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Friday, 15 April 2011

Constant Item Purchasing Power Accounting - Abstract - Part 2 of 5

Abstract - Part 2 of 5


Three economic items

It is generally accepted that there are only two basic, fundamentally different economic items in the economy: monetary items and non-monetary items. That is not correct. There are three basic, fundamentally different economic items in the economy:

(i) Monetary items: money held and other monetary items with an underlying monetary nature, e.g. bank notes and coins, bank account balances, the capital amount of money loans, bonds, notes payable, notes receivable, housing loans, car loans, credit card loans, consumer loans, student loans, etc. Despite the FASB´s and PricewaterhouseCoopers´ statements to the contrary, trade debtors and trade creditors are not monetary items as confirmed in this book by the prominent Brazilian economist, Dr. Gustavo Franco, ex-governor of the Central Bank of Brazil and one of the architects of the Real Plan that stopped 30 years of very high and hyperinflation in Brazil in 1994. Monetary items can only be valued in nominal monetary units during the current accounting period under all accounting models and under all economic models.

(ii) Variable real value non-monetary items, e.g. property, plant, equipment, raw materials, finished goods, shares, foreign exchange, etc. valued in terms of IFRS or US GAAP during low inflation and deflation at for, example, fair value, net realizable value, present value, recoverable value, etc. Variable items, being non-monetary items, are required in terms of IAS 29 Financial Reporting in Hyperinflationary Economies to be restated in terms of the measuring unit current at the balance sheet date by applying the period-end Consumer Price Index during hyperinflation. This does not maintain the stability of the real economy during hyperinflation. That can only be done by valuing all non-monetary items (variable and constant items) at the official or unofficial daily US Dollar parallel rate or a Brazilian-style daily index value during hyperinflation.

(iii) Constant real value non-monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, all items in the income statement, etc. Only constant items are continuously valued in units of constant purchasing power by applying the monthly change in the annual CPI in terms of continuous financial capital maintenance in units of constant purchasing power (CIPPA) during low inflation and deflation. The only way to maintain the non-monetary or real economy stable during hyperinflation (like Brazil did for 30 years from 1964 to 1994) is when all non-monetary items (variable and constant items) are valued daily at the official or unofficial daily US Dollar parallel rate or a Brazilian-style daily index value. Only certain (all income statement items are constant items) income statement items, e.g. salaries, wages, rentals, etc., are generally inflation-adjusted under HCA during low inflation. Other income statement items and all balance sheet constant items are currently valued in nominal monetary units, i.e. at Historical Cost, by applying the stable measuring unit assumption under HCA during low inflation and deflation.

The split of non-monetary items in variable and constant items is critical for financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA). That was what was missing at the time of FAS 89.

The split of non-monetary items is implied and authorized in IFRS with the authorization of financial capital maintenance in units of constant purchasing power during low inflation and deflation. Measurement in units of constant purchasing power implies that certain economic items have constant real values over time during low inflation and deflation. They certainly are not monetary items. Certain non-monetary items are thus constant real value non-monetary items. Non-monetary items which do not have constant real values are thus variable real value non-monetary items.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.” Deloitte.

There are no specific Standards or Interpretations applicable to the concepts of capital, the concepts of capital maintenance and the valuation of constant items. The definitions and concepts in the Framework (1989) are thus applicable.

Nicolaas Smith

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