HCA is not an appropriate accounting policy

HCA is not an appropriate accounting policy


Auditors state in the audit report that the directors´ responsibility for the financial statements includes selecting and applying appropriate accounting policies. The audit report also normally states under the Auditors´ Responsibility that an audit includes evaluating the appropriateness of accounting policies used in a company. So, both the directors and the auditors have a responsibility with regards to the appropriateness of accounting policies for a company.

The implementation of the very erosive stable measuring unit assumption which is based on a fallacy and financial capital maintenance in nominal monetary units per se which is a fallacy during inflation and deflation means that the use of the HCA model is – in principle - not an appropriate accounting policy for companies during inflation and deflation.

The IASB, on the one hand, agrees that the stable measuring unit assumption and financial capital maintenance in nominal monetary units per se are not appropriate accounting policies in hyperinflationary economies.

IAS 29 Financial Reporting in Hyperinflationary Economies states that:
“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2

Very unfortunately, the IASB, on the other hand – in the same standard, authorizes and supports the use of the HCA model during hyperinflation:

“The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.” IAS 29, Par 8

Big Four audit firms, e.g. PricewaterhouseCoopers, also support the use of HCA during hyperinflation:

“Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting.”

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

When it is clearly demonstrated and the board of directors knows that a company’s HC accounting policy - freely selected by the board - continuously erodes a significant amount of the existing constant real non-monetary value of the company´s Shareholders´ Equity as a result of the company’s implementation of the very erosive stable measuring unit assumption when the company assumes that it would be for an unlimited period of time during indefinite inflation, then the traditional HCA model is , in principle, not an appropriate accounting policy. When the board knows that financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) - as approved by the IASB in the original Framework (1989), Par 104 (a) - is an IFRS–compliant alternative freely available to the company and when the board knows that CIPPA would automatically stop the unnecessary erosion of existing constant real non–monetary value in existing constant items never maintained constant for an indefinite period of time in all entities that at least break even during low inflation – ceteris paribus - then the traditional HCA model is , in principle, not an appropriate accounting policy.

The principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation has been subjected to a “thorough, open, participatory and transparent, due process” at the IASB, and elsewhere, before it was approved in the original Framework (1989), Par 104 (a) twenty two years ago. The principle is thus generally accepted in the accounting and auditing professions. However, the practice of financial capital maintenance in unit of constant purchasing power during low inflation and deflation (CIPPA) is not yet generally accepted sine the due process is not yet complete. Neither have accounting software packages been adapted for the implementation of CIPPA, nor has accounting personnel been trained to implement financial capital maintenance in units of constant purchasing power during low inflation and deflation, nor have audit procedures been adapted by auditors to audit companies implementing the Constant Item Purchasing Accounting model. That is: the due process is not yet complete for CIPPA.

Currently financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is thus an appropriate accounting policy in principle but is not yet generally implemented in practice. HCA is thus not an appropriate accounting policy, in principle, but, is generally implemented in practice. The current implementation of the HCA model is thus still an appropriate (very costly to the world economy) accounting policy, in practice, but not in principle. However, as soon as the practical implementation of financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (CIPPA) has passed proper due process; accounting software packages have been adapted to CIPPA; accounting personnel have been trained to implement CIPPA and audit procedures have been adapted by audit firms to audit companies implementing CIPPA, then the HCA model will certainly not be an appropriate accounting policy – in principle and in practice.

This will not happen overnight. As was stated in US FAS 89 in 1986:

“Mr. Mosso dissented to the issuance of Statement 33 and he dissents to its rescission, both for the same reason. He believes that accounting for the interrelated effects of general and specific price changes is the most critical set of issues that the Board will face in this century.”

and

“Relative to most changes in financial reporting, the changes required by Statement 33 were monumental. Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.”

Any single entity can now implement CIPPA since non-monetary items have been properly split in variable and constant items since 2005.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Historical Cost Accounting is not an appropriate accounting policy

HCA is not an appropriate accounting policy


Auditors state in the audit report that the directors´ responsibility for the financial statements includes selecting and applying appropriate accounting policies. The audit report also normally states under the Auditors´ Responsibility that an audit includes evaluating the appropriateness of accounting policies used in a company. So, both the directors and the auditors have a responsibility with regards to appropriate accounting policies for a company.

The implementation of the stable measuring unit assumption which is based on a fallacy and financial capital maintenance in nominal monetary units per se which is a fallacy during inflation and deflation means that the use of the HCA model is not an appropriate accounting policy for companies during inflation and deflation. The IASB already agrees that the stable measuring unit assumption and financial capital maintenance in nominal monetary units per se are not appropriate accounting policies in hyperinflationary economies.

IAS 29 Financial Reporting in Hyperinflationary Economies states that:

“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2

When it can be clearly demonstrated that a company’s HC accounting policy selected by the board of directors eroded a significant percentage of the real value of the company´ Shareholders´ Equity as a result of the company’s implementation of the stable measuring unit assumption when the company assumes that it would be for an unlimited period of time during indefinite inflation when they know that financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework (1989), Par 104 (a), is an IFRS-compliant alternative freely available to the company and that it would stop the unknowing, unintentional and unnecessary erosion of existing constant non-monetary real value in existing constant real value non-monetary items never maintained constant by the implementation by the company´s board and accountants of financial capital maintenance in nominal monetary units during low inflation and deflation, then the traditional HCA model, in principle, is not an appropriate accounting policy.

The principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation has been subjected to a “thourough, open, participatory and transparent, due process” at the IASB before it was approved in the Framework (1989), Par 104 (a) twenty two years ago. The principle is thus generally accepted in the accounting and auditing professions. However, the practice of financial capital maintenance in unit of constant purchasing power during low inflation and deflation (CIPPA) is not yet generally accepted. Neither have accounting software packages been adapted for the implementation of CIPPA, nor have accountants and accounting personnel been trained to implement financial capital maintenance in units of constant purchasing power during low inflation and deflation, nor have audit procedures been adapted by auditors to audit companies implementing the Constant Item Purchasing Accounting model.

Currently financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is thus an appropriate accounting policy and HCA not an appropriate accounting policy, in principle, but, not in practice. The current implementation of the HCA model is thus still an appropriate accounting policy, in practice, although not in principle. However, as soon as the practical implementation of financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (CIPPA) has passed proper due process; accounting software packages have been adapted to CIPPA; accountants and accounting personnel have been trained to implement CIPPA and audit procedures have been adapted by audit firms to audit companies implementing CIPPA, then the HCA model will certainly not be an appropriate accounting policy - in principle and in practice.

This will not happen overnight. As was stated in US FAS 89 in 1986: “Mr. Mosso dissented to the issuance of Statement 33 and he dissents to its rescission, both for the same reason. He believes that accounting for the interrelated effects of general and specific price changes is the most critical set of issues that the Board will face in this century.”

and

“Relative to most changes in financial reporting, the changes required by Statement 33 were monumental. Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.”

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.