A company’s capital is synonymous with its Net Assets or Shareholders Equity under a financial concept of capital such as invested money or invested purchasing power.
100% of the inflation-adjusted original real value of all contributions to Shareholders´ Equity have to be invested in revaluable fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) in order not to erode any Shareholders Equity’s existing constant real non-monetary value during low inflation under the traditional Historical Cost Accounting model – i.e. measuring financial capital maintenance in nominal monetary units as implemented by most entities.
The existing constant real non-monetary value of that portion of existing shareholders´ equity not invested in revaluable fixed assets (revalued or not) is currently unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation when the constant real value non-monetary item Shareholders Equity is measured in nominal monetary units, i.e. implementing the very erosive stable measuring unit assumption as done by most entities when they implement the HCA model for an unlimited period of time during indefinite low inflation.
Most entities do not meet the requirement to investment 100% of the updated original real value of all contributions to Shareholders´ Equity in revaluable fixed assets. Entities that possibly meet the 100% of the updated original real value of all contributions to shareholder´s equity requirement are hotel, hospital, property and similar companies. In practice this means that the real value of Retained Profits never maintained of most companies and banks are unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation by entities implementing the IASB-approved traditional HCA model during low inflation.
Implementing the IASB-approved alternative, namely, financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) as authorized in 1989 in the exact same Framework (1989), Par 104 (a), stops this unknowing, unintentional and unnecessary erosion by the implement of the stable measuring unit assumption forever at all levels of inflation in all entities that at least break even - whether they own revaluable fixed assets or not and without the requirement of more money or more Retained Earnings just to maintain the existing constant real non-monetary value of existing Shareholders´ Equity constant.
No-one will disagree that inflation and not the stable measuring unit assumption erodes the real value of money and other monetary items in the monetary economy despite the fact that central banks and monetary authorities regard the erosion of from 2 to 6% per annum of the real value of the monetary unit as the achievement and maintenance of “price stability” in the economic system. Obviously it is not price stability at all. It is 2 to 6% per annum away from price stability. It is the central bank´s choice of “price stability”: their definition of “price stability”. Absolute price stability is a year-on-year increase of zero percent in the Consumer Price Index. Positive annual inflation of up to 2% is a high degree of price stability. It is not absolute price stability.
The IASB only requires the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. The IASB defines hyperinflation as cumulative inflation over three years approaching or equal to 100%, i.e. annual inflation of 26% for three years in a row. This means that central banks could define “price stability” as annual inflation at any rate from 0.001 to 25.99% per annum.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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