Comment letter to the IASB Exposure Draft: Management Commentary

Submitter.............Organization..................Date

Nicolaas Smith........Real Value Accounting.........25th February, 2010

Ms Amy Schmidt
Project Manager: Management Commentary
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
United Kingdom

Attempted submission Via “Open to comment” page on www.iasb.org

This comment letter is published HERE on the IFRS Foundation website with ID CL32.


Dear Ms Schmidt

Request for comment on IASB Exposure Draft: Management Commentary

Thank you for the opportunity to comment on the IASB Exposure Draft: Management Commentary.

In my opinion the Board should develop an IFRS for the preparation and presentation of management commentary to make it binding.

I suggest changes in the content elements related to the analysis of the adequacy of the entity’s capital structure requiring details about real value unnecessarily being destroyed because of the implementation of the stable measuring unit assumption; real value to be gained by its rejection; related to plans to address this inadequacy and useful disclosure regarding the entity’s justification for choosing financial capital maintenance in nominal monetary units instead of in units of constant purchasing power during low inflation and deflation as authorized by the IASB.

I do not agree with the Board’s decision not to include detailed application guidance and illustrative examples in the final management commentary document. I suggest specific guidance regarding management’s obligation to supply details about real value unnecessarily destroyed as a result of their implementation of financial capital maintenance in nominal monetary units and real value to be gained when they change over to financial capital maintenance in units of constant purchasing power during low inflation.

My detailed answers to the questions in the Exposure Draft and my suggestions are contained in the attached appendix.

If you have any questions regarding this submission, please do not hesitate to contact me at realvalueaccounting@yahoo.com

Yours sincerely

Nicolaas Smith


Appendix – Response to the questions asked in the Exposure Draft: Management Commentary

Status of the Final Work Product

Question 1

Do you agree with the Board’s decision to develop a guidance document for the preparation and presentation of management commentary instead of an IFRS? If not, why?

No, I do not agree. It should be an IFRS to make it binding. Optional implementation has in the past meant “Keep the status quo” as far as IFRS are concerned. Financial capital maintenance in units of constant purchasing power is a good example: The IASB approved financial capital maintenance in units of constant purchasing power during low inflation and deflation in the Framework, Par 104 (a) twenty one years ago. Its implementation would stop the unnecessary destruction of hundreds of billions of Euros (probably much more) per annum in the world economy in the real value of entities´ capital and profits never maintained constant during low inflation. Its implementation would mean automatically maintaining instead of destroying hundreds of billions of Euros (probably much more) per annum in the real value of entities´ capital and profits in entities that at least break even whether they own revaluable fixed assets or not - without extra money or additional retained profits required to maintain existing capital - in the world economy during low inflation. No-one chooses it during low inflation or deflation because it is not a binding IFRS: it is an option. It is nullified as our Taiwanese friends so eloquently state. I would also point to the waste of IASB resources in producing a document simply to be nullified by making it optional as in the case of financial capital maintenance in units of constant purchasing power during low inflation and deflation over the last 21 years.


Content elements of a decision-useful management commentary

Question 2

Do you agree that the content elements described in paragraphs 24–39 are necessary for the preparation of a decision-useful management commentary? If not, how should those content elements be changed to provide decision-useful information to users of financial reports?

Yes, I agree, but, I suggest that the following (in italics) should be added to paragraphs 29 and 33:

Paragraph 29

Disclosure about resources depends on the nature of the entity and the industry in which the entity operates. Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity. Analysis of the adequacy of the entity’s capital structure,


“with reference to the concept of capital maintenance: in particular

(1) supplying details of the real value destroyed in shareholders´ equity never maintained constant in real value as a result of insufficient revaluable fixed assets under Historical Cost Accounting when the entity has chosen financial capital maintenance in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a) and

(2) supplying details of the gain to the entity if it should choose continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation also authorized by the IASB in the Framework, Par 104 (a). ”

“Analysis of” financial arrangements (whether or not recognised in the statement of financial position), liquidity and cash flows, as well as plans to address any identified inadequacies

“- specifically the identified inadequacy of financial capital maintenance in nominal monetary units per se to maintain the real value of shareholders´ equity and other constant items constant during inflation and deflation taking into account the fact that its remedy, namely, continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation has been authorized by the IASB 21 years ago” - or surplus resources, are examples of disclosures that can provide useful information.

Paragraph 33

Management commentary should include a clear description of the entity’s financial and non-financial performance, the extent to which
that performance may be indicative of future performance and management’s assessment of the entity’s prospects. Useful disclosure in
that area can help users to make their own assessments about the assumptions and judgements used by management in preparing the financial statements

“specifically management’s justification in entities implementing the HCA model for their choice to measure financial capital maintenance in nominal monetary units during low inflation and deflation instead of in units of constant purchasing power in terms of the IASB´s Framework, Par 104 (a).”


Application guidance and illustrative examples

Question 3

Do you agree with the Board’s decision not to include detailed application guidance and illustrative examples in the final management commentary guidance document? If not, what specific guidance would you include and why?

No, I do not agree. The Board should include detailed application guidance to cover the items detailed in paragraphs 24-39 in the Exposure Draft as to be amended as suggested above and specifically include the following:

Management have to:

(1) state in the Management Commentary that their choice of the traditional Historical Cost basis which includes the stable measuring unit assumption, destroys the real value of constant real value non-monetary items never maintained, at a rate equal to the annual rate of inflation;

(2) state that this includes the destruction of the real value of Shareholders´ Equity when the entity does not have sufficient fixed assets that are or can be revalued via the Revaluation Reserve equal to the updated original real value of all contributions to Shareholders’ Equity under the HC basis;

(3) state the percentage and amount of Shareholders´ Equity that are not being maintained; i.e., the percentage and amount of Shareholders´ Equity that are subject to real value destruction at a rate equal to the annual inflation rate because of management’s choice, in terms of the Framework, Par 104 (a), to maintain financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – both practices being compliant with IFRS;

(4) state the amount of real value destroyed during the last and previous financial years in Shareholders´ Equity and all other constant items never maintained because of management’s choice to implement the Historical Cost Accounting model;

(5) state the updated total amount of real value destroyed from the entity’s inception to date in this manner in at least Shareholders´ Equity never maintained as described above;

(6) state the change in the updated real value of Shareholders´ Equity if management should decide – as they are freely allowed to do at any time - to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a);

(7) state management’s estimate of the amount of real value to be destroyed by their implementation of the stable measuring unit assumption during the following accounting year under the HC basis;

(8) state that the real value calculated in (7) represents the amount of real value the entity would gain during the following accounting year and every year there after for an unlimited period of time – ceteris paribus – when management choose to measure financial capital maintenance in units of constant purchasing power – which is compliant with IFRS – as authorized by the IASB in the Framework, Par 104 (a) in 1989 which they are free to choose any time they decide;

(9) state management’s reason(s) for choosing financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par 104 (a).

Rationale for my answers and suggestions above:

It is relevant information for existing and potential capital providers that the real value of the capital they provided - or are about to provide - to an entity as well as their share of other items in shareholders´ equity, e.g. retained profits which are possible dividends to them, are unnecessarily being destroyed - or would unnecessarily, be destroyed - at a rate equal to the annual rate of inflation as a result of the implementation of the Historical Cost Accounting model during low inflation for the portion of the real value of shareholders´ equity which is not maintained constant as a result of insufficient revaluable fixed assets under HCA.

It is equally relevant information for existing and potential capital providers that continuous financial capital maintenance in units of constant purchasing power which has also been authorized by the IASB 21 years ago in the Framework, Par 104 (a) would maintain the real value of shareholders´ equity and all other constant real value non-monetary items constant at all levels of inflation and deflation for an unlimited period of time in all entities that at least break even – ceteris paribus - irrespective of whether an entity owns revaluable fixed assets or not. This would happen automatically as a result of a correct IASB-authorized basic accounting model approved in 1989 at all levels of inflation and deflation without requiring more money from capital providers for additional capital contributions or additional retained profits to simply maintain existing equity’s existing real value.

The Framework, Par 104 (a) states:

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

Constant items are one of the three fundamentally different basic economic items in the economy. The other two are monetary items and variable real value non-monetary items. Variable items are non-monetary items with variable real values over time. Examples are property, plant, equipment, inventory, finished goods, foreign exchange, etc. Constant items are non-monetary items with constant real values over time. Examples are all items in the income statement, all items in shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, provisions, all non-monetary payables, all non-monetary receivables, etc. Constant items have to be continuously valued in units of constant purchasing power in order to maintain their real values constant during inflation and deflation.

The generally accepted view under the HC paradigm that economic items consist of only monetary and non-monetary items avoids the proper split of non-monetary items in variable and constant items because of the implementation of the stable measuring unit assumption. This results in variable items valued at HC (e.g. fixed assets, inventory, etc.) and constant items currently also valued at HC (e.g. shareholders´ equity and most items in the income statement – excluding salaries, wages, rentals and other items normally inflation-adjusted) being classified as simply non-monetary items under HCA.

The real value of shareholders´ equity currently being valued at HC is only 100% maintained constant in the rare cases where 100% of the updated original real values of all contributions to shareholders´ equity are invested in revaluable fixed assets. It is hardly ever the case that even 100% of the updated original real values of all contributions to shareholders´ equity excluding retained profits are invested in revaluable fixed assets. Retained profits in most entities are thus treated the same as monetary items (cash) and their real values are being destroyed at a rate equal to the annual rate of inflation when financial capital maintenance is measured in nominal monetary units in low inflationary economies.

The stable measuring unit assumption is based on the fallacy that changes in the purchasing power of money are not sufficiently important for entities to choose to continuously measure financial capital maintenance in units of constant purchasing power
during low inflation and deflation as authorized by the IASB in the Framework, Par 104(a). Hyperinflation is defined by the IASB as 100% cumulative inflation over three years, i.e. 26% annual inflation for 3 years in a row. Financial capital maintenance in units of
constant purchasing power is required by the IASB in IAS 29 during hyperinflation: it is thus required at 26% annual inflation for 3 years in a row. It is, however, left as an option at 20% or 15% or 6% or 2% for three years in a row or any number of years. Real value destruction in constant items never maintained constant by the implementation of the stable measuring unit assumption at continuous 20% inflation (which would wipe out 100% of the real value of shareholders´ equity never maintained constant in 4 years) is currently considered as not sufficiently important for the implementation of continuous financial capital maintenance in units of constant purchasing power. Financial capital maintenance in nominal monetary units per se currently unknowingly, unnecessarily and
unintentionally destroy 51% of the real value of shareholders´ equity and all other constant items never maintained constant over 35 years in all economies with continuous 2% annual inflation.

Financial capital maintenance in nominal monetary units per se as authorized by the IASB in the Framework, Par 104 (a) is a fallacy during low inflation and deflation. IFRS should not be based on fallacies as they currently are. It is impossible to maintain the real value of entities´ capital and profits constant with financial capital maintenance in nominal monetary units per se during inflation and deflation. The only way to maintain the real value of capital and profits constant for an unlimited period of time in entities that at least
break even during low inflation and deflation – all else being equal - is with continuous financial capital maintenance in units of constant purchasing power per se irrespective of whether those entities own fixed assets or not. There is no other way.

“The erosion of business profits and invested capital caused by inflation” is generally accepted.

“In Mr. Mosso's view, conventional accounting measurements fail to capture the erosion of business profits and invested capital caused by inflation.” FAS 33, 1979, P 24 (superseded by FAS 89)

There is absolutely no doubt in the accounting profession that real value is being destroyed in entities´ capital and profits and there is equally absolutely no doubt in the accounting profession that it is caused by inflation. In fact, “the erosion of business profits and invested capital caused by inflation” is a fallacy. Inflation is always and everywhere a monetary phenomenon as per the late American Nobel Laureate Milton Friedman. Inflation destroys the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. It is impossible for inflation per se to destroy the real value of non-monetary items.

“Purchasing power of non monetary items does not change in spite of variation in national currency value.” Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

It is not inflation doing the destroying: it is unnecessary, unknowing and unintentional destruction by the implementation of the stable measuring unit assumption under financial capital maintenance in nominal monetary units (the HCA model) during low inflation - as authorized by the IASB in the Framework, Par 104 (a) - of the real value of constant items never maintained constant amounting to hundreds of billions of Euros (probably much more) in the world economy each and every year. It is relatively easy for individual entities to calculate the amount of real value unnecessarily, unknowingly and unintentionally being destroyed as indicated above during the current year in low inflationary economies. That would give an estimate of the annual value to be gained from changing over to continuous financial capital maintenance in units of constant purchasing power as authorized by the IASB twenty one years ago. Basically it is Retained Earnings times the average rate of annual inflation in most entities.

The real values of all constant items, e.g. shareholders´ equity, will knowingly be maintained constant for an unlimited period of time in all entities that at least break even with continuous financial capital maintenance in units of constant purchasing power – ceteris paribus – amounting to hundreds of billions of Euros (probably much more) in the world economy each and every year, no matter what the rate of inflation without requiring more money for additional capital or additional retained profits to maintain the existing real values of existing constant items constant - whether entities own revaluable fixed assets or not. It is simply a matter of maintaining existing real value as indicated above instead of currently unnecessarily, unknowingly and unintentionally destroying existing real value.

Continuous financial capital maintenance in units of constant purchasing power only results in zero destruction of real value in constant items for an unlimited period of time at any level of inflation or deflation in entities that at least break even – ceteris paribus. It has no direct effect on the rate of inflation or deflation.

The removal of the 5 words “either nominal monetary units or” from the IASB Framework, Par 104 (a) would make this comment letter and appendix superfluous.

No other issues noted.

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This comment letter is published HERE on the IFRS Foundation website with ID CL32.

Copyright © 2010 Nicolaas J Smith