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Wednesday, 7 July 2010

The FASB and IASB do not agree on capital maintenance

The FASB defines capital maintenance in its Concepts Statement No 5, Paragraphs 45 to 48.

According to the FASB there are only two concepts of capital
1.Financial capital

2.Physical capital

and consequently two concepts of capital maintenance
i Financial capital maintenance

ii Physical capital maintenance

The IASB states the same, but, defines THREE concepts of capital and THREE concepts of capital maintenance.

The IASB´s Concepts of Capital and Capital Maintenance are defined in the Framework, paragraphs 102 to 110.

The IASB states virtually the same as the FASB above. However, in Paragraph 104 (a) the IASB went one step further and stated twenty one years ago:

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

There is no mention of units of constant purchasing power in the FASB´s definition of financial capital maintenance.

The three concepts of capital defined in IFRS during low inflation and deflation are:

(A) Physical capital. See par. 102.

(B) Nominal financial capital. See par. 104 (a).

(C) Constant purchasing power financial capital. See par. 104 (a).

The three concepts of capital maintenance authorized in IFRS during low inflation and deflation are:

(1) Physical capital maintenance: optional during low inflation and deflation. Current Cost Accounting model prescribed by IFRS. See Par 106.

(2) Financial capital maintenance in nominal monetary units (Historical cost accounting): authorized by IFRS but not prescribed—optional during low inflation and deflation. See Par 104 (a). Unfortunately, financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy: it is impossible to maintain the real value of financial capital constant with measurement in nominal monetary units per se during inflation and deflation. This fallacy did not and does not stop all companies and entities to use Historical Cost Accounting as the generally accepted tradition basic accounting model for the last 700 years. Historical cost accountants overcame this fallacy by simply assuming that the unit of account (money) is perfectly stable as far as the measurement of most constant real value non-monetary items (shareholders equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc) is concerned. They do however admit that the unit of account is not stable only in the case of certain income statement items: e.g. salaries, wages, rentals, etc. They inflation-adjust these items annually.

(3) Financial capital maintenance in units of constant purchasing power: i.e. Constant Item Purchasing Power Accounting (CIPPA) authorized in IFRS but not prescribed—optional during low inflation and deflation. See the Framework, Par 104 (a). Only constant items are measured in units of constant purchasing power during low inflation and deflation. Net monetary gains and losses have to be accounted.

Prescribed in IAS 29 during hyperinflation; i.e. Constant Purchasing Power Accounting (CPPA): all non-monetary items – constant real value non-monetary items as well as variable real value non-monetary items – have to be measured in units of constant purchasing power during hyperinflation. Net monetary gains and losses have to be accounted.

Only financial capital maintenance in units of constant purchasing power [Constant Item Purchasing Power Accounting (CIPPA) during low inflation and deflation and Constant Purchasing Power Accounting (CPPA) during hyperinflation] per se can maintain the real value of financial capital constant during inflation and deflation in all entities that at least break even—ceteris paribus—for an indefinite period of time. This would happen whether these entities own revaluable fixed assets or not and without the requirement of more capital or additional retained profits to simply maintain the existing constant real value of existing shareholders´ equity constant.

There is thus a major difference between the FASB´s and the IASB´s definitions of the concepts of capital and the concepts of capital maintenance. It is their stated objective to converge their two Frameworks.

However, after working six years on their joint Conceptual Framework project, Kevin McBeth, the FASB Project Manager for the Measurement Phase stated:

“To date the Boards have not taken a decision on where, or even whether, those topics (the concepts of capital and capital maintenance) “will be included in the converged framework."

The FASB afterwards clarified the matter as follows:

“We are of course familiar with paragraphs 102 – 110 of the IASB Framework as well as paragraphs 45-48 of FASB Concepts Statement 5. Although not labeled as such, capital maintenance ideas have been raised at various points in the discussions of measurement concepts and will continue to be discussed until the board makes decisions about measurement concepts. We do not know yet whether there will be a section in the yet-to-be-completed measurement concepts chapter labeled capital maintenance, but the concepts will almost certainly be discussed.”

This is after 6 years on the Project.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith