International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
United Kingdom
Dear Mr. Hoogervorst,
Request for comment on IASB Agenda Consultation 2011
Thank you for the opportunity to comment on the IASB Agenda Consultation 2011.
I see
A. A revision of IAS 29 Financial Reporting in Hyperinflationary Economies and
B. The joint Conceptual Framework project
as the most pressing financial reporting needs for standard-setting action from the IASB.
My detailed answers and suggestions are contained in the attached appendix.
If you have any questions regarding this submission, please do not hesitate to contact me at
Yours sincerely,
Nicolaas Smith
I promote financial capital maintenance in units of constant purchasing power during low
inflation, high inflation, hyperinflation and deflation as authorized in IFRS in the original
Framework (1989), Par 104 (a). Constant Item Purchasing Power Accounting 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.
This comment letter is published HERE on the IFRS.org website.
Appendix – Response to the Agenda Consultation 2011
Question 2
What do you see as the most pressing financial reporting needs for standard-setting action from
the IASB?
Question 2(a)
Considering the various constraints, to which projects should the IASB give priority, and why?
Where possible, please explain whether you think that a comprehensive project is needed or
whether a narrow, targeted improvement would suffice?
I see
A. A revision of IAS 29 Financial Reporting in Hyperinflationary Economies and
B. The joint Conceptual Framework project
as the most pressing financial reporting needs for standard-setting action from the IASB.
A. A revision of IAS 29 Financial Reporting in Hyperinflationary Economies
1. IAS 29 is ineffective during high inflation and hyperinflation
IAS 29´s ineffectiveness during hyperinflation was clearly demonstrated during the last 6 years of hyperinflation in Zimbabwe. Zimbabwean companies listed on the Zimbabwe Stock Exchange were required to implement IAS 29 as from 2002. IAS 29 made no difference to the hyper-erosion of the real value of constant real value non-monetary items never maintained constant during hyperinflation. The hyper-erosion of, for example, companies´ invested capital and profits, was not caused by hyperinflation - as generally accepted, but, by the implementation of the stable measuring unit assumption as part of the Historical Cost Accounting model during the 14 years of high and hyperinflation till the end on 20th November, 2008.
IAS 29´s ineffectiveness was confirmed by Michael Madsen, the Group CFO of The East Asiatic Company Ltd., the listed Danish multinational with a subsidiary in Venezuela´s hyperinflationary economy in 2009 as follows:
How is it possible that the implementation of IAS 29 – which defines the IASB´s inflation accounting model - does not affect the operation of a company during hyperinflation when Brazil used inflation accounting and achieved positive economic growth during 30 years of very high and hyperinflation? What is the purpose of implementing IAS 29 during hyperinflation? Why can IAS 29 not do what Brazil did for 30 years during very high and hyperinflation?
IAS 29 is ineffective during hyperinflation as well as in entities whose functional currency is that of an economy subject to high inflation, but which is not hyperinflationary, because the restatement of Historical Cost and Current Cost financial reports in terms of the period-end Consumer Price Index, as required by the standard, does not stop the hyper-erosion of the real value of constant real value non-monetary items never maintained constant - not by high inflation and hyperinflation, but, by the implementation of the stable measuring unit assumption, i.e. Historical Cost Accounting, during high inflation and hyperinflation.
The three basic economic items in the economy are (1) monetary items, (2) variable real value non-monetary items (e.g. property, plant, equipment, raw materials, finished goods, quoted and unquoted shares, etc.) and (3) constant real value non-monetary items (e.g. salaries, wages, rentals, all other income statement items, all items in shareholders´ equity, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, provisions etc.
This hyper-erosion referred to above hyper-erodes the constant real non-monetary value of, for example, that portion of shareholders´ equity never maintained constant by sufficient revaluable fixed assets (revalued or not) under the concept of capital is equal to net assets under HCA during high and hyperinflation.
HCA implements financial capital maintenance in nominal monetary units. However, it is impossible to maintain the real value of capital in nominal monetary units per se during high inflation and hyperinflation. It is only possible under the single scenario where an entity always invests 100% of the updated real value of all contributions to shareholders´ equity in revaluable fixed assets (revalued or not) with an equivalent updated fair value during high and hyperinflation which may be the case in only hotel, hospital and other property-intensive entities.
The erosion of companies´ capital and invested profits is not caused by inflation (including high inflation and hyperinflation) as taught to all accountants and specifically stated by the US Financial Accounting Standards Board (the erosion of business profits and invested capital caused by inflation” (FAS 33, 1979, p. 24), but, by the implementation of the stable measuring unit assumption (Historical Cost Accounting) during high inflation and hyperinflation.
2. High inflation and hyperinflation have no effect on the real value of non-monetary items
High inflation and hyperinflation can only hyper-erode the real value of money and other monetary items – nothing else. Business profits and invested capital are constant real value non-monetary items. High inflation and hyperinflation have no effect on the real value of non-monetary items as easily deduced from Milton Friedman´s now famous statement that inflation is always and everywhere a monetary phenomenon.
This was also specifically stated by two Turkish academics:
Purchasing power of non monetary items does not change in spite of variation in national currency value.
It must be remembered that Turkey emerged from hyperinflation in 2004. Profs. Gucenme and Arsoy had firsthand experience of hyperinflation. This explains their profound understanding of the singularly monetary effect of inflation, high inflation and hyperinflation – something that is much more difficult to achieve by someone only exposed to low inflation under the Historical Cost paradigm; i.e., implementing the stable measuring unit assumption during low inflation which, in principle, assumes that unstable money is perfectly stable (the stable measuring unit assumption under HCA) for the purpose of measuring constant real value non-monetary items during inflation, high inflation, hyperinflation and deflation.
3. HCA should not be implemented during high inflation and hyperinflation
IAS 29 states: The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach shall be stated in terms of the measuring unit current at the end of the reporting period. IAS 29, Par 8.
PricewaterhouseCoopers states the following regarding the use of the HCA model during hyperinflation:
Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting.
Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.
It is clear from the above that IFRS approve and PricewaterhouseCoopers support the implementation of the Historical Cost Accounting model which includes the very erosive stable measuring unit assumption during high inflation and hyperinflation. That is a fundamental mistake during high inflation and hyperinflation. HCA should not be implemented during high inflation and hyperinflation
IAS 29 is certainly not a valid inflation accounting model.
Valid inflation accounting is financial capital maintenance in units of constant purchasing power in terms of a daily hard currency parallel rate or daily index rate during high and hyperinflation. This was implemented very effectively during 30 years in Brazil.
The daily rate can be the daily US Dollar (or other hard currency) parallel rate, or a Brazilian-style Unidade Real de Valor daily index or a Chilean-style Unidad de Fomento monetized daily indexed unit of account during high and hyperinflation.
Financial capital maintenance in units of constant purchasing power during high inflation and hyperinflation was implemented very successfully by Brazil from 1964 to 1994 by means of measuring non-monetary items in terms of various daily non-monetary indices supplied by the various Brazilian governments to the population on a daily basis from 1964 to 1994 to deal with the real or non-monetary (not monetary) side of the economy as stated by the Central Bank of Brazil as follows:
Não temos como fornecer, conforme solicitado, os detalhes exatos do indexador utilizado durante o período de alta inflação no Brasil. Vale esclarecer que, desde 1964, quando foi implementado o Programa de Ação Econômica do Governo – PAEG, vários mecanismos de indexação foram introduzidos na economia brasileira objetivando reduzir os efeitos da inflação não antecipada sobre o lado real da economia. Podemos destacar os mecanismos destinados à taxa de câmbio, aos salários e e à correção monetária de ativos financeiros. Ao longo da existência das ORTNs e de seus sucedâneos, por exemplo, os governos mudaram em diversas oportunidades as fórmulas de cálculo da correção monetária e trocaram várias vezes os índices de preços que eram utilizados no cálculo da mesma.
This excellent example (compare Brazil and Zimbabwe during hyperinflation) of practical financial capital maintenance in units of constant purchasing power in terms of a daily government supplied non-monetary index was, unfortunately, completely ignored by the IASB in the formulation of IAS 29 in 1989. In my humble opinion that was an unfortunate omission of applying the results of actual due process in a standard in IFRS in the years leading up to the authorization of IAS 29 in 1989.
Financial capital maintenance in units of constant purchasing power in terms of a daily hard currency parallel rate or daily index rate during high inflation and hyperinflation allows a country to keep its non-monetary or real economy relatively stable and actually have positive economic growth during high inflation and hyperinflation: like Brazil did from 1964 to 1994.
The accounting model required by IAS 29 during hyperinflation can be classified as inflation accounting since it is an intermediate, but, ineffective attempt at solving the problem of the hyper-erosion of the real value of constant real value non-monetary items by the stable measuring unit assumption (not high inflation and hyperinflation) as a result of the misguided implementation of the Historical Cost Accounting model during high inflation and hyperinflation.
4. Constant real value non-monetary items are indirectly defined in IFRS
The original Framework (1989), Par 104 (a) [now the Conceptual Framework (2010), Par 4.59 (a)] states: Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.
All items in shareholders´ equity, all items in the income statement, provisions, trade debtors, trade creditors, etc. are non–monetary items. The IASB confirms this (with the exception of accounts payable and accounts receivable which are incorrectly treated as monetary items under IAS 29 and incorrectly specifically defined as such by PricewaterhouseCoopers and the FASB, amongst others) by clearly defining them as non-monetary items in IAS 29. These non–monetary items are constant real value non–monetary items with constant real values since they can be measured in units of constant purchasing power in terms of the original Framework (1989), Par 104 (a) in order to implement financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation - including high inflation and hyperinflation. Financial capital maintenance in units of constant purchasing power is fundamentally different from financial capital maintenance in nominal monetary units.
The definition of constant real value non–monetary items is thus implied in IFRS, which is logical since IFRSs only authorize the principle: when financial capital maintenance is measured in units of constant purchasing power during low inflation, deflation, high inflation and hyperinflation, it means that certain economic items have constant real values over time.
Everybody will agree that this certainly does not refer to monetary items. Thus, certain non–monetary items are constant real value non–monetary items, e.g. salaries, wages, rentals, all other income statement items, all items in shareholders´ equity, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, provisions etc.
Non–monetary items which are not constant real value non–monetary items are thus variable real value non–monetary items valued in terms of IFRS, e.g. property, plant, equipment, inventory, shares, etc.
A narrow, targeted improvement of IAS 29 would suffice since the principle of financial capital
maintenance in units of constant purchasing power was authorized in 1989.
1. IAS 29 has to require (not optional) only financial capital maintenance in units of constant purchasing power in terms of only a daily relatively stable foreign currency parallel rate or only a daily index rate or only a monetized daily indexed unit of account rate during high and hyperinflation.
It is to be noted that financial capital maintenance in units of constant purchasing power in terms of a daily index or rate would automatically maintain the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value during high inflation and hyperinflation – ceteris paribus – whether they own any revaluable fixed assets or not.
2. The definition of monetary items in Par 12, namely that monetary items are money held and items to be received or paid in money has to be corrected to monetary items are money held and other monetary items with an underlying monetary nature. Most items in the world economy - monetary and non-monetary items - are items to be received or paid in money.
3. IAS 29 has to define the split of non-monetary items in variable real value non-monetary items and constant real value non-monetary items. IAS 29 has to define trade debtors, trade creditors and all other non-monetary payables and receivables as constant real value non-monetary items and not monetary items.
B. The joint Conceptual Framework project
I see the joint Conceptual Framework project as a second pressing financial reporting need for
standard-setting action from the IASB because of fundamental omissions in the following two
areas:
1. The set of possible measurement methods that are to be considered
2. Capital and capital maintenance concepts
1. The set of possible measurement methods that are to be considere
The Measurement Phase of the project has been in progress for seven years, but, although the published material states: “The measurement chapter should list and describe possible measurements”, the term measurement in units of constant purchasing power has not yet been included in “the set of possible measurement methods that are to be considered”.
When we take into account that
(i) (a) The constant purchasing power financial capital concept and
(b) The financial capital maintenance in units of constant purchasing power concept
were authorized at all levels of low inflation, high inflation, hyperinflation and
deflation in IFRS in the original Framework (1989), Par 104 (a) and that
(ii) Financial capital maintenance in units of constant purchasing power in terms of a daily index or rate automatically maintains the real value of capital constant for an indefinite period of time in all entities that at least break even in real value during low inflation, high inflation, hyperinflation and deflation – ceteris paribus,
Then it is clear that measurement in units of constant purchasing power is a fundamental measurement measure authorized in IFRS in 1989. In my opinion it should be listed as such in “the set of possible measurement methods that are to be considered.”
2. Capital and capital maintenance concepts
It is generally accepted that there are only two concepts of capital and capital maintenance, namely, physical and financial capital and capital maintenance. The original Framework (1989) and the Conceptual Framework (2010) only deal with the above two concepts of capital and capital maintenance although financial capital maintenance in units of constant purchasing power is authorized in both of them: in Par 104 (a) in the original Framework (1989) and in Par 4.59 (a) in the Conceptual Framework (2010) as follows: Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power. There are no changes in the concepts of capital and capital maintenance paragraphs in the current Conceptual Framework (2010) compared to the Framework (1989).
The original Framework (1989), Par 107 and the Conceptual Framework (2010), Par 4.62 also specifically state:
The principal difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities of the entity.
The authorization of financial capital maintenance in units of constant purchasing power at all levels of inflation (low, high and hyperinflation) and deflation in the original Framework (1989), Par 104 (a) means that a third concept of capital and capital maintenance was authorized in 1989, namely, constant purchasing power financial capital and financial capital maintenance in units of constant purchasing power.
The following concepts are thus authorized in IFRS since 1989 [with reference to the Conceptual Framework (2010)]:
Concepts of capital
1. Physical capital. Par 4.57 & 4.58.
2. Nominal financial capital. Par 4.59 (a).
3. Constant purchasing power financial capital. Par 4.59 (a).
Concepts of capital maintenance
1. Physical capital maintenance: optional during inflation and deflation. The Current Cost Accounting model is prescribed when the physical capital maintenance concept is implemented. Par 4.61.
2. Financial capital maintenance in nominal monetary units (HCA): authorized but not prescribed—optional during low inflation, high inflation, hyperinflation and deflation. Par 4.59 (a).
3. Financial capital maintenance in units of constant purchasing power: authorized but not prescribed—optional during low inflation, high inflation, hyperinflation and deflation. Par 4.59 (a).
It is impossible to maintain the real value of nominal financial capital with measure-ment in nominal monetary units (HCA) per se during low inflation, high inflation and hyperinflation.
Only financial capital maintenance in units of constant purchasing power in terms of a daily index or rate can automatically maintain the real value of capital constant for an indefinite period of time in all entities that at least break even in real value during low inflation, high inflation, hyperinflation and deflation — ceteris paribus. This would happen whether these entities own revaluable fixed assets or not.
Financial capital maintenance in units of constant purchasing power
(I) was implemented in Brazil during 30 years from 1964 to 1994 in terms of a daily index supplied by the government. Brazil then went back to HCA in 1994.
(II) was implemented in Chile from 1967 till 2008 in terms of the Unidad de Fomento published daily since 1977. It was stopped when “correción monetaria” was stopped in 2008 to comply with IFRS. Chile now implements financial capital maintenance in nominal monetary units (HCA) to comply with IFRS.
(III) was authorized in some countries´ accounting codes, e.g. Portugal´s since 1989 and
(IV) was authorized in IFRS in the original Framework, Par 104 (a) in 1989 [now the Conceptual Framework (2010), Par. 4.59 (a)].
Financial capital maintenance in units of constant purchasing power is fundamentally different from financial capital maintenance in nominal monetary units and the constant purchasing power financial capital concept is fundamentally different from the nominal financial capital concept during low inflation, high inflation, hyperinflation and deflation.
Prof. Rachel Baskerville from Victoria University in Wellington, New Zealand added financial capital maintenance in units of constant purchasing power to her paper 100 Questions (and Answers) about IFRS when I pointed its omission out to her in 2010. She discussed the matter with her colleague Prof. Kevin Simpkins, the Chairman of the New Zealand Accounting Standards Review Board and then added this conclusion to her paper (Question 38): There is much to be gained from moving away from reporting on the basis of Financial Capital Maintenance in Nominal Monetary Units.
In my opinion the Conceptual Framework should be corrected during the Joint Project to specifically state the constant purchasing power financial capital concept and the financial capital maintenance in units of constant purchasing power concept as the third capital concept and the third capital maintenance concept, respectively.
A narrow, targeted improvement of the Conceptual Framework would suffice since the relevant principle was authorized in the original Framework (1989), Par 104 (a).
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Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
