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Saturday, 26 February 2011

Price-level accounting does not prevail for balance sheet constant items during low inflation

Price-level accounting as Harvey Kapnick hoped for in 1976 clearly does not prevail for balance sheet constant real value non-monetary items (e.g. equity) and most income statement items. Income statement items are all constant real value non-monetary items. Price-level accounting does prevail as far as the income statement constant real value non-monetary items salaries, wages, rentals, etc are concerned since accountants update them annually in units of constant purchasing power in terms of the change in the Consumer Price Index. Accountants unfortunately choose the Historical Cost Accounting model and implement the stable measuring unit assumption under which they value balance sheet constant real value non-monetary items at historical cost, i.e. in nominal monetary units thus eroding these constant real value non-monetary items when their existing constant real non-monetary values are never maintained as a result of insufficient revaluable fixed assets (revalued or not) during low inflation.

Price-level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when they indexed many variable real value non-monetary items and constant real value non-monetary items in their non-monetary or real economy with daily indexation with a daily index value supplied by the different governments during that period. They stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They stopped daily indexation which is, in principle, the same as continuous financial capital maintenance in units of constant purchasing power, i.e. Constant Item Purchasing Power Accounting.

US 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 an unstable 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 clearly a fallacy since it is impossible to maintain the existing constant real non-monetary value of capital constant “in nominal monetary units” during inflation and deflation.

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 accountants make will not change that value and will not affect the economy.

If accountants and accounting authorities generally understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional destruction by the implementation of the Historical Cost Accounting model of hundreds of billions of US Dollars of real value in constant real value non-monetary items (e.g. banks´ and companies´ equity) never maintained in the world´s constant item economy, they would have called for its rejection by now.

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