Friday, 29 January 2010

Historical Cost Accounting is based on popular IASB-approved accounting fallacies

Price-level accounting

SA accountants generally choose to measure financial capital maintenance in nominal monetary units (one of the three very popular accounting fallacies not yet extinct) and thus apply their very destructive stable measuring unit assumption (another of the three accounting fallacies) as part of the traditional HCA model based on these fallacies. They generally value balance sheet constant items as well as most income statement items – which are all constant items - at Historical Cost because they value them in nominal monetary units as a result of the fact that they assume the Rand is perfectly stable for this purpose. They only value certain income statement items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and inflation-adjust them by means of the annual CPI during low inflation.

Complete price-level accounting

Complete price-level accounting also called Constant Purchasing Power Accounting (CPPA) was developed as an inflation accounting model whereby all non-monetary items – variable and constant items – are inflation-adjusted by means of the period-end CPI in order to make financial statements more comparable with previous year statements during periods of high and hyperinflation. The non-monetary or real economy of a hyperinflationary economy can only be maintained stable by applying the daily parallel US Dollar exchange rate to the valuation of all non-monetary items instead of the period-end CPI as required by IAS 29.

The Framework is applicable

The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non-hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Framework, Par 102 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11. The valuation of the constant items Issued Share capital, reported retained earnings, other items in Shareholders´ Equity and other constant items is thus covered in the IASB´s Framework, Par 104 (a) which states “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” authorized in 1989.

Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:

“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”

Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.

Kindest regards,

Nicolaas Smith

© Copyright 2010 Nicolaas J Smith

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