IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation

IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation

Updated on 18-04-2013

Capital is required to create wealth. Sustainable wealth creation is the sustainable profitable application of real (not nominal during inflation and deflation) capital: the constant purchasing power of capital. Capital is generally saved up wealth or borrowed financial resources at a financial cost.

Capital needs to be separate from the human owners of capital. It is not reasonable to expect people to risk losing their homes by starting a company.

A legal company structure is thus required plus a double-entry accounting model.

A perfectly stable unit of account is required for double-entry accounting. All generally accepted units of measure, e.g. inch, centimetre, pound, gram, etc., are perfectly constant values. There is no perfectly stable nominal monetary unit of account. A Daily Consumer Price Index is thus required to implement Capital Maintenance in Units of Constant Purchasing Power as authorized in IFRS by measuring constant real value non-monetary items in units of constant purchasing power in terms of a daily index during inflation and deflation.

Capital is a constant real value non-monetary item. The constant purchasing power (real value) of capital has to be maintained constant over time during inflation/high inflation/hyperinflation and deflation. A Capital Maintenance in Units of Constant Purchasing Power accounting model (CIPPA) is thus required.

The above is the ideal (correct/logical) method of creating wealth during low inflation, high inflation, hyperinflation and deflation.

A reasonable person would apply the above method of creating wealth even if it is not authorized or required under IFRS.

Capital Maintenance in Units of Constant Purchasing Power was authorized at all levels of inflation and deflation, including during hyperinflation, in IFRS in the original Framework (1989), Par. 104 (a) [not the Conceptual Framework (2010), Par 4.59 (a)] which states:

‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

Capital Maintenance in Units of Constant Purchasing Power is not required in terms of IFRS during low inflation, high inflation or deflation. It is optional to the 3000 year old, globally implemented, general accepted, traditional Historical Cost Accounting model (financial capital maintenance in nominal monetary units) during low inflation, high inflation and deflation. Capital Maintenance in Units of Constant Purchasing Power is, however, specifically required during hyperinflation. IAS 29 Financial Reporting in Hyperinflationary Economies requires the "restatement" of Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published CPI. IAS 29 gives specific guidance regarding Capital Maintenance in Units of Constant Purchasing Power: (i) it defines monetary items; (ii) it defines non-monetary items; (iii) it states how to measure capital maintenance in units of constant purchasing power, namely, by "restating" HC or CC period-end financial statements in terms of the measuring unit current at the balance sheet date.

But, IAS 29, although it requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation, unfortunately does not result in complete (or 100%) capital maintenance in units of constant purchasing power because it is generally accepted (2013) to use the monthly published CPI instead of the generally available Daily CPI (most countries in the world issue government capital inflation-indexed bonds which are priced on a daily basis using country specific Daily CPI´s based on the monthly published CPI). Current year profits are thus eroded/destroyed because of the use of the monthly CPI instead of the generally available Daily CPI when IAS 29 is implemented using the monthly CPI. A month can have 28 to 31 different daily price levels, or even more from about 3000 per cent per annum inflation and above. It is mistakenly generally accepted under current implementation practises of IAS 29, to use the CPI at the month end instead of 28 to 31 different generally available Daily CPI values to maintain current year profit. Current year profit is thus not fully maintained in this manner. A portion is eroded/destroyed using IAS 29  in terms of a monthly published CPI during hyperinflation. It is also a well-proven and undeniable fact that the implemetation of IAS 29 can also have absolutely no positive effect during hyperinflation. This was undeniably proven during hyperinflation in Zimbabwe. Zimbabwe´s economy imploded on 20 November 2008 after 8 years of full implementation of IAS 29. Thus, beware of IAS 29 in terms of the monthly CPI during hyperinflation.

PricewaterhouseCoopers states the following regarding the use of the HCA model during hyperinflation:

‘Inflation–adjusted financial statements are an extension to, not a departure from, historical cost accounting.’

Financial Reporting in Hyperinflationary Economies –Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.

Inflation has no effect on non-monetary items. Only monetary items in financial statements can be inflation-adjusted. PricewaterhouseCoopers, other Big Four audit firms, the IASB and most historical cost accountants do not understand the concept of Capital Maintenance in Units of Constant Purchasing Power as defined in the Conceptual Framework, Par 4.59 (a) and guide-lined in IAS 29.

What PricewaterhouseCoopers wanted to state was that "Period-end Historical Cost or Current Cost 'financial statements' with non-monetary items restated in units of constant purchasing power, 'are an extension to, not a departure from, historical cost accounting.’ Reporting year financial statements are never inflation-adjusted because it is impossible to inflation-adjust non-monetary items and monetary items in reporting year financial statements are not inflation-adjusted: what happens is the net monetary loss or gain is accounted while monetary items are measured in nominal monetary units. PricewaterhouseCoopers does not understand CMUCPP as authorized in IFRS and guide-lined in IAS 29.

A standard takes precedence over the Framework according to IAS 8, Par. 11. CMUCPP as guide-lined in IAS 29 thus applies during hyperinflation: thus, Capital Maintenance in Units of Constant Purchasing Power is required in IFRS during hyperinflation.

Financial capital maintenance in nominal monetary units (HCA) is a fallacy: it is impossible to maintain the real value of capital in nominal monetary units during inflation per se. It is only possible in the single case where an entity always invests 100 per cent of all contributions to shareholders´ equity in revaluable fixed assets (revalued or not) with an equivalent updated fair value which is most probably only the case with hotel, hospital and other property-intensive entities.

Every company in the world implementing IFRS can now change over to Capital Maintenance in Units of Constant Purchasing Power (CIPPA). Entities in economies subject to hyperinflation implementing IAS 29 already implement an incomplete version of CMUCPP. See IFRS 'X' Capital Maintenance in Units of Constant Purchasing Power. Zimbabwean listed companies implemented IAS 29 Financial Reporting in Hyperinflationary Economies during the last eight years of hyperinflation in that country. The implementation of IAS 29 in Zimbabwe made absolutely no difference.

Capital maintenance in units of constant purchasing power automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation (including during hyperinflation) - ceteris paribus - whether they own any revaluable fixed assets or not.

Nicolaas Smith

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