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Tuesday, 13 October 2009

SA accountants simply assume there is no inflation


SA accountants simply assume there is no such thing as inflation and never ever was before either.


Inflation is a rise in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation destroys the real value (purchasing power) of money.

The effect of inflation is distributed evenly in money and monetary items and as a consequence there are hidden costs to some and hidden benefits to others from this destruction in purchasing power in items that are assets to some while a the same time liabilities to others. For example, with inflation lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers will benefit. Individuals and institutions with net monetary assets will experience a net monetary loss (less real value owned/more real value – real assets – destroyed) while individuals and institutions with net monetary liabilities will experience a net monetary gain (less real value owed/more real liabilities destroyed) during inflation.

Increases in the price level (inflation) destroy the real value of money (the functional currency) and other monetary items with an underlying monetary nature (e.g. bonds and loans). However, inflation has no effect on the real value of variable real value non-monetary items (e.g. property, plant, equipment like cars, gold, inventories, finished goods, foreign exchange, etc) and constant real value non-monetary items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc).

Inflation destroys the real value of money. Inflation has no effect on the real value of non-monetary items. Fixed constant real value non-monetary items never maintained are effectively treated like monetary items under traditional Historical Cost Accounting. Their real values are destroyed at a rate equal to the rate of inflation because they are measured in nominal monetary units and inflation destroys the real value of money which is the monetary unit of account.

SA accountants choose to implement the stable measuring unit assumption during low inflation when they value constant items in fixed nominal monetary units. Accountants´ choice of implementing the stable measuring unit assumption instead of measuring constant items´ real values in units of constant purchasing power, as they are authorized to do in the Framework, Par. 104 (a), results in the real values of these fixed constant items being destroyed at a rate equal to the rate of inflation when they are never maintained during low inflation because inflation destroys the real value of money which is the monetary unit of account. Fixed constant items never maintained are effectively monetary items under HCA. Their real values are destroyed at a rate equal to the rate of inflation because they are measured in nominal monetary units and inflation destroys the real value of money which is the monetary unit of account.

This costs the SA real economy about R200 billion per annum in unknowing real value destruction by SA accountants implementing their very destructive stable measuring unit assumption. They can freely stop this by measuring financial capital maintenance in units of constant purchasing power as they have been authorized to do by the IASB in 1989 in the Framework, Par. 104 (a) which states:

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

They refuse to do that.
The extremely rapid destruction of the real value of the monetary unit of account is compensated for during hyperinflation by the rejection of the stable measuring unit assumption in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29, which has to be implemented during hyperinflation, requires all non-monetary items (variable items and constant items) to be measured in units of constant purchasing power.

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