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Wednesday 27 April 2011

Measurement during low inflation

Measurement during Low inflation

 
The real values of many constant real value non-monetary items, for example, that portion of shareholders´ equity never covered by sufficient revaluable fixed assets (revalued or not) under the HCA model, are not automatically maintained constant (as they should be) in the world´s low inflation economies as demonstrated during the recent financial crisis that necessitated huge amounts of additional capital for under-capitalized banks and companies. To the contrary: their constant real non-monetary values are unnecessarily, unknowingly and unintentionally being eroded at a rate equal to the annual rate of inflation by the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional HCA model. HCA is based on the accounting fallacy that financial capital maintenance can be measured in nominal monetary units per se during inflation and deflation as originally authorized in IFRS in the Framework (1989), Par 104 (a) as well as approved in the FASB´s Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (1984).
Many people see financial reporting as simply providing historic economic information. It is not realized that it is a basic objective of accounting (financial reporting) to automatically maintain the constant purchasing power of capital constant in all entities that at least break even for an indefinite period of time by continuously measuring all constant real value non-monetary items in units of constant purchasing power during inflation and deflation.

The reasons for this are:

(1) The Three Popular Accounting Fallacies.


(a) The stable measuring unit assumption based on the fallacy that changes in the purchasing power of money are not sufficiently important to measure financial capital maintenance in units of constant purchasing power during low inflation and deflation.

(b) Financial capital maintenance in nominal monetary units per se during low inflation and deflation.

(c) The generally accepted belief that the erosion of companies´ profits and capital is caused by inflation fully supported in IFRS and by the FASB.
(2) It is not realized that it is the stable measuring unit assumption and not inflation that erodes the real value of constant real value non-monetary items never maintained constant when financial capital maintenance in nominal monetary units (the traditional HCA model) is implemented during low inflationary periods .

(3) It is not realized that continuous measurement of financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) automatically remedies this erosion by the stable measuring unit assumption.

If the above were realized then the stable measuring unit assumption / financial capital maintenance in nominal monetary units, i.e. the HCA model, would have been stopped during low inflation, deflation and hyperinflation by now.

Although the principle of financial capital maintenance in units of constant purchasing power during inflation and deflation was authorized in IFRS in 1989, it has not been implemented generally because the eroding effect of the stable measuring unit assumption on the real value of constant items never maintained is not recognized as such. It is generally believed that it is inflation doing the eroding in, for example, companies´ invested capital and profits when this erosion in constant item real value is actually caused by the stable measuring unit assumption. Inflation has no effect on the real value of non-monetary items. Capital and profits are non-monetary items.

Nicolaas Smith

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

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