terms of the Daily CPI till the next valuation in terms of IFRS because there is no stable measuring unit assumption under CIPPA during inflation and deflation. This is done in order to always reflect the IFRS valuation in terms of the current depreciated or appreciated real value of money over time. Variable items are always updated – per se – in terms of the current daily parallel or other daily index rate during hyperinflation.          

         The fact that specific variable items are valued at Historical Cost in terms of IFRS, e.g. stock valued at the lower of cost or net realizable value, does not mean that the HCA model is being implemented because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power (CIPPA).

        The Framework states that the concept of capital maintenance plus the measuring basis chosen determines the accounting model implemented. Under CIPPA financial capital maintenance is measured in units of constant purchasing power: there is no stable measuring unit assumption under CIPPA. Historical Cost is one of the various measurement bases used under CIPPA. HC valuations are thus always updated daily at the current, today´s, Daily CPI under CIPPA; i.e. the stable measuring unit is never applied.

         Under CIPPA monetary items in ledger accounts and in current period financial reports published during the current accounting period are valued / accounted in  nominal monetary units, but, the net monetary loss or gain is always calculated and accounted: i.e. there is no stable measuring unit assumption as implemented under Historical Cost Accounting. The net monetary loss or gain is not calculated and accounted under HCA because the stable measuring unit assumption is implemented.

       Specific variable items are valued at HC in terms of IFRS, but, then they are continuously updated during inflation, deflation and hyperinflation under financial capital maintenance because there is no stable measuring unit assumption under CIPPA.

Nicolaas Smith

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

Four reasons why CIPPA automatically maintains the constant purchasing power of capital constant for an indefinite period of time

Four reasons why CIPPA automatically maintains the constant purchasing power of capital constant for an indefinite period of time

Financial capital maintenance in units of constant purchasing power in terms of a Daily CPI (CIPPA) automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value during inflation and deflation – ceteris paribus – as a result of the following reasons:

1.      Double entry accounting: For every credit (e.g., capital) there is an equivalent debit (e.g., fixed assets, stock, trade debtors, cash, etc.).

2.      There is no stable measuring unit assumption under this model: (a) monetary items are inflation adjusted daily at the current Daily CPI with the net monetary gain or loss accounted during the current accounting period; (b) variable items are valued daily in terms of IFRS excluding the stable measuring unit assumption and updated daily at the current Daily CPI when not valued daily with revaluations and impairments treated in terms of IFRS and (c) constant items are measured daily in units of constant purchasing power in terms of the current Daily CPI with the net constant item loss or gain accounted during the current accounting period.

3.      The constant real non–monetary value of equity is equal to the real value of net assets in all entities that at least break even in real value during inflation and deflation – ceteris paribus.

4.      A company, in principle, has an unlimited lifetime.

Nicolaas Smith

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

Price–level accounting does not prevail

Price–level accounting does not prevail

Price–level accounting as Harvey Kapnick hoped for in 1976 clearly does not prevail for balance sheet constant real value non–monetary items (e.g., owners´ equity) and most income statement items during low inflation. Income statement items are all constant real value non–monetary items. Price–level accounting does prevail as far as the income statement constant items salaries, wages, rentals, etc. are concerned since they are generally measured annually in units of constant purchasing power in terms of the annual change in the Consumer Price Index, but, they are then paid monthly applying the stable measuring unit assumption.

In terms of the HCA model the stable measuring unit assumption is implemented under which balance sheet constant items are valued at historical cost, i.e., in nominal monetary units thus eroding the existing constant real value of these constant items when they are not maintained constant  during low inflation.

Price–level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when Brazil indexed all non–monetary items (variable and constant items) in their non–monetary or real economy with a daily index value supplied by the different governments during that period. Brazil stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They should have changed from daily indexation of all non–monetary items (variable and constant items) during hyperinflation to financial capital maintenance in units of constant purchasing power during low inflation by applying their Daily CPI.

William Paton noted:

‘the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.’

As quoted in FAS 33, p. 29.

There is no substance in the claim that the existence and value of economic resources, for example owners´ equity items, exist independently of how we measure them – and that the choice of the measuring unit does not affect their fundamental value, only how we choose to represent that value – and that we can use any monetary unit, US Dollars of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced.  See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit – but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices made in accounting will not change that value and will not affect the economy. Measuring constant real value non–monetary items in units of constant purchasing power over time does affect the economy. That is generally known and a fact.

The HCA model would have been rejected by now if it were generally understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional erosion of hundreds of billions of US Dollars of real value in constant items (e.g., banks´ and companies´ equity) never maintained in the world´s constant item economy year in year out.

Nicolaas Smith

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

Accounting cannot and does not create real value out of nothing

Accounting cannot and does not create real value out of nothing

It must be clearly understood that accounting per se cannot and does not create real value out of nothing – out of thin air. Accounting cannot and does not create real value or wealth by simply passing some update or financial capital maintenance in units of constant purchasing power accounting entries when no real value actually exists. Constant real value non-monetary items first have to actually exist for the accounting model (CIPPA) to be able to automatically maintain the real values of those existing constant items constant for an indefinite period of time in all entities that at least break even in real value during inflation and deflation – ceteris paribus. This is achieved by continuously measuring financial capital maintenance in units of constant purchasing power as authorized in IFRS in terms of a daily index or other daily rate. Maintaining the constant purchasing power of capital constant is consequently a basic objective of financial reporting.

The IASB authorized very erosive financial capital maintenance in nominal monetary units (HCA) during inflation and deflation, as well as its real value maintaining remedy, financial capital maintenance in units of constant purchasing power (CIPPA), in one and the same sentence in 1989.

Obviously, at sustainable zero inflation constant items will maintain their real values constant in all companies that at least break even in real value during inflation and deflation – all else being equal- under both HCA and CIPPA. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.

The IASB confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 and in the original Framework (1989) that most companies´ primary financial reports are prepared based on the traditional Historical Cost Accounting model without taking changes in the general price level or specific price changes of assets into account, with the exception that investments, equipment, plant and properties (all variable real value non-monetary items) can be revalued. The IASB does not mention the other exception, namely, that salaries, wages, rentals, etc. (all constant real value non-monetary items) are generally measured in units of constant purchasing power on an annual basis.

The IASB does not mention the erosion of the real value of balance sheet constant items never maintained constant when the stable measuring unit assumption (a Generally Accepted Accounting Practice) is implemented during low inflationary periods in companies with insufficient revaluable fixed assets (revalued or not) because this process of erosion of the real value of constant items never maintained constant is not generally understood. The IASB, like the FASB and most others, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation, as specifically stated by the FASB. They also support the stable measuring unit assumption which is based on the fallacy that money is perfectly stable. They both authorized HCA based on the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation.

The erosion of the real value of constant items by the implementation of  the stable measuring unit assumption is very well understood and remedied by measuring  them in units of constant purchasing power by applying the annual CPI in the case of the income statement constant items salaries, wages, rentals, etc. The real value maintaining effect on balance sheet constant items is not understood of freely choosing to continuously measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved in IFRS in the original Framework (1989), Par 104 (a).

The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position.

The FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89.

‘Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.’

FAS 89, Par. 4, 1986

‘The integrity of the historical cost / nominal dollar system relies on a stable monetary system.’

FAS 33, 1979

The IASB never mentioned the stable measuring unit assumption in either IAS 6 Accounting Response to Changing Prices (approved in March, 1977 for publication in June, 1977) or IAS 15 (approved in June, 1981 for publication in November, 1981 and became effective on 1 January, 1983). IAS 15 completely superseded IAS 6. IAS 15 was withdrawn in December, 2003.

Nicolaas Smith

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

Two per cent inflation also erodes real value

Two per cent inflation also erodes real value

There is a school of thought that the effects of two per cent inflation are not more harmful than zero per cent inflation.  This school of thought is incorrect in two of the three valuation processes in our current HC economy and would also be mistaken in one of the three valuation processes under continuous financial capital maintenance in units of constant purchasing power, i.e., the Constant Item Purchasing Power paradigm during low inflation.  The three valuation processes in our economy under both the HC and CIPP paradigms are the valuation of monetary, variable and constant items.

Variable items are valued in terms of IFRS under both the HC and CIPP paradigms with the stable measuring unit assumption being applied under HCA. The stable measuring unit assumption is never implemented under the CIPP paradigm. The two paradigms are fundamentally different paradigms.

The view that a high degree of price stability of a positive inflation rate of up to two per cent per annum is completely unharmful and that it has no disadvantages compared to absolute price stability is never true in the case of monetary items under any accounting model, either the HCA model or the CIPPA model, since inflation always erodes the real value of monetary items. A high degree of price stability of two per cent per annum in this case erodes two per cent per annum of the real value of money and other monetary items which equates to the erosion of 51 per cent of real value in all current monetary items over the next 35 years. It will over a long enough time period lead to all current monetary items arriving at the point of being completely worthless in economies with continuous two per cent inflation. The five cents coin was recently withdrawn from the South African money supply since it was practically worthless. South Africa has an inflation target of three to six per cent per annum. Swedish rounding whereby the cost of a purchase paid for in cash is rounded to the nearest multiple of the smallest denomination of currency is implemented in a number of countries.

In the case of monetary items we can thus confidently disagree with those who assume that a high degree of price stability of above zero and up to two per cent per annum is unharmful in all respects and that it has absolutely no disadvantages compared to absolute price stability or zero inflation.

The assumption that two per cent inflation is unharmful and that it has no disadvantages compared to zero inflation is acceptable in the case of variable real value non–monetary items valued continuously in terms of IFRS (excluding the stable measuring unit assumption) under the CIPPA model. The nature of the valuing processes in valuing variable real value non–monetary items continuously, for example, at fair value or the lower or cost and net realizable value or market value, etc., in terms IFRS (excluding the stable measuring unit assumption), allows this idea to be justifiable under CIPPA.

The above view is acceptable in this instance, because, in principle, any level of inflation or deflation – high or low – is automatically adjusted for in determining the price of a variable real value non–monetary item at the moment of a transaction in terms of IFRS, excluding valuation in nominal monetary units, under CIPPA.

The above assumption relating to two per cent inflation is acceptable under the HC model with the valuation of variable items in terms of IFRS accept in the case where the stable measuring unit is implemented. It is thus not acceptable per se with reference to variable items under the HC paradigm.

Two per cent inflation erodes two per cent per annum – i.e., 51 per cent over 35 years – of the real value of constant real value non–monetary items never maintained, e.g., retained profits, etc.  under the current HC paradigm. The only constant items generally maintained constant with annual measurement in units of constant purchasing power under the HC paradigm are certain (not all) income statement items, e.g., salaries, wages, rentals, etc. They are, however, paid monthly at the same value after being updated annually. All existing constant real value non–monetary items´ real values would automatically be maintained constant with continuous measurement in units of constant purchasing power at any level of inflation or deflation under the CIPP paradigm for an unlimited period of time in entities that at least break even in real value – ceteris paribus.

We can thus safely disagree in the case of constant real value non–monetary items under the HC paradigm too, that the effects of two per cent inflation is completely unharmful. Two per cent inflation – in fact, any level of inflation or deflation – would be the same as zero inflation as far as the valuation of constant real value non–monetary items under the CIPPA model is concerned.

Nicolaas Smith

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

Absolute price stability in constant items

Absolute price stability in constant items

Constant Item Purchasing Power Accounting is a price–level accounting model where under financial capital maintenance in units of constant purchasing power is implemented at all levels of inflation and deflation.

Continuous financial capital maintenance in units of constant purchasing power was authorized by the IASC Board thirteen years after Harvey Kapnick´s 1976 prediction. The IASC Board approved the original Framework (1989), Par 104 (a), now Conceptual Framework (2010), Par. 4.59 (a), which state:

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

However, the enormous real value eroding effect of implementing the very erosive stable measuring unit assumption when entities choose, also in terms of the original Framework (1989), Par. 104 (a), IASB–approved financial capital maintenance in nominal monetary units (the HCA model) and apply it in the valuing of constant real value non–monetary items never maintained constant, e.g., retained earnings, in low inflationary economies is not generally realized at all. This is clearly verified by the fact that both financial capital maintenance in nominal monetary units (a very popular accounting fallacy) and real value maintaining continuous financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation were approved by the IASB in the original Framework, Par 4.59 (a) in 1989 – in one and the same sentence.

Hundreds of billions of US Dollars is eroded in constant items never maintained constant in the world’s constant item economy per annum by the implementation of the stable measuring unit assumption as part of HCA during low inflation in this manner.

Entities can choose the one or the other and state that they have prepared primary financial statements in terms of IFRS. However, when they choose the traditional HCA model they unknowingly, unintentionally and unnecessarily erode real value on a significant scale in the real or non–monetary economy during low inflation when they implement the very erosive stable measuring unit assumption. When they choose IASB–approved continuous financial capital maintenance in units of constant purchasing power they would maintain the real values of all constant real value non–monetary items during inflation and deflation in companies which at least break even in real value, empowering and enriching those companies, their shareholders and the economy in general with the accompanying benefits to workers and employment for an unlimited period of time – ceteris paribus.

As the Deutsche Bundesbank stated:

‘The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.’

Deutsche Bundesbank, 1996 Annual Report, P 83.

Financial capital maintenance in units of constant purchasing power would result in absolute price stability under complete co-ordination in constant real value non–monetary items for an unlimited period of time in companies that at least break even in real value at all levels of inflation and deflation – all else being equal – without the need for extra capital from capital providers or more retained earnings simply to maintain the existing constant real value of existing constant real value non–monetary capital constant. The IASB predecessor body, the IASC Board, approved absolute price stability in income statement and balance sheet constant real value non–monetary items when they authorized the original Framework (1989), Par 104 (a) approving the option of continuously measuring financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation.

Nicolaas Smith

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

Price-level accounting

Price-level accounting

Entities generally choose to measure financial capital maintenance in nominal monetary units and thus apply the very erosive stable measuring unit assumption as part of the traditional HCA model. They generally value all balance sheet constant items, e.g., owners´ equity, trade debtors, trade creditors, etc. as well as most income statement items, which are all constant items, at Historical Cost. They value them in nominal monetary units as a result of the fact that they assume that changes in the purchasing power of the unstable monetary unit are not sufficiently important to require financial  capital maintenance in units of constant purchasing power during low inflation and deflation.

Entities, in practice, assume unstable money is perfectly stable for this purpose. They, in practice, assume there has never been inflation or deflation in the past, there is no inflation and deflation in the present and there never will be inflation and deflation in the future as far as the valuation of most constant real value non-monetary items is concerned. They only value certain income statement constant items, e.g. salaries, wages, rentals, etc. in real value maintaining units of constant purchasing power annually by means of the annual CPI during low inflation. They then pay these items monthly in fixed nominal amounts, again implementing the stable measuring unit assumption.

IAS 29 Financial Reporting in Hyperinflationary Economies does not require the valuation of non–monetary items in units of constant purchasing power at the time of the transaction or event. IAS 29 simply requires the restatement of Historical Cost or Current Cost financial statements in terms of the period–end monthly published CPI in order to make them ‘more useful’ during hyperinflation. The non–monetary or real economy of a hyperinflationary economy can only be maintained relatively stable by applying the daily parallel US Dollar exchange rate or a Brazilian–style URV daily index to the valuation of all non–monetary items instead of simply restating HC or CC financial statement in terms of the period–end monthly published CPI as required by IAS 29.

The Framework is applicable

The concepts of capital, the capital maintenance concepts and the profit / loss determination concepts are not covered in IAS, IFRS or Interpretations. These concepts were covered in the original Framework for the Preparation and Presentation of Financial Statements (1989), now The Conceptual Framework for Financial Reporting (2010), Chapter 4: The Framework (1989): the remaining text. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, Par.11.

Deloitte states:

‘In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.’

IAS 8, Par. 11 states:

‘In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.’

The valuation of the constant items issued share capital, retained earnings, other items in owners´ equity and other constant  items was thus covered in IFRS in the original Framework (1989), Pa. 104 (a), now the Conceptual Framework (2010), Par. 4.59 (a).

Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:

‘Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price–level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.’

Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.

Nicolaas Smith

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

Value accounting

Value accounting

On the other hand, there has also been strong awareness in the accounting profession for a very long time that financial reporting is actually about value and not simply about Historical Cost.

‘...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions.’

Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.

It is broadly agreed that financial reporting should be value based. By value based it is  meant that variable items cannot always be valued at Historical Cost and are to be valued in terms of specific measurement bases defined in IFRS and US GAAP; for example, market value, the lower of cost and net realizable value, fair value, present value, recoverable value, etc.  

Value accounting has been defined in International Standards since 1976 via International Accounting Standards and IFRS relating to variable items. Value accounting thus clearly prevails in the valuation and accounting of variable items in terms of IFRS.

The real value of monetary items is eroded daily by inflation and increased daily by deflation while it is normally hyper-eroded daily by hyperinflation. The real value of monetary items is eroded by inflation, increased by deflation and hyper–eroded by hyperinflation. The nominal value of monetary items stays the same during the current financial period, i.e., in all active ledger accounts under any accounting model and under any economic environment, but, the real value is automatically adjusted by inflation, deflation and hyperinflation. The real value of monetary items can be halved every 24.7 hours as it happened during hyperinflation in Zimbabwe in 2008. According to Prof. Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.  

The net monetary loss or net monetary gain in monetary items caused by inflation, deflation and hyperinflation resulting from holding net monetary item assets or net monetary item liabilities is calculated and accounted in terms of IAS 29 in hyperinflationary economies and in terms of financial capital maintenance in units of constant purchasing power (CIPPA) at all levels of inflation and deflation. They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick.

‘Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical–cost basis.’

Harvey Kapnick, Chairman of Arthur Anderson & Company, Value based accounting: Evolution or revolution, Saxe Lecture, 1976, Page 6.  


Nicolaas Smith

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

Basic objective of accounting not realized

Basic objective of accounting not realized

Many people still see financial reporting as simply providing historic economic information. It is not realized that it is a basic objective of general purpose financial reporting to maintain the constant purchasing power of capital.

The reasons for this are:

(1) The Three Popular Accounting Fallacies.

(a)   The stable measuring unit assumption based on the fallacy that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance inunits of constant purchasing power during low inflation and deflation. Changes in the purchasing power of unstable money logically require financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation in terms of a daily rate.

(b)   Financial capital maintenance in nominal monetary units per se during low inflation and deflation originally authorized in IFRS in the Framework (1989), Par 104 (a) and in the FASB´s Concepts Statement No. 5. It is impossible to maintain the real value of capital in nominal monetary units per se during inflation and deflation.

(c) The generally accepted belief that the erosion of companies´ profits and capital is caused by inflation fully supported in IFRS and specifically stated by the FASB. Inflation has no effect on the real value of non-monetary items. Companies´ profits and capital are constant real value non-monetary items. The implementation of the stable measuring unit assumption during inflation erodes the constant purchasing power of owners´ equity that is not being maintained constant by the real value of net assets.

(1)   It is not realized that the stable measuring unit assumption and not inflation erodes the real value of constant items never maintained constant when financial capital maintenance in nominal monetary units (the traditional HCA model) is implemented during low inflationary periods.

(2)   It is not realized that continuous measurement of financial capital maintenance in units of constant purchasing power (CIPPA) in terms of a daily index rate automatically remedies this erosion by the stable measuring unit assumption in all entities that at least break even in real value during low inflation – ceteris paribus- whether they own any revaluable fixed assets or not.

The stable measuring unit assumption as implemented under financial capital maintenance in nominal monetary units, i.e., the HCA model, would already have been stopped by now, if the above were realized.

(3)   Although the principle of financial capital maintenance in units of constant purchasing power during inflation and deflation was authorized in IFRS in 1989, it is not generally implemented during low inflation and deflation because the very erosive effect of the stable measuring unit assumption on the real value of constant items never maintained constant is not recognized as such. It is generally believed that it is inflation doing the eroding in, for example, companies´ invested capital and profits – as  specifically stated in FAS 89 – when this erosion in constant item real value is, in fact, caused by the stable measuring unit assumption. Inflation has no effect on the real value of non–monetary items. Capital and profits are constant real value non–monetary items.

Nicolaas Smith


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

IAS 29 made no difference in Zimbabwe

IAS 29 made no difference in Zimbabwe

The implementation of IAS 29 by Zimbabwean listed companies as required by the Zimbabwean Stock Exchange made no difference to the collapse of the Zimbabwean constant item economy during hyperinflationary. Valuing all non–monetary items in restated HC or CC financial statement as required by IAS 29 in terms of the period–end CPI which was published a month or more after the month to which it related when the real value of the Zimbabwe Dollar sometimes halved every day, obviously, made no difference to the collapse of the economy.

Massive increases in the local currency money supply hyper–eroded the real value of only the ZimDollar and ZimDollar monetary items in the Zimbabwean monetary economy during hyperinflation.

Most variable items in Zimbabwe´s variable item economy, especially in the private sector, were valued in terms of the daily unofficial US Dollar parallel rate. The real values of most variable items in the private sector were thus maintained while the unofficial US Dollar parallel rate and finally the Old Mutual Implied Rate (OMIR) were available.

The real values of variable items in the public sector were not maintained in terms of the daily US Dollar parallel rate. The government attempted various periods of price freezes in the private and public sector.

The continued use of the HCA model in the Zimbabwean economy during the financial year unknowingly, unintentionally and unnecessarily eroded Zimbabwe´s constant item economy with the use of the stable measuring unit assumption during hyperinflation, as approved by the IASB and supported by PricewaterhouseCoopers (amongst others). HC financial statements of Zimbabwean companies were then restated in terms of the period–end CPI (while the CPI was still made available in Zimbabwe) to make these restated HC financial statements ‘more useful’. That made no difference to the collapse of the constant item economy.

Brazil rejected the HCA model and the stable measuring unit assumption during 30 years of very high and hyperinflation from 1964 to 1994. Brazil introduced the Historical Cost Accounting model again in 1994. The Brazilian real or non–monetary economy was kept relatively stable with daily indexing of most non–monetary items (variable and constant items) in terms of a daily index supplied by the various governments during that period while they had hyperinflation of up to 2000 per cen per annum in only their monetary unit.  Hyperinflation has no effect on the real value of non–monetary items.

How anyone can use or accept the use of the HCA model during hyperinflation is completely incomprehensible. The use of the HCA model during hyperinflation should specifically be banned by law.

Nicolaas Smith

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

HCA should be banned during hyperinflation

HCA should be banned during hyperinflation

IAS 29 Financial Reporting in Hyperinflationary Economies is not a departure from, but an extension to Historical Cost Accounting.

The only way a country with a hyperinflationary economy can maintain its variable item and constant item economies relatively stable during hyperinflation is by continuously measuring all non–monetary items (variable and constant items) in units of constant purchasing power. The real economy would still be affected by the stable measuring unit assumption in constant items never maintained constant at a rate of real value erosion equal to the annual rate of inflation of the hard currency used for determining the parallel rate, normally the US Dollar.

The real economy can be maintained relatively stable during hyperinflation in the local currency monetary unit not by restating Historical Cost or Current Cost financial statements at the end of the reporting period in terms of the period–end monthly published CPI to make them ‘more useful’ as required by IAS 29, but, by applying the daily parallel US Dollar or other hard currency exchange rate, or – as was done in Brazil during the 30 years of very high and hyperinflation from 1964 to 1994 – with daily indexation.

Daily indexation is, in principle, better than applying the daily US Dollar parallel rate. Daily indexation in terms of a Brazilian-style Unidade Real de Valor daily index would keep the real economy more stable: the erosion of the real value of constant items never maintained constant caused by the stable measuring unit assumption as applied to the US Dollar parallel rate is eliminated in the formulation of the index value when the CPI is included in the formula as it was in the case of the URV.

Nicolaas Smith

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

Valuing constant real value non–monetary items

Valuing constant real value non–monetary items

All constant items have always and everywhere (historic and current period constant items) to be measured in units of constant purchasing power in terms of a Daily CPI or other daily rate under financial capital maintenance in units of constant purchasing power (CIPPA) in order to automatically maintain the constant purchasing power of capital constant in all 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 in a double-entry accounting model under which the real value of owners´ equity is equal to the real value of net assets. This is not always the case, hence the necessity to calculate the net constant item loss or gain during the current financial period when constant items are not measured in units of constant purchasing power, e.g., in the case of trade debtors and trade creditors as well as other non-monetary payables and receivables treated incorrectly as monetary items by third parties who still implement HCA.

The constant real values of constant items in the constant item economy are automatically maintained constant under Constant Item Purchasing Power Accounting during low inflation and deflation by means of continuous financial capital maintenance in units of constant purchasing power

Annual measurement in units of constant purchasing power is only currently implemented under the HCA model in the case of certain (not all) income statement items, e.g., salaries, wages, rentals, etc. in non–hyperinflationary economies. Once updated annually, these items are normally paid at the same monthly value; i.e., the stable measuring unit assumption is applied in their monthly payments during the financial year.

Financial reporting has to take all three scenarios – occurring simultaneously – into account over time when an entity´s economic activities are accounted daily and financial reports are prepared and presented periodically and accessed or viewed today at the current Daily CPI or other daily rate.

Harvey Kapnick was correct when he stated in the Saxe Lecture in 1976:

‘In the long run both value accounting and price–level accounting should prevail.’

Nicolaas Smith

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

Valuing variable items

Valuing variable items

Variable real value non–monetary items are valued and accounted in terms of IFRS at, for example, fair value, market value, the lower of cost or net realizable value, recoverable value, present value, etc. excluding the stable measuring unit assumption under financial capital maintenance in units of constant purchasing power (CIPPA). These prices change all the time: even minute by minute in many markets, e.g., the prices of foreign currencies, commodities, precious metals, quoted shares, properties, finished goods, services, raw materials, etc. Their historic prices (e.g., of the day before) are updated on a daily basis to the current (today´s) rate in terms of a Daily CPI or other daily rate when they are not valued at the current date (today) in terms of IFRS as qualified.

Under the stable measuring unit assumption it is assumed that changes in the purchasing power of money are not sufficiently important to require capital maintenance in units of constant purchasing power on a daily basis. Another way to state the stable measuring unit assumption is to state that it is assumed that the real value of money is perfectly stable over time. The stable measuring unit assumption is applied to the measurement of certain non-monetary items under HCA. It is never applied under financial capital maintenance in units of constant purchasing power (CIPPA).

Inflation and deflation have no effect on the real value of non-monetary items. Historic variable items are thus not inflation-adjusted or deflation-adjusted daily. Historic variable items are updated daily in terms of a daily index or other daily rate when they are not valued daily in terms of IFRS as qualified.

Nicolaas Smith

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