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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.