Constant Item Purchasing Power Accounting - Abstract - Part 3 of 5

Three concepts of capital maintenance in IFRS

There are not only two concepts of capital - as generally accepted and specifically stated in IFRS - authorized in IFRS, namely, physical and financial capital.

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

• (1) Physical capital. See the Framework (1989), Par 102.

• (2) Nominal financial capital. Par 104 (a).

• (3) Constant purchasing power financial capital. Par 104 (a) and 108.

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

• (a) Physical capital maintenance: optional during low inflation and deflation. The Current Cost basis of measurement is prescribed in the Framework, Par 106 when the physical capital maintenance concept is chosen.

• (b) Financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting): authorized in IFRS but not prescribed - optional during low inflation and deflation. See Par 104 (a). It is adopted by most entities in preparing their financial statements. It is a popular accounting fallacy: it is impossible to maintain the real value of financial capital constant during inflation and deflation with measurement in nominal monetary units per se. It requires the implementation of the stable measuring unit assumption which is also based on a fallacy.

• (c) Financial capital maintenance in units of constant purchasing power: authorized in IFRS but not prescribed - optional during low inflation and deflation. See Par 104 (a) and 108. Only constant real value non-monetary items (not variable items) are continuously measured/valued in units of constant purchasing power by applying the monthly change in the annual CPI during low inflation and deflation (CIPPA). Variable items are measured in terms of specific IFRS or US GAAP during low inflation and deflation. Monetary items are and can only be measured in nominal monetary units. The net monetary loss or gain from holding net monetary item assets or net monetary item liabilities is calculated and accounted in the income statement during low inflation and deflation. The stable measuring unit assumption is rejected under this concept.

Accounting cannot and does not create real value out of nothing.

CIPPA is the only accounting model that automatically maintains the real value of all existing constant items constant forever in all entities that at least break even – ceteris paribus – whether they own revaluable fixed assets or not and without the need for extra capital in the form of extra money or extra retained profits simply to maintain the existing constant real value of existing shareholders´ equity constant during low inflation and deflation.

Constant Purchasing Power Accounting (CPPA) is the IASB´s inflation accounting model defined in IAS 29 which requires the restatement of all non-monetary items – constant and variable items – in HC or Current Cost financial statements by applying the period-end CPI during hyperinflation in order to make these statements more meaningful. This book is not about CPPA inflation accounting during hyperinflation as required in IAS 29 or any other inflation accounting model. CIPPA is not an inflation accounting model. Inflation accounting is used during hyperinflation. CIPPA is used during low inflation and deflation.

The difference between CIPPA and CPPA:

CPPA

In terms of IAS 29 CPPA is required only during hyperinflation: All non-monetary items are measured in units of constant purchasing power.

CIPPA

In terms of the Framework (1989), Par 104 (a) CIPPA is optional during low inflation and deflation: only constant items are measured in units of constant purchasing power. Variable items are measured in terms of US GAAP or IFRS.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.