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Monday, 4 January 2010

Hyperinflation

Historical Cost accountants freely choosing to measure financial capital maintenance in nominal monetary units - a 700 year old generally accepted accounting practice (which is a popular accounting fallacy approved by the IASB) - in terms of the Framework, Par 104 (a) or as the traditional HCA model in terms of GAAP, unknowingly hyper-destroy the real value of reported constant items never maintained because they implement their very destructive stable measuring unit assumption (another IASB approved popular accounting fallacy) during hyperinflation. They know and admit that this destruction is occurring during inflation and hyperinflation and that it is especially evident during hyperinflation, but, they mistakenly blame inflation and hyperinflation (instead of their own choice of the HCA model) for the erosion of companies´ profits and capital - the third very popular accounting fallacy.

Hyperinflation is defined by the IASB in IAS 29 Financial Reporting in Hyperinflationary Economies as a rate of inflation approaching or surpassing 100% cumulative inflation over three years. 26% annual inflation for three years in a row would result in cumulative inflation of 100% over that period.

The IASB requires countries to implement IAS 29 during hyperinflation as defined above. IAS 29 requires companies to value all non-monetary items – both variable and constant items – in units of constant purchasing power by applying the CPI at the financial year end date.

Accountants freely choosing continuous financial capital maintenance in units of constant purchasing power would maintain the real value of all existing reported constant items stable in companies that at least break even during low inflation, hyperinflation and deflation per se for an unlimited period of time – all else being equal. Continuous financial capital maintenance in units of constant purchasing power (an IASB approved accounting model) is the only way to maintain the real value of constant items stable in companies that at least break even during low inflation, hyperinflation and deflation per se – ceteris paribus.

In short:

1.) Accountants unknowingly destroy massive amounts of real value in the real economy with traditional HCA during inflation and hyperinflation.

2.) The only way to stop that destruction is with another freely available accounting model also authorized by the IASB in 1989; namely, continuous financial capital maintenance in units of constant purchasing power during inflation and hyperinflation.

Unfortunately IAS 29, as it is currently formulated, does not incorporate continuous financial capital maintenance in units of constant purchasing power during hyperinflation. IAS 29 requires that all non-monetary items (variable and constant items) in HC or current cost financial statements are restated in terms of the CPI, generally at the year end date, to make the financial statements more useful during hyperinflation. IAS 29 is about the restatement of financial statements to make them more useful during hyperinflation. It is, unfortunately - currently, not the objective of IAS 29 to engender continuous financial capital maintenance in units of constant purchasing power and to continuously maintain the real values of non-monetary items during hyperinflation although it is almost correctly formulated to be used for this purpose. When it were to be used for this purpose it would stop the hyper-destruction of the real economy during hyperinflation. It would instead ensure economic stability in the real economy during hyperinflation. It is not currently the objective of IAS 29 to maintain the real value of constant items for an unlimited period of time by implementing continuous financial capital maintenance in units of constant purchasing power during hyperinflation because the IASC Board and accountants in general were not yet aware of this function of accounting during inflation and hyperinflation at the time of authorizing IAS 29 in 1989 for reasons explained before.

PricewaterhouseCoopers tell us very succinctly what happens under IAS 29:

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

PricewaterhouseCoopers: International Financial Reporting Standards - Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, p. 3

Kindest regards,

Nicolaas Smith