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Monday, 15 March 2010

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