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Tuesday, 8 December 2009

The IASB and FASB still get this wrong - but not street vendors.

Money cannot be declared by statute or by institutional definition to be a non-monetary item. Money is either money or it is not money. To be money it has to fulfil the three functions of money in an economy: medium of exchange, store of value and unit of account.

This applies to non-monetary items too. Trade debtors and trade creditors are defined incorrectly by the International Accounting Standards Board and US Financial Accounting Standards Board to be monetary items. They are generally non-monetary items. Defining them as monetary items means the net monetary gain or loss in companies with trade debtors and trade creditors will always be calculated incorrectly under the IASB and FASB definition.

They are generally non-monetary items. All street vendors in hyperinflationary economies know that trade debtors and trade creditors (or their equivalents) are non-monetary items by experience, even if they have never been to school.

The IASB and FASB still get this wrong.

Who else got it right? Brazil got it right for 30 years from 1964 to 1994 as confirmed by the previous head of the Central Bank of Brazil, Dr Gustavo Franco:

When I asked him: "Were trade debtors and trade creditors treated as monetary items under the URV and not updated or were they treated as non-monetary items an updated in terms of the Unidade Real de Valor? What are trade debtors and trade creditors in your opinion? Are they monetary or non-monetary items?"

He responded: "Dear Mr. Smith

I am not sure I understood your question. If I got it right, two observations are in order. First, for spot transactions the existence of the URV is imaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enteres the picture only when at least one leg of a commercial transaction is defferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs are to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.

It was essentil, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denomiated obligation had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetized.

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