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Monday, 10 May 2010

SA´s second enemy

There are two processes of systemic real value destruction in the SA economy, although everybody thinks there is only one economic enemy. This is a mistake. The one enemy is well known. It is inflation. This economic enemy manifests itself in the Rand´s store of value function and only destroys real value in the SA monetary economy at the rate of inflation. Inflation is the enemy in the monetary economy and the Governor of the Reserve Bank is the enemy of inflation. Inflation per se has no effect on the real value of non-monetary items.

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.

Inflation, by itself, cannot destroy the real value of variable real value non-monetary items or constant real value non-monetary items items. It is impossible. Inflation is destroying the real value of the Rand and all other monetary items only in the SA monetary economy at the rate of 5.1 % per annum, at the moment (value date: March, 2010 CPI 111.1). The actual amount of real value destroyed in the real value of Rand notes and coins and other monetary items (bank loans, other monetary loans and deposits, etc) over the twelve months to March, 2010 amounted to about R102 billion.

The second process of real value destruction – the second enemy - is the unknowing, unintentional and completely unnecessary destruction by SA accountants of the real value of only constant items never maintained only in the SA constant item economy. This is the result of their implementation of the very destructive stable measuring unit assumption during low inflation as part of the traditional Historical Cost Accounting model used by most, if not all, SA companies.

Increases in the general price level (inflation) destroy the real value of the Rand (the functional currency) and other monetary items with an underlying monetary nature (e.g. loans and bonds). However, inflation has no effect on the real value of variable real value non-monetary items (e.g. land, buildings, goods, commodities, cars, gold, real estate, inventories, finished goods, foreign exchange, etc) and constant real value non-monetary items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc).

SA accountants freely choose to implement the stable measuring unit assumption during low inflation when they value constant items never maintained, e.g. companies´ capital and profits, in nominal monetary units; i.e. when they choose to measure financial capital maintenance in nominal monetary units in terms of the IASB´s Framework, Par 104 (a) or in terms of SA GAAP. SA accountants´ choice of implementing the stable measuring unit assumption instead of measuring constant items´ real values in units of constant purchasing power results in the real values of these constant real value non-monetary items never maintained with sufficient revaluable fixed property being destroyed at a rate equal to the annual rate of inflation because inflation destroys the real value of the Rand which is the monetary measuring unit of account in the SA economy.

It is not inflation doing the destroying as the IASB, the FASB and most accountants mistakenly believe. It is SA accountants´ free choice of the very destructive stable measuring unit assumption during low inflation. They will knowingly maintain the real values of all constant items constant (amounting to about R167 billion per year) in all companies that at least break even forever – all else being equal - no matter what the level of inflation or deflation when they reject the stable measuring unit assumption and implement financial capital maintenance in units of constant purchasing power during low inflation and deflation.

Copyright © 2010 Nicolaas J Smith