Tuesday, 20 April 2010

An amazing contradiction of basic economic logic

Money illusion is so pervasive in our low inflation societies that we do not even notice it any more. It is a complete state of mind - a way of thinking.

We have to stop thinking in nominal terms and start thinking in real value terms. As long as there is inflation in an economy, the national currency created and used in that inflationary economy is not a store of stable real value. It is a store of decreasing real value. Money is losing real value all the time when an economy is in a state of inflation. All current bank notes and coins will actually be completely worthless some time in the future when an economy remains in an inflationary mode for a long enough period of time.

Money developed upon the mistaken belief that it is stable – as in fixed – in real value in the short to medium term in economies with low inflation. The term stable money is seen as meaning that money’s real value stays intact over the short to medium term in low inflationary economies. Money illusion is still very evident today in most economies in money, other monetary items and constant real value non-monetary items that are mistakenly considered to be monetary items, for example, trade debtors, trade creditors, dividends payable, dividends receivable, taxes payable, taxes receivable, etc.

The correct definition of monetary items is critical for the correct classification of non-monetary items since the latter are all items that are not monetary items. If the definition of monetary items is wrong then some constant real value non-monetary items can be incorrectly classified as monetary items. This happens mainly with the incorrect classification of trade debtors and trade creditors as monetary items. This will affect the valuing of these items, the calculation of the net monetary gain or loss and consequently the profit or loss for the reporting period which will influence the correctness of the financial reports when the Constant Item Purchasing Power Accounting model is implemented by accountants in terms of the Framework, Par 104 (a) during non-hyperinflationary conditions as well a in terms of IAS 29 during hyperinflation.

In an amazing contradiction of basic economic logic, there is no net monetary gain or loss calculation when accountants choose the traditional HCA model. The calculation of the net monetary gain or loss is an essential part of the CIPPA model while it is non-existent under the HCA model. This is one of the main failures of the HCA model which is corrected under the CIPPA model - both authorized in the exact same statement, namely, the Framework, Par 104 (a) in 1989.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

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