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Tuesday, 25 August 2009

Units of constant purchasing power for dummies

The two confirmed disbelievers in this area are the accounting professor and Market Monkey.

The accounting professor states:

“So its fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't affect the nature of the underlying resources.”

Market Monkey says he is dead right.

The accounting professor and Market Monkey are both dead wrong.
Units of constant purchasing power

Inflation can only destroy the real value of money and other monetary items over time. Inflation has no effect on the real value of non-monetary items.

Stating or valuing economic items in nominal monetary units over time thus means that the real values of these items will be destroyed over time in an inflationary environment if they are monetary items or if they are treated as monetary items.

Valuing constant real value non-monetary items, eg. salaries, wages, etc., in units of constant purchasing power over time means that the real value of these items will be maintained constant over time since the nominal values are inflation-adjusted by means of the Consumer Price Index over time. This is the case with salaries and wages in South Africa. Everybody including the accounting professor and Market Monkey understand that.

There are three basic economic items in the economy:

1. Monetary items

2. Variable items

3. Constant items

We will analyse the possibility and the effect of valuing items in units of constant purchasing power in each case.

Monetary items


It is impossible to update or inflation-adjust money and other monetary items during the current financial period during low inflation or hyperinflation.

It is thus impossible to inflation-adjust money and other monetary items by means of units of constant purchasing power during low inflation or hyperinflation.

SA accountants can only VALUE monetary items in nominal monetary units, eg. bank account balances, capital amounts of bank loans, capital amounts of bank savings, car loans, housing loans, consumer loans, student loans, all other monetary loans, etc.

Since monetary items can ONLY be VALUED by SA accountants in nominal monetary units it also appears as if they in this case simply report on what happened in the past as the accounting professor and Market Monkey believe.

Monetary items thus cannot be valued in units of constant purchasing power during the current financial period.

The accounting professor, Market Monkey and I all agree on this item.

Sorry, no bun fight in the monetary item area.

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