Applicability of IAS 29 No 2

Applicability of IAS 29 No 2

06  November 2012

IASB Staff member April Pitman´s preliminary work on the Potential Agenda Item Request.

Hello Nicolaas

I have been asked to prepare a very simple summary of the nature of your agenda item request. Do you think this is a fair summary – or have I missed the point?

“The Conceptual Framework assesses whether profit has been earned in terms of whether the entity’s capital has been maintained. It states (CF 4.59 (a)) that for these purposes, financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.

IAS 29 Financial Reporting in Hyperinflationary Economies notes that reporting an entity’s operating result and financial position in a hyperinflationary economy is not helpful unless local currency values are restated.  Money loses purchasing power at such a rate that comparison of amounts from transactions that have occurred at different times are misleading.  The Standard requires that the financial statements should be stated in terms of the measuring unit current at the end of the reporting period (IAS 29.8).

The submitter raises queries about when it is appropriate to use units of constant purchasing power as a measurement basis and not apply the measuring unit current at the end of the reporting period as required by IAS 29.”

Thanks

April

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April Pitman | Technical Manager

International Accounting Standards Board (IASB)

30 Cannon Street | London EC4M 6XH | UK

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From: Nicolaas Smith

Sent: 07 November 2012 17:06

To: Pitman April

Subject: IAS 29 Agenda proposal

Hello April,

Thank you for the opportunity to give you my input.

You are not actually quoting IAS 29 in the second paragraph of your summary. So, we may use correct concepts /principles where IAS 29 implies one incorrectly. In my opinion, the second sentence in the second paragraph of your summary is not entirely correct. You state (not officially quoting IAS 29): “Money loses purchasing power at such a rate that comparison of amounts from transactions that have occurred at different times are misleading.”

Your statement implies that comparisons of all amounts of all transactions that have occurred at different times are misleading as a result of money losing purchasing power. That is not correct. Onlycomparisons of amounts of transactions involving monetary items that have occurred at different times are misleading as a result of money losing purchasing power.

All economic items have monetary values since money is the monetary unit of account.

Monetary items are units of local currency held and other monetary items with an underlying monetary nature, being substitutes of the former. Non-monetary items are items that are not monetary items.

[This is a complex situation because we use different definitions for the same items as a result of the fact that there are two paradigms authorized in IFRS: the HC paradigm and the units of constant purchasing power paradigm. The above is the definition of monetary items under the second paradigm. Both paradigms are involved in this request.]

Money loses purchasing power as a result of inflation. Inflation only affects money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items.

“Inflation is always and everywhere a monetary phenomenon.”

Milton Friedman

“Purchasing power of non-monetary items does not change in spite of variation in national currency value.”

Gucenme U and Arsoy A P 2005 Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 -2005 Academy of Accounting Historians 2005 Research Conference 6-8 Oct 2005 Ohio State University Columbus Ohio USA

(It is the second last item on the link page.)

The stable measuring unit assumption affects the real value of only constant real value non-monetary items not maintained constant at all levels of inflation and deflation.

Comparisons of amounts from transactions involving constant real value non-monetary items in Historical Cost financial statements that have occurred at different times are misleading as a result of the implementation of the stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model under which financial capital maintenance in nominal monetary units is implemented.

The definition of constant real value non-monetary items is inferred in CF 4.59 (a) as follows: When financial capital maintenance can be measured in units of constant purchasing power it means logically that there are actual economic items with constant real values over time. They are certainly not monetary items. Thus, certain non-monetary items have constant real value values over time. They are thus constant real value non-monetary items (constant items).

Examples are salaries, wages, rents, all items in shareholders´ equity, provisions, trade debtors, trade creditors, all non-monetary payables and receivables, etc.

Thus, very logically, it also means that non-monetary items that are not constant real value non-monetary items are variable real value non-monetary items (variable items).

Examples are property, plant, equipment, inventories, quoted and unquoted shares, foreign exchange, etc.

Variable items are valued are in terms of IFRS at fair value, net realizable value, recoverable value, present value, etc. under the HC paradigm.

The stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power; under the second paradigm.

Although their real values are not affected by the stable measuring unit assumption, comparisons of amounts from variable item transactions that have occurred at different times are misleading as a result of the implementation of the stable measuring unit assumption (a GAAP) and not the fact that money loses real value over time, namely as a result of inflation – an economic process.

So, in my opinion the following may be a better statement:

“Money losing purchasing power at such a rate - as far as monetary items are concerned - and the implementation of the stable measuring unit assumption - as far as non-monetary items are concerned - make comparisons of amounts from monetary and non-monetary item transactions, respectively, that have occurred at different times, misleading.”

I - unintentionally - complicated my request by asking two questions.

To fix that problem we may, in my opinion, combine the two questions into one by stating

a)      the last sentence in your second paragraph as follows:

“The Standard requires that Historical Cost and Current Cost financial statements should be stated in terms of the measuring unit current at the end of the reporting period (IAS 29.8).” and

b)      your last paragraph as follows:

“The submitter raises queries about whether it is correct that IAS 29 is not required during hyperinflation when financial statements are prepared in terms of financial capital maintenance in units of constant purchasing power since all items in such financial statements would already be stated at the measuring unit current at the end of the reporting period.”

Explanation

All items in financial statements prepared in terms of financial capital maintenance in units of constant purchasing power are always stated in terms of the measuring unit current (the Daily – not monthly - CPI) at the end of the reporting period and after the date of the financial statements always automatically updated to today’s Daily CPI.

All items in these financial statements

(1. constant items always and everywhere measured in units of constant purchasing power in terms of the Daily CPI, including at the balance sheet date, with the calculation and accounting of the net constant item loss or gain when they are not measured in units of constant purchasing power during the financial period;

2. variable items valued in terms of IFRS-authorized measurement bases at the balance sheet date, excluding nominal Historical Cost, i.e., excluding the stable measuring unit assumption which is never implemented under this model – Historical Costs under this model always being updated Historical Costs and

3. monetary items inflation-adjusted daily in terms of the Daily CPI, with the calculation and accounting of the net monetary loss or gain when they are not inflation-adjusted daily in terms of the Daily CPI,)

are always, after the balance sheet date, automatically updated in terms of the current (today´s) Daily CPI (in electronic – digital – form: financial statements preferably never to be printed on hard copy).

All these items are only stated at the measuring unit current at the balance sheet (that day´s Daily CPI) on that specific day. Thereafter they are all updated to the current, today´s, Daily CPI, whenever they are accessed or read or dealt with thereafter.

Tomorrow they will all be different in nominal value (their nominal values will be updated in terms of tomorrow’s Daily CPI, which we all already know today), but they will always be the same in real or constant value: always to be automatically updated in nominal value at all future Daily CPIs.

In principle and practice, they will never be the same in nominal value from the one day to the next during all levels of inflation and deflation, including during high inflation and hyperinflation, but they will always be the same in real or constant value.

Regarding the first paragraph of your summary:

It is very useful to remember the following:

“It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings – that there can be no earnings unless and until the purchasing power of capital is maintained.”

FAS 33 Par. 24

I am sure the above quote makes you think about the credibility of financial capital maintenance in nominal monetary units (the 3000-year-old, globally implemented, generally accepted, traditional Historical Cost Accounting model, which IAS 29 promotes even during hyperinflation of millions percent per annum) when we acknowledge the fact that it is generally impossible to maintain the real value of financial capital (equity) constant in nominal monetary units during inflation and deflation resulting in the real value (constant purchasing power) of that portion of entities´ equity not maintained constant by the real value of their net assets, being eroded / destroyed by the stable measuring unit assumption, not by inflation and hyperinflation, although almost all accountants and economists would tell you that the erosion of companies´ capital and invested profits is caused by inflation as it is actually stated in US FASs and as implied in IFRS.

Especially when we also acknowledge that it is a fact that financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index automatically maintains the constant purchasing power of equity constant for an indefinite period of time in all entities that at least break even in real value – all else being equal – at all levels of inflation and deflation, whether they own any fixed assets or not.

Not a single company in the world knows whether it has maintained the real value (constant purchasing power) of its equity constant over its lifetime.

Makes you think, doesn’t it?

FAS 33 Par. 24 would automatically eliminate Historical Cost Accounting as a choice as an appropriate accounting model at all levels of inflation.

I attached a Pdf copy of my e-book CONSTANT ITEM PURCHASING POWER ACCOUNTING per IFRS (Available at Amazon.com). Your systems blocked the email that had the Kindle file in a zip file.

The book is a comprehensive introduction to financial capital maintenance in units of constant purchasing power in terms of a daily CPI or other index.

I acknowledge your assistance in my project in the book.

Another mistake in my agenda item request was the title of the draft IFRS ´X`. It is not draft IFRS ´X` CONSTANT ITEM PURCHASING POWER ACCOUNTING, but draft IFRS ´X` CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER per IFRS. I would appreciate it very much if you could be so kind as to correct it.

When I was ready to send in my agenda item request I did not know at the time that there is an actual agenda item request form. I suddenly discovered it on your site and promptly completed it in about 30 minutes. I did not check it before I submitted it.

Thank you very much for the opportunity to give you my input. The IASB has tremendous credibility as an international accounting standard institution with this approach and especially with your very public and very prominent annual improvement process.

Best regards,

Nicolaas Smith

Nicolaas Smith Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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09 November 2012

Thank you for this additional information. I’ve reflected your changes in our summary of work in project that goes to members of the Interpretations Committee.

April Pitman | Technical Manager

International Accounting Standards Board (IASB)

30 Cannon Street | London EC4M 6XH | UK

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