IASB believes that capital maintenance is only required during high inflation and hyperinflation

The constant purchasing power (real value) of capital needs to be maintained constant during low inflation and deflation and not only during high inflation and hyperinflation as it is generally accepted.


‘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 1979: 24

The above statement refers to low inflation and deflation too.

The following is Question 26 regarding Capital Maintenance in the IASB´s Discussion Paper on the Conceptual Framework:

Question 26 - Other Issues:

Capital maintenance

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change.

Do you agree? Why or why not? Please explain your reasons

The IASB clearly implies above that capital maintenance in units of constant purchasing power (which would maintain the real value of equity) is only required as from the onset of high inflation. The IASB luckily also discovered recently (in June 2013 after I had pointed it out to them) that capital maintenance in units of constant purchasing power was actually required in IAS 29 Financial Reporting in Hyperinflationary Economies even though the Board had authorised it twenty four years ago in 1989. The IASB staff recently (April 2013) still mistakenly stated that there is no guidance in IFRS regarding capital maintenance in units of constant purchasing power. The IASB is by now at least well aware that IAS 29 requires capital maintenance in units of constant purchasing power in terms of the monthly published CPI. 

Entities - including the IASB - operating during low inflation and deflation generally believe that Capital Maintenance in Units of Constant Purchasing Power as authorised in the Conceptual Framework, Par. 4.59 (a) at all levels of inflation and deflation does not need to be applied to ensure the maintenance of the real value (constant purchasing power) of equity during low inflation and deflation. This is the case despite the fact that financial capital maintenance in nominal monetary units (HCA) during continuous 2% annual inflation results in the erosion / destruction of 51% of the real value of that portion of equity not covered by the real value of net assets over 35 years. 

No company in the world knows whether it maintained in the past and currently maintains the constant purchasing power of its capital constant during low and high inflation and deflation. No company in the world does that calculation during low and high inflation and deflation. No-one knows.

Financial capital maintenance in nominal monetary units during 2 percent annual inflation - mistakenly regarded as price stability in the US and European Monetary Union (and everywhere else) - results in the erosion (destruction) of the constant purchasing power (real value) of equity in that portion of equity that is not covered by the REAL value of net assets. 100% of equity being equal to 100% of net assets IN NOMINAL MONETARY TERMS (i.e., balancing the books under financial capital maintenance in nominal monetary units under the Historical Cost Accounting model) does not guarantee that the real value (constant purchasing power) of equity is being maintained constant during low and high inflation and deflation. 

The following are the answers of some respondents to Question 26. It can be seen that they mistakenly believe that capital maintenance only applies as from the onset of high inflation and that it is not required during low inflation.


1. AUSTRALASIAN COUNCIL OF AUDITORS‐GENERAL

ACAG has no view on this issue. The Australian public sector has not been in a high inflation environment for many years and the capital maintenance paragraphs in the existing Conceptual Framework are rarely used.

It is very clear from the above that concepts of capital maintenance are rarely used during low inflation in Australasia.

This view that the capital maintenance paragraphs in the existing Conceptual Framework are rarely used is a very good overall summary regarding capital maintenance during low inflation and deflation, not only in Australasia, but also in the world economy.

2. INSTITUT DER WIRTSCHAFTSPRUFER

We agree with the Board´s view to deliberate the appropriate capital maintenance concept when discussing accounting for high inflation. 

Capital maintenance - maintaining the real value of equity - during low inflation is obviously not considered important in Germany.

3. EUROPEAN SECURITIES AND MARKET AUTHORITY

ESMA is not aware of any issues with IAS 29 Financial Reporting in Hyperinflationary Economies but would welcome a clearer reference in the ED as ESMA agrees that something could be done in the revised CF. 

4. THE HONG KONG ASSOCIATION OF BANKS

We agree with the IASB to defer revision or refinement until it is needed, because we have 

not encountered high inflation issues. 

The Hong Kong Association of Banks clearly also believes no capital maintenance is required during low inflation.

5. THE CERTIFIED GENERAL ACCOUNTANTS ASSOCIATION OF CANADA

We agree that the IASB should defer its work on capital maintenance until it develops new provisions or revises the extant Standard (IAS 29) on accounting for hyperinflation. 

See also: IASB has "a lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework"

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