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Thursday, 3 February 2011

Valuing the three economic items

Economic items are made up of monetary items, variable items and constant items. Accountants value, record, classify, summarize and report transactions and events involving economic items in terms of depreciating functional currencies during inflation and appreciating functional currencies during deflation.

Monetary items

(1) The real value of the functional currency and all other monetary items in the monetary economy generally changes every month during low inflation. Months of zero annual inflation are rare and not sustained over a significant period of time.

Variable items

(2) The real value of variable items may change all the time, e.g. the price of foreign currencies, precious metals, quoted shares, commodities, properties, finished goods, services, raw materials, etc.

Constant items

(3) The real values of constant items stay the same (or are supposed to stay the same) all the time – all else except inflation and deflation being equal – e.g. salaries, wages, rentals, issued share capital, retained profits, shareholders equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.

Accountants have to take all three scenarios - occurring simultaneously - into account over time when they account economic activity and prepare and present financial reports.

Monetary items

(1) Accountants value and account monetary items at their original historical cost nominal values in nominal monetary units during the current accounting period under all accounting models during low inflation, hyperinflation and deflation. Inflation, deflation and hyperinflation determine the always current real value of the functional currency (US Dollar, Bolívar, Euro, Yen, Yuan, etc.) and other monetary items within a monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period. The real value of the functional currency and other monetary items in the monetary economy changes equally (all monetary units are affected evenly) normally on a monthly basis during low inflation and deflation. The change is confirmed or quantified with the monthly publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in many low inflationary economies. The daily black market or parallel US Dollar exchange rate or street rate is generally constantly (24/7, 365 days a year) available in a hyperinflationary economy. The CPI is the internal exchange rate between the real value of a unit of the functional currency and a unit of real value in an economy. The parallel US Dollar exchange rate fulfils this role in a hyperinflationary economy.

Variable items

(2) Variable items in a national economy are valued and accounted in terms of IFRS or GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc. These prices change all the time: even minute by minute in many markets.

Constant items

(3) The real values of constant real value non-monetary items in the constant item economy have to be continuously maintained constant during low inflation and deflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation and deflation by means of the CPI as authorized by the IASB in the Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done, generally in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in non-hyperinflationary economies.

Harvey Kapnick was correct when he stated in the Saxe Lecture in 1976: “In the long run both value accounting and price-level accounting should prevail.”

Valuation of all non-monetary items during Hyperinflation

Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a hyperinflationary country can maintain its non-monetary or real economy relatively stable (at a rate of real value erosion in constant items never maintained limited to the inflation rate of the hard currency used for determining the parallel rate) during hyperinflation is by continuously measuring all non-monetary items (variable and constant items) in units of constant purchasing power; however, not by restating HC and Current Cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done in Brazil during the 30 years from 1964 to 1994 - with daily indexation which is, in principle, the same as measurement in units of constant purchasing power by applying the daily parallel rate.

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