Finweek
SA Chartered Accountants can pump hundreds of billions of Rand into the SA real economy for an indefinite period of time when they stop their assumption that the Rand is perfectly stable only for the purpose of accounting salaries, wages, rent, issued share capital, retained income, taxes, trade debtors, trade creditors, etc. Now they destroy hundreds of billions of Rand in constant item real value by not maintaining that real value.
No-one forces them to implement the stable measuring unit assumption.
When they stop assuming the Rand is perfectly stable only for that purpose they will stop destroying hundreds of billions of Rand in constant item real value in the SA real economy for an indefinite period of time.
It will increase GDP, economic growth and job creation.
The benefits of SA Chartered Accountants abandoning the stable measuring unit assumption can scarcely be overestimated , especially as these are, in principle, unlimited in duration and accrue year after year.
Friday, 30 May 2008
Nicolaas Smith on 2008/05/30 01:09:08 AM - Re: Bradley
Nicolaas Smith on 2008/05/30 01:09:08 AM - Re: Bradley
Finweek
"Not updating share capital doesnt destroy any value, not in any real sense at least."
It only destroys real value at the annual rate of inflation in companies with no well located and well maintained land and/or buildings or other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital. Companies can always revalue land and buildings and add the revaluation reserve to capital when they have those assets. When do not have them like many thousands in SA do not have, then real value of their issued share capital is destroyed at the annual rate of inflation.
"The share capital number in the balance sheets is just that, a number."
No it is not. It is a constant real value non-monetary item. See IAS 29. Under hyperinflation (26% pa continuous inflation) the IASB mandates you to update capital as it is a non-monetary item. They are just completely illogical not to allow you to do it under non-hyperinflationary conditions like in SA. That is obviously wrong.
"What use would there possibly be in increasing this by inflation?"
As the IASB states in IAS 29: capital is a non-monetary item and its real value must be updated. Capital is a constant real value non-monetary item and must be updated at the monthly inflation rate in SA. All SA companies with no items to revalue are having their capital destroyed by accountants stable measuring unit assumption at the annual rate of inflation.
"Does it change the underlying value of the company? No."
Yes it does. Updating the issued share capital as well as retained income at the monthly rate of inflation obviously changes the underlying value of the company. R111 million is clearly different from R100 million. That is very obvious.
"When a company issues shares, it gets he money, an amount equal to share capital. How does updating this amount monthly, or yearly, by inflation improve anything?"
Remember the IASB mandates you to update capital under hyperinflation. My example: You start a company today with R100 million. Without updating: In 30 years time at continuous 10% annual inflation that R100 million will still be in the balance sheet but it will have lost 88% of its real value: it will be worth R12 million in today´s real value.
Updating it monthly at the inflation rate means that in 30 years time it will still be worth R100 million in today´s real value - it´s nominal value in 30 year´s time will be R1 744 940 227 or R1.7 trillion. Its real value will still be R100 million in todays terms. Take your pick. The IASB says you can do it only under hyperinflation. That is obviously a complete mistake.
Finweek
"Not updating share capital doesnt destroy any value, not in any real sense at least."
It only destroys real value at the annual rate of inflation in companies with no well located and well maintained land and/or buildings or other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital. Companies can always revalue land and buildings and add the revaluation reserve to capital when they have those assets. When do not have them like many thousands in SA do not have, then real value of their issued share capital is destroyed at the annual rate of inflation.
"The share capital number in the balance sheets is just that, a number."
No it is not. It is a constant real value non-monetary item. See IAS 29. Under hyperinflation (26% pa continuous inflation) the IASB mandates you to update capital as it is a non-monetary item. They are just completely illogical not to allow you to do it under non-hyperinflationary conditions like in SA. That is obviously wrong.
"What use would there possibly be in increasing this by inflation?"
As the IASB states in IAS 29: capital is a non-monetary item and its real value must be updated. Capital is a constant real value non-monetary item and must be updated at the monthly inflation rate in SA. All SA companies with no items to revalue are having their capital destroyed by accountants stable measuring unit assumption at the annual rate of inflation.
"Does it change the underlying value of the company? No."
Yes it does. Updating the issued share capital as well as retained income at the monthly rate of inflation obviously changes the underlying value of the company. R111 million is clearly different from R100 million. That is very obvious.
"When a company issues shares, it gets he money, an amount equal to share capital. How does updating this amount monthly, or yearly, by inflation improve anything?"
Remember the IASB mandates you to update capital under hyperinflation. My example: You start a company today with R100 million. Without updating: In 30 years time at continuous 10% annual inflation that R100 million will still be in the balance sheet but it will have lost 88% of its real value: it will be worth R12 million in today´s real value.
Updating it monthly at the inflation rate means that in 30 years time it will still be worth R100 million in today´s real value - it´s nominal value in 30 year´s time will be R1 744 940 227 or R1.7 trillion. Its real value will still be R100 million in todays terms. Take your pick. The IASB says you can do it only under hyperinflation. That is obviously a complete mistake.
Nicolaas Smith on 2008/05/30 12:34:37 AM - Re: Ben
Nicolaas Smith on 2008/05/30 12:34:37 AM - Re: Ben
Finweek
Ben, I am sure you will agree that it is not very easy to grasp something that took one person 13 years to unravel by reading a few lines in an article comment.
It will not worsen cash inflation. You must understand that a price increase as a result of higher demand is not inflation.
A price increase as a result of demand staying exactly the same is inflation. The first is simply a genuine price increase, the second is inflation.
You may not know, but this was done for 30 years by Brazil and not under low inflation but under hyperinflation of up to 2000% per annum. They updated all non-monetary items in the real economy DAILY including salaries and they had positive economic growth - under hyperinflation because they stabalized their real economy.
Updating all constant items simply keeps everything the same in the real economy and does not kill the real economy. You are only worried about salaries. That is only one constant item. What about the rest of them? Issued capital and retained income maintaining the investment and capital base of the economy instead of destroying it year after year? That will make a massive difference and for an indefinite period of time - forever.
Firms update salaries but their issued capital and retained income are also updated as well as taxes to the government. All constant items are simply kept at the same real values and their real values are not destroyed at the rate of inflation when they are never updated, eg. retained income. As Logan pointed out: salaries are updated in any case. Instead of giving an annual once off increase of now 11.1% to just maintain the real value, the updating is done monthly. I am sure you understand that. So, with salaries you have exactly the same, more or less. So that takes care of your worry about increasing prices for salaries.
It will be the same as the present. Isn´t this obvious? When people demand higher wages it does not automatically worsen inflation - only when it is higher than the inflation rate and higher than the productivity increase if there was actually an increase in productivity. I think that puts your worry about passing the salary increase on to the company´s products every month to rest. Now it is done yearly. When accountants abandon the stable measuring unit assumption it will be done monthly instead of yearly - so nothing will really change as far as salary increases and product price increase are concerned.
I am sure you agree. So this will not cause massive inflation and spiral out of control. So, that sort out salaries. Now updating issued share capital, retained income, trade debtors, trade creditors, taxes etc will maintain all these items´ real values instead of destroying hundreds of billions of Rand in SA´s real economy each and every year. This will increase GDP, economic growth and job creation
Finweek
Ben, I am sure you will agree that it is not very easy to grasp something that took one person 13 years to unravel by reading a few lines in an article comment.
It will not worsen cash inflation. You must understand that a price increase as a result of higher demand is not inflation.
A price increase as a result of demand staying exactly the same is inflation. The first is simply a genuine price increase, the second is inflation.
You may not know, but this was done for 30 years by Brazil and not under low inflation but under hyperinflation of up to 2000% per annum. They updated all non-monetary items in the real economy DAILY including salaries and they had positive economic growth - under hyperinflation because they stabalized their real economy.
Updating all constant items simply keeps everything the same in the real economy and does not kill the real economy. You are only worried about salaries. That is only one constant item. What about the rest of them? Issued capital and retained income maintaining the investment and capital base of the economy instead of destroying it year after year? That will make a massive difference and for an indefinite period of time - forever.
Firms update salaries but their issued capital and retained income are also updated as well as taxes to the government. All constant items are simply kept at the same real values and their real values are not destroyed at the rate of inflation when they are never updated, eg. retained income. As Logan pointed out: salaries are updated in any case. Instead of giving an annual once off increase of now 11.1% to just maintain the real value, the updating is done monthly. I am sure you understand that. So, with salaries you have exactly the same, more or less. So that takes care of your worry about increasing prices for salaries.
It will be the same as the present. Isn´t this obvious? When people demand higher wages it does not automatically worsen inflation - only when it is higher than the inflation rate and higher than the productivity increase if there was actually an increase in productivity. I think that puts your worry about passing the salary increase on to the company´s products every month to rest. Now it is done yearly. When accountants abandon the stable measuring unit assumption it will be done monthly instead of yearly - so nothing will really change as far as salary increases and product price increase are concerned.
I am sure you agree. So this will not cause massive inflation and spiral out of control. So, that sort out salaries. Now updating issued share capital, retained income, trade debtors, trade creditors, taxes etc will maintain all these items´ real values instead of destroying hundreds of billions of Rand in SA´s real economy each and every year. This will increase GDP, economic growth and job creation
Ben on 2008/05/29 11:53:46 PM - Nicolaas
Ben on 2008/05/29 11:53:46 PM - Nicolaas
Finweek
Are you serious? This would worsen inflation like you have no idea. Inflation targeting hinges CRITICALLY on the extent to which players in the economy believe the target will be maintained and sought after. If wages are increased in line with inflation, or possibly above inflation, this causes what economists call a "wage spiral".
Costs like salaries - what you term contant items - will need to be covered by way of higher prices from the firm. Isnt this obvious? If people demand higher wages, this worsens inflation. So if the accountant raises your salary by 1.2% every month, and this cost is passed on to the consumer as a 1.2% increase in the price of that company's product every month, can you see that this causes inflation? It all well and good to "maintain a persons real salary" but this will cause massive inflation that will spiral out of control.
A better tactic is to aggressively tackle inflation, to make everyone aware that the government is ADAMANT that they are sticking to it, lest workers demand increases in wages above inflation. It simply isnt possible to keep inflation at 3-6% if people demand wage increases of 10% a year...
Finweek
Are you serious? This would worsen inflation like you have no idea. Inflation targeting hinges CRITICALLY on the extent to which players in the economy believe the target will be maintained and sought after. If wages are increased in line with inflation, or possibly above inflation, this causes what economists call a "wage spiral".
Costs like salaries - what you term contant items - will need to be covered by way of higher prices from the firm. Isnt this obvious? If people demand higher wages, this worsens inflation. So if the accountant raises your salary by 1.2% every month, and this cost is passed on to the consumer as a 1.2% increase in the price of that company's product every month, can you see that this causes inflation? It all well and good to "maintain a persons real salary" but this will cause massive inflation that will spiral out of control.
A better tactic is to aggressively tackle inflation, to make everyone aware that the government is ADAMANT that they are sticking to it, lest workers demand increases in wages above inflation. It simply isnt possible to keep inflation at 3-6% if people demand wage increases of 10% a year...
Nicolaas Smith on 2008/05/29 11:23:50 PM - Re: Logan
Nicolaas Smith on 2008/05/29 11:23:50 PM - Re: Logan
Buy the ebook for $2.99 or £1.53 or €2.68
"Isn't the monthly inflation taken care of by the annual wage increase if based on annualised inflation rate?" Yes. That is one constant item. That is only salaries and wages. What about retained income, issued share capital, personal taxes, company taxes, VAT, trade debtors, trade creditors, profit and loss items, shareholders equity, etc? I always state: Historical Cost Accounting inflation destroys the real value of constant items never or not fully updated. Retained earnings, issued share capital of companies with no non-monetary items to revalue, etc, are never updated in non-hyperinflationary economies. Their values are destroyed and have always been destroyed at the full rate of inflation. The real values of salaries, wages, taxes, rents, etc are, only where they are not fully updated, destroyed at a lower rate than the full inflation rate.
Logan on 2008/05/29 10:54:06 PM - Maybe we need change
Logan on 2008/05/29 10:54:06 PM - Maybe we need change !
If the aNC does decide to relax the inflation targets a bit that won't be a problem, economists are fiercely divided anyway over what level of inflation is ok. To deny that is contested terrain would be silly, the research papers are all over the place. The problem is that we have to be flexible enough to maintain social stability. Economic policy purity is for lecture halls, not the real world. Anyway, where is all this so-called investment? Years of low inflation and very little FDI, a few biggies and that's it, compared to Brazil, India etc. Investors want growth, not policy purity. p.s. Nicolaas, interesting points! Isn't the monthly inflation taken care of by the annual wage increase if based on annualised inflation rate?
If the aNC does decide to relax the inflation targets a bit that won't be a problem, economists are fiercely divided anyway over what level of inflation is ok. To deny that is contested terrain would be silly, the research papers are all over the place. The problem is that we have to be flexible enough to maintain social stability. Economic policy purity is for lecture halls, not the real world. Anyway, where is all this so-called investment? Years of low inflation and very little FDI, a few biggies and that's it, compared to Brazil, India etc. Investors want growth, not policy purity. p.s. Nicolaas, interesting points! Isn't the monthly inflation taken care of by the annual wage increase if based on annualised inflation rate?
"OK, so what measure of inflation do we use?"
Nicolaas Smith on 2008/05/29 11:15:17 PM - Re: Neelsie Naamloos
Finweek
"OK, so what measure of inflation do we use"
CPI which is 11.1% at the moment.
"should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement?"
When all accountants decide to abandon the stable measuring unit assumption it will apply throughout SA. It will be an automatic monthly adjustment to all constant items [salaries, wages, rents, fees, retainers, royalties, issued share capital, retained income, personal taxes, trade debtors, trade creditors, company taxes, value added taxes, all items in the profit and loss account, etc] in terms of the monthly inflation rate (CPI). Computer accounting programs will have to be upgraded for this purpose. Any individual company or economic entity can do this.
"How will such a system be administrated so that it is equitable to everyone,"
It is equitable since all constant items are updated monthly in a non-hyperinflationary economy at the monthly inflation rate and daily in a hyperinflationary economy at the daily parallel rate of daily index rate. It is simply an admittance that the Rand´s real value is being destroyed by inflation. So, only all constant items have to be adjusted at the monthly rate of inflation. It is simply a matter of maintaining all constant items´ real values, because, when any constant item is never updated, eg. retained income, then its real value is destroyed at the rate of infaltion
See this peer reviewed article in Accountancy SA
"and what will the costs be?"
The cost of upgrading accounting programs and training accounting staff in updating constant items.
"And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case?"
Inflation is the destruction of value. When constant items are never or not fully updated at the monthly rate of inflation then their real values are being destroyed at the rate of inflation when they are never updated (retained income) or at a lower rate when they are not fully updated (salaries, wages). When accountants abandon the stable measuring unit assumption and update all constant items monthy then no real value will be destroyed in constant items for an indefinite period of time. That is thus zero destruction of real value in constant items, that is 0% inflation in constant items only.
We will still have 11.1% cash inflation in monetary items, that is in the Rand and in all monetary items. The real economy will be stabilized, internal demand will be stabilized. The destruction of the real economy will stop for an indefinite period of time. Accountants will maintain billions of Rand in constant item real value in the real economy instead of destroying billions of Rand in the real economy each and every year
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Finweek
"OK, so what measure of inflation do we use"
CPI which is 11.1% at the moment.
"should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement?"
When all accountants decide to abandon the stable measuring unit assumption it will apply throughout SA. It will be an automatic monthly adjustment to all constant items [salaries, wages, rents, fees, retainers, royalties, issued share capital, retained income, personal taxes, trade debtors, trade creditors, company taxes, value added taxes, all items in the profit and loss account, etc] in terms of the monthly inflation rate (CPI). Computer accounting programs will have to be upgraded for this purpose. Any individual company or economic entity can do this.
"How will such a system be administrated so that it is equitable to everyone,"
It is equitable since all constant items are updated monthly in a non-hyperinflationary economy at the monthly inflation rate and daily in a hyperinflationary economy at the daily parallel rate of daily index rate. It is simply an admittance that the Rand´s real value is being destroyed by inflation. So, only all constant items have to be adjusted at the monthly rate of inflation. It is simply a matter of maintaining all constant items´ real values, because, when any constant item is never updated, eg. retained income, then its real value is destroyed at the rate of infaltion
See this peer reviewed article in Accountancy SA
"and what will the costs be?"
The cost of upgrading accounting programs and training accounting staff in updating constant items.
"And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case?"
Inflation is the destruction of value. When constant items are never or not fully updated at the monthly rate of inflation then their real values are being destroyed at the rate of inflation when they are never updated (retained income) or at a lower rate when they are not fully updated (salaries, wages). When accountants abandon the stable measuring unit assumption and update all constant items monthy then no real value will be destroyed in constant items for an indefinite period of time. That is thus zero destruction of real value in constant items, that is 0% inflation in constant items only.
We will still have 11.1% cash inflation in monetary items, that is in the Rand and in all monetary items. The real economy will be stabilized, internal demand will be stabilized. The destruction of the real economy will stop for an indefinite period of time. Accountants will maintain billions of Rand in constant item real value in the real economy instead of destroying billions of Rand in the real economy each and every year
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Neelsie Naamloos on 2008/05/29 10:43:07 PM - Nicolaas Smith
Neelsie Naamloos on 2008/05/29 10:43:07 PM - Nicolaas Smith
OK, so what measure of inflation do we use, should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement? How will such a system be administrated so that it is equitable to everyone, and what will the costs be? And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case? Just asking. Everyone's Friend Neelsie
OK, so what measure of inflation do we use, should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement? How will such a system be administrated so that it is equitable to everyone, and what will the costs be? And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case? Just asking. Everyone's Friend Neelsie
"where is TITO? In the "real economy" or in the "monetary economy"?"
Nicolaas Smith on 2008/05/29 10:19:37 PM - Re: Benzo
Finweek
"where is TITO? In the "real economy" or in the "monetary economy"?"
Tito is in the monetary economy. 11.1% inflation (Tito?) is destroying R194 billion in the real value of all monetary items (M3 = R1751.361 billion) in SA. At 3% inflation Tito would only destroy R52 billion of the real value of all money in SA. His job is thus worth R142 billion at the moment. If he can bring inflation down to 3% he will not destroy - or maintain R142 billion in the real value of all money and monetary items in SA. It would be wonderful if he can bring inflation down to 3% and maintain R142 billion in the SA economy. We can pay him a big bonus for that - when he achieves that.
"Where am I? in the "real economy" or in the "monetary economy"?"
You are in both.
Where you own money or montary items your are in the monetary economy and Tito destroys the real value of your money at 11.1% instead of 3% at the moment. You can make your own calculations how much Tito is destroying in the real value of your average cash balance you keep over a year. Where you own or use or buy or sell things that are not money or monetary items and these things are variable items, e.g. your house, car, mobile phone, clothes, food, energy, fuel, clothes, consumer goods, etc your are in the variable item part of the real economy. You are simply in the market for these things: you are paying market prices for these items in the variable part fo the real economy.
You are in the constant items part of the real economy with your salary you receive, the taxes you pay, the rent you pay or receive, the issued share capital of your company, the retained income in your company, etc.
Here your company accountant makes as if he is very dumb and assumes that there is no inflation at all. All company accountants do this. Your company accountant assumes that there is no inflation in SA only for this purpose. He assumes the Rand is perfectly stable. But we all know it is not. Your salary is a constant item. Your company accountant should increase your salary by about 1.2% per month at the moment.
He does not do that. He assumes there is no inflation - only for this purpose and nothing else. So he pays you out the same salary every month end. So he destroys the real value of your salary at 1.2% per month or 11.1% per annum. So to the retained income and the issued share capital of your company and the taxes he pays over to the government.
In total all accountants in SA destroy billions of constant item real value every year in SA. No-one forces them to do that. They can stop assuming there is no inflation in SA only for this purpose anytime they want to. When they do they will maintain b billions and billions of real value in the SA economy, increase economic growth and create more jobs in SA.
"Will the two ever meet? If so; when? If not, who should care?"
The two are always there together.
Benzo on 2008/05/29 09:36:42 PM - Nic Smith
Benzo on 2008/05/29 09:36:42 PM - Nic Smith
"South African's sound economic policies" ???? where is TITO? In the "real economy" or in the "monetary economy"? Where am I? in the "real economy" or in the "monetary economy"? Will the two ever meet? If so; when? If not, who should care?
"South African's sound economic policies" ???? where is TITO? In the "real economy" or in the "monetary economy"? Where am I? in the "real economy" or in the "monetary economy"? Will the two ever meet? If so; when? If not, who should care?
Nicolaas Smith on 2008/05/29 09:28:26 PM - Re: Viparo
Nicolaas Smith on 2008/05/29 09:28:26 PM - Re: Viparo
Finweek
Viparo, For example: cars are variable items - their prices vary in the car market: there is a market for cars. Their prices depend on demand and supply. But, salaries and wages are constant items: there is no market for salaries. You cannot sell your salary in a market. Or you cannot buy someone else´s salary in a market. They are constant items.
The value of your salary - a constant real value - is paid over to you in Rands. But, cash inflation destroys the real value of the Rand. So the Rand is always worth less. So, your constant value salary must be updated at the monthly inflation rate to maintain its constant value. It is not done anywhere.
The company accountant ignores the fact that the Rand is losing value every month. The company accountant assumes that there is no inflation in the Rand as far as your salary is concerned. So the company accountant pays you out in Rands that are always worth less. So, your salary should be increased every month that inflation increases. Now at about the rate of 1.2% per month. This is not done. So the real value of your salary is being destroyed by the accountant at 1.2% per month. This is easy to change.
The company accountant can update your salary and all other constant items in the company every month. All accountants in SA are assuming that there is no inflation in the Rand for this purpose. So they are destroying billions of Rand in real value every year in SA. The real vlaue of your salary and all salaries, all taxes, all retained income, all companies´ capital etc.
We can stop this. This will increase economic growth in SA and create more jobs.
Finweek
Viparo, For example: cars are variable items - their prices vary in the car market: there is a market for cars. Their prices depend on demand and supply. But, salaries and wages are constant items: there is no market for salaries. You cannot sell your salary in a market. Or you cannot buy someone else´s salary in a market. They are constant items.
The value of your salary - a constant real value - is paid over to you in Rands. But, cash inflation destroys the real value of the Rand. So the Rand is always worth less. So, your constant value salary must be updated at the monthly inflation rate to maintain its constant value. It is not done anywhere.
The company accountant ignores the fact that the Rand is losing value every month. The company accountant assumes that there is no inflation in the Rand as far as your salary is concerned. So the company accountant pays you out in Rands that are always worth less. So, your salary should be increased every month that inflation increases. Now at about the rate of 1.2% per month. This is not done. So the real value of your salary is being destroyed by the accountant at 1.2% per month. This is easy to change.
The company accountant can update your salary and all other constant items in the company every month. All accountants in SA are assuming that there is no inflation in the Rand for this purpose. So they are destroying billions of Rand in real value every year in SA. The real vlaue of your salary and all salaries, all taxes, all retained income, all companies´ capital etc.
We can stop this. This will increase economic growth in SA and create more jobs.
CAs please drop the stable measuring unit assumption
Nicolaas Smith on 2008/05/29 09:01:15 PM - CAs please drop the stable measuring unit assumpti
Finweek 29 May 2008
When CAs drop their assumption that there is no inflation when they account constant items like salaries, wages, taxes, retained income, issued share capital, etc they will guarantee the achievement of a 0% inflation target in the real economy for an indefinite period of time. http://realvalueaccounting.blogspot.com/
Finweek 29 May 2008
When CAs drop their assumption that there is no inflation when they account constant items like salaries, wages, taxes, retained income, issued share capital, etc they will guarantee the achievement of a 0% inflation target in the real economy for an indefinite period of time. http://realvalueaccounting.blogspot.com/
0% inflation in the real economy = value stability
Nicolaas Smith on 2008/05/29 08:53:53 PM - 0% inflation in the real economy = value stability
Finweek 29 May 2008
0% inflation in the real economy is value stability in the real economy when SA Chartered Accountants abondon their stable measuring unit assumption. CAs assume that there is no inflation (they just simply ignore the 11.1% current inflation - can you believe that!!!!!!) when they account constant items like salaries, wages, rents, taxes, retained income, issued share capital etc.
They thus destroy billions of Rand in constant item real value this year and every year as long as they keep on assuming there is not inflation only for this purpose. When they abondon the stable measuring unit assumption they will maintain billions of Rand in the SA real economy instead of destroying it.
By abondoning the stable measuring unit assumption - no one stops them from doing that - SA Chartered Accountants will guarantee 0% inflation in the real economy. We will still have 11.1% cash inflation in the monetary economy.
Finweek 29 May 2008
0% inflation in the real economy is value stability in the real economy when SA Chartered Accountants abondon their stable measuring unit assumption. CAs assume that there is no inflation (they just simply ignore the 11.1% current inflation - can you believe that!!!!!!) when they account constant items like salaries, wages, rents, taxes, retained income, issued share capital etc.
They thus destroy billions of Rand in constant item real value this year and every year as long as they keep on assuming there is not inflation only for this purpose. When they abondon the stable measuring unit assumption they will maintain billions of Rand in the SA real economy instead of destroying it.
By abondoning the stable measuring unit assumption - no one stops them from doing that - SA Chartered Accountants will guarantee 0% inflation in the real economy. We will still have 11.1% cash inflation in the monetary economy.
Saturday, 24 May 2008
Accounting for Inflation
Financial Mail 09 May 2008
Accounting for inflation
Nicolaas Smith, Lisbon
DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).
SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.
There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.
We have to remember that inflation is the destruction of value in monetary and constant items over time.
Inflation has two components: a monetary component - cash inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.
The 10,6% (March) cash inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.
Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.
The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.
We will still have 10,6% cash inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.
Inflation would then have only a monetary component, namely, cash inflation.
No-one stops us from revoking the stable measuring unit assumption.
The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.
Thursday, 22 May 2008
Inflation value destruction in South Africa
March 2008 CPI 153.9 Annual inflation 10.6%
Real value destroyed in 2008
1. By 10.6% cash inflation in monetary items, that is, in M3: 10.6% of R1.751361 trillion = R185 billion per annum
2. Unwittingly by SA Chartered Accountants: 10.6% Historical Cost Accounting inflation in the real value of Retained Income of companies listed on the Johannesburg Stock Exchange = Billions per annum. Actual amount in the process of being calculated.
3. Unwittingly by SA Chartered Accountants in other constant items never or not fully updated = Billions per annum. Value unknown.
Real value destroyed in 2008
1. By 10.6% cash inflation in monetary items, that is, in M3: 10.6% of R1.751361 trillion = R185 billion per annum
2. Unwittingly by SA Chartered Accountants: 10.6% Historical Cost Accounting inflation in the real value of Retained Income of companies listed on the Johannesburg Stock Exchange = Billions per annum. Actual amount in the process of being calculated.
3. Unwittingly by SA Chartered Accountants in other constant items never or not fully updated = Billions per annum. Value unknown.
Accountants eroding real value
Accountants are eroding real value in South Africa each and every day with their assumption that the Rand is perfectly stable only when they account constant items like salaries, wages, taxes, retained income, issued share capital, etc in SA.
That is, they assume that changes in the Rand´s general purchasing power are not sufficiently important to require adjustments to the basic financial statements with regard to these constant items.
Accountants thus destroy hundreds of billions of Rand in real value in SA each and every year.
That will benefit everyone in SA for an indefinite period of time.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
That is, they assume that changes in the Rand´s general purchasing power are not sufficiently important to require adjustments to the basic financial statements with regard to these constant items.
Accountants thus destroy hundreds of billions of Rand in real value in SA each and every year.
That will benefit everyone in SA for an indefinite period of time.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Congratulations Mr Mboweni
I wish to congratulate Mr Mboweni for admitting that 10.6% inflation is not consistent with price stability. Price stability is a year-on-year increase in the CPI of 0%. A high degree of price stability is a year-on-year increase in the CPI of 2%.
10.6% South African inflation destroys R185 billion per annum in the real value of M3 valued at R1.751 trillion. 6% inflation will destroy R105 billion in M3 while 3% inflation will destroy R52.5 billion in M3 real value per annum. I support an upper limit of 2% inflation in SA that will destroy R35 billion in M3 real value per annum.
When SA Chartered Accountants stop assuming that the Rand is perfectly stable only when they account constant items (e.g. retained income) they will guarantee 0% inflation in the real economy for an indefinite period of time.
The benefits of 0% inflation in the real economy can scarcely be overstimated, especially as these are, in principle, unlimited in duration and accrue year after year.
Instead CAs are currently destroying billions of Rand each and every year in retained income real value in all SA companies.
10.6% South African inflation destroys R185 billion per annum in the real value of M3 valued at R1.751 trillion. 6% inflation will destroy R105 billion in M3 while 3% inflation will destroy R52.5 billion in M3 real value per annum. I support an upper limit of 2% inflation in SA that will destroy R35 billion in M3 real value per annum.
When SA Chartered Accountants stop assuming that the Rand is perfectly stable only when they account constant items (e.g. retained income) they will guarantee 0% inflation in the real economy for an indefinite period of time.
The benefits of 0% inflation in the real economy can scarcely be overstimated, especially as these are, in principle, unlimited in duration and accrue year after year.
Instead CAs are currently destroying billions of Rand each and every year in retained income real value in all SA companies.
Monday, 19 May 2008
IAS 29 doubly flawed
It is not only flawed in it´s definition of monetary items as being money held and "items to be received or paid in money" (everything is received or paid in money - both monetary and non-monetary items) but also when it states that Retained Income in the first period of restatement is the balancing figure after restatement of all other balance sheet items.
This is a very serious mistake by the IASB.
Retained Income is a constant real value non-monetary item like Issued Share Capital and should be restated at the daily parallel rate or daily index rate in hyperinflationary economies and at the monthly inflation rate in non-hyperinflationary economies from the date it came about to today´s date.
The book "RealValueAccounting.Com - The next step in our fundamental model of accounting" which is available as a free download from a link on this blog, followed the flawed IASB approach.
This will be corrected in the new book: "Killing the real economy - South African Chartered Accountants unwittingly destroy real value on a massive scale." Unpublished.
This is a very serious mistake by the IASB.
Retained Income is a constant real value non-monetary item like Issued Share Capital and should be restated at the daily parallel rate or daily index rate in hyperinflationary economies and at the monthly inflation rate in non-hyperinflationary economies from the date it came about to today´s date.
The book "RealValueAccounting.Com - The next step in our fundamental model of accounting" which is available as a free download from a link on this blog, followed the flawed IASB approach.
This will be corrected in the new book: "Killing the real economy - South African Chartered Accountants unwittingly destroy real value on a massive scale." Unpublished.
Saturday, 17 May 2008
Historical Cost Accounting versus revoking the stable measuring unit assumption in SA
Under HCA
1. Variable items are valued correctly in terms of SA Generally Accepted Accounting Practice and International Financial Reporting Standards. No value is being destroyed by SA Chartered Accountants implementing the above or automatically by the combination of inflation and the HCA model.
2. 10.6% inflation destroys R185 billion per annum in R1.751 trillion M3 real value. 2% inflation would have only destroyed R35 billion. Think about that Mr Mboweni. [Tito, your job is most probably worth R150 billion per annum at the moment - and rising. :) ]
3. Chartered Accountants most probably (actual value in the process of being calculated) destroy another R60 billion (estimate) per annum in constant item real value because they assume the Rand is stable (a very silly and a very costly assumption) only when they account constant items never of not fully updated. At 2% inflation they would only destroy R35 billion per annum.
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Revoking the stable measuring unit assumption
A. Variable items would be valued correctly by CA´s exactly as in 1 above.
B. 10.6% inflation will destroy R185 billion per annum in R1.751 trillion M3 real value exactly the same as in 2 above.
C. Chartered Accountants will not destroy any real value in constant items. They will maintain R185 billion (estimated value) per annum in constant items real value in the case of 10.6% cash inflation instead of destroying it. This is the same as investing R60 billion per annum in constant items in the SA economy for an indefinite period of time - all else being equal. There will be 0% inflation in the real economy. The benefits to GDP and the economic growth rate will be unlimited in duration and accrue year after year.
It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in South Africa´s high inflationary economy.
The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy like Zimbabwe´s - as it was done for 30 years by Brazil.
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It will be completely impossible for SA Chartered Accountants to unwittingly carry on with their current destruction of the SA real economy.
1. Variable items are valued correctly in terms of SA Generally Accepted Accounting Practice and International Financial Reporting Standards. No value is being destroyed by SA Chartered Accountants implementing the above or automatically by the combination of inflation and the HCA model.
2. 10.6% inflation destroys R185 billion per annum in R1.751 trillion M3 real value. 2% inflation would have only destroyed R35 billion. Think about that Mr Mboweni. [Tito, your job is most probably worth R150 billion per annum at the moment - and rising. :) ]
3. Chartered Accountants most probably (actual value in the process of being calculated) destroy another R60 billion (estimate) per annum in constant item real value because they assume the Rand is stable (a very silly and a very costly assumption) only when they account constant items never of not fully updated. At 2% inflation they would only destroy R35 billion per annum.
Buy the ebook for $2.99 or £1.53 or €2.68
Revoking the stable measuring unit assumption
A. Variable items would be valued correctly by CA´s exactly as in 1 above.
B. 10.6% inflation will destroy R185 billion per annum in R1.751 trillion M3 real value exactly the same as in 2 above.
C. Chartered Accountants will not destroy any real value in constant items. They will maintain R185 billion (estimated value) per annum in constant items real value in the case of 10.6% cash inflation instead of destroying it. This is the same as investing R60 billion per annum in constant items in the SA economy for an indefinite period of time - all else being equal. There will be 0% inflation in the real economy. The benefits to GDP and the economic growth rate will be unlimited in duration and accrue year after year.
It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in South Africa´s high inflationary economy.
The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy like Zimbabwe´s - as it was done for 30 years by Brazil.
Buy the ebook for $2.99 or £1.53 or €2.68
It will be completely impossible for SA Chartered Accountants to unwittingly carry on with their current destruction of the SA real economy.
IAS 29 versus revoking the stable measuring unit assumption.
Restatement in terms of the hyperinflation rate as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is simply the restatement of Historical Cost Accounting financial reports with the intention of making them more meaningful in a hyperinflationary economy like Zimbabwe.
Restated values become the actual new real values when the restated financial reports are accepted by a country´s tax authorities for the purpose of calculating annual taxes due.
The restated values will not be actual real values when the tax authorities do not accept them for the purpose of calculating annual taxes due.
IAS 29 has no effect at all on the hyper destruction of the real economy in a hyperinflationary country because restatement is not done on a daily basis in terms of a dialy index rate or a daily parallel hard currency rate. IAS 29 is almost a complete failure. It can stop the hyper destruction of the real economy in a country with hyperinflation if it required the daily restatement of all non-monetary items.
Revoking the stable measuring unit assumption will change the current accounting and economic paradigm from the Historical Cost paradigm to the Real Value paradigm in low, high and hyperinflationary economies.
The stable measuring unit assumption can be revoked in a single company, group of companies, single economy, economic region or world wide.
It will replace the Historical Cost Accounting model with the Real Value Accounting model. The current HCA model automatically becomes the RVA model only at zero inflation.
It will stop the perennial destruction of hundreds of billions of Euros of real value in the real economy world wide.
It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in non-hyperinflationary economies.
The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy.
It will result in 0% inflation only in the real economy with continued cash inflation in the cash economy.
The stable measuring unit assumption is a Historical Cost Accounting principle implemented by Chartered Accountants only for the purpose of valuing the above constant value items never or not fully updated.
Chartered Accountants unwittingly destroy the real economy in this manner.
Restated values become the actual new real values when the restated financial reports are accepted by a country´s tax authorities for the purpose of calculating annual taxes due.
The restated values will not be actual real values when the tax authorities do not accept them for the purpose of calculating annual taxes due.
IAS 29 has no effect at all on the hyper destruction of the real economy in a hyperinflationary country because restatement is not done on a daily basis in terms of a dialy index rate or a daily parallel hard currency rate. IAS 29 is almost a complete failure. It can stop the hyper destruction of the real economy in a country with hyperinflation if it required the daily restatement of all non-monetary items.
Revoking the stable measuring unit assumption will change the current accounting and economic paradigm from the Historical Cost paradigm to the Real Value paradigm in low, high and hyperinflationary economies.
The stable measuring unit assumption can be revoked in a single company, group of companies, single economy, economic region or world wide.
It will replace the Historical Cost Accounting model with the Real Value Accounting model. The current HCA model automatically becomes the RVA model only at zero inflation.
It will stop the perennial destruction of hundreds of billions of Euros of real value in the real economy world wide.
It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in non-hyperinflationary economies.
The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy.
It will result in 0% inflation only in the real economy with continued cash inflation in the cash economy.
The stable measuring unit assumption is a Historical Cost Accounting principle implemented by Chartered Accountants only for the purpose of valuing the above constant value items never or not fully updated.
Chartered Accountants unwittingly destroy the real economy in this manner.
Friday, 16 May 2008
Stop Chartered Accountants from destroying the real economy and everyone will gain.
Get Chartered Accountants to admit that the Rand is not stable and that changes in its general purchasing power are sufficiently important to require adjustments to the basic financial statements and the following will happen automatically:
1. Salaries, wages, taxes, issued share capital, retained income and all constant items will be updated monthly with the change in the CPI;
2. CA´s will stop destroying hundreds of billions of Rand in real value in the real economy each and every year(how can they sleep at night?);
3. GDP and sustainable economic growth will increase;
4. It will be IMPOSSIBLE for inflation and hyperinflation to destroy the SA real economy like it did in Zimbabwe.
1. Salaries, wages, taxes, issued share capital, retained income and all constant items will be updated monthly with the change in the CPI;
2. CA´s will stop destroying hundreds of billions of Rand in real value in the real economy each and every year(how can they sleep at night?);
3. GDP and sustainable economic growth will increase;
4. It will be IMPOSSIBLE for inflation and hyperinflation to destroy the SA real economy like it did in Zimbabwe.
Wednesday, 14 May 2008
Higher interest rates
"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, Page 83.
Only if higher interest rates bring down inflation will it benefit the man in the street - and also attract foreign investment.
Price stability is a year on year increase in the CPI of 0%. A HIGH DEGREE of price stability is a year on year increase in the CPI of 2%.
SA should have an upper limit for cash or monetary inflation of 2% like the Euro and the USD - AND SA should stop the stable measuring unit assumption by an act of parliament which will result in 0% inflation ONLY in the REAL economy and prevent the destruction of the SA real economy by inflation or hyperinflation.
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.” Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.
Only if higher interest rates bring down inflation will it benefit the man in the street - and also attract foreign investment.
Price stability is a year on year increase in the CPI of 0%. A HIGH DEGREE of price stability is a year on year increase in the CPI of 2%.
SA should have an upper limit for cash or monetary inflation of 2% like the Euro and the USD - AND SA should stop the stable measuring unit assumption by an act of parliament which will result in 0% inflation ONLY in the REAL economy and prevent the destruction of the SA real economy by inflation or hyperinflation.
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.” Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.
The man in the street
The man in the street´s salary or wage is a constant real value non-monetary item.
When SA Chartered Accountants stop their assumption that the Rand is PERFECTLY stable (can you believe that!!) ONLY for the purpose of accounting CONSTANT items NEVER or NOT FULLY updated, namely their stable measuring unit assumption, then salaries will be automatically updated every month when the new CPI value is announced.
Salaries will automatically be maintained at their real values, that is, they will currently be updated at about 1.2% per month, every month. The man in the street will thus have more money to pay the higher installments on his house and car and higher prices for fuel, food and electricity. In economic terms: total internal demand will be maintained in the economy.
At the same time taxes will be updated monthly too. In economic terms: government´s tax receipts will maintain their real value over time.
At the same time companies´ issued share capital and retained income balances will be updated monthly too. In economic terms: the capital and investment base in the country will be maintained at its real value all the time:
In overall economic terms: probably hundreds of billions of Rand in real value will be maintianed in the SA REAL economy - instead of being destroyed by Chartered Accountants each and every year.
Result: 0% inflation or 0% destruction of REAL value in the REAL economy.
We will still have 10.6% inflation in money (the Rand).
For the man in the street: the real value of his salary will be maintained month after month - no matter what the rate of cash inflation. Internal demand in the economy will be maintained - no matter what the rate of cash inflation.
Brazil did that for 30 years from 1964 to 1994 with a DAILY index under hyperinflation. Their economy grew UNDER HYPERINFLATION.
For the man in the street: it will be IMPOSSIBLE for the SA REAL economy to be destroyed under inflation or HYPERINFLATION (see Brazil) no matter what the rate of inflation or hyperinflation in the Rand.
When SA Chartered Accountants stop their assumption that the Rand is PERFECTLY stable (can you believe that!!) ONLY for the purpose of accounting CONSTANT items NEVER or NOT FULLY updated, namely their stable measuring unit assumption, then salaries will be automatically updated every month when the new CPI value is announced.
Salaries will automatically be maintained at their real values, that is, they will currently be updated at about 1.2% per month, every month. The man in the street will thus have more money to pay the higher installments on his house and car and higher prices for fuel, food and electricity. In economic terms: total internal demand will be maintained in the economy.
At the same time taxes will be updated monthly too. In economic terms: government´s tax receipts will maintain their real value over time.
At the same time companies´ issued share capital and retained income balances will be updated monthly too. In economic terms: the capital and investment base in the country will be maintained at its real value all the time:
In overall economic terms: probably hundreds of billions of Rand in real value will be maintianed in the SA REAL economy - instead of being destroyed by Chartered Accountants each and every year.
Result: 0% inflation or 0% destruction of REAL value in the REAL economy.
We will still have 10.6% inflation in money (the Rand).
For the man in the street: the real value of his salary will be maintained month after month - no matter what the rate of cash inflation. Internal demand in the economy will be maintained - no matter what the rate of cash inflation.
Brazil did that for 30 years from 1964 to 1994 with a DAILY index under hyperinflation. Their economy grew UNDER HYPERINFLATION.
For the man in the street: it will be IMPOSSIBLE for the SA REAL economy to be destroyed under inflation or HYPERINFLATION (see Brazil) no matter what the rate of inflation or hyperinflation in the Rand.
Friday, 9 May 2008
Variable real value non-monetary items
There are three distinct economic items in the South African economy:
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1. Variable items
2. Monetary items
3. Constant items
They are valued in three distinctly different ways by South African Chartered Accountants. CA´s do not simply account economic activity. They value economic items when they account them in the accounting records and prepare financial reports of SA economic entities.
Monetary items are money held and monetary values pertaining only to money.
Non-monetary items are all items that are not monetary items. This is perhaps one of the very few undisputed economic definitions.
Non-monetary items are sub-divided into:
(a) variable items and
(b) constant items.
Constant items only came about with the introduction of the double entry accounting model that was concluded about seven centuries ago. There were no constant items before the double entry accounting model.
Barter economies
The first economies functioned without money. They were barter economies. People bartered economic items they possessed or produced in excess of their own personal needs for other products they desired from other people who had an excess of the products they in turn possessed or produced.
The first economic items had variable values. A baker baking bread bartered her extra rolls of bread for rabbits that a hunter would barter. When the hunter had many rabbits to barter he would accept a certain number of bread rolls for a rabbit. When he had few rabbits to barter and he was the only hunter in that area, then he would trade the rabbits for more rolls of bread per rabbit.
Both the rabbits and the bread rolls had variable values depending on demand and supply. This applied to all economic items in barter economies.
Neither money nor the double entry accounting model was invented yet. There was no Historical Cost Accounting model. There was no stable measuring unit assumption. There was no inflation. There was no medium of exchange. There was no monetary unit of account. There were no financial reports: no profit and loss accounts and no balance sheets.
There were no monetary items and no constant items. Only variable items.
Money
Money was then invented over a long period of time. Eventually money came to fulfil three functions:
a. Medium of exchange
b. Store of value
c. Unit of account
At that stage there were two distinct economic items in the economy: variable items and monetary items. The double entry accounting model was still not invented yet with the result that there were no constant items.
Original monetary inflation, then being only the destruction of real value in money, appeared soon after money was invented. There was no Historical Cost Accounting inflation in constant items since there was no double entry accounting model and there were no constant items.
Double Entry Accounting
Finally the introduction of the double entry accounting model was concluded round about the year 1300. This resulted in the creation of the third distinct economic item: a constant real value non-monetary item.
Variable real value non-monetary items
The first distinct economic item is a variable item.
Economic items we see around us - excluding constant items that appear in accounting records and financial reports - that are not monetary items, are variable items.
Examples
Property, plant, equipment, all forms of vehicles, office and home furniture and fixtures, information technology equipment, consumables, office, home and factory materials, etc.
Investment property
Raw materials, work in progress and finished goods stocks
Foreign currency
Quoted and unquoted shares
Consumer goods and similar economic items owned by economic entities.
Under Constant Item Purchasing Power Accounting (CIPPA), variable items are valued at fair value or the lower of cost or net realisable value or recoverable value or market value or present value in terms of International Financial Reporting Standards (IFRSs), International Accounting Standards (IASs) and South African Generally Accepted Accounting Practice (SA GAAP) excluding the stable measuring unit assumption in all the aforementioned.
CIPPA is exactly the same as Historical Cost Accounting excluding the stable measuring unit assumption, International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies and the definition of monetary items in International Accounting Standard IAS 21.
Under CIPPA variable items are updated every time the Consumer Price Index (CPI) changes between valuations.¹ Footnote: All aspects of hyperinflation are dealt with in the chapter on hyperinflation.
Variable items are adequately valued in terms of IFRSs and SA GAAP. Originally all variable items were valued at historical cost. SA accountants, like their counterparts in the rest of the world, excluding the United States of America, accept that certain variable items, e.g. property, cannot be valued at historical cost. They accept fair value valuation for these items.
SA accountants agree with accountants in the rest of the world that raw materials, work in progress and finished goods stocks cannot be valued simply at historical cost. They value them at the lower of cost or net realizable value.
SA accountants also agree with generally accepted accounting practice world wide to value shares quoted on the stock exchange not at the historical cost purchase price, but at the market value at the balance sheet date.
The same is true with variable items valued at recoverable value or present value. SA accountants agree that these items cannot be valued at historical cost.
Variable items´ real values are not being destroyed by SA Chartered Accountants as a result of their implementation of IFRSs and SA GAAP. The real values of these items are not being destroyed uniformly at, e.g., the inflation rate because of IFRSs and SA GAAP.
Neither the Historical Cost Accounting model nor inflation nor the combination of the two nor IFRSs nor SA GAAP is destroying the real value of variable items.
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Where real losses are made in dealing with variable items in SA, these losses are the result of business and private or public decisions, e.g. selling at a bad price, obsolescence, etc, etc. They do not result from the application of the traditional accounting model or from the combination of the Historical Cost Accounting model and inflation.
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1. Variable items
2. Monetary items
3. Constant items
They are valued in three distinctly different ways by South African Chartered Accountants. CA´s do not simply account economic activity. They value economic items when they account them in the accounting records and prepare financial reports of SA economic entities.
Monetary items are money held and monetary values pertaining only to money.
Non-monetary items are all items that are not monetary items. This is perhaps one of the very few undisputed economic definitions.
Non-monetary items are sub-divided into:
(a) variable items and
(b) constant items.
Constant items only came about with the introduction of the double entry accounting model that was concluded about seven centuries ago. There were no constant items before the double entry accounting model.
Barter economies
The first economies functioned without money. They were barter economies. People bartered economic items they possessed or produced in excess of their own personal needs for other products they desired from other people who had an excess of the products they in turn possessed or produced.
The first economic items had variable values. A baker baking bread bartered her extra rolls of bread for rabbits that a hunter would barter. When the hunter had many rabbits to barter he would accept a certain number of bread rolls for a rabbit. When he had few rabbits to barter and he was the only hunter in that area, then he would trade the rabbits for more rolls of bread per rabbit.
Both the rabbits and the bread rolls had variable values depending on demand and supply. This applied to all economic items in barter economies.
Neither money nor the double entry accounting model was invented yet. There was no Historical Cost Accounting model. There was no stable measuring unit assumption. There was no inflation. There was no medium of exchange. There was no monetary unit of account. There were no financial reports: no profit and loss accounts and no balance sheets.
There were no monetary items and no constant items. Only variable items.
Money
Money was then invented over a long period of time. Eventually money came to fulfil three functions:
a. Medium of exchange
b. Store of value
c. Unit of account
At that stage there were two distinct economic items in the economy: variable items and monetary items. The double entry accounting model was still not invented yet with the result that there were no constant items.
Original monetary inflation, then being only the destruction of real value in money, appeared soon after money was invented. There was no Historical Cost Accounting inflation in constant items since there was no double entry accounting model and there were no constant items.
Double Entry Accounting
Finally the introduction of the double entry accounting model was concluded round about the year 1300. This resulted in the creation of the third distinct economic item: a constant real value non-monetary item.
Variable real value non-monetary items
The first distinct economic item is a variable item.
Economic items we see around us - excluding constant items that appear in accounting records and financial reports - that are not monetary items, are variable items.
Examples
Property, plant, equipment, all forms of vehicles, office and home furniture and fixtures, information technology equipment, consumables, office, home and factory materials, etc.
Investment property
Raw materials, work in progress and finished goods stocks
Foreign currency
Quoted and unquoted shares
Consumer goods and similar economic items owned by economic entities.
Under Constant Item Purchasing Power Accounting (CIPPA), variable items are valued at fair value or the lower of cost or net realisable value or recoverable value or market value or present value in terms of International Financial Reporting Standards (IFRSs), International Accounting Standards (IASs) and South African Generally Accepted Accounting Practice (SA GAAP) excluding the stable measuring unit assumption in all the aforementioned.
CIPPA is exactly the same as Historical Cost Accounting excluding the stable measuring unit assumption, International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies and the definition of monetary items in International Accounting Standard IAS 21.
Under CIPPA variable items are updated every time the Consumer Price Index (CPI) changes between valuations.¹ Footnote: All aspects of hyperinflation are dealt with in the chapter on hyperinflation.
Variable items are adequately valued in terms of IFRSs and SA GAAP. Originally all variable items were valued at historical cost. SA accountants, like their counterparts in the rest of the world, excluding the United States of America, accept that certain variable items, e.g. property, cannot be valued at historical cost. They accept fair value valuation for these items.
SA accountants agree with accountants in the rest of the world that raw materials, work in progress and finished goods stocks cannot be valued simply at historical cost. They value them at the lower of cost or net realizable value.
SA accountants also agree with generally accepted accounting practice world wide to value shares quoted on the stock exchange not at the historical cost purchase price, but at the market value at the balance sheet date.
The same is true with variable items valued at recoverable value or present value. SA accountants agree that these items cannot be valued at historical cost.
Variable items´ real values are not being destroyed by SA Chartered Accountants as a result of their implementation of IFRSs and SA GAAP. The real values of these items are not being destroyed uniformly at, e.g., the inflation rate because of IFRSs and SA GAAP.
Neither the Historical Cost Accounting model nor inflation nor the combination of the two nor IFRSs nor SA GAAP is destroying the real value of variable items.
Buy the ebook for $2.99 or £1.53 or €2.68
Where real losses are made in dealing with variable items in SA, these losses are the result of business and private or public decisions, e.g. selling at a bad price, obsolescence, etc, etc. They do not result from the application of the traditional accounting model or from the combination of the Historical Cost Accounting model and inflation.
Monday, 5 May 2008
Historical Cost
Historical cost is the original monetary value of an economic item.
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When an historical cost item, for example money or retained income, is never updated its real value is destroyed at the rate of inflation or hyperinflation. Money cannot be updated. Retained income is currently (April 2008) not updated in low inflationary economies as a result of the application of the stable measuring unit assumption.
Retained income is: The accumulated net income retained for reinvestment in a business, rather than being paid out in dividends to stockholders.[2]
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.” .[1]
The combination of the historical cost accounting model and low inflation is thus indirectly responsible for the destruction of the real value of retained income equal to the annual average value of retained income times the average annual rate of inflation. [3]
Historical cost does not generally reflect current market valuation.
"In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued.”[2]
Different accounting standards may require that the real value of variable real value non-monetary items be updated to the market price (mark-to-market valuation) or some other estimate of value that better approximates the real value. [4]
Accounting standards may also have different methods required or allowed (even for different types of balance sheet assets or liabilities) as to how the resultant change in value of an asset or liability is recorded, as a part of income or as a direct change to shareholders' equity.
Historical cost principle
Under U.S. generally accepted accounting principles (US GAAP), the historical cost principle dictates that most assets and liabilities should be recorded at their historical cost. For example, a tract of land which was purchased 50 years ago for $10,000 may be worth $1 million today, but it will be recorded on the balance sheet at its historical cost of $10,000.
In the United States the historical cost principle is used because of its reliability and freedom from bias when compared to the fair market value principle. However, the application of the historical cost principle by the accounting profession results in the destruction of "hundreds of billions of dollars in retained income real value year in year out" [5]
- as well as in all other constant real value non-monetary items never or not fully updated throughout the world economy.
The International Accounting Standards Board only recognizes monetary and non-monetary items. [6] The IASB does not recognize constant real value non-monetary items.
The destruction of constant real value non-monetary items never updated by the application of the historical cost accounting model can be stopped by the revoking of the stable measuring unit assumption. This has been explicitily authorised by the IASB in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies; but, only in hyperinflationary economies.
"Par 8 The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the balance sheet date.
Par 11 Balance sheet amounts not already expressed in terms of the measuring unit current at the balance sheet date are restated by applying a general price index.
Income statement
Par 26 This Standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date. Therefore all amounts need to be restated by applying the change in the general price index from the dates when the items of income and expenses were initially recorded in the financial statements."
"Once you are not in hyperinflation anymore, for example, 15% annual inflation for as many years as you want, then you are not allowed to update constant real value non-monetary items any more. Then you must destroy their real value again – at 15% per annum." [7]
"Par 38 When an economy ceases to be hyperinflationary and an entity discontinues the preparation and presentation of financial statements prepared in accordance with this Standard, ....."
Implied authorization by the IASB
Paragraph 40 of IAS 29 can be taken as revoking the stable measuring unit assumption in low inflationary economies as the word inflation is used instead of hyperinflation.
"Par 40 The disclosures required by this Standard are needed to make clear the basis of dealing with the effects of inflation in the financial statements."
Authorization to revoke the stable measuring unit assumption in low inflationary economies can also be taken to be implied from the IASB´s Framework for the Preparation and Presentation of Financial Statements, Concepts of Capital Maintenance and the Determination of Profit:
"Par 104. ......(a)....Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The concept "units of constant purchasing power" [8] is generally taken as updating constant real value non-monetary items in terms of the monthly change in the Consumer Price Index in low inflationary economies and daily at a daily index rate (see Unidade Real de Valor: "The exchange rate of URVs to cruzeiros reais was recalculated and published daily by the government.") or the parallel exchange rate (in the absence of a daily index rate) in hyperinflationary economies (See Hyperinflation).
No economic entity needs authorization to maintain the real value he, she or it creates. Any country or business/organization can revoke the stable measuring unit assumption unilaterally to stop this unnecessary destruction of real value. See sovereignty and Adam Smith´s "invisible hand".
The combination of the historical cost accounting model and low inflation destroys real value on a massive scale in the world economy. [9]
Adjustment for current valuation
In the US, the Financial Accounting Standards Board allows current valuation for certain assets such as marketable securities, impaired assets, and derivatives.[3]
In contrast to US GAAP, under UK GAAP firms may revalue assets based on appraised market values. This can result in the recognition of unrealized gains as income.
The above are adjustments for current valuation of variable real value non-monetary items. Neither US GAAP nor the IASB explicitly allow the updating of constant real value non-monetary items, for example retained income, in low inflationary economies thus contributing to the continuous massive destruction of real value as described above. [10]
Adjustment for inflation
As PricewaterhouseCoopers described it in a paper on accounting in hyperinflationary environments:
Financial statements unadjusted for inflation in most countries are prepared on the basis of historical cost without regard to changes in the general level of prices. The individual assets, liabilities, shareholders’ equity, revenue, expenses and gains and losses are therefore stated at cost at the time at which these items were originated. The impact of inflation is ignored. This produces a meaningful result provided that there are no dramatic changes in the purchasing power of money.
Significant changes in the purchasing power of money mean that financial statements unadjusted for inflation are likely to be misleading. Amounts are not comparable between periods, and the gain or loss in general purchasing power that arises in the reporting period is not recorded. Financial statements unadjusted for inflation do not properly reflect the company’s position at the balance sheet date, the results of its operations or cash flows.[4]
During periods of severe monetary inflation, such as during the 1970s in the United States, accounting standard-setting bodies such as the Financial Accounting Standards Board have considered various new ways to present financial information. In the United States, as in all low inflationary economies, financial information regarding historical cost items are not adjusted for inflation.[5]
It is accepted in low inflationary economies that the historical cost model will undermine the accuracy of financial statements whenever inflation is non-zero, which means always. When inflation is low or moderate however, the inaccuracy is considered insufficiently important to warrant applying other methods. The IASB requires that hyperinflation accounting methods be used whenever cumulative inflation over a three-year period is greater than 100%. This limit has been criticized as too high and arbitrary.[6],[7]
Low or moderate 2% annual inflation is regarded as "price stability" by many entities including the European Central Bank.
"The ECB’s Governing Council has announced a quantitative definition of price stability:
"Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%."
"The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term."[11]
Low or moderate continuous 2% annual inflation will destroy 51% of the real value of money and retained income as well as all other constant real value non-monetary items never updated over 35 years as any inflation calculator will demonstrate. Low or moderate 2% inflation being "price stability" is thus a very dubious definition.
Alan Greenspan´s definition of price stability is very accurate:
"Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making." [12]Page 1.
Buy the ebook for $2.99 or £1.53 or €2.68
The annual destruction under low or moderate inflation of 2% of the real value of retained income of all companies with retained income world wide amounts to hundreds of billions of Euros (March 2008 value). That is a significant amount of unnecessary and easily avoidable real value destruction in the world economy each and every year.
Buy the ebook for $2.99 or £1.53 or €2.68
When an historical cost item, for example money or retained income, is never updated its real value is destroyed at the rate of inflation or hyperinflation. Money cannot be updated. Retained income is currently (April 2008) not updated in low inflationary economies as a result of the application of the stable measuring unit assumption.
Retained income is: The accumulated net income retained for reinvestment in a business, rather than being paid out in dividends to stockholders.[2]
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.” .[1]
The combination of the historical cost accounting model and low inflation is thus indirectly responsible for the destruction of the real value of retained income equal to the annual average value of retained income times the average annual rate of inflation. [3]
Historical cost does not generally reflect current market valuation.
"In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued.”[2]
Different accounting standards may require that the real value of variable real value non-monetary items be updated to the market price (mark-to-market valuation) or some other estimate of value that better approximates the real value. [4]
Accounting standards may also have different methods required or allowed (even for different types of balance sheet assets or liabilities) as to how the resultant change in value of an asset or liability is recorded, as a part of income or as a direct change to shareholders' equity.
Historical cost principle
Under U.S. generally accepted accounting principles (US GAAP), the historical cost principle dictates that most assets and liabilities should be recorded at their historical cost. For example, a tract of land which was purchased 50 years ago for $10,000 may be worth $1 million today, but it will be recorded on the balance sheet at its historical cost of $10,000.
In the United States the historical cost principle is used because of its reliability and freedom from bias when compared to the fair market value principle. However, the application of the historical cost principle by the accounting profession results in the destruction of "hundreds of billions of dollars in retained income real value year in year out" [5]
- as well as in all other constant real value non-monetary items never or not fully updated throughout the world economy.
The International Accounting Standards Board only recognizes monetary and non-monetary items. [6] The IASB does not recognize constant real value non-monetary items.
The destruction of constant real value non-monetary items never updated by the application of the historical cost accounting model can be stopped by the revoking of the stable measuring unit assumption. This has been explicitily authorised by the IASB in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies; but, only in hyperinflationary economies.
"Par 8 The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the balance sheet date.
Par 11 Balance sheet amounts not already expressed in terms of the measuring unit current at the balance sheet date are restated by applying a general price index.
Income statement
Par 26 This Standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date. Therefore all amounts need to be restated by applying the change in the general price index from the dates when the items of income and expenses were initially recorded in the financial statements."
"Once you are not in hyperinflation anymore, for example, 15% annual inflation for as many years as you want, then you are not allowed to update constant real value non-monetary items any more. Then you must destroy their real value again – at 15% per annum." [7]
"Par 38 When an economy ceases to be hyperinflationary and an entity discontinues the preparation and presentation of financial statements prepared in accordance with this Standard, ....."
Implied authorization by the IASB
Paragraph 40 of IAS 29 can be taken as revoking the stable measuring unit assumption in low inflationary economies as the word inflation is used instead of hyperinflation.
"Par 40 The disclosures required by this Standard are needed to make clear the basis of dealing with the effects of inflation in the financial statements."
Authorization to revoke the stable measuring unit assumption in low inflationary economies can also be taken to be implied from the IASB´s Framework for the Preparation and Presentation of Financial Statements, Concepts of Capital Maintenance and the Determination of Profit:
"Par 104. ......(a)....Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The concept "units of constant purchasing power" [8] is generally taken as updating constant real value non-monetary items in terms of the monthly change in the Consumer Price Index in low inflationary economies and daily at a daily index rate (see Unidade Real de Valor: "The exchange rate of URVs to cruzeiros reais was recalculated and published daily by the government.") or the parallel exchange rate (in the absence of a daily index rate) in hyperinflationary economies (See Hyperinflation).
No economic entity needs authorization to maintain the real value he, she or it creates. Any country or business/organization can revoke the stable measuring unit assumption unilaterally to stop this unnecessary destruction of real value. See sovereignty and Adam Smith´s "invisible hand".
The combination of the historical cost accounting model and low inflation destroys real value on a massive scale in the world economy. [9]
Adjustment for current valuation
In the US, the Financial Accounting Standards Board allows current valuation for certain assets such as marketable securities, impaired assets, and derivatives.[3]
In contrast to US GAAP, under UK GAAP firms may revalue assets based on appraised market values. This can result in the recognition of unrealized gains as income.
The above are adjustments for current valuation of variable real value non-monetary items. Neither US GAAP nor the IASB explicitly allow the updating of constant real value non-monetary items, for example retained income, in low inflationary economies thus contributing to the continuous massive destruction of real value as described above. [10]
Adjustment for inflation
As PricewaterhouseCoopers described it in a paper on accounting in hyperinflationary environments:
Financial statements unadjusted for inflation in most countries are prepared on the basis of historical cost without regard to changes in the general level of prices. The individual assets, liabilities, shareholders’ equity, revenue, expenses and gains and losses are therefore stated at cost at the time at which these items were originated. The impact of inflation is ignored. This produces a meaningful result provided that there are no dramatic changes in the purchasing power of money.
Significant changes in the purchasing power of money mean that financial statements unadjusted for inflation are likely to be misleading. Amounts are not comparable between periods, and the gain or loss in general purchasing power that arises in the reporting period is not recorded. Financial statements unadjusted for inflation do not properly reflect the company’s position at the balance sheet date, the results of its operations or cash flows.[4]
During periods of severe monetary inflation, such as during the 1970s in the United States, accounting standard-setting bodies such as the Financial Accounting Standards Board have considered various new ways to present financial information. In the United States, as in all low inflationary economies, financial information regarding historical cost items are not adjusted for inflation.[5]
It is accepted in low inflationary economies that the historical cost model will undermine the accuracy of financial statements whenever inflation is non-zero, which means always. When inflation is low or moderate however, the inaccuracy is considered insufficiently important to warrant applying other methods. The IASB requires that hyperinflation accounting methods be used whenever cumulative inflation over a three-year period is greater than 100%. This limit has been criticized as too high and arbitrary.[6],[7]
Low or moderate 2% annual inflation is regarded as "price stability" by many entities including the European Central Bank.
"The ECB’s Governing Council has announced a quantitative definition of price stability:
"Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%."
"The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term."[11]
Low or moderate continuous 2% annual inflation will destroy 51% of the real value of money and retained income as well as all other constant real value non-monetary items never updated over 35 years as any inflation calculator will demonstrate. Low or moderate 2% inflation being "price stability" is thus a very dubious definition.
Alan Greenspan´s definition of price stability is very accurate:
"Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making." [12]Page 1.
Buy the ebook for $2.99 or £1.53 or €2.68
The annual destruction under low or moderate inflation of 2% of the real value of retained income of all companies with retained income world wide amounts to hundreds of billions of Euros (March 2008 value). That is a significant amount of unnecessary and easily avoidable real value destruction in the world economy each and every year.
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