“The South African Reserve Bank (the SARB) is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as "the achievement and maintenance of price stability.
The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. The Bank has a floating exchange rate policy and there are no exchange rate targets.
Financial stability is not an end in itself, but, like price stability, is generally regarded as an important precondition for sustainable economic growth and employment creation.”
SARB
The average annual inflation rate in SA has been 6% over the last 10 years while Tito Mboweni was the Governor of the SARB. This is half the 12% average annual inflation rate during the 18 years before Mboweni took over the helm at SA´s central bank.
SA is thus committed to low inflation. This is the correct policy.
“Real economic gain can be achieved by reducing the trend growth of money.”
Money, Inflation and Economic Growth. Keith Carlson, Federal Reserve Bank of St. Luis. 1980
“Monetary policymakers have assumed that faster sustainable growth can only occur in a climate where the inflation monster is tamed.
A reduction in inflation of even a single percentage point leads to an increase in per capita income of 0.5 percent to 2 percent.
As the authors point out, their analysis leaves little room for interpretation. Inflation is not neutral, and in no case does it favor rapid economic growth. Higher inflation never leads to higher levels of income in the medium and long run, which is the time period they analyze. This negative correlation persists even when other factors are added to the analysis, including the investment rate, population growth, schooling rates, and the constant advances in technology. Even when the authors factor in the effects of supply shocks characteristic of a part of the analyzed period, there is still a significant negative correlation between inflation and growth.
Inflation not only reduces the level of business investment, but also the efficiency with which productive factors are put to use. The benefits of lowering inflation are great, according to the authors, but also dependent on the rate of inflation. The lower the inflation rate, the greater are the productive effects of a reduction. For example, reducing inflation by one percentage point when the rate is 20 percent may increase growth by 0.5 percent. But, at a 5 percent inflation rate, output increases may be 1 percent or higher. It is therefore more costly for a low inflation country to concede an additional point of inflation than it is for a country with a higher starting rate. Given their detailed analysis, the authors conclude that "efforts to keep inflation under control will sooner or later pay off in terms of better long-run performance and higher per capita income.”
Does Inflation Harm Economic Growth? Evidence for the OECD: Javier Andres, Ignacio Hernando, The US National Bureau of Economic Research, 1997
“The tests revealed that a weak negative correlation exists between inflation and growth, while the change in output gap bears significant bearing. The causality between the two variables ran one-way from GDP growth to inflation.
Correlation coefficients showed only a weak negative link, while causality was shown to run from economic growth to inflation. With the majority of Fiji’s inflation being imported, the influence of domestic factors (being unit labour costs and to a lesser extent the output gap) is limited. The findings of other empirical studies, however, provide some guidance for Fiji policymakers on the importance of maintaining low inflation, in order to foster higher economic growth. For its part, the Reserve Bank of Fiji will need to maintain monetary policy consistent with low inflation and inflation expectations.”
Relationship between Inflation and Economic Growth: Gokal and Hanif, Reserve Bank of Fiji, 2004
“ There are also significant feedbacks between inflation and economic growth. These results have important policy implications. Moderate inflation is helpful to growth, but faster economic growth feeds back into inflation.
Attempts to achieve faster economic growth may overheat the economy to the extent that the inflation rate becomes unstable. Thus, these economies are on a knife-edge. The challenge for them is to find a growth rate which is consistent with a stable inflation rate. They need inflation for growth, but too fast a growth rate may accelerate the inflation rate and take them downhill as found by Bruno and Easterly (1998).”
INFLATION AND ECONOMIC GROWTH: EVIDENCE FROM FOUR SOUTH ASIAN COUNTRIES, Asia-Pacific Development Journal Vol. 8, No. 1, June 2001, Girijasankar Mallik and Anis Chowdhury
Kindest regards,
Nicolaas Smith
Monday 7 December 2009
Saturday 5 December 2009
Who drives inflation - Part 1
Who drives inflation, Kalinka asked a day or two ago.
Inflation is always and everywhere the destruction of the real value of money.
Mainstream economists state that inflation is a rise in the general level of prices of goods and services in the economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation destroys the purchasing power of money – the destruction of the real value of the internal medium of exchange and unit of account in the economy. Monetarists believe the most significant factor influencing inflation is the management of money supply through the easing or tightening of credit via the central bank’s interest rate policy.
The Austrian School states that inflation is an excessive increase in the money supply by central banks. They want to ban them and go back to the gold standard.
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied.
Rational expectations result in the outcome depending partly on what people expect to happen.
Adaptive expectations means that people form their expectations about what will happen in the future based on what has happened in the past. For example, if inflation has been higher than expected in the past, people would expect the same to happen in the future.
Structural inflation (built-in inflation) is an economic term referring to inflation that results from past events and persists in the present. It then becomes a normal aspect of the economy, via inflationary expectations and the price/wage spiral.
Inflationary expectations play a role because if workers and employers expect inflation to persist in the future, they will increase their (nominal) wages and prices now. This means that inflation happens now simply because of subjective views about what may happen in the future. Of course, following the generally accepted theory of adaptive expectations, such inflationary expectations arise because of persistent past experience with inflation.
The price/wage spiral refers to the adversarial nature of the wage bargain in modern capitalism. Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages (or to attain a target real wage) by pushing for higher money (or nominal) wages. Thus, if they expect price inflation - or have experienced price inflation in the past - they push for higher money wages. If they are successful, this would raise the costs faced by their employers – if they do not inflation-adjust their selling prices – which they do. To protect the real value of their profits (or to attain a target profit rate or rate of return on investment), employers then pass the higher costs on to consumers in the form of higher prices. This encourages workers to push for higher money wages again as the cycle starts all over.
In the end, built-in inflation involves a vicious circle of both subjective and objective elements, so that inflation encourages inflation to persist.
Inertial inflation is a concept coined by structuralist inflation theorists. It refers to a situation where all prices of non-monetary items in an economy are continuously adjusted with relation to a price index by force of contracts as Brazil did for 30 years from 1964 to 1994 and as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies
Changes in price indices trigger changes in prices of all non-monetary items. Contracts are made to accommodate this price-changing scenario by means of indexation. Indexation in a hyperinflationary economy is evident when, for instance, a given price must be recalculated at a later date, incorporating inflation accumulated over the period to correct the nominal price.
In other cases, local currency prices can be expressed in terms of a foreign currency: normally the US Dollar like in Zimbabwe. In some point in the future, prices are converted back from the foreign currency equivalent into local currency. This conversion from a stronger currency equivalent value (ie, the foreign currency) is intended to protect the real value of goods, as the nominal value depreciates.
In the medium-to-long term, economic agents begin to forecast inflation and to use those forecasts as de facto price indexes that can trigger price adjustments before the actual price indices are made known to the public. This cycle of forecast-price adjustment-forecast closes itself in the form of a feedback loop and inflation indices get beyond control since current inflation becomes the basis for future inflation (more formally, economic agents start to adjust prices solely based on their expectations of future inflation).
South Africa does not have inertial inflation. There is no indexation of all non-monetary items by contract.
So, Kalinka who drives inflation in SA?
We will have a look next time.
Kindest regards,
Nicolaas Smith
Inflation is always and everywhere the destruction of the real value of money.
Mainstream economists state that inflation is a rise in the general level of prices of goods and services in the economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation destroys the purchasing power of money – the destruction of the real value of the internal medium of exchange and unit of account in the economy. Monetarists believe the most significant factor influencing inflation is the management of money supply through the easing or tightening of credit via the central bank’s interest rate policy.
The Austrian School states that inflation is an excessive increase in the money supply by central banks. They want to ban them and go back to the gold standard.
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied.
Rational expectations result in the outcome depending partly on what people expect to happen.
Adaptive expectations means that people form their expectations about what will happen in the future based on what has happened in the past. For example, if inflation has been higher than expected in the past, people would expect the same to happen in the future.
Structural inflation (built-in inflation) is an economic term referring to inflation that results from past events and persists in the present. It then becomes a normal aspect of the economy, via inflationary expectations and the price/wage spiral.
Inflationary expectations play a role because if workers and employers expect inflation to persist in the future, they will increase their (nominal) wages and prices now. This means that inflation happens now simply because of subjective views about what may happen in the future. Of course, following the generally accepted theory of adaptive expectations, such inflationary expectations arise because of persistent past experience with inflation.
The price/wage spiral refers to the adversarial nature of the wage bargain in modern capitalism. Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages (or to attain a target real wage) by pushing for higher money (or nominal) wages. Thus, if they expect price inflation - or have experienced price inflation in the past - they push for higher money wages. If they are successful, this would raise the costs faced by their employers – if they do not inflation-adjust their selling prices – which they do. To protect the real value of their profits (or to attain a target profit rate or rate of return on investment), employers then pass the higher costs on to consumers in the form of higher prices. This encourages workers to push for higher money wages again as the cycle starts all over.
In the end, built-in inflation involves a vicious circle of both subjective and objective elements, so that inflation encourages inflation to persist.
Inertial inflation is a concept coined by structuralist inflation theorists. It refers to a situation where all prices of non-monetary items in an economy are continuously adjusted with relation to a price index by force of contracts as Brazil did for 30 years from 1964 to 1994 and as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies
Changes in price indices trigger changes in prices of all non-monetary items. Contracts are made to accommodate this price-changing scenario by means of indexation. Indexation in a hyperinflationary economy is evident when, for instance, a given price must be recalculated at a later date, incorporating inflation accumulated over the period to correct the nominal price.
In other cases, local currency prices can be expressed in terms of a foreign currency: normally the US Dollar like in Zimbabwe. In some point in the future, prices are converted back from the foreign currency equivalent into local currency. This conversion from a stronger currency equivalent value (ie, the foreign currency) is intended to protect the real value of goods, as the nominal value depreciates.
In the medium-to-long term, economic agents begin to forecast inflation and to use those forecasts as de facto price indexes that can trigger price adjustments before the actual price indices are made known to the public. This cycle of forecast-price adjustment-forecast closes itself in the form of a feedback loop and inflation indices get beyond control since current inflation becomes the basis for future inflation (more formally, economic agents start to adjust prices solely based on their expectations of future inflation).
South Africa does not have inertial inflation. There is no indexation of all non-monetary items by contract.
So, Kalinka who drives inflation in SA?
We will have a look next time.
Kindest regards,
Nicolaas Smith
Friday 4 December 2009
Inflation - a nebulous subject
Who drives inflation, Kalinka asked a day or two ago. As I said: that is a very sensitive question – especially in South Africa.
Inflation is a huge, hazy, vague, indistinct and confusing subject because of the monetary nature of money and the human nature of consumers and business people. We could have solved the problem very quickly if money was not a store of value (and only a medium of exchange and unit of account) and consumers and business people were not human beings. Remember, central bankers have to guess the collective effects of hundreds of millions of consumers and business people (greedy wall street bankers) exercising their individual self-interests.
I do not like discussing inflation because I question everything, I have already seen many theories disproved, I am not a macroeconomist, nor a central banker, every Tom, Dick and Harrry are experts in inflation and how it comes about is not that important to me.
It’s correct measurement is. Thank heavens for the people in the past who developed the Consumer Price Index. I could not believe it when I saw that Statistics SA had the calculation wrong in the past. That should never, ever happen.
We know exactly what the problem is in accounting: the stable measuring unit assumption and we know exactly how to get rid of it: financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) twenty years ago. When our accountants stop assuming there is no such thing as inflation and never has been in the past as far as the valuation of the reported Retained Profits and other constant items in the SA economy are concerned, there will be zero real value destruction in the constant item economy.
We will be left with the final problem in real value destruction in the three economic items. IFRS solve the valuation of variable item problems. Abandoning the stable measuring assumption will stop real value destruction in constant items. Then we are left with the destruction of the real value of money and other monetary items by inflation. The last frontier before real value Nirvana: a world where we do not destroy the real value of our medium of exchange simply by the way our economy works as our accountants are currently unknowingly destroying the real value of existing reported Retained Profits of all SA companies simply by the way they do accounting.
Accountants admit it is happening - or something is happening - I don´t think they really know what. The best they can do is to state that "inflation influences reported results". They mistakenly blame inflation as driven by the ANC´s economic policy and the SARB´s monetary policy - in their opinion. They are so wrong.
Kalinka, I still have to answer your question about who drives inflation. As you can see it is very foggy out there.
That will be in the next blog.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Inflation is a huge, hazy, vague, indistinct and confusing subject because of the monetary nature of money and the human nature of consumers and business people. We could have solved the problem very quickly if money was not a store of value (and only a medium of exchange and unit of account) and consumers and business people were not human beings. Remember, central bankers have to guess the collective effects of hundreds of millions of consumers and business people (greedy wall street bankers) exercising their individual self-interests.
I do not like discussing inflation because I question everything, I have already seen many theories disproved, I am not a macroeconomist, nor a central banker, every Tom, Dick and Harrry are experts in inflation and how it comes about is not that important to me.
It’s correct measurement is. Thank heavens for the people in the past who developed the Consumer Price Index. I could not believe it when I saw that Statistics SA had the calculation wrong in the past. That should never, ever happen.
We know exactly what the problem is in accounting: the stable measuring unit assumption and we know exactly how to get rid of it: financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) twenty years ago. When our accountants stop assuming there is no such thing as inflation and never has been in the past as far as the valuation of the reported Retained Profits and other constant items in the SA economy are concerned, there will be zero real value destruction in the constant item economy.
We will be left with the final problem in real value destruction in the three economic items. IFRS solve the valuation of variable item problems. Abandoning the stable measuring assumption will stop real value destruction in constant items. Then we are left with the destruction of the real value of money and other monetary items by inflation. The last frontier before real value Nirvana: a world where we do not destroy the real value of our medium of exchange simply by the way our economy works as our accountants are currently unknowingly destroying the real value of existing reported Retained Profits of all SA companies simply by the way they do accounting.
Accountants admit it is happening - or something is happening - I don´t think they really know what. The best they can do is to state that "inflation influences reported results". They mistakenly blame inflation as driven by the ANC´s economic policy and the SARB´s monetary policy - in their opinion. They are so wrong.
Kalinka, I still have to answer your question about who drives inflation. As you can see it is very foggy out there.
That will be in the next blog.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Thursday 3 December 2009
Inflation at the micro level
Kalinka, yesterday we saw that no-one gains in SA from inflation at the macro level.
Who gains from inflation at the micro level?
Everyone who pays fixed prices and payments over time for the same real value – all else being equal. He, she or it gains in his or her personal or company capacity. It does not mean the economy gains. It may have the opposite effect in aggregate. See Zimbabwe.
You can see this too in very old lifetime fixed rentals in many cities in Europe. All these areas have been destroyed by these fixed lifetime rentals. The lessee or his or her grand children now pays almost nothing for apartments. This results in these apartments falling apart since the lessor does not get any money to invest in the maintenance of the building. This is however a much larger structural problem. Those lessees´ salaries were also not always inflation adjusted over the decades.
[Financial capital maintenance in units of constant purchasing power will eventually solve all these problems because its ultimate effect is economic stability in the real economy.]
Every month when inflation goes up a little, stays the same or goes down even, the real value of your Rands goes down a little, stays the same or maybe even goes up for one month.
So Kalinka, you gain when you pay the same price for the same products or services any time after a month from the first purchase – as long as your salary is inflation-adjusted with the change in the CPI too. If your salary stays the same and the prices stay the same you, obviously, do not gain.
Companies gain in the very short term by keeping workers´ salaries and wages the same while they put up their selling prices with inflation. This is very bad for economic stability. It is obviously the opposite of economic stability.
They did that in Zimbabwe. Companies adjusted their selling prices to keep up with hyperinflation but kept salaries fixed. They first killed their internal economy – the workers had no money to buy anything - and in the end they killed their money, the ZimDollar. There is no ZimDollar today.
In the case of money you borrow, you will gain if you pay a fixed interest rate and inflation increases, but, your salary has to be inflation-adjusted too.
In the case of your book:
Not to lose any real value you should increase its selling price every time inflation increases, i.e. more or less every month. This obviously depend on the market for your book. If there is bigger demand you may even increase the real price. Lower demand may induce you to lower your real price (by keeping it the same during inflation). The CPI (not inflation) was the same in Oct 2009 as in Sept 2009. You would not change your price when the CPI does not change. The CPI is an internal exchange rate inside the SA economy between the Rand and real value within the SA economy.
The CPI is just an index number at a date. Inflation is indicated by the change in the CPI over a period of time. From 1 Oct 2008 to 30 Sept 2009 annual inflation was 6.1%. From 1 Nov 2008 to 31 Oct 2009 annual inflation was 5.9%. But, from 1 Sept 2009 to 31 Oct 2009 monthly inflation was zero percent: The CPI was the same in Oct 2009 as at was in Sept 2009.
See Statistics SA
I hope this helped a little.
Next I will try and answer your question about who drives inflation. That is a very sensitive question.
As I stated before: inflation is not my forte. I am only really interested in getting rid of the stable measuring unit assumption in SA.
Kindest regards,
Nicolaas Smith
Who gains from inflation at the micro level?
Everyone who pays fixed prices and payments over time for the same real value – all else being equal. He, she or it gains in his or her personal or company capacity. It does not mean the economy gains. It may have the opposite effect in aggregate. See Zimbabwe.
You can see this too in very old lifetime fixed rentals in many cities in Europe. All these areas have been destroyed by these fixed lifetime rentals. The lessee or his or her grand children now pays almost nothing for apartments. This results in these apartments falling apart since the lessor does not get any money to invest in the maintenance of the building. This is however a much larger structural problem. Those lessees´ salaries were also not always inflation adjusted over the decades.
[Financial capital maintenance in units of constant purchasing power will eventually solve all these problems because its ultimate effect is economic stability in the real economy.]
Every month when inflation goes up a little, stays the same or goes down even, the real value of your Rands goes down a little, stays the same or maybe even goes up for one month.
So Kalinka, you gain when you pay the same price for the same products or services any time after a month from the first purchase – as long as your salary is inflation-adjusted with the change in the CPI too. If your salary stays the same and the prices stay the same you, obviously, do not gain.
Companies gain in the very short term by keeping workers´ salaries and wages the same while they put up their selling prices with inflation. This is very bad for economic stability. It is obviously the opposite of economic stability.
They did that in Zimbabwe. Companies adjusted their selling prices to keep up with hyperinflation but kept salaries fixed. They first killed their internal economy – the workers had no money to buy anything - and in the end they killed their money, the ZimDollar. There is no ZimDollar today.
In the case of money you borrow, you will gain if you pay a fixed interest rate and inflation increases, but, your salary has to be inflation-adjusted too.
In the case of your book:
Not to lose any real value you should increase its selling price every time inflation increases, i.e. more or less every month. This obviously depend on the market for your book. If there is bigger demand you may even increase the real price. Lower demand may induce you to lower your real price (by keeping it the same during inflation). The CPI (not inflation) was the same in Oct 2009 as in Sept 2009. You would not change your price when the CPI does not change. The CPI is an internal exchange rate inside the SA economy between the Rand and real value within the SA economy.
The CPI is just an index number at a date. Inflation is indicated by the change in the CPI over a period of time. From 1 Oct 2008 to 30 Sept 2009 annual inflation was 6.1%. From 1 Nov 2008 to 31 Oct 2009 annual inflation was 5.9%. But, from 1 Sept 2009 to 31 Oct 2009 monthly inflation was zero percent: The CPI was the same in Oct 2009 as at was in Sept 2009.
See Statistics SA
I hope this helped a little.
Next I will try and answer your question about who drives inflation. That is a very sensitive question.
As I stated before: inflation is not my forte. I am only really interested in getting rid of the stable measuring unit assumption in SA.
Kindest regards,
Nicolaas Smith
Wednesday 2 December 2009
Who gains from inflation?
Kalinka asked me on the previous blog in South Africa: Who gains from inflation?
Kalinka,
Inflation is always and everywhere the destruction of the real value of money and other monetary items, e.g. monetary loans, over time.
As at 31 Oct 2009 SA´s money supply was R 1 939 278 million. Let us assume it was the same for the 12 months to Oct, 2009. Inflation was 5.9% over that period.
That means inflation destroyed 5.9% or R114.4 billion of the real value of that R1.9 trillion over those 12 months.
SA thus lost R114.4 billion in economic real value during that period although all the money is still there in nominal value.
Kalinka, no-one gains from inflation in the Rand at the macro level. But, this is only half the story.
Everybody loses as being part of the SA monetary economy that is the same in nominal value but R114.4 billion smaller in real value over the last year to Oct, 2009.
Everyone in SA is supposedly happy with this destruction in the real value of the Rand because it is within the SARB´s inflation-targeting range of 3% to 6%. Apparently everyone in SA will also be happy when Gill Marcus brings down inflation to 3% and only R58.1 billion in real value is destroyed. SA will gain R56.3 billion per annum. What a nice annual present from Gill and her team at the SARB that would be.
It is very obvious that everyone will be happier at R58.1 billion real value destruction than at R114.4 billion real value destruction per annum. Both are in the target range. Why the lower much happier target is not chosen, I do not know.
Kalinka, now I have some shocking news for you! You think that there is only one economic enemy in SA, namely, inflation. Unfortunately, I must inform you that there is a second one. It is called the stable measuring unit assumption which the accountants at all the companies that your sister audits as well as all other accountants at all other SA companies implement.
Kalinka, as you know Cosatu and Numsa and all the other trade unions see to it that workers´ wages and salaries are valued in units of constant purchasing power, i.e. inflation-adjusted in SA´s low inflationary environment to compensate at least for the annual destruction in the real value of the Rand. SA workers´ salaries and wages are constant real value non-monetary items but they are accounted in the Rand, a depreciating nominal monetary unit of account. They have constant real values but are paid out in a continuously depreciating monetary unit, the SA Rand.
SA accountants agree that inflation of 5.9% destroys the real value of the Rand, which is the depreciating monetary unit of account they use to account all economic activity in SA companies and prepare all financial reports, at 5.9% per annum. They know that if they keep workers´ salaries and wages (which have constant real values over time) the same they would be destroying the constant real values of those salaries and wages because they use the depreciating Rand as depreciating monetary medium of exchange to pay out constant item salaries and wages. They just happily inflation-adjust them at the union agreed values per industry and company.
Where do their companies get the extra money from to pay the inflation-adjusted salaries? In general, they all inflation-adjust all their selling prices too. In fact, the ones who increase their selling prices at levels higher than inflation when there is no actual real increase in real value in the products they sell, actually create this 5.9% inflation that we all have to pay for in the destruction of the real value in the Rand.
Inflation-adjusting or valuing salaries and wages in units of constant purchasing power is of great importance in the SA economy since it maintains internal demand for goods and services and adds greatly to economic, social and political stability in SA. This was not done in Zimbabwe and we all know what happened there.
All those accountants know that inflation was 5.9%. However, when they value all their companies´ reported retained profits and other constant real value non-monetary items never maintained in the companies (which are constant non-monetary items exactly the same as salaries and wages), they suddenly change their collective minds and they all collectively assume that the 5.9% change in the real value of the Rand is not sufficiently important to measure these items in units of constant purchasing power, i.e. they refuse to inflation-adjust them like they did with the salaries and wages.
Kalinka, can you imagine that! Now we are in for big trouble! They collectively implement their very destructive stable measuring unit assumption, the second economic enemy operating only in the constant item part of the SA real economy.
As they would have destroyed the real values of the workers´ salaries and wages if they had not inflation-adjusted them, so they, in fact, unknowingly and unintentionally destroy the real values of all these reported constant items never maintained in their companies; e.g. the reported Retained Profits of all SA companies, including the ones your sister audits.
They unknowingly destroy about R200 billion per annum in SA companies´ like that – each and every year. I am going to calculate this value as accurately as I can.
No-one forces them to do that. They simply do it because it has always been done like that. But, they do not have to do it like that. The International Accounting Standards Board authorized them 20 years ago to stop this destruction in the Framework, Par. 104 (a) which states:
“Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power.”
This is in agreement with International Financial Reporting Standards.
They can thus freely choose to measure all those constant items in units of constant purchasing power and stop their unknowing destruction of the real value of those items. They do not understand that they are unknowingly doing it with their very destructive stable measuring unit assumption. Neither do accounting lecturers at universities. They vaguely know that inflation has some effect on financial reports.
They implement their very destructive stable measuring unit assumption at annual inflation rates ranging from 0.1% per annum to 25.99% per annum for three years in a row. At these levels of inflation they assume that the change in the purchasing power of the Rand is not sufficiently important for them to measure financial capital maintenance in units of constant purchasing power.
However, when inflation increases just a little bit more by 0.1% to 26% per annum for 3 years in a row then they all happily would measure all constant items as well as all variable items in units of constant purchasing power. Why? Because 26% annual inflation for 3 years in a row will add up to 100% cumulative inflation over 3 years which is the IASB´s definition of hyperinflation. They have to inflation adjust all non-monetary items during hyperinflation as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies.
But, at 25.99% annual inflation they assume it is not sufficiently important for them to inflation-adjust constant items. They refuse to measure financial capital maintenane in units of constant purchasing power. They insist on unknowingly destroying the real value of reported constant items never maintained in SA companies.
Strange is it not?
Accountants simply blame inflation, the ANC´s economic and growth policy and the SARB´s monetary policy for this at all levels of inflation from 0.1 to 25.99% per annum for 3 years in a row.
It is very clear that accountants and accounting lecturers at do not understand the effects of measuring finacial capital maintenance in units of contstant purchasing power during low inflation as authorized by the IASB in the Framework, Par. 104 (a) although it was published in 1989. If they did, they would have stopped the stable measuring unit assumption in SA by now and they would not make unbelievable statements like
"We do not concur with the suggestion that the standards should reject the stable unit measuring assumption." when the Standards reject it in IAS 29 and its rejection has been approved as an option by the IASB 20 years ago.
Kalinka, your sister audits their accounts and then she or the partner at her audit firm signs the financial reports off as fairly representing the business of the companies when this is in fact happening in all of them. Can you believe that?
Kalinka, as you can see, no-one gains from inflation at the macro level although it is seen as a way to get out of deflation like Japan is trying right this very moment. That is another macro aspect of inflation. As you can see, in SA´s case it is twice as bad as you thought.
But, don´t despair. As soon as SA accountants start measuring financial capital maintenance in units of constant purchasing power they will collectively and knowingly kill the stable measuring unit assumption in SA forever. Then there will only be one economic enemy: inflation and we know Gill Marcus is the enemy of inflation.
Kalinka, I will deal with inflation on a micro level for you in the next blog.
By the way, I am simply an accountant. I am not a macroeconomist or central banker or banker, but, I will try and help with the concepts I do understand. Inflation is a very complex subject especially at the macro level. I am not an expert in inflation at all.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Kalinka,
Inflation is always and everywhere the destruction of the real value of money and other monetary items, e.g. monetary loans, over time.
As at 31 Oct 2009 SA´s money supply was R 1 939 278 million. Let us assume it was the same for the 12 months to Oct, 2009. Inflation was 5.9% over that period.
That means inflation destroyed 5.9% or R114.4 billion of the real value of that R1.9 trillion over those 12 months.
SA thus lost R114.4 billion in economic real value during that period although all the money is still there in nominal value.
Kalinka, no-one gains from inflation in the Rand at the macro level. But, this is only half the story.
Everybody loses as being part of the SA monetary economy that is the same in nominal value but R114.4 billion smaller in real value over the last year to Oct, 2009.
Everyone in SA is supposedly happy with this destruction in the real value of the Rand because it is within the SARB´s inflation-targeting range of 3% to 6%. Apparently everyone in SA will also be happy when Gill Marcus brings down inflation to 3% and only R58.1 billion in real value is destroyed. SA will gain R56.3 billion per annum. What a nice annual present from Gill and her team at the SARB that would be.
It is very obvious that everyone will be happier at R58.1 billion real value destruction than at R114.4 billion real value destruction per annum. Both are in the target range. Why the lower much happier target is not chosen, I do not know.
Kalinka, now I have some shocking news for you! You think that there is only one economic enemy in SA, namely, inflation. Unfortunately, I must inform you that there is a second one. It is called the stable measuring unit assumption which the accountants at all the companies that your sister audits as well as all other accountants at all other SA companies implement.
Kalinka, as you know Cosatu and Numsa and all the other trade unions see to it that workers´ wages and salaries are valued in units of constant purchasing power, i.e. inflation-adjusted in SA´s low inflationary environment to compensate at least for the annual destruction in the real value of the Rand. SA workers´ salaries and wages are constant real value non-monetary items but they are accounted in the Rand, a depreciating nominal monetary unit of account. They have constant real values but are paid out in a continuously depreciating monetary unit, the SA Rand.
SA accountants agree that inflation of 5.9% destroys the real value of the Rand, which is the depreciating monetary unit of account they use to account all economic activity in SA companies and prepare all financial reports, at 5.9% per annum. They know that if they keep workers´ salaries and wages (which have constant real values over time) the same they would be destroying the constant real values of those salaries and wages because they use the depreciating Rand as depreciating monetary medium of exchange to pay out constant item salaries and wages. They just happily inflation-adjust them at the union agreed values per industry and company.
Where do their companies get the extra money from to pay the inflation-adjusted salaries? In general, they all inflation-adjust all their selling prices too. In fact, the ones who increase their selling prices at levels higher than inflation when there is no actual real increase in real value in the products they sell, actually create this 5.9% inflation that we all have to pay for in the destruction of the real value in the Rand.
Inflation-adjusting or valuing salaries and wages in units of constant purchasing power is of great importance in the SA economy since it maintains internal demand for goods and services and adds greatly to economic, social and political stability in SA. This was not done in Zimbabwe and we all know what happened there.
All those accountants know that inflation was 5.9%. However, when they value all their companies´ reported retained profits and other constant real value non-monetary items never maintained in the companies (which are constant non-monetary items exactly the same as salaries and wages), they suddenly change their collective minds and they all collectively assume that the 5.9% change in the real value of the Rand is not sufficiently important to measure these items in units of constant purchasing power, i.e. they refuse to inflation-adjust them like they did with the salaries and wages.
Kalinka, can you imagine that! Now we are in for big trouble! They collectively implement their very destructive stable measuring unit assumption, the second economic enemy operating only in the constant item part of the SA real economy.
As they would have destroyed the real values of the workers´ salaries and wages if they had not inflation-adjusted them, so they, in fact, unknowingly and unintentionally destroy the real values of all these reported constant items never maintained in their companies; e.g. the reported Retained Profits of all SA companies, including the ones your sister audits.
They unknowingly destroy about R200 billion per annum in SA companies´ like that – each and every year. I am going to calculate this value as accurately as I can.
No-one forces them to do that. They simply do it because it has always been done like that. But, they do not have to do it like that. The International Accounting Standards Board authorized them 20 years ago to stop this destruction in the Framework, Par. 104 (a) which states:
“Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power.”
This is in agreement with International Financial Reporting Standards.
They can thus freely choose to measure all those constant items in units of constant purchasing power and stop their unknowing destruction of the real value of those items. They do not understand that they are unknowingly doing it with their very destructive stable measuring unit assumption. Neither do accounting lecturers at universities. They vaguely know that inflation has some effect on financial reports.
They implement their very destructive stable measuring unit assumption at annual inflation rates ranging from 0.1% per annum to 25.99% per annum for three years in a row. At these levels of inflation they assume that the change in the purchasing power of the Rand is not sufficiently important for them to measure financial capital maintenance in units of constant purchasing power.
However, when inflation increases just a little bit more by 0.1% to 26% per annum for 3 years in a row then they all happily would measure all constant items as well as all variable items in units of constant purchasing power. Why? Because 26% annual inflation for 3 years in a row will add up to 100% cumulative inflation over 3 years which is the IASB´s definition of hyperinflation. They have to inflation adjust all non-monetary items during hyperinflation as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies.
But, at 25.99% annual inflation they assume it is not sufficiently important for them to inflation-adjust constant items. They refuse to measure financial capital maintenane in units of constant purchasing power. They insist on unknowingly destroying the real value of reported constant items never maintained in SA companies.
Strange is it not?
Accountants simply blame inflation, the ANC´s economic and growth policy and the SARB´s monetary policy for this at all levels of inflation from 0.1 to 25.99% per annum for 3 years in a row.
It is very clear that accountants and accounting lecturers at do not understand the effects of measuring finacial capital maintenance in units of contstant purchasing power during low inflation as authorized by the IASB in the Framework, Par. 104 (a) although it was published in 1989. If they did, they would have stopped the stable measuring unit assumption in SA by now and they would not make unbelievable statements like
"We do not concur with the suggestion that the standards should reject the stable unit measuring assumption." when the Standards reject it in IAS 29 and its rejection has been approved as an option by the IASB 20 years ago.
Kalinka, your sister audits their accounts and then she or the partner at her audit firm signs the financial reports off as fairly representing the business of the companies when this is in fact happening in all of them. Can you believe that?
Kalinka, as you can see, no-one gains from inflation at the macro level although it is seen as a way to get out of deflation like Japan is trying right this very moment. That is another macro aspect of inflation. As you can see, in SA´s case it is twice as bad as you thought.
But, don´t despair. As soon as SA accountants start measuring financial capital maintenance in units of constant purchasing power they will collectively and knowingly kill the stable measuring unit assumption in SA forever. Then there will only be one economic enemy: inflation and we know Gill Marcus is the enemy of inflation.
Kalinka, I will deal with inflation on a micro level for you in the next blog.
By the way, I am simply an accountant. I am not a macroeconomist or central banker or banker, but, I will try and help with the concepts I do understand. Inflation is a very complex subject especially at the macro level. I am not an expert in inflation at all.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Tuesday 1 December 2009
Accountants mistakenly blames inflation
What accountants and accounting lecturers at universities do not understand is that accountants unknowingly destroy massive amounts of real value in companies doing normal accounting during low inflation. This unknowing and unintentional destruction amounts to about R200 billion per annum in the existing real values of existing constant items in companies. It is existing real value that is being destroyed. It is not a matter of making more money to update capital.
The IASB authorized them 20 years ago to change that and to stop accountants unknowingly destroying value, but, because they mistakenly think it is inflation doing the destroying, they do nothing about it and say it is up to Gill Marcus and her team at the South African Reserve Bank to bring down inflation.
The crux of the matter is their blind belief that it is inflation doing the destroying and not accountants with normal accounting. They simply cannot contemplate even considering the possibility that measuring financial capital maintenance in units of constant purchasing power during low inflation as the IASB authorized them 20 years ago in the Framework, Par. 104 (a), which states
"Financial capital maintenance can be measured in nominal monetary units or in units of constant purchasing power"
would stop accountants from this unknowing and unintentional destruction during low inflation while they all accept it as absolutely essential during hyperinflation as it is required in IAS 29 Financial Reporting in Hyperinflationary Economies.
It is clear they mistakenly think accountants have absolutely nothing to do with it. They are completely wrong.
Summary
Accountants admit that "inflation influences reported results" doing Historical Cost Accounting during low inflation. They blame inflation resulting from the government´s and the central bank´s economic policy. The Institute apparently does not know that the stable measuring unit assumption is rejected outright in IAS 29 and as an option in the Framework, Par. 104 (a). They refuse to reject the stable measuring unit assumption under any circumstance. They totally disagree that accountants destroy value in any way.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
The IASB authorized them 20 years ago to change that and to stop accountants unknowingly destroying value, but, because they mistakenly think it is inflation doing the destroying, they do nothing about it and say it is up to Gill Marcus and her team at the South African Reserve Bank to bring down inflation.
The crux of the matter is their blind belief that it is inflation doing the destroying and not accountants with normal accounting. They simply cannot contemplate even considering the possibility that measuring financial capital maintenance in units of constant purchasing power during low inflation as the IASB authorized them 20 years ago in the Framework, Par. 104 (a), which states
"Financial capital maintenance can be measured in nominal monetary units or in units of constant purchasing power"
would stop accountants from this unknowing and unintentional destruction during low inflation while they all accept it as absolutely essential during hyperinflation as it is required in IAS 29 Financial Reporting in Hyperinflationary Economies.
It is clear they mistakenly think accountants have absolutely nothing to do with it. They are completely wrong.
Summary
Accountants admit that "inflation influences reported results" doing Historical Cost Accounting during low inflation. They blame inflation resulting from the government´s and the central bank´s economic policy. The Institute apparently does not know that the stable measuring unit assumption is rejected outright in IAS 29 and as an option in the Framework, Par. 104 (a). They refuse to reject the stable measuring unit assumption under any circumstance. They totally disagree that accountants destroy value in any way.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Accountants implement the stable measuring unit assumption
Gill Marcus, the Governor of the SA Reserve Bank is the enemy of inflation.
No-one in SA is the enemy of the stable measuring unit assumption because no-one understands how it operates.
Accountants inexplicably forget that IFRS reject the stable measuring unit assumption in two instances:
(1) In IAS 29 Financial Reporting in Hyperinflationary Economies and
(2) The IASB approved its rejection during low inflation as an option in the Framework, Par. 104 (a) in 1989 which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
Fact: Most countries, including SA, inflation-adjust salaries, wages, rentals, etc. during low inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
No-one in SA is the enemy of the stable measuring unit assumption because no-one understands how it operates.
Accountants inexplicably forget that IFRS reject the stable measuring unit assumption in two instances:
(1) In IAS 29 Financial Reporting in Hyperinflationary Economies and
(2) The IASB approved its rejection during low inflation as an option in the Framework, Par. 104 (a) in 1989 which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
Fact: Most countries, including SA, inflation-adjust salaries, wages, rentals, etc. during low inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Monday 30 November 2009
Two economic enemies
There are two processes of systemic real value destruction in the SA economy. The first process is by the well known enemy inflation. This economic enemy manifests itself in the Rand´s store of value function and only operates in the SA monetary economy since inflation can only destroy the real value of the Rand and other monetary items - nothing else. Inflation has no effect on the real value of variable or constant real value non-monetary items.
The second economic enemy is SA accountants´ very destructive stable measuring unit assumption which they implement as part of the real value destroying traditional Historical Cost Accounting model in most, if not all, SA companies during low inflation. This second process of systemic real value destruction in the SA economy manifests itself in accountants´ stable measuring unit assumption only in the constant item part of the SA non-monetary or real economy when they freely choose to measure financial capital maintenance in nominal monetary units when they implement the HCA model in most SA companies during low inflation.
This second enemy is a stealth enemy since the way it operates is not understood by accountants and accounting lecturers at universities. If they understood it, they would have stopped it by now as they have been authorized by the IASB 20 years ago in the Framework, Par. 104 (a) which states"
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
The second economic enemy is SA accountants´ very destructive stable measuring unit assumption which they implement as part of the real value destroying traditional Historical Cost Accounting model in most, if not all, SA companies during low inflation. This second process of systemic real value destruction in the SA economy manifests itself in accountants´ stable measuring unit assumption only in the constant item part of the SA non-monetary or real economy when they freely choose to measure financial capital maintenance in nominal monetary units when they implement the HCA model in most SA companies during low inflation.
This second enemy is a stealth enemy since the way it operates is not understood by accountants and accounting lecturers at universities. If they understood it, they would have stopped it by now as they have been authorized by the IASB 20 years ago in the Framework, Par. 104 (a) which states"
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Sufficient unreported hidden holding gains can maintain un-updated capital
The real value of Issued Share Capital and Share Premium Account can be maintained even if they are not updated over 100´s of years with unreported and hidden holding gains ONLY if 100% of the original updated real values of all contributions to these accounts are invested in sufficient revaluable variable item fixed assets (revalued via the Revaluation Reserve account or not). But, only in the case of these two items. All other reported constant real value non-monetary items´ real values never maintained are unknowingly destroyed by accountants choosing the HCA model during low inflation.
Very, very few companies have 100% of the original real values of Issued Share Capital and Share Premium Account invested in revaluable fixed assets. Only hotel groups and other property companies.
Hidden and unreported holding gains can not and are not applied to maintaining the real values of other items in Shareholders´ Equity. The reported Retained Profits of all companies are thus being unknowingly destroyed by HC accountants at a rate equal to the inflation rate in all low inflationary economies as they always have been in the past and as it is happening right now and as it will carry on as long as they keep choosing the HCA model - or as long as we do not have sustainable zero inflation.
With financial capital maintenance in units of constant purchasing power the real value of companies´ shareholders equity will be maintained for an unlimited period of time even without any fixed assets at all - as long as these companies at least break even for an unlimited period of time - all else being equal.
Kindest regards,
Nicolaas Smith
Very, very few companies have 100% of the original real values of Issued Share Capital and Share Premium Account invested in revaluable fixed assets. Only hotel groups and other property companies.
Hidden and unreported holding gains can not and are not applied to maintaining the real values of other items in Shareholders´ Equity. The reported Retained Profits of all companies are thus being unknowingly destroyed by HC accountants at a rate equal to the inflation rate in all low inflationary economies as they always have been in the past and as it is happening right now and as it will carry on as long as they keep choosing the HCA model - or as long as we do not have sustainable zero inflation.
With financial capital maintenance in units of constant purchasing power the real value of companies´ shareholders equity will be maintained for an unlimited period of time even without any fixed assets at all - as long as these companies at least break even for an unlimited period of time - all else being equal.
Kindest regards,
Nicolaas Smith
Sunday 29 November 2009
Accountants destroy value
Inflation destroys the real value of money and other monetary items over time. This fact is generally accepted and appears in Wikipedia stated as "inflation erodes or decreases or reduces the real value of money" and in IFRS as "general forces may result in changes in the general level of prices and therefore in the general purchasing power of money" (IAS29.5).
HC accountants destroy the real value of reported constant real value non-monetary items never maintained, e.g. reported retained profits, when they choose to value them in nominal monetary units during low inflation. This fact is not generally accepted.
This destruction of reported Retained Profit real value is generally attributed to inflation when, in fact, it is the result of accountants´ free choice of the traditional Historical Cost Accounting model whereunder they implement the stable measuring unit assumption, i.e. they simply assume that changes in the real value of the money (inflation) is not sufficiently important during low inflation for them to choose the alternate basic accounting model of financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, Par. 104 (a) in 1989 which would stop this destruction.
It is thus HC accountants´ free choice of accounting model and not inflation that is doing the destroying in the real value of reported Retained Profits. HC accountants would stop this destuction when they reject the stable measuring unit assumption and with it traditional Historical Cost Accounting and measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989.
This destruction (by HC accountants) generally incorrectly attributed to inflation is generally accepted by accountants and economists and expressed in Wikipedia in phrases such as:
Inflation results in the overstatement of margins and the overpayment of dividends which results in the erosion of companies´ capital that is paid away in overstated dividends.
Example: R2.4 billion of real value is destroyed by HC accountants in the real value of R40 billion reported Retained Profits during a year in the South African real economy at 6% per annum (a rate equal to the rate of inflation) when inflation is 6% because they value reported Retained Profist in Rand monetary unit terms and the real value of the Rand is being destroyed by inflation at 6% per annum. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.
HC accountants implement their very destructive stable measuring unit assumption at inflation rates ranging from 0.01% per annum to 25.99% per annum continuous inflation for 3 years in a row; i.e. they assume the destruction of 25.99% of the real value of reported Retained Profits and all other existing constant real value non-monetary items never maintained (eg. all items in shareholders equity, provisions, etc) is not sufficiently important for them to freely decide to stop this destruction by implementing financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is complaint with IFRS.
26% annual inflation for 3 years in a row totalling 100% cumulative inflation over 3 years would define an economy as being an hyperinflationary economy. IAS 29 requires accountants in hyperinflationary economies to value all non-monetary items (variable and constant items) in units of constant purchasing power. Accountants thus agree that 26% annual inflation for 3 years in a row is sufficiently important for them to stop destroying the real values of all reported constant items never maintained, but, not 25.99% annual inflation for 3 years in a row or inflation approaching 26% annual inflation for 3 years in a row.
This is obviously not true and correct. It results in HC accountants unknowingly and unintentionally destroying hunderds of billions of US Dollars of real value annually in existing reported constant items never maintained.
What in reality happens is that accountants do not know that they are doing this because HCA has been the traditional accounting model for the last 700 years.
They unknowingly evade fixing their massive annual destruction in companies´ reported constant real value non-monetary items never maintained by ascribing this destruction in real value to inflation when it is a fact that inflation can only destroy the real value of money and other monetary items - nothing else. It is impossible for inflation to destroy the real value of non-monetary items. Inflation can only destroy the real value of money and monetary items. As Milton Friedman so eloquently stated: inflation is always and everywhere a monetary phenomenon.
Kindest regards,
Nicolaas Smith
HC accountants destroy the real value of reported constant real value non-monetary items never maintained, e.g. reported retained profits, when they choose to value them in nominal monetary units during low inflation. This fact is not generally accepted.
This destruction of reported Retained Profit real value is generally attributed to inflation when, in fact, it is the result of accountants´ free choice of the traditional Historical Cost Accounting model whereunder they implement the stable measuring unit assumption, i.e. they simply assume that changes in the real value of the money (inflation) is not sufficiently important during low inflation for them to choose the alternate basic accounting model of financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, Par. 104 (a) in 1989 which would stop this destruction.
It is thus HC accountants´ free choice of accounting model and not inflation that is doing the destroying in the real value of reported Retained Profits. HC accountants would stop this destuction when they reject the stable measuring unit assumption and with it traditional Historical Cost Accounting and measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989.
This destruction (by HC accountants) generally incorrectly attributed to inflation is generally accepted by accountants and economists and expressed in Wikipedia in phrases such as:
Inflation results in the overstatement of margins and the overpayment of dividends which results in the erosion of companies´ capital that is paid away in overstated dividends.
Example: R2.4 billion of real value is destroyed by HC accountants in the real value of R40 billion reported Retained Profits during a year in the South African real economy at 6% per annum (a rate equal to the rate of inflation) when inflation is 6% because they value reported Retained Profist in Rand monetary unit terms and the real value of the Rand is being destroyed by inflation at 6% per annum. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.
HC accountants implement their very destructive stable measuring unit assumption at inflation rates ranging from 0.01% per annum to 25.99% per annum continuous inflation for 3 years in a row; i.e. they assume the destruction of 25.99% of the real value of reported Retained Profits and all other existing constant real value non-monetary items never maintained (eg. all items in shareholders equity, provisions, etc) is not sufficiently important for them to freely decide to stop this destruction by implementing financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is complaint with IFRS.
26% annual inflation for 3 years in a row totalling 100% cumulative inflation over 3 years would define an economy as being an hyperinflationary economy. IAS 29 requires accountants in hyperinflationary economies to value all non-monetary items (variable and constant items) in units of constant purchasing power. Accountants thus agree that 26% annual inflation for 3 years in a row is sufficiently important for them to stop destroying the real values of all reported constant items never maintained, but, not 25.99% annual inflation for 3 years in a row or inflation approaching 26% annual inflation for 3 years in a row.
This is obviously not true and correct. It results in HC accountants unknowingly and unintentionally destroying hunderds of billions of US Dollars of real value annually in existing reported constant items never maintained.
What in reality happens is that accountants do not know that they are doing this because HCA has been the traditional accounting model for the last 700 years.
They unknowingly evade fixing their massive annual destruction in companies´ reported constant real value non-monetary items never maintained by ascribing this destruction in real value to inflation when it is a fact that inflation can only destroy the real value of money and other monetary items - nothing else. It is impossible for inflation to destroy the real value of non-monetary items. Inflation can only destroy the real value of money and monetary items. As Milton Friedman so eloquently stated: inflation is always and everywhere a monetary phenomenon.
Kindest regards,
Nicolaas Smith
Accounting model maintains value - Part 2
Capital - as a variable real value non-monetary item (as traded or untraded shares in a company) - would have emerged even without double-entry accounting.
It is clear, however, that the real value of capital - as a constant real value non-monetary item - i.e. being all the items in shareholders´ equity (issued share capital, reported retained profits, share premium account, capital reserves, etc), can only be maintained constant during inflation with double entry accounting implementing not traditional Historical Cost Accounting (the stable measuring unit assumption) but financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is compliant with IFRS.
Double entry accounting can maintain the real value of existing constant items (issued share capital, reported retained profits, etc.) even in companies with no fixed assets as long as they at least break even for an unlimited period of time during indefinite inflation, but, only with financial capital maintenance in units of constant purchasing power - not with the traditional 700 year old Historical Cost Accounting model implementing the very destructive stable measuring unit assumption during low inflation.
Thus, instead of saying that the accounting model creates value we can say the accounting model maintains value - qualified as above.
Kindest regards,
Nicolaas Smith
It is clear, however, that the real value of capital - as a constant real value non-monetary item - i.e. being all the items in shareholders´ equity (issued share capital, reported retained profits, share premium account, capital reserves, etc), can only be maintained constant during inflation with double entry accounting implementing not traditional Historical Cost Accounting (the stable measuring unit assumption) but financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 which is compliant with IFRS.
Double entry accounting can maintain the real value of existing constant items (issued share capital, reported retained profits, etc.) even in companies with no fixed assets as long as they at least break even for an unlimited period of time during indefinite inflation, but, only with financial capital maintenance in units of constant purchasing power - not with the traditional 700 year old Historical Cost Accounting model implementing the very destructive stable measuring unit assumption during low inflation.
Thus, instead of saying that the accounting model creates value we can say the accounting model maintains value - qualified as above.
Kindest regards,
Nicolaas Smith
Friday 27 November 2009
Accounting model maintains value - Part 1
“What advantages does the Merchant derive from Book-keeping by double-entry? It is amongst the finest inventions of the human mind.” Goethe
Capital as we know it today only exists as a result of the double-entry accounting model.
Not the traditional Historical Cost Accounting model, but, simply the double entry accounting model. Measuring financial capital maintenance in units of constant purchasing power is also a double entry accounting model. So are Current Cost Accounting and various others.
Without double-entry accounting there would be no capital which is a constant real value non-monetary item. Without double-entry accounting there would only be monetary items and variable real value non-monetary items.
"The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double-entry bookkeeping.” Sombart 1953, p. 38.
Capitalism is based on double-entry accounting.
"Capitalism develops rationality and adds a new edge to it in two interconnected ways. First it exalts the monetary unit-not itself a creation of capitalism-into a unit of account. That is to say, capitalist practice turns the unit of money into a tool of rational cost-profit calculations, of which the towering monument is double-entry bookkeeping. . . . We will notice that, primarily a product of the evolution of economic rationality, the cost-profit calculus in turn reacts upon that rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise." Schumpeter 1950, p. 123.
http://www.dse.unive.it/summerschool/course2007/accounting%20and%20rationality.pdf
Kindest regards,
Nicolaas Smith
Capital as we know it today only exists as a result of the double-entry accounting model.
Not the traditional Historical Cost Accounting model, but, simply the double entry accounting model. Measuring financial capital maintenance in units of constant purchasing power is also a double entry accounting model. So are Current Cost Accounting and various others.
Without double-entry accounting there would be no capital which is a constant real value non-monetary item. Without double-entry accounting there would only be monetary items and variable real value non-monetary items.
"The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double-entry bookkeeping.” Sombart 1953, p. 38.
Capitalism is based on double-entry accounting.
"Capitalism develops rationality and adds a new edge to it in two interconnected ways. First it exalts the monetary unit-not itself a creation of capitalism-into a unit of account. That is to say, capitalist practice turns the unit of money into a tool of rational cost-profit calculations, of which the towering monument is double-entry bookkeeping. . . . We will notice that, primarily a product of the evolution of economic rationality, the cost-profit calculus in turn reacts upon that rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise." Schumpeter 1950, p. 123.
http://www.dse.unive.it/summerschool/course2007/accounting%20and%20rationality.pdf
Kindest regards,
Nicolaas Smith
Wednesday 25 November 2009
SA accountants´ incomprehensible logic
SA accountants value existing reported Retained Profits in SA companies at Historical Cost, i.e. in nominal monetary units. They assume that changes in the real value of the Rand are not sufficiently important for them to stop their destruction of the real value of existing reported Retained Profits as a result of their stable measuring unit assumption.
They make this assumption while inflation ranges from 0.01% to 25.99% per annum for 3 years in a row.
When inflation increases from 25.99% to 26% for three years in a row totalling 100% which would indicate that SA is in hyperinflation, they would immediately change their collective minds and agree that 26% inflation would result in them destroying 26% of all existing reported Retained Profits in SA companies – but not 25.99% inflation for 3 years in a row.
They would inflation-adjust all non-monetary items – variable and constant items – in SA when inflation is 26% per annum for 3 years in a row – but not at 25.99% for 3 years in a row.
They are currently unknowingly destroying 5.9% or about R200 billion of all existing reported Retained Profits and other constant items never maintained in SA companies. When inflation increases to 25.99% they would unknowingly destroy about R866 billion in this way per annum. They would assume the destruction of R866 billion per annum (at current prices) in this manner is not significantly important.
Kindest regards,
Nicolaas Smith
They make this assumption while inflation ranges from 0.01% to 25.99% per annum for 3 years in a row.
When inflation increases from 25.99% to 26% for three years in a row totalling 100% which would indicate that SA is in hyperinflation, they would immediately change their collective minds and agree that 26% inflation would result in them destroying 26% of all existing reported Retained Profits in SA companies – but not 25.99% inflation for 3 years in a row.
They would inflation-adjust all non-monetary items – variable and constant items – in SA when inflation is 26% per annum for 3 years in a row – but not at 25.99% for 3 years in a row.
They are currently unknowingly destroying 5.9% or about R200 billion of all existing reported Retained Profits and other constant items never maintained in SA companies. When inflation increases to 25.99% they would unknowingly destroy about R866 billion in this way per annum. They would assume the destruction of R866 billion per annum (at current prices) in this manner is not significantly important.
Kindest regards,
Nicolaas Smith
700 year old paradigm based on a single wrong assumption
SA companies´ Issued Share Capital and Share Premium Account values stay the same and so do other reported constant real value non-monetary items in audited financial reports, for example reported Retained Earnings and Capital Reserves under the Historical Cost paradigm in SA´s low inflationary economy. This all helps to reinforce the illusion that the Rand maintains its real value over time which is not true. It is an illusion, namely money illusion.
The SA low inflationary economy is locked into the HC paradigm by a single wrong assumption: the stable measuring unit assumption whereby SA accountants assume that changes in the Rand´s real value are not of sufficient importance to justify financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g., salaries, wages, rents, regulated prices, etc. and generally implement financial capital maintenance in nominal monetary units; i.e. they implement the real value destroying HCA model which includes the very destructive stable measuring unit assumption during low inflation.
The combination of HCA and low inflation plus money illusion blinds us to the continuous destruction of existing real value in reported balance sheet constant items in companies by SA accountants implementing the stable measuring unit assumption in our low inflationary economy. It is true that everything is done in accordance with IFRS or SA GAAP because the ongoing destruction of existing real value in existing reported balance sheet constant items in companies is an integral part of the current global HCA model in countries with low inflationary economies.
This is a direct result of accountants´ stable measuring unit assumption as authorized in the Framework, Par. 104 (a) where under they choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – the other option in Par. 104 (a) also compliant with IFRS. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they would knowingly stop the destruction of existing real value in reported balance sheet constant items in SA companies forever – all else being equal. They would also stop the creation of more real value in reported balance sheet constant items not updated (decreased in nominal value) in companies in deflationary economies forever – all else being equal.
Kindest regards,
Nicolaas Smith
The SA low inflationary economy is locked into the HC paradigm by a single wrong assumption: the stable measuring unit assumption whereby SA accountants assume that changes in the Rand´s real value are not of sufficient importance to justify financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g., salaries, wages, rents, regulated prices, etc. and generally implement financial capital maintenance in nominal monetary units; i.e. they implement the real value destroying HCA model which includes the very destructive stable measuring unit assumption during low inflation.
The combination of HCA and low inflation plus money illusion blinds us to the continuous destruction of existing real value in reported balance sheet constant items in companies by SA accountants implementing the stable measuring unit assumption in our low inflationary economy. It is true that everything is done in accordance with IFRS or SA GAAP because the ongoing destruction of existing real value in existing reported balance sheet constant items in companies is an integral part of the current global HCA model in countries with low inflationary economies.
This is a direct result of accountants´ stable measuring unit assumption as authorized in the Framework, Par. 104 (a) where under they choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – the other option in Par. 104 (a) also compliant with IFRS. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they would knowingly stop the destruction of existing real value in reported balance sheet constant items in SA companies forever – all else being equal. They would also stop the creation of more real value in reported balance sheet constant items not updated (decreased in nominal value) in companies in deflationary economies forever – all else being equal.
Kindest regards,
Nicolaas Smith
Tuesday 24 November 2009
Trust me, I´m an accountant
Accountants unknowingly and unintentionally destroy at least R200 billion per annum in the real values of reported Retained Profits of most SA companies as well as in all SA companies that do not have 100% of Issued Share Capital and Share Premium Account values invested in revaluable fixed assets with their very destructive stable measuring unit assumption as part of the traditional Historical Cost Accounting model.
That is R200 billion per annum in Capital unknowingly destroyed by SA accountants assuming there is no such thing as inflation (value destruction) in the real value of the Rand when they value existing reported Retained Profits and other reported constant items never maintained during low inflation in nominal monetary units, i.e., at Historical Cost.
Inflation has no effect on reported Retained Profits, Issued Share Capital and Share Premium Account values which are all constant real value non-monetary items. Inflation can only destroy the real value of the Rand and other monetary items - nothing else. Inflation has on effect on the real value of non-monetary items.
SA accountants value the above items in nominal monetary units in terms of the SA Rand which is the monetary unit of account and functional currency in SA. They value them at their original Historical Costs over time in our low inflationary environment. These items´ nominal values thus stay the same because SA accountants simply assume there is no inflation in the Rand when they value them. They only make this assumption as far as balance sheet constant items and the majority of income statement items are concerned. Some income items they inflation-adjust, e.g. salaries, wages, rentals, etc.
SA accountants implement their infamous stable measuring unit assumption whereby they assume that changes in the purchasing power of the Rand is not sufficiently important to inflation-adjust these values. However, there is inflation in SA and their real values are thus being destroyed at a rate equal to the inflation rate because the Rand´s real value is, in fact, being destroyed by inflation.
SA accountants implement their very destructive stable measuring unit assumption because they refuse to measure them in units of constant purchasing power as they have been authorized to do 20 years ago by the IASB.
So, it is not inflation doing the destroying, but, SA accountants choosing the real value destroying Historical Cost Accounting model which includes the very destructive stable measuring unit assumption despite the fact that they have been authorized 20 years ago to stop this massive annual destruction by freely choosing to measure finacial capital maintenance in units of constant purchasing power - which they and all the boards of directors of alll JSE listed companies refuste to do.
Inflation can be whatever rate: 2% or 10% or 15% or 20% or 24% per annum - when SA accountants freely change over and choose to measure financial capital maintenance in units of constant purchasing power there will be no destruction at all in the real value of existing reported constant items.
So, it is very clear that it is not inflation doing the destroying, but, SA accountants unknowingly and unintentionally destroying about R200 billion per annum in existing reported constant items in SA companies simply because of the accounting model they choose; namely, the real value destroying traditional Historical Cost Accounting model which includes their very destructive stable measuring unit assumption.
The IASB authorized them 20 years ago to measure financial capital maintenance in units of constant purchasing power in the Framework, Par. 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
SA accountants and the boards of directors of all JSE listed companies refuse point blank to measure financial capital maintenance in units of constant purchasing power.
So, trust me, I´m an accountant: I´m destroying your company´s reported Retained Profits at the rate of inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
That is R200 billion per annum in Capital unknowingly destroyed by SA accountants assuming there is no such thing as inflation (value destruction) in the real value of the Rand when they value existing reported Retained Profits and other reported constant items never maintained during low inflation in nominal monetary units, i.e., at Historical Cost.
Inflation has no effect on reported Retained Profits, Issued Share Capital and Share Premium Account values which are all constant real value non-monetary items. Inflation can only destroy the real value of the Rand and other monetary items - nothing else. Inflation has on effect on the real value of non-monetary items.
SA accountants value the above items in nominal monetary units in terms of the SA Rand which is the monetary unit of account and functional currency in SA. They value them at their original Historical Costs over time in our low inflationary environment. These items´ nominal values thus stay the same because SA accountants simply assume there is no inflation in the Rand when they value them. They only make this assumption as far as balance sheet constant items and the majority of income statement items are concerned. Some income items they inflation-adjust, e.g. salaries, wages, rentals, etc.
SA accountants implement their infamous stable measuring unit assumption whereby they assume that changes in the purchasing power of the Rand is not sufficiently important to inflation-adjust these values. However, there is inflation in SA and their real values are thus being destroyed at a rate equal to the inflation rate because the Rand´s real value is, in fact, being destroyed by inflation.
SA accountants implement their very destructive stable measuring unit assumption because they refuse to measure them in units of constant purchasing power as they have been authorized to do 20 years ago by the IASB.
So, it is not inflation doing the destroying, but, SA accountants choosing the real value destroying Historical Cost Accounting model which includes the very destructive stable measuring unit assumption despite the fact that they have been authorized 20 years ago to stop this massive annual destruction by freely choosing to measure finacial capital maintenance in units of constant purchasing power - which they and all the boards of directors of alll JSE listed companies refuste to do.
Inflation can be whatever rate: 2% or 10% or 15% or 20% or 24% per annum - when SA accountants freely change over and choose to measure financial capital maintenance in units of constant purchasing power there will be no destruction at all in the real value of existing reported constant items.
So, it is very clear that it is not inflation doing the destroying, but, SA accountants unknowingly and unintentionally destroying about R200 billion per annum in existing reported constant items in SA companies simply because of the accounting model they choose; namely, the real value destroying traditional Historical Cost Accounting model which includes their very destructive stable measuring unit assumption.
The IASB authorized them 20 years ago to measure financial capital maintenance in units of constant purchasing power in the Framework, Par. 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
SA accountants and the boards of directors of all JSE listed companies refuse point blank to measure financial capital maintenance in units of constant purchasing power.
So, trust me, I´m an accountant: I´m destroying your company´s reported Retained Profits at the rate of inflation.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Monday 23 November 2009
Inflation-adjusting constant items during low inflation does affect the economy positively
Ask anyone receiving a wage or a salary and he or she will confirm that inflation-adjusting salaries does make a difference to the economy. It does affect the nature of the underlying resource – salary, wage, rent, reported Retained Profits, dividends receivable, etc – when a constant item value is determined in terms of units of constant purchasing power instead of in nominal monetary units over time during low inflation.
The choices SA accountants make do change those values and do affect the SA economy. All SA accountants who are members of the boards of directors of SA companies listed on the JSE choose between financial capital maintenance in nominal monetary units and units of constant purchasing power in terms of the Framework, Par. 104 (a). JSE listed companies have to do their accounts in terms of IFRS. All SA accountants on their boards of directors thus have to make that choice since they are the accounting experts on those boards of directors and have to advise the boards accordingly. Valuing existing reported constant items in units of constant purchasing power during low inflation do change those values and do affect the SA economy.
The statement that the choices accountants make won’t change those values and won’t affect the economy is dead wrong.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
The choices SA accountants make do change those values and do affect the SA economy. All SA accountants who are members of the boards of directors of SA companies listed on the JSE choose between financial capital maintenance in nominal monetary units and units of constant purchasing power in terms of the Framework, Par. 104 (a). JSE listed companies have to do their accounts in terms of IFRS. All SA accountants on their boards of directors thus have to make that choice since they are the accounting experts on those boards of directors and have to advise the boards accordingly. Valuing existing reported constant items in units of constant purchasing power during low inflation do change those values and do affect the SA economy.
The statement that the choices accountants make won’t change those values and won’t affect the economy is dead wrong.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
SA accountants are suckers for the stable measuring unit assumption
SA accountants unknowingly destroy the real value of existing reported constant items never maintained during low inflation when they implement their very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.
100% of the inflation-adjusted original real value of all contributions to Issued Share Capital and Share Premium Account values have to be invested in revaluable variable item fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) during low inflation in order for SA accountants not to destroy these item’s original real values at a rate equal to the rate of inflation under the real value destroying traditional HCA model when they implement their very destructive stable measuring unit assumption.
Very few companies in SA abide by the 100% of Issued Share Capital and Share Premium invested in fixed assets rule.
There is no unnecessary real value destruction by SA accountants in Issued Share Capital and Share Premium Account values not backed by 100% investment in revaluable fixed assets when they measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989: the constant real value of Issued Share Capital and Share Premium Account values would be maintained even with no fixed assets in SA companies - that always at least break even - when SA accountants measure financial capital maintenance in units of constant purchasing power; i.e. when they abandon their very destructive stable measuring unit assumption.
Kindest regards,
Nicolaas Smith
100% of the inflation-adjusted original real value of all contributions to Issued Share Capital and Share Premium Account values have to be invested in revaluable variable item fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) during low inflation in order for SA accountants not to destroy these item’s original real values at a rate equal to the rate of inflation under the real value destroying traditional HCA model when they implement their very destructive stable measuring unit assumption.
Very few companies in SA abide by the 100% of Issued Share Capital and Share Premium invested in fixed assets rule.
There is no unnecessary real value destruction by SA accountants in Issued Share Capital and Share Premium Account values not backed by 100% investment in revaluable fixed assets when they measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989: the constant real value of Issued Share Capital and Share Premium Account values would be maintained even with no fixed assets in SA companies - that always at least break even - when SA accountants measure financial capital maintenance in units of constant purchasing power; i.e. when they abandon their very destructive stable measuring unit assumption.
Kindest regards,
Nicolaas Smith
Friday 20 November 2009
Constant items
The Framework, Par. 102 states that most companies choose a financial concept of capital to prepare their financial reports. An entity’s capital is the same as its equity or net assets when it adopts a financial concept of capital, for example invested purchasing power or invested money.
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) then states that:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The IASB clearly defines issued share capital, capital reserves, retained earnings, all other items in shareholders´ equity, all items in the income statement, provisions, etc as non-monetary items. Since these real value non-monetary items can be measured in units of constant purchasing power in terms of the Framework, Par. 104 (a), to implement a financial capital maintenance concept in units of constant purchasing power, they are obviously constant real value non-monetary items with constant real non-monetary values expressed in terms of a monetary unit of account over time in a low inflationary or deflationary economy.
Logic would thus imply and it is a fact that real value non-monetary items that are not measured in units of constant purchasing power during low inflation or deflation on a primary valuation basis but are valued in terms of specific IFRS at, for example, market value, fair value, recoverable value, net realisable value, present value, etc are not constant but variable real value non-monetary items, e.g. property, plant, equipment, shares, inventory, foreign exchange, etc.
Examples of constant items
All income statement items once they are accounted
Revenue
Cost of sales
Gross Profit
Investment revenues
Other gains and losses
Net monetary gains and losses
Share of profits of associates
Changes in inventories of finished goods and work in progress
Raw materials and consumables used
Depreciation and amortisation expense
Employee benefits expense
Distribution expenses
Marketing expenses
Occupancy expenses
Administration expenses
Finance costs
Consulting expense
Royalities
Other expenses
Profit before tax
Income tax expense
Profit for the year from continuing operations
Profit for the year from discontinued operations
Profit for the year
All balance sheet constant items
Deferred tax assets
Finance lease receivables
Trade and other non-monetary debtors
Provision for doubtful debts
Current tax assets
Issued share capital
Share premium
Share discount
Capital reserves
General reserve
Properties revaluation reserve
Investments revaluation reserve
Equity-settled employee benefits reserve
Hedging reserve
Foreign currency translation reserve
Retained earnings
Retirement benefit obligation
Deferred tax liabilities
Provisions
Employee benefits provision
Provision for rectification work
Provision for warranties
Onerous lease contract provision
Restructuring and termination costs provision
Decommissioning costs provision
Deferred Revenue
Trade and other non-monetary creditors
Current tax liabilities
The IASB only recognizes monetary and non-monetary items in the economy. The Board manages to side-step the split between variable and constant items with the stable measuring unit assumption which it accepts as part of HCA. Constant items are valued in nominal monetary units under HCA implementing the stable measuring unit assumption.
HCA makes no difference between variable real value non-monetary items and constant real value non-monetary items. Both variable and constant items are grouped together as simply non-monetary items as opposed to monetary items. Both variable items valued at HC (e.g. fixed property) and constant items valued at HC (Retained Earnings) are classified as simply non-monetary items under HCA.
Kindest regards,
Nicolaas Smit
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) then states that:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
The IASB clearly defines issued share capital, capital reserves, retained earnings, all other items in shareholders´ equity, all items in the income statement, provisions, etc as non-monetary items. Since these real value non-monetary items can be measured in units of constant purchasing power in terms of the Framework, Par. 104 (a), to implement a financial capital maintenance concept in units of constant purchasing power, they are obviously constant real value non-monetary items with constant real non-monetary values expressed in terms of a monetary unit of account over time in a low inflationary or deflationary economy.
Logic would thus imply and it is a fact that real value non-monetary items that are not measured in units of constant purchasing power during low inflation or deflation on a primary valuation basis but are valued in terms of specific IFRS at, for example, market value, fair value, recoverable value, net realisable value, present value, etc are not constant but variable real value non-monetary items, e.g. property, plant, equipment, shares, inventory, foreign exchange, etc.
Examples of constant items
All income statement items once they are accounted
Revenue
Cost of sales
Gross Profit
Investment revenues
Other gains and losses
Net monetary gains and losses
Share of profits of associates
Changes in inventories of finished goods and work in progress
Raw materials and consumables used
Depreciation and amortisation expense
Employee benefits expense
Distribution expenses
Marketing expenses
Occupancy expenses
Administration expenses
Finance costs
Consulting expense
Royalities
Other expenses
Profit before tax
Income tax expense
Profit for the year from continuing operations
Profit for the year from discontinued operations
Profit for the year
All balance sheet constant items
Deferred tax assets
Finance lease receivables
Trade and other non-monetary debtors
Provision for doubtful debts
Current tax assets
Issued share capital
Share premium
Share discount
Capital reserves
General reserve
Properties revaluation reserve
Investments revaluation reserve
Equity-settled employee benefits reserve
Hedging reserve
Foreign currency translation reserve
Retained earnings
Retirement benefit obligation
Deferred tax liabilities
Provisions
Employee benefits provision
Provision for rectification work
Provision for warranties
Onerous lease contract provision
Restructuring and termination costs provision
Decommissioning costs provision
Deferred Revenue
Trade and other non-monetary creditors
Current tax liabilities
The IASB only recognizes monetary and non-monetary items in the economy. The Board manages to side-step the split between variable and constant items with the stable measuring unit assumption which it accepts as part of HCA. Constant items are valued in nominal monetary units under HCA implementing the stable measuring unit assumption.
HCA makes no difference between variable real value non-monetary items and constant real value non-monetary items. Both variable and constant items are grouped together as simply non-monetary items as opposed to monetary items. Both variable items valued at HC (e.g. fixed property) and constant items valued at HC (Retained Earnings) are classified as simply non-monetary items under HCA.
Kindest regards,
Nicolaas Smit
Thursday 19 November 2009
Eskom price increase does not necessarily increase inflation
A price increase is paying more money for equivalent more real value.
Inflation is paying more money for the same real value.
In theory, an Eskom electricity price increase (25% or 45%) does not necessarily increase inflation. Everyone will just have less money for other things - all else being equal (the zero increase option).
That is theory.
All else do not stay equal.
Inflation comes about when unscrupulous business people abuse the electricity price increase for unjustified other price increases with no real value increase or no cost increase.
Is it unscrupulous or is it just the normal workings of the free market?
I think it is the normal workings of the free market. I will push my price up to see if I can make more profit. Imperfect market conditions may result in my inflationary actions not being corrected or counter-acted in the free market. They may flow through to the general price increase and may increase inflation: i.e., increase the destruction of the real value of the Rand and all other monetary items in the SA economy above the current 6.1% per annum real value destruction in the Rand.
Gill Marcus and her team at the SARB have to develop measures to combat my actions to simply look after my own self-interest.
Kindest regards,
Nicolaas Smith
Inflation is paying more money for the same real value.
In theory, an Eskom electricity price increase (25% or 45%) does not necessarily increase inflation. Everyone will just have less money for other things - all else being equal (the zero increase option).
That is theory.
All else do not stay equal.
Inflation comes about when unscrupulous business people abuse the electricity price increase for unjustified other price increases with no real value increase or no cost increase.
Is it unscrupulous or is it just the normal workings of the free market?
I think it is the normal workings of the free market. I will push my price up to see if I can make more profit. Imperfect market conditions may result in my inflationary actions not being corrected or counter-acted in the free market. They may flow through to the general price increase and may increase inflation: i.e., increase the destruction of the real value of the Rand and all other monetary items in the SA economy above the current 6.1% per annum real value destruction in the Rand.
Gill Marcus and her team at the SARB have to develop measures to combat my actions to simply look after my own self-interest.
Kindest regards,
Nicolaas Smith
IASB does not recognize constant items
Hi,
Non-monetary items are subdivided in
a) Variable real value non-monetary items and
b) Constant real value non-monetary items.
Constant items are non-monetary items with constant real values over time.
IAS 29 clearly defines non-monetary items as per the IASB.
Non-monetary items are all items that are not monetary items. This IASB definition is correct for non-monetary items as a generic term. It is however taken that there are thus only two distinct items in the economy: monetary and non-monetary items. The standard to be applied in hyperinflationary economies, IAS 29, was developed on this basis.
It is not true that there are only two basic economic items as defined by the IASB. There are three fundamentally different basic economic items in the economy:
1. Variable real value non-monetary items
2. Monetary items
3. Constant real value non-monetary items
The IASB does not recognize constant real value non-monetary items directly by name or by definition, but, indirectly by implication. The fact that certain non-monetary items have constant real non-monetary values is implied by the IASB in the Framework for the Preparation and Presentation of Financial Statements which is applicable in the absence of specific IFRS. There is no specific IFRS relating to the concepts of capital or the concepts of capital maintenance. The concepts of capital, the capital maintenance concepts and the measurement bases defined in the Framework are thus applicable.
Kindest regards,
Nicolaas Smith
Non-monetary items are subdivided in
a) Variable real value non-monetary items and
b) Constant real value non-monetary items.
Constant items are non-monetary items with constant real values over time.
IAS 29 clearly defines non-monetary items as per the IASB.
Non-monetary items are all items that are not monetary items. This IASB definition is correct for non-monetary items as a generic term. It is however taken that there are thus only two distinct items in the economy: monetary and non-monetary items. The standard to be applied in hyperinflationary economies, IAS 29, was developed on this basis.
It is not true that there are only two basic economic items as defined by the IASB. There are three fundamentally different basic economic items in the economy:
1. Variable real value non-monetary items
2. Monetary items
3. Constant real value non-monetary items
The IASB does not recognize constant real value non-monetary items directly by name or by definition, but, indirectly by implication. The fact that certain non-monetary items have constant real non-monetary values is implied by the IASB in the Framework for the Preparation and Presentation of Financial Statements which is applicable in the absence of specific IFRS. There is no specific IFRS relating to the concepts of capital or the concepts of capital maintenance. The concepts of capital, the capital maintenance concepts and the measurement bases defined in the Framework are thus applicable.
Kindest regards,
Nicolaas Smith
Wednesday 18 November 2009
Dollar not money in SA
A foreign currency is not the functional currency in South Africa since it is not the generally accepted national unit of account. The Rand is the unit of account in SA. The SA economy is not a Dollarized economy. The Rand is the functional currency.
Money has three functions:
1. Medium of exchange
2. Store of value
3. Unit of account
A foreign currency like the US Dollar or the Euro is, however, a medium of exchange in SA. Most businesses and individuals would accept the USD or the Euro as a means of payment; that is, as a medium of exchange because they can easily sell the foreign currency amounts they would receive in transactions at their local banks for Rands.
A hard currency is also a store of value in SA. The USD and the Euro are hard currencies with daily changing market values. They are generally accepted world wide as a relatively stable store of value. People know there are normal daily small changes in their exchange values.
The USD and the Euro are, however, not national units of account in SA. You cannot do your SA accounts in US Dollars or Euros for tax purposes. You have to do your accounting in Rand values in the SA economy. They are not functional currencies in SA since they do not fulfil all three functions of a functional currency within the SA economy. A foreign currency like the USD or the Euro only fulfils two functions of money, namely, medium of exchange and store of value. They therefore are not "money" in SA from a strictly technical point of view. They are not monetary items subject in SA.
Foreign currencies are variable real value non-monetary items in the SA economy. They have variable real non-monetary values which are determined in the foreign exchange markets in SA.
The US Dollar is only a functional currency outside the United States of America in countries like Ecuador, Panama and Zimbabwe that have Dollarized their economies. They use the US Dollar as their functional currency. They do not have their own national currencies. That is not the case in SA.
It just appears very strange to say that the US Dollar or the Euro is not "money" in SA. Technically speaking that is correct because an economic item can only be money if it fulfils all three functions of money. The Euro is only money in the European Monetary Union (EMU) and the USD is only money in the US and in countries that have Dollarized their economies.
The man and woman in the street, however, regard anything that is a medium of exchange as “money” in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.
The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. Accountants would, however, classify foreign exchange as a variable real value non-monetary item stated at its market value at the balance sheet date and not the same as the SA Rand, that is, not as a monetary item when they choose to implement financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a).
Kindest regards,
Nicolaas Smith
Money has three functions:
1. Medium of exchange
2. Store of value
3. Unit of account
A foreign currency like the US Dollar or the Euro is, however, a medium of exchange in SA. Most businesses and individuals would accept the USD or the Euro as a means of payment; that is, as a medium of exchange because they can easily sell the foreign currency amounts they would receive in transactions at their local banks for Rands.
A hard currency is also a store of value in SA. The USD and the Euro are hard currencies with daily changing market values. They are generally accepted world wide as a relatively stable store of value. People know there are normal daily small changes in their exchange values.
The USD and the Euro are, however, not national units of account in SA. You cannot do your SA accounts in US Dollars or Euros for tax purposes. You have to do your accounting in Rand values in the SA economy. They are not functional currencies in SA since they do not fulfil all three functions of a functional currency within the SA economy. A foreign currency like the USD or the Euro only fulfils two functions of money, namely, medium of exchange and store of value. They therefore are not "money" in SA from a strictly technical point of view. They are not monetary items subject in SA.
Foreign currencies are variable real value non-monetary items in the SA economy. They have variable real non-monetary values which are determined in the foreign exchange markets in SA.
The US Dollar is only a functional currency outside the United States of America in countries like Ecuador, Panama and Zimbabwe that have Dollarized their economies. They use the US Dollar as their functional currency. They do not have their own national currencies. That is not the case in SA.
It just appears very strange to say that the US Dollar or the Euro is not "money" in SA. Technically speaking that is correct because an economic item can only be money if it fulfils all three functions of money. The Euro is only money in the European Monetary Union (EMU) and the USD is only money in the US and in countries that have Dollarized their economies.
The man and woman in the street, however, regard anything that is a medium of exchange as “money” in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.
The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. Accountants would, however, classify foreign exchange as a variable real value non-monetary item stated at its market value at the balance sheet date and not the same as the SA Rand, that is, not as a monetary item when they choose to implement financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a).
Kindest regards,
Nicolaas Smith
Monday 16 November 2009
Inflation has no effect on the real value on non-monetary items
A house is a variable real value non-monetary item. Let us assume a house in Port Elizabeth is fairly valued in the PE market at say R 2 million on 1st January in year one. With no change in the market a year later but with inflation at 6% in SA, the seller would increase his or her price to R2.12 million - all else being equal. The house’s real value remained the same. The depreciating monetary price for the house expressed in the depreciating Rand medium of exchange – all else being equal - was inflation-adjusted to compensate for the destruction of the real value of the depreciating Rand in the internal SA market by 6% annual inflation. It is clear that inflation does not affect the house’s variable non-monetary real value – all else being equal.
However much inflation rises, it can only make the Rand more worthless at a higher rate and over a shorter period of time. Heaven forbid that what happened in Zimbabwe recently would ever happen in SA. As inflation rises the price of the house would rise to keep pace with inflation or value destruction in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non-monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.
When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 28 years since January, 1981 in the company’s balance sheet. When it is eventually sold today for R 1.4 million we can see that inflation did not destroy the property’s variable real non-monetary value – all else being equal. Inflation only destroyed the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 28 year period - all else being equal. This was taken into account by the buyer and seller at the time of the sale. The selling price in Rand was increased to compensate for the destruction of the real value of the Rand by inflation. R1.4 million today (2009) is the same as R100 000 in January, 1981 – all else being equal.
As the two lady academics from Turkey state: Purchasing power of non monetary items does not change in spite of variation in national currency value.
Kindest regards,
Nicolaas Smith
However much inflation rises, it can only make the Rand more worthless at a higher rate and over a shorter period of time. Heaven forbid that what happened in Zimbabwe recently would ever happen in SA. As inflation rises the price of the house would rise to keep pace with inflation or value destruction in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non-monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.
When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 28 years since January, 1981 in the company’s balance sheet. When it is eventually sold today for R 1.4 million we can see that inflation did not destroy the property’s variable real non-monetary value – all else being equal. Inflation only destroyed the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 28 year period - all else being equal. This was taken into account by the buyer and seller at the time of the sale. The selling price in Rand was increased to compensate for the destruction of the real value of the Rand by inflation. R1.4 million today (2009) is the same as R100 000 in January, 1981 – all else being equal.
As the two lady academics from Turkey state: Purchasing power of non monetary items does not change in spite of variation in national currency value.
Kindest regards,
Nicolaas Smith
Friday 13 November 2009
First Zimbabwe. Now Venezuela. Next Malema and South Africa?
Hi,
Chavez´s nationalization continues.
26% annual inflation for 3 years in a row is hyperinflation.
Venezuela is already at 27% annual inflation.
Zimbabwe can guarantee Venezuela that price controls do not work.
As soon as price controls enter, production drops.
Robert Mugabe tried what no-one has ever done: beat the market.
Now Hugo Chavez is trying the same impossible dream: to beat the market.
He will also fail as Mugabe failed.
The market rules.
After Zimbabwe we can now watch Venezuela self-destruct.
I hope the ANC, Julius Malema, the ANCYL, Cosatu, Numsa and the SA Communist Party take careful note how this process unfolds because it always works exactly the same way. Go and look up the exact same process in Zimbabwe a year or two ago.
I see Venezuela already had 39% inflation at the end of last year. And a parallel USDollar exchange rate considerably higher than the "official" rate. And a local petrol price not increased for 10 years.
lol Exactly the same as hyperinflation in Angola and Zimbabwe.
Malema should take a sebatical year from politics in SA and go and learn again from Chavez how the above measures destroy a country´s economy in few short years.
I watched this exact same process unfold on a daily basis in Zimbabwe over the last two years. Venezuela is exactly the same. The same measures by government and the same characteristics in the economy.
Julius Malema can get first hand experience from Chavez how to destroy a country through trying unsuccessfully to surpress the market.
It is time to start reading a Venezuelan English online newspaper on a daily basis. Zimbabwe all over again. What a joke. Very interesting completely up to date daily economics though.
Kindest regards,
Nicolaas Smith
Chavez´s nationalization continues.
26% annual inflation for 3 years in a row is hyperinflation.
Venezuela is already at 27% annual inflation.
Zimbabwe can guarantee Venezuela that price controls do not work.
As soon as price controls enter, production drops.
Robert Mugabe tried what no-one has ever done: beat the market.
Now Hugo Chavez is trying the same impossible dream: to beat the market.
He will also fail as Mugabe failed.
The market rules.
After Zimbabwe we can now watch Venezuela self-destruct.
I hope the ANC, Julius Malema, the ANCYL, Cosatu, Numsa and the SA Communist Party take careful note how this process unfolds because it always works exactly the same way. Go and look up the exact same process in Zimbabwe a year or two ago.
I see Venezuela already had 39% inflation at the end of last year. And a parallel USDollar exchange rate considerably higher than the "official" rate. And a local petrol price not increased for 10 years.
lol Exactly the same as hyperinflation in Angola and Zimbabwe.
Malema should take a sebatical year from politics in SA and go and learn again from Chavez how the above measures destroy a country´s economy in few short years.
I watched this exact same process unfold on a daily basis in Zimbabwe over the last two years. Venezuela is exactly the same. The same measures by government and the same characteristics in the economy.
Julius Malema can get first hand experience from Chavez how to destroy a country through trying unsuccessfully to surpress the market.
It is time to start reading a Venezuelan English online newspaper on a daily basis. Zimbabwe all over again. What a joke. Very interesting completely up to date daily economics though.
Kindest regards,
Nicolaas Smith
Thursday 12 November 2009
Valuing fixed properties at HC before they are sold does not destroy their real values
The real values of fixed properties are not destroyed by SA accountants when they value these fixed assets at their original nominal HC values before the date that they are actually exchanged during low inflation. They would be valued at their current market values on the date of exchange in an open economy. During hyperinflation all variable items are required to be valued in units of constant purchasing power with reference to the CPI or a hard currency parallel rate – normally the US Dollar parallel rate.
This is not the case with reported constant items never maintained under the HC paradigm. Accountants unknowingly destroy the real values of reported constant items never maintained at a rate equal to the rate of inflation in a low inflationary environment with their stable measuring unit assumption under HCA.
Variable items´ real values are not being unknowingly destroyed by SA accountants as a result of their implementation of IFRS or SA GAAP since variable items exist independently of how we value them. They can value a variable item in the balance sheet at its HC 50 years ago, but, when it is sold in the market today, the variable item would be transacted at the current market price. The real values of variable items are also not being destroyed uniformly at, e.g., a rate equal to the inflation rate because of valuing them at original nominal HC. Inflation, per se, has no effect on the real values of variable items on a primary valuation basis.
Where real losses are made in dealing with variable items in SA, these losses are the result of supply and demand or business and private decisions, e.g. selling at a bad price, obsolescence, stock market crashes, credit crunches, etc. They do not result from the implementation by SA accountants of the HC accounting model.
Kindest regards,
Nicolaas Smith
This is not the case with reported constant items never maintained under the HC paradigm. Accountants unknowingly destroy the real values of reported constant items never maintained at a rate equal to the rate of inflation in a low inflationary environment with their stable measuring unit assumption under HCA.
Variable items´ real values are not being unknowingly destroyed by SA accountants as a result of their implementation of IFRS or SA GAAP since variable items exist independently of how we value them. They can value a variable item in the balance sheet at its HC 50 years ago, but, when it is sold in the market today, the variable item would be transacted at the current market price. The real values of variable items are also not being destroyed uniformly at, e.g., a rate equal to the inflation rate because of valuing them at original nominal HC. Inflation, per se, has no effect on the real values of variable items on a primary valuation basis.
Where real losses are made in dealing with variable items in SA, these losses are the result of supply and demand or business and private decisions, e.g. selling at a bad price, obsolescence, stock market crashes, credit crunches, etc. They do not result from the implementation by SA accountants of the HC accounting model.
Kindest regards,
Nicolaas Smith
Tuesday 10 November 2009
The Historical Cost Debate
Originally – before there were any GAAPs and IFRSs – all variable items as well as all constant items together with all monetary items (basically all items in financial statements) were valued at Historical Cost since money – the monetary unit of account –was generally assumed to be stable in real value over time: the infamous stable measuring unit assumption. Today, SA accountants maintain this infamous and very destructive and very economically destabilizing assumption only for the valuation of the majority of income statement items (excluding salaries, wages, rents, etc that accountants value in units of constant purchasing power) and all balance sheet constant items during low inflation and deflation.
Values used in relation to variable items include the following:
Market value
Fair value
Net realisable value
Present value
Recoverable value
Current cost
Carrying value
Residual value
“The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.”
Value in use
Settlement value
Book value
Replacement cost
Historical cost
The Historical Cost Debate
The Historical Cost Debate is the debate over the last 100 years or so about the exclusive use of Historical Cost for all accounting purposes. The accounting profession has realized for a very long time that financial reports based on Historical Cost for all economic items do not fairly represent a company’s results and operations. As a result of this debate the pure Historical Cost Accounting model has been improved dramatically during this time, so much so, that today we have a huge volume of IFRS where under variable items are not all valued at HC but at the values as indicated above. As a result of the Historical Cost Debate variable items are today valued at, e.g. fair value or the lower of cost and net realizable value or market value or recoverable value or present value. This debate has thus been a very valid and successful debate regarding the valuation of variable real value non-monetary items.
Unfortunately, the stable measuring unit assumption is still an IFRS compliant option that everyone uses for the valuation of most constant items during low inflation and deflation. Fortunately, the option of measuring financial capital maintenance in units of constant purchasing power during low inflation has been approved by the IASB in the Framework, Par. 104 (a) in 1989. Unfortunately, no-one uses it.
SA accountants value variable items in terms of IFRSs or SA GAAP when they implement both the traditional HCA model and whenever they decide to choose to measure financial capital maintenance in units of constant purchasing power. Inflation, per se, has no effect on the real values of variable items. Inflation – per se – can only destroy the real value of money and other monetary items: nothing else.
Kindest regards,
Nicolaas Smith
Values used in relation to variable items include the following:
Market value
Fair value
Net realisable value
Present value
Recoverable value
Current cost
Carrying value
Residual value
“The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.”
Value in use
Settlement value
Book value
Replacement cost
Historical cost
The Historical Cost Debate
The Historical Cost Debate is the debate over the last 100 years or so about the exclusive use of Historical Cost for all accounting purposes. The accounting profession has realized for a very long time that financial reports based on Historical Cost for all economic items do not fairly represent a company’s results and operations. As a result of this debate the pure Historical Cost Accounting model has been improved dramatically during this time, so much so, that today we have a huge volume of IFRS where under variable items are not all valued at HC but at the values as indicated above. As a result of the Historical Cost Debate variable items are today valued at, e.g. fair value or the lower of cost and net realizable value or market value or recoverable value or present value. This debate has thus been a very valid and successful debate regarding the valuation of variable real value non-monetary items.
Unfortunately, the stable measuring unit assumption is still an IFRS compliant option that everyone uses for the valuation of most constant items during low inflation and deflation. Fortunately, the option of measuring financial capital maintenance in units of constant purchasing power during low inflation has been approved by the IASB in the Framework, Par. 104 (a) in 1989. Unfortunately, no-one uses it.
SA accountants value variable items in terms of IFRSs or SA GAAP when they implement both the traditional HCA model and whenever they decide to choose to measure financial capital maintenance in units of constant purchasing power. Inflation, per se, has no effect on the real values of variable items. Inflation – per se – can only destroy the real value of money and other monetary items: nothing else.
Kindest regards,
Nicolaas Smith
Monday 9 November 2009
Variable items exist independently of how accountants value them
As we know, the economy consists of three basic economic items:
1.Monetary items
2.Variable real value non-monetary items
3.Constant real value non-monetary items
Monetary items are money held and items with an underlying monetary nature. Non-monetary items are all items that are not monetary items. Non-monetary items are further sub-divided into variable and constant items.
Variable items are non-monetary items with variable real values
valued in terms of IFRS or GAAP.
The first economic items were variable items not yet expressed in terms of money since money was not yet invented at that time. Once money was invented all economic items, including variable items, were expressed in monetary terms.
Examples of variable items and how they are valued
Property – at cost or fair value
Freehold Land – at cost or fair value
Buildings – at cost or fair value
Leasehold Improvements – at cost
Plant – at cost
Equipment – at cost
Equipment under Finance Lease – at cost
Investment Property – at fair value
Goodwill – at cost
Other Intangible Assets – at cost
Capitalised Development Items – at cost
Patents – at cost
Trademarks – at cost
Licences – at cost
Investments in Associates – at cost
Joint Ventures – at cost
Other Financial Assets – at fair value
Derivatives designated and effective as hedging instruments – at fair value
Foreign currency forward contracts – at fair value
Interest rate swaps – at fair value
Financial assets carried at fair value through profit or loss
Non-derivative financial assets designated as carried at fair value through profit or loss
Held for trading derivatives that are not designated in hedge accounting relationships – at fair value
Held for trading non-derivative financial assets – at fair value
Available-for-sale investments carried at fair value
Redeemable notes – at fair value
Shares – at fair value
Inventories – at the lower of cost and net realisable value
Raw Materials – at the lower of cost and net realisable value
Work-in-progress – at the lower of cost and net realisable value
Finished Goods – at the lower of cost and net realisable value
Foreign currency – at market value
Variable items in South Africa are valued, for example, at fair value or the lower of cost and net realizable value or recoverable value or market value or present value in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”
SA financial reports fairly represent the fundamental real values of variable items in terms of IFRS or SA GAAP only at the balance sheet date – excluding those valued at original nominal Historical Cost when that original date is not the balance sheet date on a primary valuation basis. The fundamental real values of variable items exist independently of being valued at their original nominal HC after the original date they came about or were acquired by the firm. Valuing a variable item at its original nominal HC during its lifetime does not destroy its real value because it will be valued at its current market value whenever it is finally exchanged or sold or disposed of in the future.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
1.Monetary items
2.Variable real value non-monetary items
3.Constant real value non-monetary items
Monetary items are money held and items with an underlying monetary nature. Non-monetary items are all items that are not monetary items. Non-monetary items are further sub-divided into variable and constant items.
Variable items are non-monetary items with variable real values
valued in terms of IFRS or GAAP.
The first economic items were variable items not yet expressed in terms of money since money was not yet invented at that time. Once money was invented all economic items, including variable items, were expressed in monetary terms.
Examples of variable items and how they are valued
Property – at cost or fair value
Freehold Land – at cost or fair value
Buildings – at cost or fair value
Leasehold Improvements – at cost
Plant – at cost
Equipment – at cost
Equipment under Finance Lease – at cost
Investment Property – at fair value
Goodwill – at cost
Other Intangible Assets – at cost
Capitalised Development Items – at cost
Patents – at cost
Trademarks – at cost
Licences – at cost
Investments in Associates – at cost
Joint Ventures – at cost
Other Financial Assets – at fair value
Derivatives designated and effective as hedging instruments – at fair value
Foreign currency forward contracts – at fair value
Interest rate swaps – at fair value
Financial assets carried at fair value through profit or loss
Non-derivative financial assets designated as carried at fair value through profit or loss
Held for trading derivatives that are not designated in hedge accounting relationships – at fair value
Held for trading non-derivative financial assets – at fair value
Available-for-sale investments carried at fair value
Redeemable notes – at fair value
Shares – at fair value
Inventories – at the lower of cost and net realisable value
Raw Materials – at the lower of cost and net realisable value
Work-in-progress – at the lower of cost and net realisable value
Finished Goods – at the lower of cost and net realisable value
Foreign currency – at market value
Variable items in South Africa are valued, for example, at fair value or the lower of cost and net realizable value or recoverable value or market value or present value in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”
SA financial reports fairly represent the fundamental real values of variable items in terms of IFRS or SA GAAP only at the balance sheet date – excluding those valued at original nominal Historical Cost when that original date is not the balance sheet date on a primary valuation basis. The fundamental real values of variable items exist independently of being valued at their original nominal HC after the original date they came about or were acquired by the firm. Valuing a variable item at its original nominal HC during its lifetime does not destroy its real value because it will be valued at its current market value whenever it is finally exchanged or sold or disposed of in the future.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Wednesday 4 November 2009
Measurement of the Elements of Financial Statements
Here is a verbatim copy of some paragraphs of the International Accounting Standard Board´s
Framework for the Preparation and Presentation of Financial Statements (1989)
Measurement of the Elements of Financial Statements
Par. 99. Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement. This involves the selection of the particular basis of measurement.
Par. 100. A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. They include the following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
(d) Present value. Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.
Par. 101. The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value, marketable securities may be carried at market value and pension liabilities are carried at their present value. Furthermore, some entities use the current cost basis as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets.
The above sections of the Framework do not include measurement in units of constant purchasing power. This comes next in the concept of capital and the concept of capital maintenance in the Framework. It is an actual measurement basis. It is the measurement basis currently used by all accountants worldwide - including SA accountants - to value salaries, wages, rentals, regulated prices, etc in units of constant purchasing power during low inflation. It is thus universally used for the valuation of only some income statement constant real value non-monetary items during low inflation.
It is required to be used for all non-monetary items - variable and constant real value non-monetary items - during hyperinflation. This is a requirement of IAS 29 Financial Reporting in Hyperinflationary Economies.
It is also required by the IASB to be used for the valuation of all income statement and balance sheet constant items during low inflation when accountants choose financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a) during low inflation.
Measurement in units of constant purchasing power is thus completely generally accepted as a distinct and well understood and universally used measurement basis during low inflation. It is a generally accepted accounting principle (GAAP) during low, high and hyperinflation.
See the IASB deliberations regarding MEASUREMENT as of October 2014
Buy the ebook
Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Framework for the Preparation and Presentation of Financial Statements (1989)
Measurement of the Elements of Financial Statements
Par. 99. Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement. This involves the selection of the particular basis of measurement.
Par. 100. A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. They include the following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
(d) Present value. Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.
Par. 101. The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value, marketable securities may be carried at market value and pension liabilities are carried at their present value. Furthermore, some entities use the current cost basis as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets.
The above sections of the Framework do not include measurement in units of constant purchasing power. This comes next in the concept of capital and the concept of capital maintenance in the Framework. It is an actual measurement basis. It is the measurement basis currently used by all accountants worldwide - including SA accountants - to value salaries, wages, rentals, regulated prices, etc in units of constant purchasing power during low inflation. It is thus universally used for the valuation of only some income statement constant real value non-monetary items during low inflation.
It is required to be used for all non-monetary items - variable and constant real value non-monetary items - during hyperinflation. This is a requirement of IAS 29 Financial Reporting in Hyperinflationary Economies.
It is also required by the IASB to be used for the valuation of all income statement and balance sheet constant items during low inflation when accountants choose financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a) during low inflation.
Measurement in units of constant purchasing power is thus completely generally accepted as a distinct and well understood and universally used measurement basis during low inflation. It is a generally accepted accounting principle (GAAP) during low, high and hyperinflation.
See the IASB deliberations regarding MEASUREMENT as of October 2014
Buy the ebook
Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Tuesday 3 November 2009
The net monetary gain or loss conundrum
SA accountants have to calculate the net monetary loss or gain from holding monetary items when they choose the Constant ITEM Purchasing Power Accounting model in terms of the International Accounting Standards Board´s Framework, Par. 104 (a) and measure financial capital maintenance in units of constant purchasing power in the same way as the IASB currently in terms of IAS 29 requires its calculation and accounting during hyperinflation.
There are net monetary losses and net monetary gains during low inflation too, but they are not required to be calculated when accountants choose the traditional Historical Cost Accounting model.
It is an inexplicable contradiction that net monetary gains and losses are required by the IASB to be calculated and accounted during hyperinflation but not during non-hyperinflationary periods, especially when the IASB approved alternative to HCA, namely CIPPA does require their calculation and accounting during low inflation.
Kindest regards,
Nicolaas Smith
There are net monetary losses and net monetary gains during low inflation too, but they are not required to be calculated when accountants choose the traditional Historical Cost Accounting model.
It is an inexplicable contradiction that net monetary gains and losses are required by the IASB to be calculated and accounted during hyperinflation but not during non-hyperinflationary periods, especially when the IASB approved alternative to HCA, namely CIPPA does require their calculation and accounting during low inflation.
Kindest regards,
Nicolaas Smith
Monday 2 November 2009
Ultimately, inflation-adjusting accounts in a low inflation environment is a blessing to users.
The statement "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power," in the IASB´s Framework, Paragraph 104 (a), means that Constant ITEM Purchasing Power Accounting has been authorized by the IASB since 1989 as an alternative to the traditional HCA model, including during periods of low inflation.
This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of CPP during low inflation since 1989. It also means that CIPPA and the inflation-adjustment of constant items to maintain their real values in a low inflationary environment are authorized by IFRS since the Framework is applicable in the absence of specific IFRS.
Income statement constant items like salaries, wages, rents, pensions, utilities, transport fees, etc are normally valued by accountants in units of CPP during low inflation in most economies. Payments in money for these items are normally inflation-adjusted by means of the CPI to compensate for the destruction of the real value of money (the monetary medium of exchange) by inflation.
Inflation is always and everywhere a monetary phenomenon and can only destroy the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not destroy the real value of non-monetary items. Constant items´ real values can be maintained by accountants choosing the CIPPA model as per the Framework during low inflation as authorized by the IASB since 1989 instead of currently being destroyed by the implementation by accountants of the traditional HC model when they apply the stable measuring unit assumption.
It is thus accountants´ choice of the HCA model and not inflation that destroys the real value of constant items never maintained at a rate equal to the inflation rate when HC accountants choose to implement the stable measuring unit assumption for an indefinite period of time during continuous inflation.
Implementing the CIPPA model means accountants choose to reject the stable measuring unit assumption which they implement when they choose to measure financial capital maintenance in nominal monetary units. Accountants world wide currently choose the traditional HCA model except during hyperinflation when they are required by the IASB to implement IAS 29 which is based on the CPPA inflation accounting model.
Kindest regards,
Nicolaas Smith
This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of CPP during low inflation since 1989. It also means that CIPPA and the inflation-adjustment of constant items to maintain their real values in a low inflationary environment are authorized by IFRS since the Framework is applicable in the absence of specific IFRS.
Income statement constant items like salaries, wages, rents, pensions, utilities, transport fees, etc are normally valued by accountants in units of CPP during low inflation in most economies. Payments in money for these items are normally inflation-adjusted by means of the CPI to compensate for the destruction of the real value of money (the monetary medium of exchange) by inflation.
Inflation is always and everywhere a monetary phenomenon and can only destroy the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not destroy the real value of non-monetary items. Constant items´ real values can be maintained by accountants choosing the CIPPA model as per the Framework during low inflation as authorized by the IASB since 1989 instead of currently being destroyed by the implementation by accountants of the traditional HC model when they apply the stable measuring unit assumption.
It is thus accountants´ choice of the HCA model and not inflation that destroys the real value of constant items never maintained at a rate equal to the inflation rate when HC accountants choose to implement the stable measuring unit assumption for an indefinite period of time during continuous inflation.
Implementing the CIPPA model means accountants choose to reject the stable measuring unit assumption which they implement when they choose to measure financial capital maintenance in nominal monetary units. Accountants world wide currently choose the traditional HCA model except during hyperinflation when they are required by the IASB to implement IAS 29 which is based on the CPPA inflation accounting model.
Kindest regards,
Nicolaas Smith
Friday 30 October 2009
Hyperinflation in South Africa
IFRS compliant financial capital maintenance in units of constant purchasing power would always be a better accounting model than HCA during inflation.
SA accountants unknowingly destroy the real value of reported Retained Earnings at the rate of inflation under HCA implementing the stable measuring unit assumption in the SA real economy.
Rejecting the stable measuring unit assumption by measuring financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 would stop this destruction of real value in Retained Earnings.
It would remove distortions in the real economy, improve economic stability and guarantee that no wipe-out of internal demand would be possible in the SA economy like what happened in the recent past in the Zimbabwean economy under very high rates of inflation.
Hyperinflation is still possible in SA in the Rand, but, with no stable measuring unit assumption and all constant items (including salaries, wages, rentals, shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc) being automatically updated in units of constant purchasing power, economic stability in the real economy would be guaranteed as it was in Brazil during 30 years of hyperinflation of up to 2000% per annum.
Brazil used indexation to maintain the real values of non-monetary items during the 30 years of hyperinflation in their internal currencies during that period.
Financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a), is the same as indexation, but, only in constant items - not in variable real value non-monetary items. The latter are valued in terms of IFRS or SA GAAP.
Retained Earnings can be updated under IFRS but not under HCA.
Kindest regards,
Nicolaas Smith
SA accountants unknowingly destroy the real value of reported Retained Earnings at the rate of inflation under HCA implementing the stable measuring unit assumption in the SA real economy.
Rejecting the stable measuring unit assumption by measuring financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989 would stop this destruction of real value in Retained Earnings.
It would remove distortions in the real economy, improve economic stability and guarantee that no wipe-out of internal demand would be possible in the SA economy like what happened in the recent past in the Zimbabwean economy under very high rates of inflation.
Hyperinflation is still possible in SA in the Rand, but, with no stable measuring unit assumption and all constant items (including salaries, wages, rentals, shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc) being automatically updated in units of constant purchasing power, economic stability in the real economy would be guaranteed as it was in Brazil during 30 years of hyperinflation of up to 2000% per annum.
Brazil used indexation to maintain the real values of non-monetary items during the 30 years of hyperinflation in their internal currencies during that period.
Financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a), is the same as indexation, but, only in constant items - not in variable real value non-monetary items. The latter are valued in terms of IFRS or SA GAAP.
Retained Earnings can be updated under IFRS but not under HCA.
Kindest regards,
Nicolaas Smith
How to maintain your capital
The specific choice of measuring financial capital maintenance in units of constant purchasing power (the Constant Item Purchasing Power Accounting model) during non-hyperinflationary periods as contained in the Framework, Par. 104 (a) , was approved by the IASB’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.
Deloitte
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."
IAS8, 11:
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There is no applicable IFRS or Interpretation regarding the capital concept, the capital maintenance concept and the valuation of constant items. The Framework is thus applicable.
Despite being applicable as a result of the absence of specific IFRS CIPPA is completely ignored by accountants and accounting authorities even though they would maintain the real value of constant items with it instead of currently unknowingly destroying the real values of not only all income statement constant items but also all balance sheet constant items never maintained when they implement the traditional HCA model.
This is because the CIPPA model is mistakenly viewed by almost all accountants and accounting authorities, but excluding the IASB, as the same as the 1970-style failed CPPA inflation accounting model that requires all non-monetary items - variable and constant items - to be inflation-adjusted by means of the CPI. They - including the IASB - fail to introduce the substantial real value maintaining benefits, which last for an unlimited period of time (all else being equal), of measuring financial capital maintenance in units of CPP in companies and the economy in general.
The IASB did not approve CIPPA in 1989 as an inflation accounting model. It did that with CPPA in IAS29. CIPPA by measuring financial capital maintenance in units of CPP incorporates an alternative CPP capital concept, CPP financial capital maintenance concept and CPP profit determination concept to the HC capital concept, HC financial capital maintenance concept and HC profit determination concept. CIPPA only requires all constant items to be valued in units of CPP. Variable items are valued in terms of IFRS or GAAP and are not required in terms of the Framework to be valued in units of CPP.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Deloitte
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."
IAS8, 11:
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There is no applicable IFRS or Interpretation regarding the capital concept, the capital maintenance concept and the valuation of constant items. The Framework is thus applicable.
Despite being applicable as a result of the absence of specific IFRS CIPPA is completely ignored by accountants and accounting authorities even though they would maintain the real value of constant items with it instead of currently unknowingly destroying the real values of not only all income statement constant items but also all balance sheet constant items never maintained when they implement the traditional HCA model.
This is because the CIPPA model is mistakenly viewed by almost all accountants and accounting authorities, but excluding the IASB, as the same as the 1970-style failed CPPA inflation accounting model that requires all non-monetary items - variable and constant items - to be inflation-adjusted by means of the CPI. They - including the IASB - fail to introduce the substantial real value maintaining benefits, which last for an unlimited period of time (all else being equal), of measuring financial capital maintenance in units of CPP in companies and the economy in general.
The IASB did not approve CIPPA in 1989 as an inflation accounting model. It did that with CPPA in IAS29. CIPPA by measuring financial capital maintenance in units of CPP incorporates an alternative CPP capital concept, CPP financial capital maintenance concept and CPP profit determination concept to the HC capital concept, HC financial capital maintenance concept and HC profit determination concept. CIPPA only requires all constant items to be valued in units of CPP. Variable items are valued in terms of IFRS or GAAP and are not required in terms of the Framework to be valued in units of CPP.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Wednesday 28 October 2009
Trust me, I´m an accountant
SA accountants unknowingly destroy the real value of your company’s equity since they assume there´s no inflation.
They unknowingly destroy the real value of Retained Profits with their stable measuring unit assumption, but, they also do not update the cost of inventories and cost of sales.
Consequently they overstate gross margins and instead of maintaining the full real value of equity, they pay some of it away in tax on inflation-adjustments, they fail to update trade debtors and they can also pay it away in dividends.
Kindest regards,
Nicolaas Smith
They unknowingly destroy the real value of Retained Profits with their stable measuring unit assumption, but, they also do not update the cost of inventories and cost of sales.
Consequently they overstate gross margins and instead of maintaining the full real value of equity, they pay some of it away in tax on inflation-adjustments, they fail to update trade debtors and they can also pay it away in dividends.
Kindest regards,
Nicolaas Smith
Monday 26 October 2009
The IASB´s alternative to Historical Cost Accounting
The IASB´s alternative to Historical Cost Accounting
Buy the ebook
Last updated on 17 April, 2012
Constant Purchasing Power Accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the International Accounting Standards Board´s inflation accounting model required to be implemented only during hyperinflation.
Constant ITEM Purchasing Power Accounting (CIPPA) is the IASB´s basic accounting alternative to traditional Historical Cost Accounting during low and high inflation and deflation. The stable measuring unit assumption is implemented under HCA. The stable measuring unit assumption is never implemented as a GAAP under CIPPA. HCA implements financial capital maintenance in nominal monetary units. CIPPA implements financial capital maintenance in units of constant purchasing power in terms of a daily index. CIPPA is fundamentally different from HCA. Financial capital maintenance in nominal monetary units is a fallacy because if is impossible to maintain the constant purchasing power (real value) of capital constant in nominal monetary units per se during inflation and deflation. CIPPA, on the other hand, automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation - ceteris paribus.
Both CPPA and CIPPA are price-level accounting models. IAS 29 simply requires the restatement of all non-monetary items (both variable and constant real value non-monetary items) in Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published Consumer Price Index during hyperinflation. IAS 29 is an extension to, not a departure from HCA per PricewaterhouseCoopers. IAS 29 had no effect during hyperinflation in Zimbabwe.
CIPPA as approved by the IASB in the original Framework for the Preparation and Presentation of Financial Statements (1989), Par. 104 (a) which states
'Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power'
requires the following:
(1) Daily inflation-adjustement of all historic and current period monetary items in terms of a Daily CPI or monetized daily indexed unit of account. The net monetary loss or gain is calculated and accounted when monetary items are not inflation-adjusted daily during the current accounting periõd. The net monetary loss or gain is a constant real value non-monetary item once accounted in the income statement.
(2) Daily valuation of variable real value non-monetary items in terms of IFRS excluding the stable measuring unit assumption. Historical variable items (e.g., valued yesterday) are updated daily in terms of the Daily CPI or monetized daily indexed unit of account when they are not valued daily in terms of IFRS during low and high inflation and deflation. Impairments are treated in terms of IFRS.
(3) Historic and current period constant items are always and everywhere measured in units of constant purchasing power in terms of the Daily CPI or monetized daily indexed unit of account during low and high inflation and deflation. The net constant item loss or gain is calculated and accounted when current period constant items are not measured daily in units of constant purchasing power.
In terms of the Framework, accountants can choose CIPPA to implement a financial capital concept of invested purchasing power instead of the traditional HC concept of invested money. They will thus implement a CPP financial capital maintenance concept by measuring financial capital maintenance in units of CPP instead of traditional HC nominal monetary units and they will implement a CPP profit/loss determination concept. Examples of constant items include issued share capital, retained income, shareholders´ equity, trade debtors, trade creditors, deferred tax assets and liabilities, salaries, wages, rentals, etc. Examples of variable item include property, plant, equipment, shares, inventory.
Monetary, variable and constant items are the three fundamentally different basic economic items in the economy.
CIPPA would maintain the real value of constant items including banks´ and companies´ capital base, for an unlimited period of time - all else being equal, as opposed to the traditional HCA model which unknowingly, unintentionally and unnecessarily erode the real value of constant items never maintained constant. CIPPA was authorized by the IASB in 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation in the Framework and is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of constant items.
CIPPA (not CPPA) during hyperinflation would be the same as in non-hyperinflationary economies. The only difference is that the daily rate would be a relatively stable foreign currency daily parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate. All non-monetary items (variable and constant items) would be measured in units of constant purchasing power on a daily basis as indicated above during hyperinflation.
Discredited 1970-style CPPA was a form of inflation accounting which tried unsuccessfully - by updating all non-monetary items (variable and constant items) equally by means of the CPI during high inflation - to allow for the effect of the stable measuring unit assumption in an attempt to make corporate accounts more informative when comparing current transactions with previous transactions.
Nevertheless, almost all accountants and accounting authorities - excluding the IASB - mistakenly regard CIPPA as the same as the discredited and failed 1970-style CPPA inflation accounting model. They ignore the CIPPA model's substantial benefits, for example, automatically maintaining banks´ and companies´ capital base when accountants choose to measure constant items in units of constant purchasing power by means of the Daily CPI thus maintaining instead of continuously eroding their real values at a rate equal to the rate of inflation while they value variable items daily in terms of IFRS or GAAP excluding the stable measuring unit assumption.
Certain income statement constant items, most notably salaries, wages and rentals, etc. are measured in units of constant purchasing power on an annual basis, but are paid in fixed monthly amounts again implementing the stable measuring unit assumption in most economies implementing the HCA model.
The IASB specifically requires the CPPA inflation accounting model to be used during hyperinflation as per IAS 29.
Buy the ebook for $2.99 or £1.53 or €2.68
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Buy the ebook
Last updated on 17 April, 2012
Constant Purchasing Power Accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the International Accounting Standards Board´s inflation accounting model required to be implemented only during hyperinflation.
Constant ITEM Purchasing Power Accounting (CIPPA) is the IASB´s basic accounting alternative to traditional Historical Cost Accounting during low and high inflation and deflation. The stable measuring unit assumption is implemented under HCA. The stable measuring unit assumption is never implemented as a GAAP under CIPPA. HCA implements financial capital maintenance in nominal monetary units. CIPPA implements financial capital maintenance in units of constant purchasing power in terms of a daily index. CIPPA is fundamentally different from HCA. Financial capital maintenance in nominal monetary units is a fallacy because if is impossible to maintain the constant purchasing power (real value) of capital constant in nominal monetary units per se during inflation and deflation. CIPPA, on the other hand, automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation - ceteris paribus.
Both CPPA and CIPPA are price-level accounting models. IAS 29 simply requires the restatement of all non-monetary items (both variable and constant real value non-monetary items) in Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published Consumer Price Index during hyperinflation. IAS 29 is an extension to, not a departure from HCA per PricewaterhouseCoopers. IAS 29 had no effect during hyperinflation in Zimbabwe.
CIPPA as approved by the IASB in the original Framework for the Preparation and Presentation of Financial Statements (1989), Par. 104 (a) which states
'Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power'
requires the following:
(1) Daily inflation-adjustement of all historic and current period monetary items in terms of a Daily CPI or monetized daily indexed unit of account. The net monetary loss or gain is calculated and accounted when monetary items are not inflation-adjusted daily during the current accounting periõd. The net monetary loss or gain is a constant real value non-monetary item once accounted in the income statement.
(2) Daily valuation of variable real value non-monetary items in terms of IFRS excluding the stable measuring unit assumption. Historical variable items (e.g., valued yesterday) are updated daily in terms of the Daily CPI or monetized daily indexed unit of account when they are not valued daily in terms of IFRS during low and high inflation and deflation. Impairments are treated in terms of IFRS.
(3) Historic and current period constant items are always and everywhere measured in units of constant purchasing power in terms of the Daily CPI or monetized daily indexed unit of account during low and high inflation and deflation. The net constant item loss or gain is calculated and accounted when current period constant items are not measured daily in units of constant purchasing power.
In terms of the Framework, accountants can choose CIPPA to implement a financial capital concept of invested purchasing power instead of the traditional HC concept of invested money. They will thus implement a CPP financial capital maintenance concept by measuring financial capital maintenance in units of CPP instead of traditional HC nominal monetary units and they will implement a CPP profit/loss determination concept. Examples of constant items include issued share capital, retained income, shareholders´ equity, trade debtors, trade creditors, deferred tax assets and liabilities, salaries, wages, rentals, etc. Examples of variable item include property, plant, equipment, shares, inventory.
Monetary, variable and constant items are the three fundamentally different basic economic items in the economy.
CIPPA would maintain the real value of constant items including banks´ and companies´ capital base, for an unlimited period of time - all else being equal, as opposed to the traditional HCA model which unknowingly, unintentionally and unnecessarily erode the real value of constant items never maintained constant. CIPPA was authorized by the IASB in 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation in the Framework and is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of constant items.
CIPPA (not CPPA) during hyperinflation would be the same as in non-hyperinflationary economies. The only difference is that the daily rate would be a relatively stable foreign currency daily parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate. All non-monetary items (variable and constant items) would be measured in units of constant purchasing power on a daily basis as indicated above during hyperinflation.
Discredited 1970-style CPPA was a form of inflation accounting which tried unsuccessfully - by updating all non-monetary items (variable and constant items) equally by means of the CPI during high inflation - to allow for the effect of the stable measuring unit assumption in an attempt to make corporate accounts more informative when comparing current transactions with previous transactions.
Nevertheless, almost all accountants and accounting authorities - excluding the IASB - mistakenly regard CIPPA as the same as the discredited and failed 1970-style CPPA inflation accounting model. They ignore the CIPPA model's substantial benefits, for example, automatically maintaining banks´ and companies´ capital base when accountants choose to measure constant items in units of constant purchasing power by means of the Daily CPI thus maintaining instead of continuously eroding their real values at a rate equal to the rate of inflation while they value variable items daily in terms of IFRS or GAAP excluding the stable measuring unit assumption.
Certain income statement constant items, most notably salaries, wages and rentals, etc. are measured in units of constant purchasing power on an annual basis, but are paid in fixed monthly amounts again implementing the stable measuring unit assumption in most economies implementing the HCA model.
The IASB specifically requires the CPPA inflation accounting model to be used during hyperinflation as per IAS 29.
Buy the ebook for $2.99 or £1.53 or €2.68
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Friday 23 October 2009
A 45% electricity price increase should not increase inflation - in theory.
A price increase is paying more money for more real value.
Inflation is paying of more money for the same real value.
In theory, when electricity becomes more valuable in the SA economy and it´s price is increased by 45%, then households would have to spend less on other items – all else being equal.
Thus, no increase or decrease in inflation.
Inflation comes about when business abuses the electricity price increase to increase the general price level instead of just the price of electricity.
A one percent increase in inflation – paying one per cent more for the same real value in general – is expected as a result of the electricity price increase.
A 45% price increase for three years in a row equals a 304% increase over that period.
Kindest regards,
Nicolaas Smith
Inflation is paying of more money for the same real value.
In theory, when electricity becomes more valuable in the SA economy and it´s price is increased by 45%, then households would have to spend less on other items – all else being equal.
Thus, no increase or decrease in inflation.
Inflation comes about when business abuses the electricity price increase to increase the general price level instead of just the price of electricity.
A one percent increase in inflation – paying one per cent more for the same real value in general – is expected as a result of the electricity price increase.
A 45% price increase for three years in a row equals a 304% increase over that period.
Kindest regards,
Nicolaas Smith
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