Tuesday, 12 June 2012

Valuing monetary items

Valuing monetary items

Measurement is determining the particular basis on which monetary items are to be valued and accounted on a daily basis in the functional currency – the legal unit of account for accounting purposes – in an economy under all levels of inflation and deflation. The functional currency is the currency of the primary economic environment in which an entity operates. The functional currency is normally the national (or monetary union) monetary unit which is legal tender in the economy. In dollarized economies the adopted hard currency is the functional currency for accounting purposes.

Entities implement financial capital maintenance in nominal monetary units when they prepare their financial reports in terms of the HCA model. The stable measuring unit assumption is applied to some – not all – items under HCA.  It is applied to all monetary items not inflation-adjusted on a daily basis under HCA.

Monetary items are thus generally not inflation–adjusted under HCA. The Chilean banking system is partially indexed daily using the Unidad de Fomento. Some monetary items are also inflation–adjusted daily in other economies, e.g., TIPS in the US economy, where HCA is the generally accepted accounting model.

Under CIPPA, i.e., financial capital maintenance in units of constant purchasing power in terms of a Daily CPI during inflation and deflation, there is no stable measuring unit assumption. All monetary items would thus be inflation–adjusted on a daily basis in terms of the Daily CPI or monetized daily indexed unit of account. Historical monetary items as well as current financial period monetary items would be inflation–adjusted daily. This would require inflation–indexing of all monetary items in the banking system. Complete coordination in the economy would eliminate the total cost of inflation (not actual inflation) from the monetary economy. Chile is the country closest to achieving this. HCA is the generally accepted accounting model in Chile (2012).

Chile may be closer than all other economies to eliminating the cost of inflation (not inflation) from the country´s monetary economy with the generally accepted monetary practice of inflation–adjusting a significant part of their money supply in terms of the Unidad de Fomento which is a monetized daily indexed unit of account, but the stable measuring unit assumption (not inflation) is still eroding the real values of constant items never maintained constant in the country´s constant item economy because Chile is still implementing the HCA model in 2012. Chile is thus still bearing the full cost of the stable measuring unit assumption in its constant item economy. Fully coordinated financial capital maintenance in units of constant purchasing power (CIPPA) in terms of the UF on a daily basis would eliminate this cost completely from their economy too.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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