Thursday, 21 January 2010

Hegemony of Historical Cost Accounting

Monetary items

SA accountants value and account monetary items during the current accounting period at their original nominal monetary values under all accounting models during low inflation, hyperinflation and deflation. Inflation determines the always current real value of the Rand and other monetary items in the SA monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period.

The real value of the Rand and other monetary items in the SA monetary economy changes equally normally every month with the publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in SA´s low inflationary economy. The daily parallel rate is generally constantly available in a hyperinflationary economy. The CPI is the internal exchange rate between the value of the Rand and real value in the SA economy. The parallel rate fulfils this role in a hyperinflationary economy.

Variable items

Variable items in SA are continuously valued and accounted in terms of IFRS or SA GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc.

Constant items

Real values of constant real value non-monetary items in the SA constant item economy have to be continuously maintained stable during low inflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation by means of the CPI as authorized in the IASB´s Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in South Africa as well as in most other non-hyperinflationary economies.

Harvey Kapnick was correct when he stated in 1976: In the long run both value accounting and price-level accounting should prevail.
Saxe Lecture, 1976

Meanwhile the standards, twenty years ago, already provided the option to reject the stable measuring unit assumption 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."

I want the International Accounting Standards Board to remove the accounting fallacy "financial capital maintenance can be measured in nominal monetary units" from the Framework, Par 104 (a). International Financial Reporting Standards should not be based on very popular accounting fallacies.

Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a country can maintain its non-monetary or real economy stable during hyperinflation is by measuring all non-monetary items in units of constant purchasing power; however, not by restating HC or current cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done, in principle, in Brazil - with indexation during the 30 years from 1964 to 1994.

IAS 29 was implemented by Zimbabwean companies listed on their stock exchange by applying the CPI at year-end as required by the IASB. Zimbabwean accountants unnecessarily, unknowingly and unintentionally destroyed their country’s real economy by implementing Historical Cost Accounting during the financial year, as supported by the IASB in IAS 29, and then restated their year-end Historical Cost financial statements in terms of the year-end CPI to make them more useful. That did not stop them from unknowingly destroying their real economy with HCA during hyperinflation.

PricewaterhouseCoopers state:

"Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting."

Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006.

© 2005-2010 by Nicolaas J Smith. All rights reserved

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