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Monday, 22 February 2010

Capital maintenance

Capital maintenance is the continuous maintenance of the real value of capital over time; i.e. the constant purchasing power of capital.

Financial capital maintenance in nominal monetary units per se is a fallacy: it is impossible to maintain the real value of capital constant over time in nominal monetary units per se during inflation and deflation.

There are two ways of looking at capital maintenance:

1. In terms of fact
2. In terms of IFRS

1. In terms of fact

The fact that capital maintenance is the continuous maintenance of the constant purchasing power of capital means that there are only two concepts of capital maintenance:

a) Physical capital maintenance as defined in the Framework
b) Continuous financial capital maintenance in units of constant purchasing power as defined in the Framework, Par 104 (a) which states:

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

2. In terms of IFRS

There are 3 concept of capital maintenance in terms of IFRS:

a) Physical capital maintenance as defined in the Framework.

b) Financial capital maintenance in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a) which is a fallacy, but, is implemented by 99.99% of entities in the world economy and results in their accountants (not inflation as the FASB, IASB and most accountants believe) unknowingly, unnecessarily and unintentionally destroying the real value of their companies´ shareholder’s equity (never maintained by sufficient revaluable fixed assets) with the implementation of their very destructive stable measuring units assumption during low inflation at a rate equal to the annual rate of inflation in all countries with low inflation amounting to hundreds of billions of Euros in the world economy each and every year.

c) Continuous financial capital maintenance in units of constant purchasing power which the IASB authorized in the Framework, Par 104 (a) in 1989 for implementation during low inflation and deflation as an alternative to the globally implemented generally accepted traditional Historical Cost Accounting model, but, it is ignored by almost everyone. Financial capital maintenance in units of constant purchasing power during low inflation would stop the unknowing destruction by accountants of the real value of companies´ capital and profits never maintained amounting to hundreds of billions of Euros in the world economy per annum implementing their very destructive stable measuring unit assumption under HCA during low inflation.

Accountants would knowingly maintain hundreds of billions of Euros in the real value of companies´ capital and profits per annum without extra money in new capital contributions or extra retained profits when they measure financial capital maintenance in units of constant purchasing power during low inflation as authorized by the IASB in the Framework, Par 104 (a) in 1989. This is not understood by the IASB, FASB, other accounting authorities and most accountants and accounting lecturers and professors. If they understood it, they would have stopped the stable measuring unit assumption by now. Financial capital maintenance in units of constant purchasing power units is only required by the IASB in IAS 29 Financial Reporting in Hyperinflationary Economies.

The legal requirements for satisfying the liquidity and solvency tests do not constitute a fourth concept of capital maintenance, but, are simply the legal basis for either financial capital maintenance in nominal monetary units – when you assume the that the stable measuring unit assumption satisfies the requirement for “fairly valued” as 99.99% of entities currently incorrectly assume - as well as financial capital maintenance in units of constant purchasing power where under the very destructive stable measuring unit assumption is rejected in terms of the Framework, Par 104 (a). Unfortunately no-one chooses this option.

In most jurisdictions the legal requirements of “liquidity” and “solvency” have to be satisfied in the case of

• payment of dividends to shareholders
• reduction of a company’s share capital or reserves
• a company’s purchase of its own shares

A company is prohibited from making any payment in whatever form from shareholders´ equity if there are reasonable grounds for believing:

(a) that the company is or would after the payment be unable to pay its debts as they become due in the ordinary course of business (this is known as the “liquidity” test); or

(b) the consolidated assets of the company fairly valued would after the payment be less than the consolidated liabilities of the company (this is known as the “solvency” test)
The Capital Maintenance Concept and Share Repurchases in South African Law - By F.H.I. Cassim and Rehana Cassim
Copyright © 2010 Nicolaas J Smith