Constant and variable items defined in IFRS

The terms constant real value non-monetary items and variable real value non-monetary items are new specific terms for old concepts.

IFRS only define two economic items directly: monetary items (IAS 29 Par 12 and IAS 21 Par 8) and non-monetary items (IAS 29 Par 14). There are, however, three fundamentally different basic economic items in the economy:

1. Monetary items

2. Variable real value non-monetary items

3. Constant real value non-monetary items

Constant real value non-monetary items and variable real value non-monetary items are defined indirectly in IFRS.

According to the Framework, Par 104 (a) financial capital maintenance can be measured in units of constant purchasing power during low inflation and deflation. Although IAS 29 is only to be applied during hyperinflation, it defines monetary and non-monetary items in general. According to IAS 29 Par 12: “Monetary items are not restated because they are already expressed in terms of the monetary unit current at the balance sheet date.”

IAS 29 Par 14 defines non-monetary items as all items that are not monetary items. Since monetary items are not restated only non-monetary items can thus be measured in units of constant purchasing power or inflation-adjusted or restated or updated. As such, non-monetary items measured in units of constant purchasing power during low inflation and deflation are thus constant real value non-monetary items; e.g. all income statement items, all items in shareholders´ equity, trade debtors, trade creditors, taxes payable and receivable, etc.

Non-monetary items that are not measured in units of constant purchasing power during low inflation and deflation are thus variable real value non-monetary items since they have variable real values over time and are valued in terms of specific IFRS.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Basis for Historical Cost Accounting

“In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued.” IAS 29 Par 6. HCA is the generally accepted traditional basic accounting model used by most entities during low inflation and deflation.

IFRS only define two economic items: monetary items (IAS 29 Par 12 and IAS 21 Par 8) and non-monetary items (IAS 29 Par 14). There are, however, three fundamentally distinct basic economic items in the economy as defined above. Constant real value non-monetary items and variable real value non-monetary items are defined indirectly in IFRS. According to the Framework, Par 104 (a) financial capital maintenance can be measured in units of constant purchasing power during low inflation and deflation. Although IAS 29 is only to be applied during hyperinflation, it defines monetary and non-monetary items. According to IAS 29 Par 12: “Monetary items are not restated because they are already expressed in terms of the monetary unit current at the balance sheet date.”

IAS 29 Par 14 defines non-monetary items as all items that are not monetary items. Since monetary items are not restated only non-monetary items can thus be measured in units of constant purchasing power or inflation-adjusted or restated or updated during inflation and deflation. As such, non-monetary items measured in units of constant purchasing power during low inflation and deflation are thus constant real value non-monetary items; e.g. all income statement items, all items in shareholders´ equity, trade debtors, trade creditors, taxes payable and receivable, etc. Non-monetary items that are not measured in units of constant purchasing power during low inflation and deflation are thus variable real value non-monetary items since they have variable real values over time and are valued in terms of specific IFRS.

Non-monetary items also include Historical Cost items based on the stable measuring unit assumption under the HCA model.

One of the basic principles in accounting is “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency.

This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.” ²

Inflation is always and everywhere a monetary phenomenon. Milton Friedman. Money (the functional currency) is not perfectly stable during inflation and deflation. Inflation destroys the real value of money and other monetary items at the rate of inflation as indicated by the change in the Consumer Price Index. Sustainable zero annual inflation has never been achieved in the past and is not likely to be achieved any time soon in the future.

HC accountants, on the other hand, simply assume that the functional currency (money) is perfectly stable in low inflationary and deflationary economies only for the purpose of valuing balance sheet constant items which they account as HC items; they measure them in nominal monetary units implementing financial capital maintenance in nominal monetary units. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant items, namely salaries, wages, rentals, etc which they inflation-adjust annually. HC accountants value other income statement items in nominal monetary units, i.e. at HC. HC accountants do not regard changes in the general purchasing power or real value of money to be sufficiently important during low inflation and deflation to continuously measure financial capital maintenance in units of constant purchasing power as they have been authorized in IFRS in the Framework, Par 104 (a) in 1989. They generally choose to implement financial capital maintenance in nominal monetary units, also authorized in IFRS in the Framework, Par 104 (a). However, it is impossible to maintain the real value of financial capital constant by measuring financial capital maintenance in nominal monetary units per se during inflation and deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a popular accounting fallacy.

This led accountants to choose to implement the traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption (also IFRS-approved and also based on a fallacy) for an unlimited period of time during indefinite low inflation. They value both variable items stated at HC in terms of IFRS, as well as constant items also stated at HC in terms of the HCA model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant items are thus considered by accountants to be simply HC non-monetary items.

SA accountants thus treat the portion of Shareholders´ Equity in SA companies not maintained constant by investment in sufficient revaluable fixed assets as a monetary item. They thus unknowingly destroy its real value at a rate equal to the annual rate of inflation amounting in total to about R200 billion per annum in the SA real economy.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Is your accountant looking after your capital?

No, he or she is not!

It is all actually quite simple to understand: your accountant ASSUMES there is NO inflation (that the Rand is PERFECTLY stable) ONLY when he values constant real value non-monetary items, e.g. the actual capital you used to start your company as it is currently accounted in your balance sheet. I assume you have a small business and you don´t own any revaluable fixed assets in your business. Even if you have the biggest business on the JSE you most probably did not invest 100% of all original contributions to your shareholders´ equity in revaluable fixed assets now with an equivalent updated fair value equal to the updated real value of your equity. In doing that he treats your capital the same as CASH and he unknowingly destroys the real value of your capital because he ASSUMES the Rand is perfectly stable ONLY for this purpose. He will never ever advise you to keep your company cash in the bank at zero interest - but, he is doing that with your capital in your company. He and all other accountants.

He has been authorized 21 years ago to update your capital during LOW inflation. He doesn´t do it because he thinks (because everyone in the world thinks) that inflation is doing the destroying. He and they are wrong. Inflation can only destroy the real value of the Rand - nothing else. Inflation has no effect on the real value of non-monetary items: your capital is a constant real value non-monetary item.

It is not inflation doing the destroying: he is unknowingly doing the destroying because he has been authorized 21 years ago to value your capital in UNITS OF CONSTANT PURCHASING POWER (to inflation-adjust your capital) during LOW inflation.

When he values your capital AS WELL AS ALL OTHER constant real value non-monetary items in your business (ONLY constant items) in UNITS OF CONSTANT PURCHASING POWER he will maintain the constant real value of your capital constant forever - as long as your business breaks even forever - whether you have revaluable fixed assets in your business or not. You are not required to pay in more money for extra capital or retain more profits simply to keep the existing real value of your existing capital constant. It is automatically done when he updates ALL constant items (ONLY constant items, but, ALL of them - including trade debtors) in your business - as long as you break even in your business.

It is not the same as inflation, but, it is SIMILAR to him arranging ZERO INFLATION in all your constant items: e.g. your capital.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

IFRS define three concepts of Capital Maintenance

FRS authorized financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par. 104 (a) which means that there are three concepts of capital maintenance authorized in IFRS since 1989.

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Copyright © 2010 Nicolaas J Smith

Inflation is not a solution

According to The Economist the merits of inflation as a solution to the rich world’s problems are easily overstated.

Inflation is always and everywhere a monetary phenomenon: Milton Friedman. Inflation only destroys the real value of money and other monetary items, e.g. bonds – 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 any non-monetary item.

Banks´ and companies´ capital and profits are constant real value non-monetary items. Constant items, e.g. shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, all items in the income statement, etc, have constant real non-monetary values over time. Inflation can thus not destroy the real value of banks´ and companies´ capital and profits.

However, everybody believes the fallacy that the erosion of banks´ and companies´ capital and profits is caused by inflation, including the IASB, FASB and most accountants. They and other accounting authorities, accounting professors and lecturers thus clearly know and admit that real value is currently being destroyed in banks´ and companies´ capital and profits. Everyone mistakenly think it is inflation doing the destroying.

It is not inflation, but, accountants´ choice of financial capital maintenance in nominal monetary units, another fallacy, as authorized by the IASB in the Framework, Par 104 (a) in 1989 which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” which is doing the destroying. Financial capital maintenance in nominal monetary units is the 700 year old, generally accepted, traditional Historical Cost Accounting model which includes accountants´ very destructive stable measuring unit assumption based on the fallacy that changes in the purchasing power of the monetary unit of account is not sufficiently important during low inflation to require them to measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) in 1989. It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during low inflation and deflation as stated by the IASB.

Accountants unknowingly and unnecessarily destroy the portion of the real value of banks´ and companies´ capital and profits generally never maintained with sufficient revaluable fixed assets under HCA during low inflation at a rate equal to the annual rate of inflation amounting to hundreds of billions of Euros (probably much more) in the world economy every year. Everyone mistakenly thinks it is inflation doing the destroying. Accountants would knowingly stop this destruction and boost the world economy by hundreds of billions of Euros (probably much more) every year with financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) 21 years ago – for an unlimited period of time in all entities that at least break even – ceteris paribus – without extra money or extra retained profits to maintain the existing real value of capital and profits. They would maintain existing constant item real values by not destroying existing values with their very destructive stable measuring unit assumption in a double entry accounting model in real value maintaining units of constant purchasing power instead of in real value destroying nominal monetary units during inflation.

The real value of the portion of capital and profits generally never maintained with sufficient revaluable fixed assets under HCA (normally at least retained profits) are treated like monetary items by accountants with their real values destroyed not by inflation, but, unknowingly by accountants implementing their very destructive stable measuring unit assumption at a rate equal to the annual rate of inflation.

An increase of inflation from 2% to 4% would double the unknowing destruction by accountants in banks´ and companies´ long term capital and investment base besides the effects as stated in the article.

The current 2% or an increased 4% unknowing destruction can knowingly be stopped by entities freely choosing 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) 21 years ago. There is no other way during inflation and deflation. It is complaint with IFRS. Currently IFRS are based on fallacies. IFRS should not be based on fallacies.

Copyright © 2010 Nicolaas J Smith

It wasn't them

Accorging to The Economist Alan Greenspan and Ben Bernanke still do not believe monetary policy bears any blame for the crisis.

Part of the remedy for the crisis was strengthening banks’ capital. Most big banks implement IFRS; consequently their accountants have to make a critical choice in terms of the IASB´s Framework, Par 104 (a) authorized twenty one years ago which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” Banks are given this choice during low inflation and deflation. They have to choose the one or the other when they choose a financial concept of capital as all banks do.

They all choose financial capital maintenance in nominal monetary units per se which is a complete fallacy during low inflation and deflation: it is impossible to maintain the real value of financial capital constant when measuring financial capital maintenance in nominal monetary units per se during low inflation and deflation. The only way banks can maintain the real value of their capital constant during low inflation is with 100% investment of the updated original real values of all contributions to shareholders´ equity in revaluable fixed assets with an equivalent updated fair value – revalued or not – under Historical Cost Accounting during low inflation.

Most probably not a single bank qualifies for the 100% investment rule. Most probably not a single bank qualifies for that rule even with respect to just equity excluding retained earnings. The portion of the updated real value of banks´ equity not covered by revaluable fixed assets under HCA is thus treated by their HC accountants as simply the same as a monetary item: i.e. they value it at Historical Cost as part of financial capital maintenance in nominal monetary units during low inflation. The real value of the portion not maintained with sufficient revaluable fixed assets is thus unknowingly, unnecessarily and unintentionally being destroyed at a rate equal to the annual rate of inflation by HC accountants implementing their very destructive stable measuring unit assumption (which is based on a fallacy) as part of financial capital maintenance in nominal monetary units (the IFRS authorized fallacy) during low inflation.

The real value of most probably all banks´ retained earnings is thus unnecessarily, unknowingly and unintentionally being destroyed by their accountant’s free choice of financial capital maintenance in units of nominal monetary units during low inflation as authorized in IFRS in the Framework, Par 104 (a) in 1989.

Amazingly the only and perfect remedy to the problem was authorized in IFRS as a free choice to accountants in the exact same IASB´s Framework, Par 104 (a) twenty one years ago, namely, financial capital maintenance in units of constant purchasing power during low inflation and deflation. All banks´ accountants are free to choose this option any time they want. If they had chosen that option in 1989, the world’s banking system would have been much more robust before, during and after the crisis. No-one stops them from doing it now.

HC accountants world wide are unnecessarily, unknowingly and unintentionally destroying hundreds of billion of Euros (perhaps much more) per annum in the real value of companies´ and banks´ shareholders´ equity never maintained with sufficient revaluable fixed assets at a rate equal to the annual rate of inflation year in year out while they implement traditional Historical Cost Accounting during low inflation. They will stop this unnecessary, unknowing and unintentional destruction forever the moment they freely choose financial capital maintenance in units of constant purchasing power during low inflation as authorized in IFRS in the Framework, Par 104 (a) any time they want. They will knowingly boost the world’s real economy with hundreds of billions of Euros (perhaps much more) per annum for an unlimited period of time when they freely switch over to financial capital maintenance in units of constant purchasing power as authorized in IFRS in the IASB´s Framework, Par 104 (a) twenty one years ago.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Capital maintenance - Part 1

No-one will disagree that 5.7% annual inflation and not SA accountants destroy the real value of the Rand and other monetary items in the SA monetary economy despite the fact that the SARB regards the destruction of about R114 billion per annum in the real value of the Rand as the achievement and maintenance of “price stability” in the SA economic system. Obviously it is not price stability at all. It is 5.7 % or R114 billion per annum away from price stability. It is the SARB´s choice of “price stability”: their definition of “price stability”. Absolute price stability is a year-on-year increase of zero percent in the Consumer Price Index.

SA accountants freely choose HCA

By doing listed companies´ accounts in terms of IFRS as required by the rules of the Johannesburg Stock Exchange, SA boards of directors – advised by the accountants on the boards - have to choose between a physical and a financial capital concept in terms of the IASB´s Framework, Par 102. According to Par103 the choice of the appropriate concept of capital by a company should be based on the needs of the users of its financial reports.

A company’s capital is synonymous with its Shareholders´ Equity or Net Assets when a financial concept of capital, such as invested purchasing power or invested money, is chosen. Most, if not all, boards of directors of SA companies decide that they will adopt, in terms of the Framework, Par 102, a financial (instead of a physical) concept of capital, namely invested money (instead of invested purchasing power), in preparing their companies’ financial statements. As a result of choosing a financial concept of capital, namely invested money in terms of Par 102, the boards of directors next choose a financial concept of capital maintenance in terms of Par 104.

Under the financial capital maintenance concept a company, in terms of the Framework, Par 104, only earns a profit when the financial (or money) value of the net assets at the end of the accounting period exceeds the financial (or money) value of net assets at the beginning of the period, after excluding any contributions from and distributions to shareholders during the accounting period. This is obviously not correct in real or constant purchasing power terms - only in nominal terms.

SA listed company boards of directors generally choose financial capital maintenance in nominal monetary units in terms of Par 104 (a) because, in their opinion - in terms of Par 103 - the users of the company’s financial statements are primarily concerned with the maintenance of nominal invested capital instead of the maintenance of the purchasing power of invested capital when a financial capital maintenance in units of constant purchasing power concept – as per Par 104 (a) – should be used. The boards of directors thus choose to do their companies´ accounts based on the traditional Historical Cost Accounting model. They believe and support the IASB statement in Par 104 (a) that “financial capital maintenance can be measured in nominal monetary units” which is a complete fallacy during inflation and deflation. It is impossible to maintain the real value of Shareholders´ Equity constant with financial capital maintenance in nominal monetary units per se during inflation and deflation.

In my opinion, the users of SA companies´ financial statements are generally primarily concerned with the maintenance of the constant purchasing power (real value) instead of the nominal value of their invested capital.

It is only possible to maintain the real value of Shareholders´ Equity constant in nominal monetary units when 100% of the inflation-adjusted original real values of all contributions to Shareholders´ Equity are invested in revaluable fixed assets with an equivalent fair value - either revalued or with unrecorded holding gains - under the traditional Historical Cost Accounting model implemented by most companies in South Africa during low inflation. It is not normally the case in the SA economy that companies invest 100% of the original real values of all contributions to Shareholders´ Equity in revaluable fixed assets.

In terms of the Framework, Par 105, the capital maintenance concept deals with how companies define the capital they want to preserve. It is the link between the concept of capital and the concept of profit or loss since it is the point of reference for calculating profit or loss. A company first has to choose a capital maintenance concept before its return of capital and return on capital can be calculated. Only acquired net asset values greater than the capital maintenance requirement can be taken as profit; i.e. a return on capital.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Inflation at 5.7% pa. No way: SA accountants assume it is zero per cent - forever.

Statistics SA announces that the annual inflation rate came down to 5.7%

Gill Marcus reduces interest rates by half a per cent.

SA accountants say: No way: there is no such thing as inflation: inflation in SA is zero per cent, always has been zero per cent and will always in the future be zero per cent.
I state that all constant item accounts have to be adjusted during low inflation - as the IASB authorized 21 years ago.
The US Finanial Accounting Standard Board stated in FAS 33: "The erosion of business profits and invested capital caused by inflation" which is a complete fallacy.  In June, 2008 I also still believed it. Now I know it is a complete fallacy. Inflation per se has no direct effect and never in the past had any direct effect on any non-monetary item. Inflation is always and everywhere a monetary phenomenon. Inflation can only destroy or erode the real value of money and other monetary items - nothing else. The fact that the FASB, the IASB and most accountants believe that the erosion of business profits and invested capital is caused by inflation will never make it so.

So, although the IASB authorized SA accountants 21 years ago to measure financial capital maintenance in units of constant purchasing power during low inflation (see the Framework, Par 104 a) they refuse point blank to do it.

SA accountants will rather unknowingly destroy about R200 billion each and every year in SA companies´ capital and profits never maintained, than listen to the IASB and implement financial capital maintenance in units of constant purchasing power - as the IASB authorized them to do 21 years ago.
Yes, I do say they are terrible destroyers of real value in the SA constant item economy, albeit unknowingly and unintentionally. They still do it - year after year after year.

Gill Marcus said: "But growth in private sector fixed capital formation remains negative:" Of course it will remain negative with SA accountants unknowingly destroying about R200 billion pa in SA Shareholders´ Equity never maintained (SA´s fixed capital base) with their very destructive stable measuring unit assumption.

Copyright © 2010 Nicolaas J Smith

SA accountants unknowingly destroy more real value than inflation

A company’s capital is synonymous with its Net Assets or Shareholders Equity under a financial concept of capital such as invested money or invested purchasing power.

100% of the inflation-adjusted original real values of all contributions to Shareholders´ Equity have to be invested in revaluable fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) in order not to destroy Shareholders Equity’s real value during low inflation under the traditional Historical Cost Accounting model – i.e. measuring financial capital maintenance in nominal monetary units - implemented by most, if not all, companies in South Africa.

The real value of the portion not invested as such is currently unknowingly being destroyed at a rate equal to the annual rate of inflation when the constant real value non-monetary item Shareholders Equity is measured in nominal monetary units, i.e. implementing the very destructive stable measuring unit assumption as done by most, if not all, accountants in SA when they maintain HCA for an unlimited period of time during indefinite low inflation.

Most companies do not meet the requirement to investment 100% of the original real value of all contributions to Shareholders´ Equity in revaluable fixed assets. In practice this means that the real value of Retained Profits never maintained of most SA companies and banks are unknowingly, unintentionally and unnecessarily being destroyed at a rate equal to the annual rate of inflation by SA accountants implementing the IASB-approved traditional HCA model.

Implementing the IASB-approved alternative, namely, financial capital maintenance in units of constant purchasing power as authorized in 1989 in the exact same Framework, Par 104 (a), would stop this unknowing destruction by SA accountants forever under all levels of inflation in all entities that at least break even - whether they own revaluable fixed assets or not - and without the requirement of more money or more Retained Earnings just to maintain the real value of existing Shareholders´ Equity.
One percent inflation destroys about R20 billion per annum in the real value of the Rand in SA. 5.7% annual inflation (Feb 2010) thus destroys about R114 billion per annum in the real value of the Rand.

SA accountants would maintain instead of currently unknowingly and unnecessarily destroy about R200 billion per annum in constant item real value in the SA real economy when they reject the stable measuring unit assumption as approved by the IASB in the Framework, Par 104 (a). SA accountants thus unknowingly, unnecessarily and unintentionally destroy more real value in the SA real economy than inflation.

This R200 billion per annum completely unnecessary real value destruction can be reduced to zero overnight by SA accountants simply implementing the other option authorized by the IASB twenty one years ago in the Framework, Par 104 (a), namely financial capital maintenance in units of constant purchasing power.

Makes you think, doesn´t it?
Copyright © 2010 Nicolaas J Smith

The difference between disinflation and deflation

Deflation is a sustained absolute decrease in the general price level resulting in a sustained increase in the real value of the functional currency (money) and other monetary items.

The functional currency is the currency of the primary economic environment in which an entity operates. It is normally the national or regional currency or monetary unit and monetary unit of account in an economy or monetary union like the Rand in South Africa and the Euro in the European Monetary Union. In dollarized economies the functional currency – recently mostly the US Dollar – is a relatively stable currency of another (the US) national or regional economy. The German Mark was also used in the past for the same purpose.

Deflation only happens below zero percent annual inflation. Deflation is not one or more months of month-on-month negative inflation during a twelve month period when it does not result in an absolute year-on-year decrease in the general price level. Deflation is the opposite of annual inflation. Deflation is negative annual inflation.

Money and other monetary items are worth more all the time during deflation as opposed to being worth less all the time during inflation. Inflation destroys the real value of money and other monetary items. Deflation creates more real value in money and other monetary items.

Disinflation is simply lower inflation. Disinflation is a decrease in the rate of inflation. Prices in an economy are still rising during disinflation, but at a slower rate. The general price level still rises, but, at a slower rate resulting in a continued, but, lower rate of real value destruction in money and other monetary items.

Disinflation is a lowering of the rate of increase in the general price level. A lowering of the absolute value of the general price level is deflation.

Deflation means the general price level is not increasing at all, but, actually decreasing continuously and money and other monetary items are worth more all the time. Deflation causes an increase in the real value of money and other monetary items.

Inflation destroys the real value of money. Disinflation destroys the real value of money at a slower rate. Deflation creates more real value in money.

Inflation is a sustained increase in the general price level. Disinflation is a slower sustained increase in the general price level. Deflation is a sustained decrease in the general price level.

Disinflation happens, for example, after a period of higher inflation in what are normally considered low inflationary economies and often is initially popularly confused with deflation. During disinflation many prominent prices, for example, oil, fuel, property and food prices are falling, but, the general price level is still actually rising, albeit at a slower rate than during normal low inflation. When the slowing annual inflation rate (slowing increase in general price level) moves lower and lower it eventually gets to a zero percent annual rate. The absolute value of the general price level decrease; i.e. the economy switches over from inflation to deflation: not just a slower increase in the generally increasing price level as during disinflation but actually a sustained decrease in the absolute value of the general price level below zero percent inflation which causes an increase in the real value of money and other monetary items: deflation.

Countries, excluding Japan, have little experience of deflation. Deflation is generally regarded as a very serious economic problem that everyone is trying to avoid at all costs especially after what happened during the Great Depression. Japan, however, has been moving in and out of deflation over the last 15 years or more.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

One who does not ask a question remains a fool forever

One who asks a question is a fool for five minutes; one who does not ask a question remains a fool forever. Chinese Proverb

The Framework applies

SA accountants of companies listed on the Johannesburg Stock Exchange have to prepare primary financial reports in terms of the IASB´s International Financial Reporting Standards. IFRS are Standards, Interpretations and the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the IASB´s Framework for the Preparation and Presentation of Financial Statements in the absence of a Standard or an Interpretation that specifically applies to a transaction.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8." IAS Plus, Deloitte. Date: 21st March, 2010 http://www.iasplus.com/standard/framewk.htm

IAS8, 11:
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

There are no specific IFRS relating to the valuation of the constant items Issued Share Capital, Retained Earnings, other items in Shareholders Equity, the concepts of capital, the concepts of capital maintenance and the determination of profit or loss. The definitions, the concepts for their measurement and the criteria for their recognition in the Framework are thus applicable in terms of IAS8.11.

A fundamental attribute of the traditional Historical Cost Accounting model which SA boards of directors select when they decide on behalf of JSE listed companies to measure financial capital maintenance in nominal monetary units (a generally accepted accounting fallacy) in terms of the IASB´s Framework, Par 104 (a) is that the companies´ accountants unknowingly, unnecessarily and unintentionally destroy the real values of constant items never maintained as a result of their implementation of the very destructive stable measuring unit assumption.

Accountants, on the other hand, unknowingly create real value in constant items never maintained constant (not decreased at a rate equal to the rate of deflation) as a result of their implementation of the real value creating stable measuring unit assumption during deflation (today mainly in Japan).

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Three concepts of capital maintenance under IFRS

IFRS authorized financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par. 104 (a) which means that there are three concepts of capital maintenance authorized in IFRS since 1989.


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© 2010 Nicolaas J Smith. All rights reserved
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Value does not always exist independently of how we measure it

Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.” As quoted in FAS 33 p. 29.

Shareholder’s equity forms part of an entity’s financial resources.

“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.” IASB Exposure Draft: Management Commentary, June 2009, Par 29.

Shareholders´ equity is a financial resource with a constant real non-monetary value expressed in terms of monetary unit of measure. The IASB statement in the Framework, Par 104 (a) that “financial capital maintenance can be measured in nominal monetary units” is a fallacy.

There is no substance in the claim that the existence and value of economic resources, for example shareholders´ equity items, exist independently of how we measure them - and that the choice of the measuring unit does not affect their fundamental values, only how we choose to represent that value – and that we can use Rands, Rands of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced. See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices SA accountants make will not change that value and will not affect the SA economy.

If SA accountants understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional destruction by SA accountants of massive amounts of real value in constant items never maintained in the SA constant item economy, they would have called for its rejection by now.
Copyright © 2010 Nicolaas J Smith

The Historical Cost Mistake

Constant ITEM Purchasing Power Accounting, the financial capital maintenance in units of constant purchasing power model is, unfortunately, not chosen by a single SA accountant in SA to measure financial capital maintenance in real value maintaining units of constant purchasing power despite the fact that it is authorized in the IASB´s Framework, Par 104 (a) since 1989 as an alternative to the very destructive traditional HC model at all levels of low inflation and deflation. SA accountants value balance sheet constant real value non-monetary items using the traditional HC model in terms of which they implement the stable measuring unit assumption. SA accountants unknowingly destroy the real values of constant items never maintained at a rate equal to the rate of inflation because they, unfortunately, choose to measure financial capital maintenance in nominal monetary units when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. They unknowingly make the wrong choice. Since they all do it, since it is the traditional choice and since it is also authorized in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS, they unknowingly make the Historical Cost Mistake.

In the same breath, SA accountants do exactly the opposite: they acknowledge that inflation is destroying the real value of the depreciating Rand used as a depreciating monetary medium of exchange and they index or inflation-adjust by means of the CPI constant real value non-monetary income statement items like salaries, wages, rentals, etc by increasing their nominal values at a rate at least equal to the rate of inflation thus keeping their non-monetary real values constant over the time period in question.

On the one hand they acknowledge that the nominal values of income statement items like salaries and wages have to be indexed or inflation-adjusted by means of the CPI because inflation is destroying the real value of the Rand and on the other hand they assume - at exactly the same time and during exactly the same period - that the constantly depreciating Rand is perfectly stable, but, only for the valuation of balance sheet constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, provisions, other shareholder equity items, etc as well as for the other income statement items not inflation adjusted. SA accountants thus, unknowingly, destroy their real values at a rate equal to the rate of inflation to the amount of about R200 billion (Date 2010), year in year out, decade after decade when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Inflation has no effect on the real value of non-monetary items

Inflation cannot erode or destroy the real value of non-monetary items. Erode is in the case of the functional currency, in fact, the same as destroy – there is absolutely no difference. Inflation can only destroy the real value of the unstable monetary medium of exchange (the unstable functional currency - the unstable Rand) used to transfer the constant real non-monetary values of salaries and wages from the employer to the employee.

“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.

The destruction at a rate equal to the rate of inflation of all constant real value non-monetary items never maintained during inflation stops the very moment the Boards of Directors of SA companies and SA accountants choose to implement the IASB-approved financial capital maintenance in units of constant purchasing power model no matter what the level of inflation in the SA economy. The choice is theirs. The power to stop killing the real economy is in their hands - as authorized since 1989 in the IASB´s Framework, Par 104 (a) which is applicable in the absence of specific IFRS. It is SA accountants´ choice of accounting model and not inflation that maintains or destroys the real value of constant real value non-monetary items in SA´s low inflationary economy.

The constant real non-monetary values of salaries and wages expressed in terms of the depreciating unstable Rand as the depreciating unstable monetary unit of account are presently being maintained at the actual levels currently being achieved in SA when their nominal monetary values are indexed or inflation-adjusted by means of the CPI in SA´s low inflationary environment. This happens not because of a lowering of inflation, but because of SA accountants and SA trade unions valuing salaries and wages in units of constant purchasing power - inflation-adjusting them - instead of the Historical Cost measurement basis for this particular purpose.

If the parties to the salary and wage determination process were to agree to value salaries and wages at fixed Historical Cost – like Iceland recently decided to freeze salaries because of their financial crisis - then their constant real non-monetary values would be destroyed at a rate equal to the rate of inflation since constant real value non-monetary salaries and wages are expressed in term of the depreciating monetary unit of account in SA, namely, in depreciating Rands and are normally paid in depreciating Rands. Salaries and wages are not depreciating monetary items. They are constant real value non-monetary items. They are, however, normally paid in depreciating Rands which are depreciating monetary items during inflation.

“Income Statement

This standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date.” IAS 29, Par 26.

All items in the income statement are constant real value non-monetary items to be expressed or maintained or inflation-adjusted in terms of the measuring unit current (normally the CPI) at the balance sheet date in the case of IAS 29 and CIPPA models. Salaries and wages, being income statement items, are constant real value non-monetary items.

The real values of salaries and wages would thus not be destroyed by inflation if they were valued in nominal monetary units, but by the choice of the measurement basis, namely, Historical Cost which means the implementation of the very destructive stable measuring unit assumption whereby SA accountants consider that the continuous destruction of the purchasing power of the Rand – currently at 6.2% p.a. - is not sufficiently important to index or inflation-adjust the nominal values of constant real value non-monetary salaries and wages by means of the CPI in order to maintain their real values constant. What SA accountants do, in essence, is they assume the constantly depreciating monetary unit of account – the depreciating Rand – is perfectly stable when they implement the stable measuring unit assumption. SA accountants assume the depreciating Rand is perfectly stable, but, only for this particular purpose.

Constant purchasing power indexation or inflation-adjustment or measurement in units of constant purchasing power as authorized in the Framework, Par 104 (a) is thus applicable for financial capital maintenance in units of constant purchasing power since there is no particular IFRS which deals with it. It is a SA Generally Accepted Accounting Practice and well understood in SA´s low inflationary economy, but, currently, only for some - not all - constant real value non-monetary items in the income statement, e.g. salaries, wages, rentals, etc.
Copyright © 2010 Nicolaas J Smith

SA accountants are unknowingly doing the destroying - not inflation

We commonly find that SA companies state in their opening notes to their balance sheet that their financial reports have been prepared based on the traditional Historical Cost model. We normally find that they use different measurement bases to different degrees and in different combinations including constant items in the income statement that are indexed or inflation-adjusted or valued in units of constant purchasing power by applying the CPI in SA´s low inflationary economy: e.g. salaries, wages, rentals, utility fees, transport fees, etc. Indexation or inflation-adjustment or valuing in units of constant purchasing power is thus already a generally accepted accounting practice in SA´s low inflationary economy, but, only for some, not all, income statement items and not at all for balance sheet constant items. SA accountants generally choose financial capital maintenance in nominal monetary units implementing their very destructive stable measuring unit assumption unknowingly destroying about R200 billion per annum in the SA real economy.
The annual indexation or inflation-adjustment of salaries and wages in SA´s low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages during inflation. This involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating Rand payment values for constant real value non-monetary salaries and wages to maintain their purchasing power constant in the low inflationary SA economy where the real value of the Rand is continuously being destroyed by inflation of about 6% per annum which is the SARB´s definition of "price stability". The nominal values of constant real value non-monetary salaries and wages are thus increased or indexed or inflation-adjusted by means of the CPI to cover or compensate for at least the expected rate of destruction in the real value of the depreciating Rand which is the depreciating unstable monetary unit of account for accounting purposes as well as the depreciating unstable monetary medium of exchange for payment purposes in the SA economy. The period is normally for the year ahead. They normally agree on an additional percentage increase for increases in productivity or for social reasons.

Both parties to the salary and wage negotiations agree that constant real value non-monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very destructive stable measuring unit assumption whereby SA accountants simply assume that the depreciating Rand is perfectly stable in SA´s low inflationary economy. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated Rands whose real values are continuously being destroyed by inflation. They would not receive their full real values of their salaries and wages.

“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman.

Inflation can only destroy the real value of the depreciating unstable monetary medium of exchange (depreciating unstable money, i.e. the depreciating unstable functional currency inside an inflationary economy) - the depreciating unstable Rand in South Africa’s case - and other depreciating unstable monetary items.

Inflation has no effect on the real values of salaries and wages which are constant real value non-monetary items. Inflation can only destroy the real value of money and other monetary items. Accountants implementing the very destructive stable measuring unit assumption as part of the traditional HCA model unknowingly destroy the real value of salaries and wages when they do not inflation-adjust them by means of the CPI when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation; i.e. when they keep salaries fixed.

SA accountants are unknowingly doing the destroying - not inflation (as they so mistakenly believe) - and that inflation has no effect on the real value of any non-monetary item. Also inform them that SA accountants - with their full support - unknowingly destroy about R200 billion per annum in the SA constant item economy with financial capital maintenance in nominal monetary units per se - a complete fallacy - as authorized by the IASB in 1989. It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

Although, I am sure they realize that by now.
Copyright © 2010 Nicolaas J Smith

CIPPA during low inflation authorized by the IASB 21 years ago

Monetary Items

Current period monetary item accounts cannot be indexed or inflation-adjusted or valued in units of constant purchasing power under any accounting model because the real value of money cannot be maintained constant during inflation or deflation.

Variable items

It is not proposed on this blog that the historical costs of variable real value non-monetary items are to be value in units of constant purchasing power or to be consistently indexed or inflation-adjusted by SA accountants by means of the CPI for the purpose of valuation during the current accounting period, for financial capital maintenance and for calculating the period-end profit or loss during low inflation. I have never advocated inflation accounting during low inflation in SA.

Variable items are valued by SA accountants in terms of IFRS or SA Generally Accepted Accounting Practice. The IASB specifically requires the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. Variable items are required to be valued in units of constant purchasing power during hyperinflation in terms of IAS 29. SA has never experienced hyperinflation like, for example, Germany, Brazil and Turkey. That may explain a possible lack of profound analysis of price-level accounting in SA.

I believe SA will never experience hyperinflation. The culture of relatively low inflation and the understanding by the public in SA that low inflation is what long term sustainable economic growth is based upon are already solid parts of the SA economic identity.

It is very clear from the IASB´s Framework, Par 104 (a) that measuring financial capital maintenance in real value maintaining units of constant purchasing power is authorized by the IASB as the basis for a Constant ITEM Purchasing Power Accounting (CIPPA) model at any level of inflation and deflation. The IASB does not state that financial capital maintenance can be measured in nominal monetary units (the traditional HCA model) only during low inflation and that it can be measured in units of constant purchasing power only during high and hyperinflation. In typical international accounting standard fashion it simply states that either the one or the other can be used. That means at all levels of inflation and deflation.

The IASB does, however, specifically require the implementation of IAS 29 during hyperinflation. IAS 29 is based on the CPP inflation accounting model requiring all non-monetary items to be inflation-adjusted by means of the CPI during hyperinflation. This results in most accountants, accounting authorities, accounting professors and lecturers assuming that price-level accounting always refers only to inflation accounting. They thus ignore the CIPPA model authorised by the IASB in the Framework, Par 104 (a) in 1989 for financial capital maintenance in units of constant purchasing power during low inflation.

In the Framework, Par 101 the IASB states that companies most commonly use the traditional HC model to prepare their financial reports and that other measurement bases are used in combination with HC. The IASB does, however, specifically require entities only in hyperinflationary economies – being exceptional circumstances - to implement IAS 29.

The IASB - as far as measurement bases are concerned - specifically deals with historical cost, current cost, realizable (settlement) value, present value, market value, recoverable value and fair value, all of which SA accountants, in fact, use to value variable items in terms of IFRS or SA GAAP during low inflation in SA.

In the Framework, Par 104 (a) the IASB authorizes SA accountants to measure financial capital maintenance in real value maintaining units of constant purchasing power at all levels of inflation and deflation – including low inflation. Whenever they choose to do that, it would indicate that they choose the CIPPA model instead of their current choice, the very destructive traditional Historical Cost model.

Although SA accountants choose to measure financial capital maintenance in nominal monetary units, that is, they choose the very destructive HC model, they do, in fact, also use the real value maintaining constant purchasing power measurement basis to index or inflation-adjust some - not all - income statement constant real value non-monetary items like salaries, wages, rentals, transport fees, utility fees, etc by means of the CPI. They measure them in units of constant purchasing power instead of in nominal monetary units. SA accountants can also use real value maintaining units of constant purchasing power, in terms of the Framework, Par 104 (a), to value balance sheet constant items like Retained Earnings, Issued Share capital, other shareholder equity items, etc to implement a constant purchasing power concept of financial capital maintenance. The IASB notes that entities use various different measurement bases in varying combinations and to different degrees in their financial reports.

Copyright © 2010 Nicolaas J Smith

How to kill the stable measuring unit assumption

Non-monetary items are subdivided in variable and constant items. Only constant items have to be inflation-adjusted in terms of the Framework, Par 104 (a) to maintain their real values constant during low inflation in order to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units. That is what this blog is about. Variable items are valued in terms of IFRS or SA GAAP in a manner that takes into account all elements - including inflation - which determine the variable item’s real value at the date of valuation during low inflation and deflation. Monetary items are always valued at their original nominal monetary values under all accounting models and under all economic environments.

This blog is about SA accountants maintaining the real values of all constant real value non-monetary items - e.g., SA banks´ and companies´ Shareholders´ Equity – constant during low inflationary conditions for an unlimited period of time – ceteris paribus - by implementing the real value maintaining financial capital maintenance in units of constant purchasing power model as approved in the IASB´s Framework, Par 104 (a) in 1989.

This blog is about SA accountants indexing or inflation-adjusting only constant items by implementing the Constant ITEM Purchasing Power Accounting model as approved in the IASB´s Framework, instead of unknowingly and unintentionally destroying their real values on a massive scale with their implementation of the very destructive stable measuring unit assumption as it forms part of the traditional HCA model when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

This blog is about SA accountants choosing to measure financial capital maintenance in SA banks and companies in real value maintaining units of constant purchasing power during low inflation as approved in the IASB´s Framework, Par 104 (a) instead of in nominal monetary units as a result of their choice to implement the very destructive stable measuring unit assumption during low inflation also authorized by the IASB in the Framework, Par 104 (a) twenty one years ago.

This blog is about SA accountants rejecting the stable measuring unit assumption and instead adopting IASB-approved real value maintaining constant purchasing power units as the measurement basis for only constant items including SA banks´ and companies´ Shareholders´ Equity and not only for income statement constant items, e.g. salaries, wages, rentals, etc during non-hyperinflationary conditions.

This blog is about stopping SA accountants unknowingly destroying about R200 billion per annum in real value in the SA real economy because they choose to implement the traditional HCA model when they maintain the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation instead of the IASB-approved real value maintaining CIPPA model.

SA accountants make the Historical Cost Mistake by implementing the very destructive stable measuring unit assumption during inflation as part of the traditional HCA model for an unlimited period of time during indefinite inflation.

This blog is about SA accountants being able to maintain about R200 billion per annum of real value in the SA real economy for an unlimited period of time complying with IFRS instead of unknowingly destroying that value year in year out as they unknowingly do at the moment when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

This blog is about SA accountants abandoning the very destructive traditional HCA model and adopting the real value maintaining CIPPA model in SA´s low inflationary economy as authorized in 1989 in the IASB´s Framework, Par 104 (a).

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

SA accounting profession clueless about CIPPA

The statement that financial capital maintenance can be measured in either constant purchasing power units or in nominal monetary units in the IASB´s Framework, Par 104 (a) means that Constant ITEM Purchasing Power Accounting has been authorized by the IASB since 1989 as an alternative to the traditional HCA model during periods of low inflation. This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of constant purchasing power during low inflation since 1989.

Income statement constant real value non-monetary items like salaries, wages, rentals, utilities, transport fees, etc are normally valued by accountants in units of constant purchasing power during low inflation in most economies including South Africa. Payments in money for these items are normally inflation-adjusted by means of the CPI to compensate for the destruction of the real value of the unstable monetary medium of exchange by inflation. Inflation is always and everywhere a monetary phenomenon and can only destroy the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not destroy the real value of non-monetary items. See GUCENME and ARSOY.

Constant real value non-monetary items´ real values can be maintained by accountants choosing the CIPPA model as per the IASB´s Framework during low inflation as authorized since 1989 instead of currently unknowingly being destroyed by them by the implementation of the traditional HCA model when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. It is thus accountants´ choice of accounting model and not inflation that maintains or destroys the real value of constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, other shareholder equity items, etc when accountants choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Implementing the low inflation CIPPA model as approved in the Framework, Par 104 (a) means accountants choose to reject the stable measuring unit assumption which they implement when they choose to measure financial capital maintenance in nominal monetary units – also in terms of the Framework, Par 104 (a).

SA accountants do not select financial capital maintenance in units of constant purchasing power and SA accounting professors and lecturers do not teach SA accounting students to select the real value maintaining IASB approved alternative to the 700 year old very destructive generally accepted traditional Historical Cost Accounting model because

(1) they automatically assume that any price-level accounting model always refers to the CPP inflation accounting model,

(2) they do not understand the fact that they unknowingly destroy real value on a massive scale (at least R200 billion per annum) in the SA real economy when they select to measure financial capital maintenance in nominal monetary units, and

(3) they do not understand the fact that they can stop that by simply selecting the alternative approved by the IASB predecessor body, the IASC Board, 21 years ago, namely, the measurement of financial capital maintenance in units of constant purchasing power as approved in the Framework, Par 104 (a) which is compliant with IFRS and was adopted by the IASB in 2001.

(4) they believe and implement the IASB´s authorization of the fallacy that "Financial capital maintenance can be measured in nominal monetary units."

(5) they believe and implement the stable measuring unit assumption that is based on a fallacy.

(6) they believe the fallacy that "the erosion of business profits and capital is caused by inflation."

If they understood it, they would have stopped the stable measuring unit by now.
Copyright © 2010 Nicolaas J Smith

I support Greta Steyn

Hi,

Greta Steyn recently stated that she would be happy if the government controlled all the shares in the South African Reserve Bank.

In simple terms, abandoning monetary prudence at the SARB can only destroy the SA monetary economy – period. Example: Zimbabwe. Inflation is only a monetary phenomenon and can only destroy the real value of the Rand and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. SA accountants would destroy the SA constant real value non-monetary economy (like Zimbabwean accountants did) with their very destructive stable measuring unit assumption – even during hyperinflation – if hyperinflation was ever created by the SARB in SA.

SA accountants currently destroy the real value of SA banks´ and companies´ capital and profits never maintained with sufficient revaluable fixed assets under the HCA model at the rate of 6.2% per annum amounting to about R200 billion each and every year. PricewaterhouseCoopers state very clearly in their publication Understanding IAS 29: “Inflation adjusted financial statements are an extension to and not a departure from historic cost accounting.” Accountants – unbelievably supported by PricewaterhouseCoopers – still apply the stable measuring unit assumption during hyperinflation and then only restate the year-end Historical Cost financial statements of their hyper-destroyed businesses at the year end CPI rate – after they have hyper-destroyed all constant real value non-monetary items never maintained or never updated during the financial year with their stable measuring unit assumption – during hyperinflation.

This is prevented with either financial capital maintenance in units of constant purchasing power during low inflation as authorized by the IASB in the Framework, Par 104 (a) twenty one years ago or with indexation – which is in principle the same process – as Brazil did for 30 years from 1964 to 1994.

Destroying SA´s economy like it happened in Zimbabwe is a political act. The SARB having some private shareholders who have no influence will not stop a Zimbabwe style destruction of the SA monetary economy. Either SA has the right political leaders or not.

Contrary to what some people state and believe, the government already owns the majority of shares in the SARB. It is not privately controlled. It has some private shareholders - a minority. The Bank´s independence from government interference in monetary policy is stated in the constitution.

I support Greta’s position.

Obviously, for the government to hold all the shares in the SARB is not the same as nationalizing the mining industry or banks or the economy as a whole as Malema wants.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

The IASB may be to blame

The IASB may be to blame since 1989 for financial capital maintenance in nominal monetary units which is a complete fallacy during inflation and deflation by simply stating in the Framework, Par 104 (a) that financial capital maintenance can be measured in nominal monetary units without qualifying that statement. It is only possible per se during zero inflation. We have never had sustainable zero inflation in the past and we are not likely to have sustainable zero inflation any time soon in the future. It is, in fact, only possible under the HCA model during low inflation and deflation when an entity invests 100% of the real value of all contributions to Shareholders´ Equity in revaluable fixed assets. It is impossible to maintain the real value of capital constant with financial capital maintenance per se during inflation and deflation.

All economic items are valued by accountants and the values are stated in terms of the functional currency (money) as the unit of account. All functional currencies are unstable in real value: either their real values are being destroyed by inflation or, in the case of Japan lately, the Yen’s real value is being increased internally by deflation. It is thus impossible to maintain the real value of financial capital constant in nominal monetary units – per se – during low inflation and deflation - unless qualified as above.

The IASB did not approve financial capital maintenance in units of constant purchasing power in the Framework, Par 104 (a) in 1989 as an inflation accounting model. They did that with the CPP inflation accounting model in IAS 29 – also in 1989. Constant ITEM Purchasing Power Accounting as approved in the Framework, Par 104 (a), by measuring financial capital maintenance in units of constant purchasing power constitutes an IASB authorized alternative to the Historical Cost financial capital concept, HC financial capital maintenance concept and HC profit or loss determination concept, namely a constant purchasing power financial capital concept, constant purchasing power financial capital maintenance concept and constant purchasing power profit or loss determination concept during low inflation and deflation.

CIPPA as approved in the Framework only requires all constant real value non-monetary items to be valued in units of constant purchasing power. Variable real value non-monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS or SA GAAP and are not required in terms of the Framework, Par 104 (a) to be valued in units of constant purchasing power to determine their values during the accounting period during non-hyperinflationary periods.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Capital maintenance ignored by IASB and FASB

Inflation-adjusted balance sheet constant real value non-monetary items, e.g. Issued Share capital, Retained Earnings, Share premiums, Capital Reserves, General Reserves, all other items in Shareholders´ Equity, trade debtors, trade creditors, taxes payable, taxes receivable, salaries payable, salaries receivable, all other non-monetary payables, all other non-monetary receivables, etc in SA´s low inflation economy would be a blessing to everyone in SA when our accountants simply decide to change from their current implementation of their very destructive stable measuring unit assumption – which is based on a fallacy – and their financial capital maintenance in nominal monetary units per se which is impossible during inflation and another fallacy and freely choose to implement the real value maintaining financial capital maintenance in units of constant purchasing power model as approved by the IASB in the Framework, Par 104 (a) twenty one years ago. They would knowingly maintain - instead of currently unknowingly, unnecessarily and unintentionally destroy as they also did last year and all the years before and will do next year if they do not stop with their very destructive stable measuring unit assumption - at least R200 billion annually in constant item real value in the SA real economy for an unlimited period of time – all else being equal.
Financial capital maintenance in units of constant purchasing power authorized during low inflation

Financial capital maintenance in units of constant purchasing power during low inflation, despite being approved by the IASB in the Framework twenty one years ago, is completely ignored by accountants in non-hyperinflationary economies even though it would maintain instead of destroy the real values of not only all income statement constant items but also all balance sheet constant items in all companies that at least break even for an unlimited period of time during low inflation and deflation. Financial capital maintenance in units of constant purchasing power would stop SA accountants unknowingly destroying about R200 billion in the real value of constant items never maintained in the SA real economy each and every year. It would result in SA accountants knowingly boosting the SA real economy by at least R200 billion per annum for an unlimited period – all else being equal.

The reason accountants ignore financial capital maintenance in units of constant purchasing power is because any price-level accounting model is generally viewed by almost all accountants and accounting authorities as a 1970-style failed and discredited inflation accounting model that required all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) to be inflation-adjusted by means of the CPI during high inflation. They, inexplicably and unbelievably, seemed not to understand, at all, the implications of the Framework, Par 104 (a) which the IASB authorized 21 years ago and which states:

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


Deloitte, one of the Big Four accounting and auditing multi-nationals, also ignore the paragraphs in the Framework that deal with the concepts of capital, capital maintenance and the determination of profit or loss in their presentation of the Framework on their site IAS Plus as at 13th February, 2010. http://www.iasplus.com/standard/framewk.htm

Deloitte do not even mention one word in their presentation of the Framework about the fact that companies can measure financial capital maintenance in units of constant purchasing power. This appears to be another example of the lack of understanding by accountants in general that an essential function of accounting is continuous maintenance of the constant purchasing power of capital by continuously maintaining the real value of all constant items at all levels of inflation and deflation which can only be achieved with the IASB approved financial capital maintenance in units of constant purchasing power model in the Framework, Par 104 (a) and IAS 29 with valuation of all non-monetary items at the daily parallel rate during hyperinflation.

Similarly the paragraphs in the Framework dealing with the concepts of capital, the concepts of financial capital maintenance and units of constant purchasing power were also omitted from the presentation of the Framework in the Wikipedia article on IFRS till they were added very recently. The whole of the Framework was summarized in the Wikipedia article, except those paragraphs.

The IASB and FASB are currently working on a joint project called Conceptual Framework. “The project's overall objective is to create a sound foundation for future accounting standards that are principles-based, internally consistent and internationally converged.” (IASB site). All items in the IASB´s current Framework are covered in this project, except the concepts of capital and capital maintenance. In response to a request for information about when the concepts of capital and capital maintenance would be covered in the current project the FASB project leader, who is not a spokesman for the Boards, stated: “I can only say that early on in the measurement phase the staff suggested that capital and capital maintenance be discussed in the measurement phase, as it was in the original FASB Conceptual Framework. However, to date the Boards have not taken a decision on where, or even whether, those topics will be included in the converged framework.”

The concept of financial capital maintenance in units of constant purchasing power during low inflation and deflation seems to have been correctly treated by the IASC Board twenty one years ago – and then simply just ignored by everyone.
Copyright © 2010 Nicolaas J Smith

Constant items

As a result of a lack of understanding the destructive nature of their implementation of the very destructive stable measuring unit assumption, 1970-style CPP inflation accounting was not an accounting system implemented by accountants to correct or eliminate the destruction of the real value of constant items by the use of the stable measuring unit assumption, but, a failed attempt to simply make financial reports more understandable and more comparable with previous year statements during periods of high inflation by inflation-adjusting all non-monetary items equally in terms of the CPI.

Accountants simply do not understand that they unknowingly destroy real value on a massive scale in all constant items never maintained when they choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. In many cases they do not even know that they make that choice. Neither do they understand that they will stop that destruction by freely choosing to measure financial capital maintenance in units of constant purchasing power, as approved in the IASB Framework, Par 104 (a) in 1989.

Prof Geoffrey Whittington in his definitive work on inflation accounting in the beginning of the 1980´s, Inflation Accounting - An Introduction to the Debate, published in 1983, clearly indicated that with 1970-style CPP inflation accounting all non-monetary accounts (with no distinction being made between variable and constant real value non-monetary item accounts) were updated by means of the CPI.

"Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."

This eventually led to the failure of 1970-style CPP accounting as an inflation accounting model.

The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never maintained.
Copyright © 2010 Nicolaas J Smith

Generally accepted fact and fiction

The IASB approved Framework, Par 104 (a) which is applicable in the absence of specific IFRS relating to the concepts of capital, the capital maintenance concepts, the valuation of constant items, e.g. Issued Share Capital, Retained Earnings and other items in Shareholders´ Equity, etc during non-hyperinflationary periods, allows accountants to reject the stable measuring unit assumption during all levels of inflation and deflation when they choose to measure financial capital maintenance in units of constant purchasing power as an alternative to measurement in nominal monetary units as applied in the traditional HCA model.

It is not generally understood by SA accountants that they are unknowingly and unintentionally responsible for the unnecessary destruction of the real value of constant items never maintained with sufficient revaluable fixed assets when they implement the traditional HCA model: more specifically, their very destructive stable measuring unit assumption during periods of low inflation when they maintain it for an unlimited period of time during indefinite inflation. This lack of understanding also applies to economists, business people and the public in general.

It is also not generally understood by SA accountants that they can stop this destruction by selecting financial capital maintenance in units of constant purchasing power as authorized by the IASB 21 years ago in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS. If they understood it, they would have stopped the stable measuring unit assumption by now.

It is generally accepted and a fact that inflation destroys the real value of money (the internal functional currency) and other monetary items over time. It is also a fact that hyperinflation can destroy the real value of a country’s entire monetary base as happened in Zimbabwe recently. That was the result of a massive increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, with an equivalent extreme rate of destruction of the real value of the Zimbabwe Dollar since the massive nominal increase in the ZimDollar money supply was not in response to an equal increase in real value in the real or non-monetary economy of Zimbabwe. Gono was actually "printing money" in the popular belief that you can create wealth by simply printing pretty pictures on paper. When the German company from which he was buying the special bank note paper was pressurized to stop supplying him, he started printing the 100 trillion ZimDollar notes on normal A4 photostat paper.


“There is no subtler, no surer means of overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”The Economic Consequences of the Peace by John Maynard Keynes, 1919http://socserv2.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace

This certainly was true in the case of Zimbabwe.

It is generally accepted and a fact that inflation destroys the real value of money and the original real value of monetary savings and money lent over time. It is generally accepted, but not a fact, that inflation erodes, which is the same as destroys, the real value of constant real value non-monetary items with fixed nominal payments over time, e.g. fixed salary, wage, rental payments, etc.

The constant real non-monetary values of salaries, wages, rentals, etc are generally maintained, i.e. not destroyed, when accountants choose to measure the real value of these constant real value non-monetary items in units of constant purchasing power in terms of the CPI in most economies with payment in depreciating money during inflation.

It is not generally accepted, but a fact, that SA accountants unknowingly destroy the real value of constant items never maintained, e.g. Retained Earnings, of all SA companies and banks over time when they choose to measure financial capital maintenance in nominal monetary units in terms of the traditional HCA model during low inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

World Institute of Research and Publication

World Institute of Research and Publication

World Institute for Research and Publication Accounting Annual Meeting


June 4 - 6, 2010

In 2010, we will be meeting online for the first time. As result of the effort of researchers all around the world, accounting researchers are going to make a more sustainable conference. WIRP Accounting saves travel costs and can avoid tons of CO2 from airline emissions.

Also, without sacrificing the communication efficiency by allowing the participation of researchers of every part of the globe thru our platform, academicians and practitioners can present new research and discussing current issues. WIRP is divided in thematic areas and the participants can at any time attend the previously available presentations during the event.

The debates occur in our virtual rooms with resources of audio and video, making possible all the interactions between the participants without costs of locomotion and lodging. Likewise, making possible and viable the participation of any researcher, independent of its place of origin.

Direct text copy of WIRP Accounting site
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I have been invited to submit a paper for possible selection to be presented at the World Institute for Research and Publication Accounting Annual Meeting.

Nicolaas Smith

100 Questions (and Answers) about IFRS: Prof Rachel Baskerville

Prof Baskerville: "There is much to be gained from moving away from reporting on the basis Financial Capital Maintenance in Nominal Monetary Units."

Buy the ebook for $2.99 or £1.53 or €2.68.

Nicolaas Smith

Copyright © 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.