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Saturday, 12 September 2009

Inflation accounting is only implemented during hyperinflation

During the period of high inflation in the 1970´s accountants tried various inflation accounting models in an attempt to adjust company financial reports supposedly to reflect the apparent effect of high inflation on non-monetary items.

During that period inflation accounting described a range of accounting models designed to correct comparison problems arising from historical cost accounting in the presence of high and hyperinflation. It was and still is generally accepted that inflation affects the real value of non-monetary items. That is not true. Inflation has no effect on the real value of non-monetary items. Inflation is a uniquely monetary phenomenon. It is not inflation, but, SA accountants selecting the Historical Cost Accounting model and implementing the very destructive stable measuring unit assumption who unknowingly and unintentionally destroy the real value of SA constant real value non-monetary items never or not fully updated during non-hyperinflationary periods.

Inflation accounting models that were tried unsuccessfully in the 1970´s include Constant Purchasing Power inflation accounting (CPPA) and Current Cost Accounting.

The Financial Accounting Standards Board issued an exposure draft in the United States in January, 1975, that required supplemental financial reports on a Constant Purchasing Power inflation accounting price-level basis. The Securities and Exchange Commission in the USA proposed in 1976 the disclosure of the current replacement cost of amortizable, depletable and depreciable assets used for production as well as most inventories at the financial year-end. It also proposed the disclosure of the approximate value of amortization, depletion and depreciation as well as the approximate value of cost of sales that would have been accounted in terms of the current replacement cost of productive capacity and inventories.

Both supplemental Constant Purchasing Power inflation accounting financial statements and value accounting were experimented with in Canada. Australia tried both replacement-cost inflation accounting and CPP price-level inflation accounting. Netherland companies experimented with value accounting. Replacement-cost disclosures for equity capital financed items were considered in Germany. CPP inflation accounting supplemental financial statements were tried in Argentina. Brazil used various indexes to update constant and variable non-monetary items for the 30 years from 1964 to 1994. In the United Kingdom an original proposal of supplementary CPP financial accounting financial reports was replaced by the Sandilands Committee proposal for a value accounting approach for inventories, marketable securities and productive property.

South Africa had published a discussion paper on value accounting at the time.

Presently, inflation accounting describes a complete price-level inflation accounting model, namely the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies required by the IASB to be implemented during hyperinflation. It serves to maintain the real values of all non-monetary items – variable and constant real value non-monetary items - by inflation-adjusting them by means of the CPI during hyperinflation which is an exceptional circumstance according to the IASB.

“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses value at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29.2

Constant ITEM Purchasing Power Accounting (CIPPA) during low inflation as authorized by the IASB in 1989 in the Framework, Par. 104 (a) which states

"Financial capital maintenance can be measured in either units of nominal monetary units or in units of constant purchasing power."

is not an inflation accounting model. It is a real value maintaining basic accounting model alternative to the real value destroying traditional Historical Cost Accounting model which includes the very destructive stable measuring unit assumption.

Kindest regards,

Nicolaas Smith