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Thursday, 10 September 2009

Money is the only unstable unit of measure

Money is the only unstable unit of measure


The unit of measure in accounting is the base money unit of the most relevant currency. Money is not stable in real value during inflation. This means that the unit of measure in accounting is not a stable unit of measure during inflation and deflation. Accountants´ unstable monetary unit of measure or unstable monetary unit of account is the only generally accepted unit of measurement that is not an absolute value. It does not contain a fundamental constant. All other generally accepted units of measurement of time, distance, velocity, mass, momentum, energy and weight are absolute values, e.g. second, minute, hour, metre, yard, litre, kilogram, pound, mile, kilometre, inch, centimetre, gallon, ounce, etc.

The South African Reserve Bank is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as “the achievement and maintenance of price stability". SARB.

The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. SARB.

Price stability is a year-on-year increase in the Consumer Price Index of zero percent. A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.

“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.”

http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html

A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. The SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”.

Accountants, on the other hand, simply assume that the unstable monetary unit of account or unstable monetary unit of measure is perfectly stable in non-hyperinflationary economies for the purpose of valuing constant real value non-monetary items. Changes in the general purchasing power or real value of the unstable monetary unit of measure (functional currency or money) are not considered to be sufficiently important to require adjustments to financial reports during non-hyperinflationary periods.

This led accountants to choose to measure financial capital maintenance in nominal monetary units and to choose to implement the real value destroying traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation. They value both variable items stated at Historical Cost in terms of SA GAAP or IFRS, as well as constant items also stated at Historical Cost in terms of the Historical Cost Accounting model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant real value non-monetary items are thus considered by SA accountants to be simply HC non-monetary items.

There is a fixation in accounting that constant purchasing power inflation-adjustment simply means adjusting company financial statements mainly to make current year statements more comparable with previous year statements.

Inflation-adjustment is not automatically thought of as affecting the fundamental values of the underlying resources although that is what is done with world wide annual inflation-adjustment of salaries, wages, rentals, etc. The two processes are seen as different processes.

Kindest regards,

Nicolaas Smith