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Sunday, 13 August 2017

IFRS and US GAAP authorized Historical Cost Accounting destroys the real value of capital

IFRS and US GAAP authorized Historical Cost Accounting destroys the real value of capital

Historical Cost Accounting - as implemented under International Financial Reporting Standards and US GAAP - has always destroyed, is currently destroying and will always destroy the real value of all companies´ capital in all economies in the world under inflationary and hyper-inflationary conditions because of the implementation of the stable measuring unit assumption. Capital is always a constant real value non-monetary item in a company implementing a double entry accounting model.

Authorized Double Entry Accounting Models 

(i) Historical Cost Accounting in terms of Financial Capital Maintenance in terms of Nominal Monetary Units is one of the three double entry accounting models authorized under IFRS and US GAAP. The other two are (ii) Physical Capital Maintenance and (iii) Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI.

Perpetual Destruction

This perpetual destruction of the real value of companies´capital under the globally implemented Historical Cost Accounting model which applies the stable measuring unit assumption can only be stopped with (a) Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI during inflation and hyperinflation or (b) with sustainable zero inflation. Under sustainable zero inflation the stable measuring unit assumption is irrelevant. 

The equity equal to net assets argument is not a solution for the impossibility of maintaining the real value of capital under nominal Historical Cost Accounting during inflation and hyperinflation. See Equity Equal To Net Assets Capital Maintenance Fallacy. 

Capital Maintenance is non-existent in the the world economy

Not a single company, private or public, has ever maintained the constant purchasing power (real value) of its capital and never will under Historical Cost Accounting during inflation and hyperinflation.

It can only be done with Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI. 

Capital maintenance is non-existent in the world economy despite the fact that the European Accounting Association states "Capital maintenance is a competing objective of financial reporting." 

The IASB´s IFRS and the FASB´s US GAAP contain several paragraphs regarding Capital Maintenance stating that financial capital maintenance can be measured in nominal monetary units under Historical Cost Accounting in their respective Conceptual Frameworks. 


However, the FASB states:


‘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.

US FASB Financial Accounting Standard 33 (1979) Paragraph 24


Both standard setters authorize Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI by stating that financial capital can be measured in units of constant purchasing power in their Conceptual Frameworks.



Unification of the Two Financial Capital Maintenance Models

(i) Financial Capital Maintenance in terms of Nominal Monetary Units (Historical Cost Accounting) and (ii) Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI would be one and the same accounting model under sustainable zero inflation.

The IFRS Framework states: "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Implementing Financial Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI would stop the use of the stable measuring unit assumption and the constant purchasing power of capital would be maintained constant over time in all entities that at least break even in real value during inflation and hyperinflation, all else being equal.


Nicolaas Smith Copyright (c) 2005-2017 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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