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Friday 29 February 2008

If South Africa were a hyperinflationary economy ...

If SA were a hyperinflationary economy with continuous 26% inflation for three years in a row (the International Accounting Standards Board’s definition of hyperinflation) SA companies would implement International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. Well behaving SA companies dutifully following useless (1) IASB requirements.

This would have no effect on hyperinflation in SA. IAS 29 is being applied in Zimbabwe since 2000 and is a complete and utter failure. The reason is that IAS 29 does not require DAILY updating of all non-monetary items as required under Real Value Accounting (2) but instead useless annual updating.

PricewaterhouseCoopers advocates equally useless monthly updating under hyperinflationary conditions.(3)

If SA were to copy Zimbabwe and were to follow the ineffectual IASB requirements and equally ineffectual PwC advice in this hypothetical hyperinflationary scenario, hyperinflation would destroy the SA economy in the same way it has been doing over the last 14 years of actual hyperinflation in Zimbabwe. SA companies would update commercial item prices daily (like in Zimbabwe ) but not salaries (like in Zimbabwe ) thus destroying the internal market very rapidly and destroying the whole economy equally rapidly.

If, on the other hand, SA, by chance, were to copy the very successful Brazilians in their 30 year (1964 to 1994) battle against hyperinflation and implement an Unidade Real de Valor (4) type of non-monetary index to update all non-monetary items (including salaries) DAILY under hyperinflation, the SA economy would keep on growing like in Brazil during hyperinflation.

Simply … because of DAILY updating of all non-monetary items under hyperinflation.

How singularly clever the Brazilians are.

If, in this hypothetical example, the South African Reserve Bank then were to manage to bring cash hyperinflation down to low levels again,

and if, by chance, all SA companies – which would have, by chance, come to understand the correctness of updating all non-monetary items DAILY (following the brilliant Brazilians) under hyperinflation -

then, by chance, stubbornly refuse to follow the very destructive and useless IASB requirement to go back to NOT updating all constant real value non-monetary items under LOW inflation, (the current state of affairs world wide)

SA would be the first country in the world to revoke the stable measuring unit assumption under LOW inflationary conditions.

This is something the accounting profession has been spectacularly unsuccessful in resolving for at least the last 100 years.

The stable measuring unit assumption is the silent, invisible destroyer of real value in all constant real value non-monetary items (eg. retained income) currently NEVER updated in all inflationary economies.

The IASB mandates you to update under hyperinflation, but then forbids you to update once you are back in low inflation thus supporting the destruction of hundreds of billions of US Dollars in real value in retained income world wide. Crazy and incomprehensible - but true.

One of the basic principles in accounting is “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency.

This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.” (5)

If, on the other hand, we were to invert the above process and revoke the stable measuring unit assumption in SA in the very short term (not a snowball’s hope in hell),

it would be impossible in the very short term for the combination of low inflation and the stable measuring unit assumption ever more to destroy the real value of constant real value non-monetary items (eg. retained income) in SA.

This is happening at this very moment in all SA companies at the rate of 9.4% (Jan 2008 annual inflation rate) per annum equalling the destruction of hundreds of billions of Rands in retained income real value each and every year. Revoking the stable measuring unit assumption would maintain hundreds of billions of Rands of real value each and every year in the SA economy instead of annually destroying it.

It would also be impossible for hyperinflation ever to destroy the non-monetary economy in SA in the future - as long as we revoke the stable measuring unit assumption forever. We could still have Cash Hyperinflation (the one component of hyperinflation) but it would be impossible to have Historical Cost Accounting Hyperinflation - the second component of hyperinflation.

Simply … because of revoking ONE accounting assumption, namely, the stable measuring unit assumption.

How singularly clever we would be as a nation.

If …

Nicolaas Smith

realvalueaccounting@yahoo.com

(1) Useless in eliminating non-monetary inflation whereas daily updating of non-monetary items in a hyperinflationary economy does exactly that.

(2) Understanding IAS 29 PricewaterhouseCoopers.

(3) http://en.wikipedia.org/wiki/Unidade_real_de_valor

(4) Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York : Harcourt Brace Javonovich, Inc. Page 429.

Saturday 23 February 2008

Dual Destruction of Real Value in the Economy.

Inflation always and everywhere results in the destruction of real value in

(A) all monetary items over time (which cannot be updated) and

(B) constant real value non-monetary items (historical cost items, eg. retained income) when the latter are NEVER updated as a result of the stable measuring unit assumption which is a generally accepted accounting principle or GAAP.

Retained income has never been and is never updated in economies that are not hyperinflationary economies under the current Historical Cost paradigm. Retained income is only updatable since 1989 in hyperinflationary economies in terms of International Accounting Standards IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29 does not require daily updating (as required under Real Value Accounting) and thus fails to have any effect in hyperinflationary economies.

A good example is the situation in Zimbabwe where IAS 29 is being applied without any effect on the state of the Zimbabwean economy. The International Accounting Standards Board´s IAS 29 is thus a complete and utter failure that serves no purpose at all and reduces the IASB´s credibility tremendously.

The IASB´s as well as the FASB´s credibility is even further diminished by the fact that they require the updating of all constant real value non-monetary items under hyperinflation but ban it under all other inflationary conditions thus supporting the annual destruction of hunderds of billions of US Dollars of real value in all companies´ retained income balances world wide in non-hyperinflationary economies.

Wednesday 20 February 2008

Inflation and the stable measuring unit assumption are the two universal enemies.

Inflation IS the universal enemy as far as monetary items are concerned. Each one per cent rise in inflation instantaneously destroys more hunderds of billions of US Dollars in all monetary items throughout the whole economy. It is very difficult to arrive at zero per cent inflation. Two per cent inflation - defined incorrectly as "price stability" - destroys 51% of the real value of all monetary items over 35 years time.

The combination of inflation and the stable measuring unit assumption is the universal enemy as far as constant real value non-monetary items (historical cost items) NEVER updated (eg. retained income) are concerned. Each one per cent rise in inflation destroys even more hunderds of billions of US Dollars in the real value on constant real value non-monetary items NEVER updated each and every year on top of the hundreds of billions of US Dollars currently being destroyed each and every year by current inflation world wide.

Your contribution need not be deleted. The other side of the story need to be added.

You are only referring to one component of inflation, namely, cash inflation. What about the hunderds of billions of US Dollars destroyed each and every year in all companies´ retained income balances world wide in inflationary economies by the combination of inflation and the stable measuring unit assumption?

Revoke the stable measuring unit assumption (as mandated by the International Accounting Standards Board in IAS 29 in hyperinflationary economies) and you stop the second component of inflation forever. That is easy. It is simply an accounting procedure. Arriving at zero inflation is much more difficult to eliminate cash inflation.

Inflation and the stable measuring unit assumption are the two universal enemies