Inflation has no effect on the real value of non-monetary items

Inflation, being a uniquely monetary phenomenon, can not, by definition, destroy the real value of non-monetary items. Inflation has no effect on the real value of non-monetary items.

It is SA accountants’ choice of accounting model that determines whether they carry on currently unintentionally destroying real value in constant real value non-monetary items never or not fully updated (the real value destroying traditional HCA model) when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation or maintain those values in future for an unlimited period of time (the IASB approved real value maintaining CIPPA model) – all else being equal.

It is not inflation that is doing the destroying in the real value of constant items. It is our accountants unknowingly doing the destroying when they implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation.

This is the case with all constant items never or not fully inflation-adjusted including the unintentional destruction by SA accountants of the real value of Shareholders´ Equity in SA banks and companies which do not have sufficient variable items that can be or are revalued via the Revaluation Reserve or with insufficient holding gains to compensate for the real value shortfall in Shareholders´ Equity under HCA.

Rejecting the stable measuring unit assumption is compliant with IFRS

Today´s Fin24 has an article starting: " South Africa's inflation-targeting framework is likely to be fine-tuned by the new government, said chief economist from Brait, Colen Garrow, on Friday."

"Target may be fine tuned" Fin24 28 June 2009

Mboweni averaged 5.93% annual inflation so far.

Upping the upper band to 7% will result in SA accountants unknowingly destroying a further cumulative 10% in constant items they refuse to maintain over the next 10 years.

They will thus unknowingly destroy 56% instead of 46% of the real value of all Retained Earnings never maintained in SA companies and banks today over the next 10 years.

That may amount to unknowingly destroying R202 billion instead of R200 billion p.a

When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as approved by the IASB 20 years ago in the Framework, Par. 104 (a) which is compliant with IFRS, they will maintain instead of unknowingly destroy - as they are now doing - about R200 billion p.a. in the SA real economy for an unlimited period of time - ceteris paribus.

ABSA´s accountants are unknowingly destroying R3.3 bil. like that now.

Rejecting the stable measuring unit assumption is compliant with IFRS.

It will result in our accountants boosting the SA real economy by at least R200 billion (a conservative estimate) p.a. for an unlimited period of time - ceteris paribus.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

The confusion about inflation accounting

Most accountants and accounting authorities completely ignore the real value maintaining Constant Item Purchasing Power basic accounting model as approved by the IASB in the Framework, Par. 104 (a) as an alternative for the real value destroying traditional HC basic accounting model.

They do not appreciate, firstly, that SA accountants unknowingly destroy real value on a massive scale in the SA real economy when they implement the real value destroying stable measuring unit assumption for an unlimited period of time during indefinite inflation in the case of balance sheet constant items when they do not have sufficient revaluable fixed assets or holding gains to compensate for a real value shortfall in Shareholders´ Equity.

Secondly, they mistakenly assume that any price-level accounting always only relates to inflation accounting during high and hyperinflation despite the fact that the IASB approved a constant item price-level basic accounting model twenty years ago.

Thirdly, they do not appreciate the real value maintaining effect on balance sheet constant items of choosing to measure financial capital maintenance in constant purchasing power units as approved by the IASB in the Framework, Par. 104 (a).

Financial capital maintenance in units of constant purchasing power is generally not implemented in non-hyperinflationary economies.

Measurement in units of constant purchasing power is, however, comprehensively and extensively used for the valuation of income statement constant items, e.g., salaries, wages, rentals, etc in most economies at all levels of inflation, including in South Africa.


© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission

Difference between basic and inflation accounting

The Constant Purchasing Power inflation accounting model required by the IASB in IAS 29 is in contrast to the Constant Item Purchasing Power basic accounting model approved by the IASB in the Framework, Par. 104 (a) as an alternative to the real value destroying traditional basic Historical Cost Accounting model also approved in Par. 104 (a).

Constant Item Purchasing Power Accounting requires that ONLY constant items (instead of constant AND variable non-monetary items in the case of CPP inflation accounting) are inflation-adjusted by means of the CPI during non-hyperinflationary periods for the purpose of implementing a constant purchasing power capital concept of invested purchasing power, a constant purchasing power financial capital maintenance concept and a constant purchasing power profit or loss determination concept.

Variable items are valued in terms of IFRS or SA GAAP for primary valuation purposes during non-hyperinflationary periods. Monetary items are always stated at their original nominal values during the current accounting period.

Current SA inflation - May 2009

Percentage unknowing real value destruction by SA accountants in constant items never maintained since

Jan 1981

93.2%

April 1994

61.9%

May 2008

8.0%

Example: R3.338 billion of the real value of Retained Earnings have unknowingly been destroyed by ABSA´s accountants implementing the stable measuring units assumption as chosen by their board of directors during their 2008 financial year if they maintain that assumption for an unlimited period of time during indefinite inflation.


Cumulative inflation since Jan 1981

1 360.3%

Cumulative inflation since Apr 1994

162.6%

Annual inflation

8.0%

Source of base data: Statistics South Africa

Price-level accounting clearly does not prevail

Price-level accounting clearly does not prevail for balance sheet constant items, as Harvey Kapnick hoped for in 1976, except during rare instances of hyperinflation (e.g., Turkey’s latest period of hyperinflation) when companies are required to implement IAS 29 which is the IASB´s CPP inflation accounting model.
The implementation of IAS 29 inflation accounting by Zimbabwean listed companies as required by the Zimbabwean Stock Exchange made no difference to the Zimbabwean economy during the final stages of the hyperinflationary destruction of the Zimbabwe Dollar. Updating all non-monetary items as required by IAS 29 inflation accounting in terms of the Consumer Price Index when it is not calculated and supplied by the government and when the value of the Zimbabwe Dollar halved every 15 hours, was obviously of no use.

The IASB specifically requires financial capital maintenance in terms of units of constant purchasing power during hyperinflation, but, leaves it as an option to the disastrously destructive traditional HCA model during non-hyperinflationary periods. An option that is ignored by almost all accountants during non-hyperinflationary periods because of, firstly, the lack of appreciating the very destructive effect of the stable measuring unit assumption on the real values of balance sheet constant items during non-hyperinflationary periods; secondly, the lack of appreciating the real value maintaining effect on balance sheet constant items of choosing to measure financial capital maintenance in units of constant purchasing power during non-hyperinflationary periods; as well as, thirdly, the general assumption by most accountants that price-level accounting always refers ONLY to CPP inflation accounting when all non-monetary items (variable and constant items) are inflation adjusted by means of the CPI during high and hyperinflationary periods in terms of IAS 29 inflation accounting.

Price-level accounting does prevail in certain income statement items, e.g. salaries, wages, rentals, etc. which are inflation-adjusted by means of the CPI in most economies, including South Africa.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Changing the way a company does its accounts does change the value of the company for the better

"ABSA joins chorus of doom" on today´s Fin24.com states that ABSA´s operating performance had been knocked by a REDUCTION IN THE VALUE of investment portfolios"

R3.326 Billion of the real value of ABSA´s Retained Earnings was not just reduced during their 2008 financial year but actually unknowingly DESTROYED by ABSA´s accountants implementing the stable measuring unit assumption as an accounting policy chosen by their Board of Directors. They are doing the same this year. Measurement in units of constant purchasing power is compliant with IFRS.

R3.326 Billion is also, more or less, the amount that ABSA´s accountants will unknowingly destroy in the real value of the bank´s Retained Earnings during their current financial year as a result of their implementation of the stable measuring unit assumption because the ABSA Board of Directors selected financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a) which states that "Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

Both bases are compliant with IFRS since the Framework applies (see IAS 8.11). There is not one specific IFRS relating to the valuing of Retained Earnings.

R3.326 Billion is the estimated amount that ABSA´s accountants will maintain in the real value of the banks Retained Earnings during this finacial year and every year there after - ceteris paribus - if ABSA´s Board of Directors decide today to reject the stable measuring unit assumption and to maintain the banks financial capital in real value maintaining units of constant purchasing power - which is compliant with IFRS - instead of in real value destroying nominal monetary units - which is also compliant with IFRS, but, results in their accountants unknowingly destroying the real value of their Retained Earnings as described above.

I think Maria Ramos should perhaps have a look at this.

R3.326 Billion is 4.5% of ABSA´s current market value.

Changing the way a company does its accounts does change the value of the company for the better.

Audited Historical Cost annual financial statements do not fairly present the financial position of a company

1st Update: 24 June 2009

Audited annual financial statements provided by SA companies which prepare them using the traditional Historical Cost basis, i.e., when the directors choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a), are compliant with IFRS, but, do not fairly present the financial position of the companies as required by Art. 29.1(b) of the Companies Act.



Article 29.1 (b) of the SA Companies Act, No 71 of 2008 states:



“If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must-



(b) present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company;”



SA company directors´ choice to measure financial capital maintenance in nominal monetary units, i.e., the traditional HC basis which includes implementing the very destructive stable measuring unit assumption, is compliant with IFRS. However, audited financial statements prepared under this basis do not fairly present the financial position of SA companies, as required by the Companies Act, when the directors do not:



(1) state in those annual financial statements that their choice of the traditional Historical Cost basis which includes the very destructive stable measuring unit assumption, destroys the real value of ONLY constant real value non-monetary items never maintained, at a rate equal to the annual rate of inflation and at a lower rate when they are not fully maintained.



(2) state that this includes the destruction of the real value of Shareholders´ Equity when the company does not have sufficient variable real value non-monetary items that are or can be revalued via the Revaluation Reserve or do not present sufficient hidden and unrecognised holding gains to compensate for the shortfall in real value in Shareholders’ Equity under the HC basis;



(3) state the percentage and amount of Shareholders´ Equity that is not being maintained; i.e., the percentage and amount of Shareholders´ Equity that is subject to real value destruction at a rate equal to the annual inflation rate because of the directors´ choice, in terms of the Framework, Par. 104 (a), to maintain financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – both methods being compliant with IFRS;



(4) state the amount of real value destroyed during the last financial year in Shareholders´ Equity and all other constant items because of the directors´ choice to implement the HC basis;



(5) state the updated total amount of real value destroyed from the company’s start to date in this manner in at least Shareholders´ Equity never or not fully maintained;



(6) state the change in the updated real value of Shareholders´ Equity if the directors decide to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units as provided in the Framework, Par. 104 (a) which is complaint with IFRS;



(7) state the directors´ estimate of the amount of real value to be destroyed by their implementation of the stable measuring unit assumption during the following accounting year under the HC basis;



(8) state that the real value calculated in (7) represents the amount of real value the company would gain during the following accounting year and every year there after for an unlimited period of time – ceteris paribus - if the directors´ choose to measure financial capital maintenance in units of constant purchasing power – which is compliant with IFRS – as provided in the Framework, Par. 104 (a);



(9) state the directors´ reason(s) for choosing financial capital maintenance in real value destroying nominal monetary units instead of in real value maintaining units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a).


It is obviously a million times better for company directors to choose to measure financial capital maintenance in constant purchasing power units as provided for in the IASB´s Framework, Par. 104 (a) which states: "Finacial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Both bases are compliant with IFRS. Measuring financial capital maintenance in constant purchasing power units instead of in nominal monetary units stops the unknowing destruction by accountants of massive amounts in real value in constant real value non-monetary items never or not fully updated, for example, Retained Earnings, in the real economy.

There is magic in lower inflation

Thought Leader

Alan Greenspan correctly stated that low inflation is what sustained economic growth is built upon.

It is very irresponsible to suggest an inflation target of 10% to 15%.

Under the current Historical Cost paradigm there are always TWO simultaneous systemic economy-wide real value destruction processes operating in the economy during inflation: (a) inflation in the monetary economy and (b) SA accountants implementing the Historical Cost Accounting model in the non-monetary or real economy:

(1) 161.6% cumulative inflation since April 1994 have destroyed 61.8% of the real value of the Rand in our monetary economy.

(2) During the same period SA accountants have unknowingly destroyed 61.8% of the real value in the non-monetary or real economy of all Retained Earnings balances that remained in SA companies during that period and in the Shareholders´ Equity of all companies with no fixed assets or a lower percentage in companies with insufficient fixed assets to revalue because our accountants implement the very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.

When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as per the International Accounting Standards Board´s Framework, Par. 104 (a) which is compliant with International Financial Reporting Standards, they will maintain instead of unknowingly destroy about R200 billion per annum in real value in constant items not updated in the SA real economy for an unlimited period of time and reduce economy-wide value destruction to simply a single destruction process by inflation in the real value of the Rand.

SA accounting facts as at end of April 2009

Real value unknowingly destroyed by SA accountants in Retained Earnings remaining in SA companies from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in Shareholders´ Equity of SA companies with no variable real value non-monetary items to revalue with equivalent entries in Revaluation Reserve from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in Retained Earnings remaining in SA companies from Apr 1994 to Apr 2009

61.8%

Real value unknowingly destroyed by SA accountants in Shareholders´ Equity of SA companies with no variable real value non-monetary items to revalue with equivalent entries in Revaluation Reserve from Apr 1994 to Apr 2009

61.8%


Cumulative inflation since Jan 1981: 1 354.8%

Cumulative inflation since Apr 1994: 161.6%

Annual inflation: 8.4%

Source of base data: Statistics South Africa