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Wednesday, 1 July 2009

Normal Rands and Rands of constant purchasing power are not the same.

When SA accountants choose to measure financial capital maintenance in real value maintaining units of constant purchasing power (the CIPPA model) – as they can freely do in terms of the IASB´s Framework, Par. 104 (a) - they will maintain all constant item real values over time including Shareholders´ Equity in companies that at least break even – all else being equal - whether companies have fixed property or other variable items to revalue or not.

Variable Items


SA accountants value variable real value non-monetary items in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”


IAS 16 deals with Property Plant & Equipment. It allows two methods of valuation or measurement; either historical cost or revaluation based on fair value. The charge for depreciation relates to the carrying value, whether historical cost or fair value. It is not acceptable under HCA to index up the original cost of an asset by reference to subsequent inflation or to base the depreciation charge on that indexed amount.


There are similar requirements in respect of intangible assets (IAS 38) and inventories (IAS 2).


IAS 39 requires fair values to be applied in valuing investments and derivative financial instruments. A historical cost basis of accounting is not acceptable for these items.

The real values of variable real value non-monetary items, e.g. property, are not destroyed when accountants value them at Historical Cost in terms of IFRS or SA GAAP. These items will be fair valued when they are eventually sold.

Monetary items

Low inflation is what long term sustainable economic growth is built on. Alan Greenspan.
SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items can not be updated or indexed during the current financial period for the purpose of

1.accounting their values during the reporting period,
2.determining the profit or loss for the reporting period, and
3.measuring financial capital maintenance in either nominal monetary units or constant purchasing power units
during inflation or deflation.

Inflation (some people will hold Tito Mboweni responsible) – not SA accountants - destroys the real value of the Rand and other SA monetary items over time at the annual rate of inflation as determined by the change in the CPI.

Cumulative SA inflation from January 1981 to April 2009: 1 354%

Cumulative SA inflation from April 1994 to April 2009: 161%

Source of base data used for calculations: Statistics South Africa

The internal real value of the Rand is automatically adjusted downwards as it is being destroyed by the economic process of inflation in SA´s low inflationary economy as indicated by the rate of change in the CPI. Inflation destroys the real value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors. The accounting model has no affect on the real value of monetary items during the reporting period.

Double entry accounting cannot maintain the real value of monetary items during the reporting period. It is not an attribute of double entry accounting to maintain the real value of monetary items during the reporting period. Inflation destroys the real value of money and other monetary items no matter which accounting model is used. That is why low inflation is so critical for long term sustainable economic growth.

Constant items


SA accountants can choose to measure financial capital maintenance in either nominal monetary units (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 in real value maintaining units of constant purchasing power (the CIPPA model). Both models are approved by the IASB in the Framework, Par. 104 (a).


It is very obvious that how SA accountants as a group choose to measure financial capital maintenance does make a big difference to the underlying real value of constant items like Retained Earnings in the SA economy and has important effects on the economy as a whole.
I wrote a letter “Accounting for Inflation” to the Financial Mail which was published in the 9th May 2008 edition in which I stated:

“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.

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.

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.”
Rejecting the stable measuring unit assumption is simply a logical, but, long overdue improvement in basic accounting approved by the IASB 20 years ago which, I am confident, will be speedily implemented after proper due process in South Africa.


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