IASB completely unaware of its social responsibility

Countries like Belarus and Venezuela - both in hyperinflation - are not the best examples of modern democracies. The president of Belarus describes himself as the last dictator in Europe.

The president of Belarus is also the only person with the power to authorise sweeping accounting changes that would stabilise Belarus´s economy. Sweeping changes like the adoption of a Daily Index with IAS 29 Financial Reporting in Hyperinflationary Economies which is not actually being implemented in the country although Belarus signed up to implement IFRS.

The only reason Venezuela´s non-monetary economy is not stable today, is because IAS 29 is being implemented in terms of a monthly CPI. Brazil had a relatively stable non-monetary economy during the 30 years of very high and hyperinflation from 1964 to 1994 because of the use of government-supplied daily indices with Capital Maintenance in Units of Constant Purchasing Power in the form of indexation or monetary correction which was also widely used in other Latin American countries during that period in the form of price-level restatement in terms of a daily index. IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power. Unfortunately IAS 29 has been implemented since its inception in 1990 in terms of the monthly published CPI.

IAS 29 does not prescribe the use of the monthly published CPI. It is generally accepted to implement IAS 29 in terms of the monthly CPI, but it is not prescribed in IAS 29.  IAS 29 simply requires restatement in terms of the general price level. The Daily CPI is based on the general price level since it is simply a lagged, daily interpolation of the monthly published general price level CPI. IAS 29 can thus currently be implemented in terms of a Daily CPI or another Daily Index, for example, a Brazilian-style Unidade-Real-de-Valor-based Daily Index that was almost entirely made up of the US Dollar daily exchange rate - by any country with the political will to use a Daily Index with IAS 29 to stabilise its hyperinflationary economy.

In short: if the IASB were to add the two words “Daily Index” to IAS 29, it would immediately stabilise the Venezuelan non-monetary economy over a short period of time. It would also stabilise the Belarus non-monetary economy whenever Belarus would actually implement such a revised version of IAS 29. An IAS 29 requiring a Daily Index would thus currently stabilise Venezuela´s non-monetary economy, but not in the case of Belarus because Belarus is not actually implementing IAS 29 as per my American accredited source in Belarus.

According to my source: "the government has not recognized the existence of hyperinflation in the country."

If the IASB were to add the two words “Daily Index” to the future IFRS regarding Financial Reporting in High Inflationary Economies, it would stabilise the non-monetary economies of all countries with inflation in excess of 10 percent per annum or 26 percent cumulative inflation over three years.

Stable non-monetary economies would be a great benefit to the people of Venezuela and Belarus and of countries with high inflationary economies.

The IASB can thus with two words do what now would be required to be done by the last dictator in Europe and by the newly elected president in Venezuela.

Unfortunately the IASB is currently completely unaware of this social responsibility it has to the people of high inflationary and hyperinflationary economies to - where it could it should - authorise standards that would automatically stabilise a non-monetary economy because the IASB itself does not understand the stabilising effect in the non-monetary economy of  Capital Maintenance in Units of Constant Purchasing Power as required in IAS 29, but with requiring a Daily Index instead of the monthly published CPI . The power to automatically stabilise high inflationary and hyperinflationary economies thus lies in the hands of the IASB because most of these countries implement IFRS. All that is required is the addition of two words. All the rest of the requirements and authorisations are already in place in IFRS.

This is not something new. It was widely implemented in Latin America from the early 1960´s to the mid 1990´s.

The IASB “are hoping to publish the Conceptual Framework discussion paper” regarding capital maintenance “next month.”

Nicolaas Smith

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

IFRS are based on a fallacy

Maintaining the constant purchasing power of capital in nominal monetary units is impossible during inflation (including during low inflation) when net assets include constant real value non-monetary items not measured in units of constant purchasing power and monetary items not inflation-adjusted - both in terms of an index which recognizes all changes in the general price level (normally a Daily Index).

It is generally assumed that capital maintenance means that the real value (constant purchasing power) of capital is maintained constant over time.

It is generally impossible to maintain the constant purchasing power of capital constant in nominal monetary units during inflation. The statement in IFRS in the Conceptual Framework, par. 4.59 (a) that “Financial capital maintenance can be measured in nominal monetary units” is thus a fallacy. IFRS are thus based on a fallacy which came about through social and economic practice over the last 3000 years. It may take another 200 years to undo that practice.

Nicolaas Smith

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

Constant purchasing power maintenance

‘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 clearly excludes a financial concept of capital such as invested money, i.e., Historical Cost Accounting or financial capital maintenance in nominal monetary units, from being part of what bestows credibility on financial reporting.

Capital is equal to the real value of net assets.

However, the Conceptual Framework states:

‘Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity.’

Conceptual Framework, par. 4.57

The CF mistakenly implies that under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the nominal net assets or equity of the entity.

This is obviously a mistake to be corrected in IFRS.

It is thus generally impossible to maintain the constant purchasing power of capital with Historical Cost Accounting, i.e., under financial capital maintenance in units of constant purchasing power per se.

However, “A financial concept of capital is adopted by most entities in preparing their financial statements.’

Conceptual Framework, par. 4.57

The CF assumes a nominal financial concept of capital - the traditional model in the world economy - since capital maintenance in units of contant purchasing power is only prescribed in IFRS (in IAS 29) in “exceptional circumstances.” CF par. 4.63.

Thus most entities do not maintain the purchasing power of their capital constant during low inflation, (high inflation and hyperinflation). It is very obvious during high inflation and hyperinflation. Financial capital maintenance in nominal monetary units is thus a fallacy since it is impossible - in general - to maintain the real value of capital constant in nominal monetary units per se during inflation. IFRS should not be based on generally accepted accounting fallacies.

The opening constant purchasing power of capital can be maintained constant in entities that at least break even in real value - all else being equal - with measurement in units of constant purchasing power in terms of the measuring unit current at the end of the reporting period during hyperinflation, i.e., with restatement as currently applied in IAS 29 in terms of the month-end CPI - because opening capital is a balance sheet item, i.e., it has an unlimited lifetime: it is not time dependent. Current year profits and losses are time-dependent. When they are not maintained - during the reporting period - in terms of every change in the general price level, then 100% of their constant purchasing power are not being maintained constant, e.g., currently in Venezuela and Belarus. The same has always happened during low inflation (all levels of inflation).

Current year results at the end of the reporting period pass to equity. Their constant purchasing power cannot be maintained 100% during the reporting period unless all changes in the general price level are recognized which is  impossible with restatement in terms of the month-end CPI as it is currently implemented under IAS 29. IAS 29 had no relevance in Zimbabwe.

Thus, what is important is constant purchasing power maintenance and not just capital maintenance. The two concepts are in fact the same under ideal capital maintenance in units of constant purchasing power. The two are the same only with measurement in units of constant purchasing power when all changes in the general price level are recognized - which does not happen under IAS 29 in terms of the month-end CPI. A Daily Index - as used very successfully from 1964 to 1994 in Brazil and in other Latin American countries during that period - is thus required.

Capital maintenance in units of constant purchasing power in terms of a Daily Index is not something new. It was widely used in Latin America in the period mentioned above. The very successful and wide use of daily indices over 30 years in Latin America was - very unfortunately (see Zimbabwe) ignored by the IASC - the IASB´s predecessor body - with the authorization of IAS 29 in 1989. The IASB plans to undertake research to determine whether to revise IAS 29.

Nicolaas Smith

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