Accountants value economic activity

The three distinct economic items in the economy:

1. variable items
2. monetary items and
3. constant items
are all three economic values. Each economic item has an economic value expressed in terms of money. The accounting model deals with these three economic items in an organized manner: journal entries, trial balances, general ledger accounts, cash flow statements, items in the Profit and Loss Account, assets and liabilities in the balance sheet plus other financial, management and costing reports.

South African accountants value economic items when they account economic activity in the accounting records and prepare financial reports of SA economic entities based on the double entry accounting model. Every accounting entry is a valuation of the economic items (the debit item and the credit item) being accounted.

SA accountants do not simply record economic activity. Accounting is not just a scorekeeping of economic events. Accountants value economic items when they account them. Subsequent accounting entries are part of continuous generally accepted accounting practices of valuation of the economic items originally valued and accounted over time as required by SA Generally Accepted Accounting Practices, International Accounting Standards and IFRSs applied in conjunction with the IASB´s Framework.

Variable Items

SA accountants value variable items in terms of IASs and IFRSs or SA GAAPs. No real value is unknowingly destroyed in the value of variable items by accountants choosing the traditional HCA model as long as the International Standards or GAAPs are implemented. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

Monetary items

SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items cannot be updated in current period accounts and financial reports published during the current period. Inflation – not accountants - destroys the real value of monetary items over time – currently at the high rate of 13% per annum. The real value of a monetary item is determined by the rate of inflation as indicated by the change in the CPI. Inflation destroys the value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors.

Constant items

SA accountants choose to value constant items in either nominal monetary units or in units of constant purchasing power in terms of the Framework, Par. 104 (a):

“Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

How they value constant items does make a difference to the fundamental values of constant items. The accounting model accountants choose in terms of Par. 104 (a) is of critical importance. When SA accountants choose to measure financial capital maintenance in units of constant purchasing power they choose to value constant items in units of constant purchasing power, as provided for by IFRSs in the Framework, Par. 104 (a) and they maintain their real values over time. The only way SA accountants can maintain the real value of constant items during inflation or deflation is by choosing the Constant Purchasing Power Accounting model. Not a single SA accountant in SA chooses to measure financial capital maintenance in units of constant purchasing power as per Par. 104 (a). All SA accountants, unfortunately, choose to value constant items in nominal monetary units and thus, unknowingly, destroy their real values at the rate of inflation. In so doing, SA accountants are, for example, unknowingly destroying the real value of all retained earnings balances in all SA companies at the rate of inflation and unknowingly destroying the real value of issued share capital balances of companies with no Fixed Assets to revalue at least equal to the original real value of their issued share capital. SA accountants are unintentionally killing the real economy.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

The Historical Cost Mistake

There are three distinct economic items in the economy:

1. Variable real value non-monetary items
2. Monetary items
3. Constant real value non-monetary items


Variable real value items

The first economic items were variable real value items. Their real values were determined by supply and demand. Their values were not yet expressed in terms of money because money has not yet been invented at that time.

The first economies functioned without money. They were barter economies. People bartered economic items they possessed or produced in excess of their own personal needs for other products they desired from other people who had an excess of the products they in turn possessed or produced.

There was no money and no double entry accounting model at that time. There was no stable measuring unit assumption. There were no historical cost items. There was no inflation because there was no money. There was no medium of exchange. There was no monetary unit of account. There were no financial reports: no profit and loss accounts and no balance sheets. There was no Consumer Price Index. There were no nominal monetary units since there was no money and there were no units of constant purchasing power because there was no CPI.

There were no monetary items and no constant items. There were only variable items.


Money


Money was then invented over a long period of time. Eventually money came to fulfil the following three functions:

a. Medium of exchange
b. Store of value
c. Unit of account

At that stage there were two distinct economic items in the economy: variable items and monetary items.

Variable items were defined in monetary terms after the invention of money, since money came to be used as the basic unit of account in the economy. The economy was divided in the monetary economy and the non-monetary or real economy. There were monetary items and non-monetary items.

Monetary items

Monetary items are money held and items with an underlying monetary nature.

Non-monetary items

Non-monetary items are all items that are not monetary items.

Non-monetary items were made up of only variable items at that time. There were no constant items because double entry accounting was still not invented yet.

There were still no units of constant purchasing power because there was still no CPI. There was still no HCA model, no stable measuring unit assumption and no HC items. There were still no double entry financial reports: still no profit and loss accounts and still no balance sheets.

Inflation

When inflation reared its ugly head soon after the invention of money it destroyed the real value of money and other monetary items as it does today. Inflation caused the only systemic economy-wide real value destruction in monetary items at that time and as it continues today in inflationary economies.

There was no second systemic economy wide real value destruction in constant real value non-monetary items as a result of accountants unknowingly destroying the real value of constant items never or not fully updated because they choose to measure financial capital maintenance in nominal monetary units when they implement the stable measuring unit assumption as part of the HC model.


Constant items


Finally the double entry accounting model was invented. It was first comprehensively codified by Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.

The invention of the double entry accounting model established the accounting framework for maintaining the real values of constant real value non-monetary items – the third distinct category of economic items. The double entry accounting model’s fundamental function of maintaining the real value of constant items is only possible with a Constant Purchasing Power Accounting model as provided for in International Financial Reporting Standards by the International Accounting Standards Board in the Framework for the Preparation and Presentation of Financial Statements, Paragraph 104 (a) in an inflationary or deflationary economy. South African accountants unknowingly destroy the real value of constant items never or not fully updated in the SA real economy on a massive scale when they implement the stable measuring unit assumption as part of the traditional Historical Cost Accounting model. This mistake costs South Africa about R200 billion per annum compounded into the future if SA accountants keep on selecting the traditional Historical Cost model as they all do today instead of the CIPPA model as provided for by IFRSs.

Examples of constant items in today’s economy are salaries, wages, rents, pensions, taxes, duties, fixed interest payments, all other Profit and Loss Account items, retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, all other shareholder’s equity items, provisions, trade debtors, trade creditors, other non-monetary debtors and creditors, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, etc.

Copyright © 2008 Nicolaas Smith

DOUBLE ENTRY ACCOUNTING - per se – neither creates nor destroys value

DOUBLE ENTRY ACCOUNTING - per se – neither creates nor destroys value.

Double entry accounting - per se - maintains value.

Historical Cost Accounting destroys real value during low inflation when entities do not own sufficient revaluable fixed assets.

Only Constant ITEM Purchasing Power Accounting which rejects the stable measuring unit assumption maintains the real value of constant real value non-monetary items over time in low inflationary economies.

The IASB´s Framework:

Par 104 (a):

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

INFLATION destroys value in monetary items with and without an accounting model.

Inflation or hyperinflation can not destroy the real value of constant real value non-monetary items never or not fully updated over time. Put in another way: inflation and hyperinflation do not destroy the real value of non-monetary items which do not hold their value in terms of purchasing power.

Real value is only destroyed in constant items never or not fully updated over time when accountants freely choose to implement the stable measuring unit assumption instead of units of constant purchasing power as they can do in terms of IFRSs.

SA Chartered Accountants unknowingly destroy real value on a massive scale in the SA real economy when they choose – without anyone forcing them to make that choice - to measure financial capital maintenance in nominal monetary units in terms of Paragraph 104 (a) of the IASB´s Framework.

CAs freely choose the Historical Cost Accounting model under which they implement the stable measuring unit assumption. In so doing, they unintentionally destroy about R200 billion in the real value of constant items never or not fully updated in the real economy each and every year.

Only when accountants choose to implement the stable measuring unit assumption is value destroyed in constant items never or not fully updated. Both the Historical and the Current Cost Accounting models destroy value in an inflationary economy because accountants choose to implemnt the stable measuring unit assumption in the valuation and accounting of constant real value non-monetary items.

When CA´s choose to measure financial capital maintenance in units of constant purchasing power they will stop destroying about R200 billion in real value annually in the real economy.

Inflation-adjusting accounts in a low inflation environment is part of International Financial Reporting See the Framework (1989), par 104 (a). Salaries, wages, rents, interest, pensions, utilities, etc are inflation-adjusted in most economies.
When CAs choose to measure financial capital maintenance in units of constant purchasing power they will reject the stable measuring unit assumption in terms of IFRSs.
Simply choosing to measure financial capital maintenance in units of constant purchasing power, as per Par 104 (a), SA accountants will stop unknowingly destroying about R200 billion in real value in the SA real economy each and every year, they will follow IFRSs, they will reject the stable measuring unit assumption and they will inflation-adjust all constant items in the SA economy.

© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

It does make a big difference

Nicolaas Smith

Fin24

Oct 15 2008 23:23

Some clarification about the R200 billion unknowingly being destroyed in SA retained earnigns balances by Chartered Accountants implementing the stable measuring unit assumption in combination with inflation:

+/- R200 billion PER ANNUM will be maintained for an unlimited period of time PER ANNUM - all else being equal: a new +/- R200 billion PER ANNUM each and every year FOREVER - all else (including 13% inflation) being equal.

Inflation is hopelessly too high in SA. The higher inflation the higher the value and vice versa. It is PER ANNUM for an unlimited period of time. It does make a big difference. And that is only with respect to real value destroyed or maintained in retained earnings balances.

It is also very interesting that IFRSs are already prepared for rejecting the stable measuring unit assumption via Par 104 (a) in the IASB´s Framework: ""Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

I think the reason the majority of accountants world wide choose nominal monetary units instead of units of constant pruchasing power is because of relatively low inflation world wide - or the absence of very high inflation.

Brazil chose units of constant purchasinc power during 30 years of hyperinflation: from 1964 to 1994 BECAUSE they were in hyperinflation. They implemented units of constant purchasing power via their indexing of all non-monetary items during those 30 years.

In that way they maintained their real economy while they had hyperinflation in their monetary economy.

Impressive advantages to just brush away.

Nicolaas Smith

Fin24

Oct 15 2008 21:46

What about the +/- R200 billion real value destroyed in retained earnings annually in the SA real economy by Chartered Accountants implementing the stable measuring unit assumption? That value will be maintained for an unlimited period of time when CA´s stop the stable measuring unit assumption. Also remember that 90% of private sector investment is funded from retained earnings. Rejecting the stable measuring unit assumption is already part of IFRS´s since it is part of The Framework (Par. 104 a )Rejecting the stable measuring unit assumption will make the hyperinflationary or high inflationary destruction of the SA real economy impossible. Impressive advantages to just brush away. I´m sure the SA government will be quite interested to hear the full story. I plan to tell them and everyone in SA the full story. http://realvalueaccounting.blogspot.com/

True though it may be ...

Jack

Fin24

Oct 15 2008 21:06

You've been banging on about this for a long time. However, true though it may be, businessmen dont like it! It helps them to have equity and assets stated at artificially lower values, because it inflates ROE, ROA etc! Of course, its good in another way too. They can point to higher, more recent COS and use this as an excuse to increase prices! These are the real reasons businesses don't want RVA. I dont believe they can be persuaded otherwise. It would have to be a statutory rule

One small step for accountants; one giant leap for mankind.

Collateralised Debt Obligations (CDOs) are variable real value non-monetary items valued at fair value. They are neither constant real value non-monetary items nor monetary items.

Real Value Accounting deals with the inflation-adjustment of historical cost non-monetary items or constant items; for example, issued share capital, retained earnings, all other items in shareholder´s equity, trade debtors, trade creditors, deferred tax assets, deferred tax liabities, etc.

Under Real Value Accounting banks´ issued share capital, retained earnings, capital reserves (excluding the revaluation reserve under current Historical Cost accounting - non-existent under Real Value Accounting) and all items in shareholder´s equity would be updated from the date each item was contributed at the rate of inflation over the time period to today´s date.

Banks would thus maintain the real value of their equity instead of having the real value of their capital destroyed at the rate of inflation under the current Historical Cost paradigm which is an important part of the current problem: see governments recapitalizing banks.

Also see the blatantly small values for historical cost share capital in older multinationals´ balance sheets compared to the large more recently contributed retained earnings balances.

The real values of the banks´ issued share capital values as well as their retained earnings balances were always in the past destroyed during inflationary periods because accountants applied the stable measuring unit assumption as they do today and will in the future be destroyed at the rate of inflation as long as accountants carry on applying the stable measuring unit assumption.

This destruction will stop under Real Value Accounting: that is, when accountants choose to maintain capital in units of constant purchasing power in terms of the IASB´s Framework Par. 104 (a):

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

One small step for accountants; one giant leap for mankind.

It´s the stable measuring unit assumption, stupid!

I do not remember that I have ever stated that I “accuse” Chartered Accountants of destroying value. I state that CAs unknowingly, unintentionally and unwittingly destroy the real value of all constant real value non-monetary items never updated (e.g. Retained Earnings) or not fully updated in the South African real economy at the annual rate of inflation to a conservatively estimated amount of about R200 billion plus per annum when they choose to implement the stable measuring unit assumption – a Generally Accepted Accounting Practice – as part of the Historical Cost Accounting model.


It is the stable measuring unit assumption that destroys the real value of all “non-monetary items which do not hold their value in terms of purchasing power”.

Chartered Accountants choose to implement the stable measuring unit assumption. They are not forced to do that by the SA government - as you are now falsely implying. I have stated this to you before on this thread but you fail to specify where in the SA Companies Act, or SA GAAPs or IASB IFRSs CAs are forced to implement the stable measuring unit assumption. Since they are not – as you well know, you now falsely imply that they are forced by the SA government to do that. That is not true. The SA Government will not fall for your false statement.

I will give you a very clear example:

At the end of year one the company CA in a hypothetical company reported that there was, inter alia, R 1 million cash in a zero interest bank account and that the Retained Earnings balance was R 1 million. The CA decided that the company will do its accounting based on the Historical Cost Accounting model. The company was completely dormant during the second financial year. At the end of the second year the board of directors decided to pay the single owner a dividend of R1 million. Inflation was 13.4% at the end of the second year.

It is very clear that inflation destroy 13.4% of the real value of the R1 million in the zero interest bank account .

Since Retained Earnings is a non-monetary item which do not hold its value it is also very clear that the stable measuring unit assumption (whereby the CA assumed that the Rand was stable as far as the accounting of Retained Earnings was concerned) destroyed 13.4% of the real value of the R1 million Retained Earnings balance during the second year.

CAs choose to implement the stable measuring unit assumption. They are not forced by the SA government or by anyone or anything to do that. They can stop any time they want.

This happens in all SA companies with Retained Earnings balances in the companies.


SA accountants are killing the real economy to the tune of about R200 billion each and every year.

CAs implement the HCA model because choosing it as the basic accounting model is generally accepted. The destruction of real value in the real economy is thus an integral part of the HCA model. CAs unknowingly choose that when they choose the generally accepted HCA model.
The abandoning of the stable measuring unit assumption would obviously lead to zero inflation in the real economy – or zero destruction of real value in the real economy.
All constant items would maintain their real values.

It does nothing to inflation in the monetary economy.

But, it maintains the real value of all constant items in the real economy. That is: 0% inflation in the real economy or maintaining about R200 billion (or maybe even double that) plus in real value in the real economy forever. I can assure you that that would warm the SA government´s heart quite a lot – and everyone´s in South Africa.

It would also make a Zimbabwe situation in the SA economy impossible.

What I propose is not “Remeasuring reported results” of all accounts on a primary valuation basis but inflation-adjusting on a primary valuation basis only all constant real value non-monetary items as they are accounted on a day to day basis during the month and at every date the CPI value changes.
It is all about inflation-adjusted accounts, but, only all constant real value non-monetary items. Not variable items and monetary items on a primary valuation basis. Only constant items.
All salaries and wages and many other values are already inflation-adjusted in SA.

© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

Inflation destroys an extra R212.54 billion in real value and Mboweni gets a 27% salary increase.

When our Chartered Accountants stop the stable measuring unit assumption as they are allowed to do by International Financial Reporting Standards as issued by the International Accounting Standards Board then workers´ salaries will automatically be inflation-adjusted on a monthly basis and their standard of living will be maintained year after year.

That will also stop our CAs destroying about R200 billion in real value in our real economy each and every year.

In the IASB´s

Framework for the Preparation and Presentation of Financial Statements

Par 104 (a) it is stated:

“Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

Measuring financial capital maintenance in units of constant purchasing power means rejecting the stable measuring unit assumption.

IFRSs thus allow the Historical Cost Accounting model and at the same time they also allow our Chartered Accountants the option of rejecting the stable measuring unit assumption when they allow them to measure financial capital maintenance in units of constant purchasing power.

A year ago inflation stood at 7%. It is now 6.4 percentage points higher at 13.4%. A 1% increase in inflation destroys an extra R18.29 billion in the real value of the Rand and about an extra R14.92 billion in the real or non-monetary economy because our CAs assume there is no inflation when they apply the stable measuring unit assumption. That means that the 6.4% increase in inflation destroyed an extra 6.4 X (18.29 + 14.92) = R 212.54 billion during the last year.

So under Mboweni´s watch an extra R212.54 billion have been destroyed in the SA economy during the last year and he gets a 27% increase in salary.

When our CAs stop the stable measuring unit assumption the destruction of real value in the non-monetary or real economy will be zero. That will help Mboweni a lot.

That will take care of about half of the real value destroyed by inflation and in the case of the non-monetary economy, the destruction by the combination of inflation and our CAs stable measuring unit assumption that they can stop in terms of IFRSs any time they want to.

R63.241 billion real value destroyed by CAs in 169 JSE listed companies

Updated: July 2008

Annual amount unknowingly being destroyed by South African Chartered Accountants in the real value of Retained Earnings in 169 companies listed on the Johannesburg Stock Exchange as a result of their implementation of the stable measuring unit assumption which is a Generally Accepted Accounting Practice:

R63.241 billion

This is a conservative calculation of the actual real value unintentionally destroyed by CAs during the 12 months to the end of July 2008 in the 169 JSE listed companies analyzed to date.

Current rate at which SA Chartered Accountants are unwittingly destroying the real value of all retained earnings balances in South African companies: 13.4% per annum.

SA Chartered Accountants are unknowingly killing the real economy in a massive way.

Next update: When the August 2008 CPI figure is released by Stats SA.

[Real Value date: July 2008 CPI 163.8 Annual monetary and non-monetary real value destruction rate: 13.4%. The non-monetary destruction rate applies to constant non-monetary items never updated, e.g. retained earnings. The above Rand value will be updated monthly in terms of future changes in the CPI.]

Abandoning the stable measuring unit assumption in South Africa

Here are some notes about abandoning the stable measuring unit assumption.

First of all, it is not the same as inflation accounting as can be found in many books and articles written about inflation accounting over the last 100 years.

That is why the term stable measuring unit assumption is not even mentioned in Geoffrey Whittington’s master work “Inflation Accounting – An introduction to the debate”.

The stable measuring unit assumption, as a Generally Accepted Accounting Practice, is, on the specific level, only applied in the valuing - by Chartered Accountants - of “non-monetary items which do not hold their value in terms of purchasing power.” Currently CAs specifically choose to value “non-monetary items which do not hold their value in terms of purchasing power” at historical cost when they apply the stable measuring unit assumption as part of the Historical Cost Accounting model.
Everyone first thinks that I want to implement 1970 style “inflation accounting” in South Africa. That is completely untrue.

I want SA to abandon the stable measuring unit assumption; that is, I want SA to update constant real value non-monetary items never updated (e.g. retained earnings) or not fully updated in the SA economy over time - at the rate of inflation under non-hyperinflationary conditions and at the parallel rate if SA ever experiences hyperinflation.

I simply show, additionally, that it is actually the combination of inflation and the stable measuring unit assumption – a Generally Accepted Accounting Practice, as implemented by choice by Chartered Accountants – and not simply “inflation” - which destroys the real value of non-monetary items that do not hold their purchasing power over time – also called constant real value non-monetary items or constant items.

If we had only inflation in money and no accounting, then there would be no destruction of value in non-monetary items since inflation only destroys real value in non-monetary items that do not hold their purchasing power over time in combination with the stable measuring unit assumption; that is, in combination with a Generally Accepted Accounting Practice that is part of the Historical Cost Accounting model and that Chartered Accountants choose to implement since they are not required to use the HCA model by IASs, IFRSs, SA GAAPs or the SA Companies Act.

I do not say abandon all current accounting International Standards and SA GAAPs: I say simply abandon one assumption. I do not say abandon a fact. I say abandon an assumption: the stable measuring unit assumption.

CAs use the unit of measure in accounting to be the base money unit of the most relevant currency in SA, namely the Rand. CAs also assume the Rand is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.

Abandoning the stable measuring unit assumption changes the HCA to the Real Value Accounting model.

Real Value Accounting is based on all current IFRSs, IASs, SA GAAPs and the SA Companies Act - excluding the stable measuring unit assumption, the definition of monetary items in IAS 21 and excluding the whole of IAS 29. IAS 29 is not required under Real Value Accounting when the stable measuring unit assumption is revoked.

CAs unknowingly / unintentionally / unwittingly destroy the real value of constant items never updated, e.g. retained earnings, or not fully updated over time in the SA economy at the inflation rate. This amounts to R57.983 billion in the case of those 169 JSE listed companies I have analyzed so far. I estimate that CAs unknowingly destroy a total of about R 200 billion each and every year in the SA real economy as a result of their application of the stable measuring unit assumption.

This destruction is an integral part of the HCA model. It is a Generally Accepted Accounting Practice under the current Historical Cost paradigm.

However, the stable measuring unit assumption is not required for the basic double entry accounting model. Real Value Accounting is also a double entry accounting model. The stable measuring unit assumption does not form part of the Real Value Accounting model.

Chartered Accountants´ unintentional destruction of the real value of constant items never or not fully updated is an indispensable part only of the HCA model. It is, fortunately, not a part of the basic double entry accounting model. It came about as a result of unavoidable historical circumstances, namely the lack of an index value to adjust constant items for inflation in the past.

This does not diminish the fact that CAs´ unwitting killing of the real economy is an integral part of generally accepted current economic activity in SA under the Historical Cost paradigm. Fortunately it is easy to stop CAs killing the real economy. Just stop the stable measuring unit assumption which is the next step in our fundamental model of accounting.

No-one stops CAs from abandoning the stable measuring unit assumption. Neither the SA Companies Act nor IASB Standards nor SA GAAPs require the HCA model.

This destruction by CAs is completely eliminated and is physically and mathematically impossible under the Real Value Accounting model which revokes the stable measuring unit assumption.

To the IASB all non-monetary items are the same. The stable measuring unit assumption allows them to do that. They have IASs and IFRSs to value non-monetary items with variable real values and they solve the problem of inflation by simply assuming there is no inflation in the valuing of constant items. They, like SA CAs, value them at historical cost and thus destroy their real value over time at the rate of inflation.

We can derive almost all of the basic theory of CIPPA from the statement that inflation destroys value in “non-monetary items which do not hold their value in terms of purchasing power”.

Then we can complete the basic theory of CIPPA from the statement in the opening post in this thread: “Even then, the adjusted figures have little meaning, since by the time they see the light of day they are already out of touch with reality.”

Real Value Accounting is so much in line with what everybody already knows but no-one implements, that we can take that statement and your statement and derive almost all of Real Value Accounting from those two statements.

What are non-monetary items?

Non-monetary items are all items that are not monetary items.

Non-monetary items are subdivided into:

1. Variable real value non-monetary items; and
2. Constant real value non-monetary items.
What is not realized is that by agreeing that inflation destroys the real value of not only monetary items – as we all know – but, also “non-monetary items which do not hold their value in terms of purchasing power” implies that he agrees that the combination of inflation and the stable measuring unit assumption as implemented by Chartered Accountants as a GAAP under HCA destroys constant real value non-monetary items never or not fully updated.

How else does inflation destroy “non-monetary items which do not hold their value in terms of purchasing power”?

Inflation destroys the real value of money as a result of the very nature of money: we could have inflation in money even if we do not have any accounting. Neither the basic double entry accounting model nor the HCA model has anything to do with the causes of inflation - the destruction of the real value of money.

The statement that inflation destroys the value of “non-monetary items which do not hold their value in terms of purchasing power” is only possible and inflation can only do that not because of the double entry accounting model per se, but because of the implementation of the stable measuring unit assumption as part of the HCA model.

Constant items only came about with the introduction of the double entry accounting model.

There is no destruction of value by inflation in variable real value non-monetary items.

Variable items in South Africa are valued at fair value or the lower of cost or net realizable value or recoverable value or market value or present value in terms of International Financial Reporting Standards (IFRSs), International Accounting Standards (IASs) and South African Generally Accepted Accounting Practice (SA GAAP). “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

Variable items in SA are adequately valued in terms of International Standards and GAAP - at the balance sheet date. Originally all variable items were valued at historical cost.


The debate today is about whether the Historical Cost Accounting model creates and destroys value.

It does destroy value. It also creates value. Without the double entry accounting model there are no constant items – only variable items.

CAs create value by implementing the double entry accounting model. They put in motion the process that creates constant items.

CAs do not destroy value by implementing the double entry accounting model per se.

Cas unknowingly destroy value when they implement the stable measuring unit assumption in conjunction with the double entry accounting model, that is, when they implement the HCA model.

When CAs abandon the stable measuring unit assumption they will maintain the real value of all constant items in SA for an unlimited period of time. They will maintain hundreds of billions of Rand in constant item real value year in year out. They will be responsible for reducing the destruction of real value in constant items in the real economy to zero percent for an unlimited period of time. I estimate that value to be about R200 billion per annum.

CAs will be responsible for protecting the SA real economy from real value destruction in constant items never or not fully updated by the combination of inflation and the stable measuring unit assumption.

We will still have inflation in monetary items in the SA monetary economy, but we will have 0% destruction of real value in the real economy.

If CAs carry on with the stable measuring unit assumption they will carry on unknowingly destroying all constant items never updated (e.g. retained earnings in all SA companies) at the annual rate of inflation as they are doing at the moment - albeit unintentionally. Constant items not fully updated will be destroyed at a lower rate than the annual rate of inflation.

© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

Monetary items

The second distinct economic item is a monetary item.

Buy the ebook for $2.99 or £1.53 or €2.68

Monetary items constitute the Money supply.

Updated on 11-05-2013

The definition of monetary items is critical for the classification of non-monetary items since the latter are all items that are not monetary items. If the definition of monetary items is wrong then the definition of non-monetary items will also be wrong. This will affect the valuing of monetary and non-monetary items and the correctness of both accounting records and financial reports.

Money

Money is the greatest economic invention of all time. Money did not exist and was not discovered. It was invented over a long period of time.

Money was critical for the level of economic development achieved to date. Modern economic development would have been very slow indeed if money was not invented. Money is one of the greatest human inventions of all time. It ranks on par with the invention of the wheel and the Gutenberg press.

Money held

Examples of money held are bank notes and bank coins.


Monetary values pertaining to money

All economic items have monetary values. Both non-monetary items and monetary items are expressed in monetary values. They are expressed in terms of money. Money is used as the unit of account or measuring unit. Variable, constant and monetary items are all expressed in terms of money and have monetary values.

There is, however, a difference between having a monetary value and being a monetary value. All economic items have monetary values, but, only monetary items are monetary values. Non-monetary items have monetary values, but, they are not monetary items.

A house has a monetary value but it is not a monetary item. A house is a variable real value non-monetary item whose value is expressed in terms of money.

Likewise a salary has a monetary value but it is not a monetary item. A salary is a constant real value non-monetary item whose value is expressed in monetary terms.

Examples of monetary values pertaining to money:

Bank account balances
Money loans
Mortgages
Bonds
Treasuries
Consumer credit
Bank credit
Notes payable
Notes receivable

The above are monetary values pertaining only to money. They are accounted monetary balances or accounted values of money lent or borrowed, payable or receivable in money.

The original nominal values lent or borrowed – the capital values - in the case of loans are nominal and fixed.

Inflation destroys the real value of money over time. Inflation thus destroys the real value of their capital values over time at the rate of inflation as determined by the change in the Consumer Price Index.

The above monetary values that are monetary items have exactly the same attributes as money held with the single exception that they are not actual bank notes and bank coins but accounted monetary values.

Examples of constant real value non-monetary items often wrongly treated as being monetary items:

Trade debtors
Trade creditors


Functions of money

Money has three functions.

1. Medium of exchange
2. Store of value
3. Unit of account


Only an economic item that fulfils all three functions of money at the same time can be money in a specific economy or monetary union. Fulfilling only two of the three functions does not qualify an economic item as money. See Foreign Exchange.

Medium of exchange

Money is a medium of exchange which is its main function. The principle reason money was invented was to serve first and foremost as a medium of exchange.

External market

Money is a medium of exchange for external trade in goods and services and other economic transactions between economic entities in different countries and/or monetary regions. Foreign currencies are bought and sold on a daily basis in foreign exchange markets at exchange rates determined by demand and supply in those markets.

Only the classification and valuation of foreign exchange in the internal economy is included in the scope of this book. See Foreign Exchange.

Internal market

Money’s main function in the internal market is that it is a medium of exchange used in the transfer of economic items between economic entities. Money is only accepted as a medium of exchange while it fulfils all there functions of money. When the official functional currency loses all its value at the end of a hyperinflationary spiral, it has no store of value function and stops being money.

Store of value

The fact that the first types of money consisted of gold or silver coins developed into money’s second function, namely, being a store of value.

The actual coin was worth its value in gold or silver. Sometimes the value of gold bullion was more than the value of the gold coins were made of. People then melted the coins and sold the gold in bullion form for a higher price.

Next money was not made of precious metal coins but money consisted of bank notes the real values of which were fully backed by gold reserves.

Today our bank notes and bank coins have no intrinsic value and they are not backed by gold reserves or other precious metal reserves. Today our money is backed by all the underlying value systems in our economy.

Some, but not all, of these underlying value systems are:

Sound

Political government
Judicial system
Law enforcement system
Economic policies
Monetary policies
Commercial policies
Industrial policies
External trade policies
Education policies
Health policies
International relations
Defence policies
Accounting model
Regional policies

The abuse of money’s store of value function led to original inflation. Money is a store of real value over time. Unfortunately inflation destroys the real value of money over time.

Buy the ebook for $2.99 or £1.53 or €2.68

The real value of Mboweni´s job

Money supply (M3) as per the South African Reserve Bank at May 2008: R 1 808.971 billion

Real value destroyed annually in the SA monetary economy by inflation at:

3%

R54.2 Billion

6%

R108.5 Billion

11.7% (May 08 inflation)

R211.6 Billion (May 08 Actual annual real value destroyed)


The cost to SA of inflation above 3%

a) R211.6 Billion - R54.2 Billion = R157.4 Billion in the monetary economy.

Plus

b) R31.903 x 8.7/11.7 = R23.7 Billion in the real economy as represented in the increase in real value unknowingly destroyed by Chartered Accountants in the Retained Earnings values of 120 JSE listed companies as a result of their implementation of the stable measuring unit assumption.

Plus

c) A further estimated R111.5 Billion in the real economy as represented in the increase in real value unknowingly destroyed by Chartered Accountants in the rest of the real economy as a result of their implementation of the stable measuring unit assumption.


Scrap inflation targeting and the stable measuring unit assumption. SA inflation should not exceed 2% at a cost of R36.1 Bilion real value destroyed in monetary items.


Cost to SA of a 1% rise in inflation:

1) R18 Billion in real value destroyed in the monetary economy.

Plus

2) Estimated R15 Billion in real value unknowinlgy destroyed by Chartered Accountants in the real economy.


Gain to the SA economy of a 1% decrease in inflation:


A) R18 Billion in real value maintained in the monetary economy.

Plus

B) Estimated R15 Billion in real value unknowingly to be maintained by Chartered Accountants in the real economy.


Annual gain to SA of a reduction of inflation to 3%:

i) R157.4 Billion in real value maintained in the monetary economy.

Plus

ii) Estimated R111.5 Billion in real value unknowingly to be maintained by Chartered Accountants in the real economy.


Estimated annual gain to SA when Chartered Accountants abandon the stable measuring unit assumption: R150 Billion

[Real Value date: May 2008 CPI 158.4 All above values to be updated in terms of future changes in the CPI.]

Alan Greenspan: "Low inflation is what creates long-term sustainable economic growth"

Alan Greenspan: "Low inflation is what creates long-term sustainable economic growth"

Abandoning the stable measuring unit assumption will result in 0% value destruction only in our real economy and create long-term sustainable economic growth in South Africa. It will stop our Chartered Accountants from unknowingly destroying up to a hundred billion Rand in constant item real value in our non-monetary economy year after year. We will still have 11.1% inflation in our cash or monetary economy.

"The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year." Deutsche Bundesbank, 1996 Annual Report.

No substance in the statement that the choices accountants make won't change that value and won't affect the economy

NO SUBSTANCE IN THE STATEMENT THAT CHOICES SA ACCOUNTANTS MAKE WON´T AFFECT THE ECONOMY


The debate of how to account for value has been around for decades.
Robert Kemp, CPA Professor, University of Virginia

The three fundamentally different basic economic items in the economy

1. variable items
2. monetary items and
3. constant items

are economic values. Each economic item is an economic value expressed in terms of money, i.e. the functional currency. SA accountants account economic transactions involving these three economic items in an organized manner when they implement a double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the Profit and Loss Account, assets and liabilities in the Balance Sheet plus other financial, management and costing reports.

SA accountants value economic items when they account economic activity in the accounting records and prepare financial reports of SA economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

SA accountants do not simply record economic activity. Accounting is not just a scorekeeping or recordkeeping of economic events. That concept of financial reporting has no substance. SA accountants value economic items when they account them. Subsequent accounting entries are part of generally accepted accounting practice of continuous valuation of the economic items originally valued and accounted over time as required by SA Generally Accepted Accounting Practice and IFRS implemented in conjunction with the IASB´s Framework.

The measurement basis and concept of financial capital maintenance SA accountants choose - either real value destroying traditional Historical Cost nominal monetary units (their current choice) or real value maintaining units of constant purchasing power (the CIPPA model) - to value constant real value non-monetary items determine whether they unknowingly destroy or maintain their real values during low, high and hyperinflation. SA accountants are required by the IASB to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. IAS 29 is based on the Constant Purchasing Power Accounting (CPPA) model. Inflation, being a uniquely monetary phenomenon, can not, by definition, destroy the real value of constant real value non-monetary items or variable real value non-monetary items. It is SA accountants’ choice of capital maintenance concept (accounting model) that determines whether they carry on currently unintentionally destroying real value in constant items never or not fully updated or maintain those values for an unlimited period of time – all else being equal.

When SA accountants apply the very destructive stable measuring unit assumption as part of the real value destroying traditional HCA model and value constant items at their HC nominal monetary values and these items are never or not fully updated or inflation-adjusted by means of the CPI over time in SA´s non-hyperinflationary environment, they unknowingly destroy their constant real non-monetary values at a rate equal to the rate of inflation. This is the case with all constant items never or not fully inflation-adjusted including the unintentional destruction by SA accountants of the real value of issued share capital in SA banks and companies which do not have variable real value non-monetary fixed property, plant and equipment that can be revalued at least equal to the updated original real value of all capital contributions under the HC paradigm.

When SA accountants choose to measure financial capital maintenance in real value maintaining units of constant purchasing power (the CIPPA model) – as they can freely do in terms of the IASB´s Framework, Par. 104 (a) - they will maintain all constant item real values over time including issued share capital, whether entities have fixed property, plant and equipment to revalue or not.

When SA accountants value constant items in HC nominal monetary units – as they all currently do – they unknowingly destroy their real values at a rate equal to the inflation rate when they are never updated under the HC paradigm.

Variable Items

SA accountants value variable real value non-monetary items in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

IAS 16 deals with Property Plant & Equipment. It allows two methods of valuation or measurement; either historical cost or revaluation based on fair value. The charge for depreciation relates to the carrying value, whether historical cost or fair value. It is not acceptable under HCA to index up the original cost of an asset by reference to subsequent inflation or to base the depreciation charge on that indexed amount.

There are similar requirements in respect of intangible assets (IAS 38) and inventories (IAS 2).

IAS 39 requires fair values to be applied in valuing investments and derivative financial instruments. A historical cost basis of accounting is not acceptable for these items.

The real values of variable real value non-monetary items, e.g. property, are not destroyed when accountants value them at Historical Cost in terms of IFRS or GAAP. These items will be valued at their market prices when they are eventually sold.


Monetary items


Low inflation is what long term sustainable economic growth is built on. Alan Greenspan.

SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items can not be updated or indexed during the current financial period for the purpose of

1. accounting their values during the reporting period,
2. determining the profit or loss for the reporting period, and
3. measuring financial capital maintenance in either nominal monetary units or constant purchasing power units

during inflation or deflation.

Inflation – not SA accountants - destroys the real value of SA monetary items over time. The internal real value of the Rand is automatically adjusted downwards as it is being destroyed by the economic process of inflation in SA´s inflationary economy as indicated by the rate of change in the CPI. Inflation destroys the real value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors. The accounting model has no affect on the real value of monetary items during the reporting period.

Double entry accounting cannot maintain the real value of monetary items during the reporting period. It is not an attribute of double entry accounting to maintain the real value of monetary items during the reporting period. Inflation destroys the real value of monetary items no matter which accounting model is used. That is why low inflation is so critical for long term sustainable economic growth.

Constant items

SA accountants can choose to measure financial capital maintenance in either nominal monetary units (the HCA model) or in real value maintaining units of constant purchasing power (the CIPPA model) as authorized by the IASB in the Framework, Par. 104 (a).

It is very obvious that how SA accountants choose to measure financial capital maintenance does make a big difference to the real value of constant items. There is absolutely no substance in the statement that the choices accountants make won't affect the economy no matter

The accounting model SA accountants choose in terms of the Framework, Par. 104 (a) is of critical importance. When they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power they will maintain the real values of, for example, all SA banks´ and companies´ retained income values constant over time, all else being equal, instead of unknowingly destroying them, as the currently do. The ONLY way SA accountants can maintain the real value of constant real value non-monetary items during inflation and deflation is by choosing a Constant Purchasing Power Accounting model as per the IASB´s Framework, Par. 104 (a).

Not a single SA accountant in SA chooses to measure financial capital maintenance in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a). SA accountants, unfortunately, choose to measure financial capital maintenance in nominal monetary units and thereby, unknowingly, destroy the real values of constant items at a rate equal to the rate of inflation when they are never or not fully updated over time when they implement the very destructive stable measuring unit assumption as part of the real value destroying HCA model. SA accountants are unknowingly killing the real economy at the rate of about R200 billion per annum – each and every year - as long as they carry on choosing to measure financial capital maintenance in nominal monetary units.

© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

CA´s can prevent a destruction spiral in the real economy.

Tito Mboweni: “A weaker exchange rate is usually a sign of high inflation, and unless the inflation problem is addressed, it can set in motion an exchange rate and inflation spiral.”

South Africa will have 0% inflation in the real economy when Chartered Accountants abandon the stable measuring unit assumption while an inflation spiral in the monetary economy will still be possible as Mboweni stated.

A destruction spiral in the real economy is what destroyed the Zimbabwe economy over the last 14 years of hyperinflation in that country.

Abandoning the stable measuring unit assumption will make this impossible in South Africa.

CA´s can pump 100´s of billions of Rands into the economy

Finweek

SA Chartered Accountants can pump hundreds of billions of Rand into the SA real economy for an indefinite period of time when they stop their assumption that the Rand is perfectly stable only for the purpose of accounting salaries, wages, rent, issued share capital, retained income, taxes, trade debtors, trade creditors, etc. Now they destroy hundreds of billions of Rand in constant item real value by not maintaining that real value.

No-one forces them to implement the stable measuring unit assumption.

When they stop assuming the Rand is perfectly stable only for that purpose they will stop destroying hundreds of billions of Rand in constant item real value in the SA real economy for an indefinite period of time.

It will increase GDP, economic growth and job creation.

The benefits of SA Chartered Accountants abandoning the stable measuring unit assumption can scarcely be overestimated , especially as these are, in principle, unlimited in duration and accrue year after year.

Nicolaas Smith on 2008/05/30 01:09:08 AM - Re: Bradley

Nicolaas Smith on 2008/05/30 01:09:08 AM - Re: Bradley

Finweek

"Not updating share capital doesnt destroy any value, not in any real sense at least."

It only destroys real value at the annual rate of inflation in companies with no well located and well maintained land and/or buildings or other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital. Companies can always revalue land and buildings and add the revaluation reserve to capital when they have those assets. When do not have them like many thousands in SA do not have, then real value of their issued share capital is destroyed at the annual rate of inflation.

"The share capital number in the balance sheets is just that, a number."

No it is not. It is a constant real value non-monetary item. See IAS 29. Under hyperinflation (26% pa continuous inflation) the IASB mandates you to update capital as it is a non-monetary item. They are just completely illogical not to allow you to do it under non-hyperinflationary conditions like in SA. That is obviously wrong.

"What use would there possibly be in increasing this by inflation?"

As the IASB states in IAS 29: capital is a non-monetary item and its real value must be updated. Capital is a constant real value non-monetary item and must be updated at the monthly inflation rate in SA. All SA companies with no items to revalue are having their capital destroyed by accountants stable measuring unit assumption at the annual rate of inflation.

"Does it change the underlying value of the company? No."

Yes it does. Updating the issued share capital as well as retained income at the monthly rate of inflation obviously changes the underlying value of the company. R111 million is clearly different from R100 million. That is very obvious.

"When a company issues shares, it gets he money, an amount equal to share capital. How does updating this amount monthly, or yearly, by inflation improve anything?"

Remember the IASB mandates you to update capital under hyperinflation. My example: You start a company today with R100 million. Without updating: In 30 years time at continuous 10% annual inflation that R100 million will still be in the balance sheet but it will have lost 88% of its real value: it will be worth R12 million in today´s real value.

Updating it monthly at the inflation rate means that in 30 years time it will still be worth R100 million in today´s real value - it´s nominal value in 30 year´s time will be R1 744 940 227 or R1.7 trillion. Its real value will still be R100 million in todays terms. Take your pick. The IASB says you can do it only under hyperinflation. That is obviously a complete mistake.

Nicolaas Smith on 2008/05/30 12:34:37 AM - Re: Ben

Nicolaas Smith on 2008/05/30 12:34:37 AM - Re: Ben

Finweek

Ben, I am sure you will agree that it is not very easy to grasp something that took one person 13 years to unravel by reading a few lines in an article comment.

It will not worsen cash inflation. You must understand that a price increase as a result of higher demand is not inflation.

A price increase as a result of demand staying exactly the same is inflation. The first is simply a genuine price increase, the second is inflation.

You may not know, but this was done for 30 years by Brazil and not under low inflation but under hyperinflation of up to 2000% per annum. They updated all non-monetary items in the real economy DAILY including salaries and they had positive economic growth - under hyperinflation because they stabalized their real economy.

Updating all constant items simply keeps everything the same in the real economy and does not kill the real economy. You are only worried about salaries. That is only one constant item. What about the rest of them? Issued capital and retained income maintaining the investment and capital base of the economy instead of destroying it year after year? That will make a massive difference and for an indefinite period of time - forever.

Firms update salaries but their issued capital and retained income are also updated as well as taxes to the government. All constant items are simply kept at the same real values and their real values are not destroyed at the rate of inflation when they are never updated, eg. retained income. As Logan pointed out: salaries are updated in any case. Instead of giving an annual once off increase of now 11.1% to just maintain the real value, the updating is done monthly. I am sure you understand that. So, with salaries you have exactly the same, more or less. So that takes care of your worry about increasing prices for salaries.

It will be the same as the present. Isn´t this obvious? When people demand higher wages it does not automatically worsen inflation - only when it is higher than the inflation rate and higher than the productivity increase if there was actually an increase in productivity. I think that puts your worry about passing the salary increase on to the company´s products every month to rest. Now it is done yearly. When accountants abandon the stable measuring unit assumption it will be done monthly instead of yearly - so nothing will really change as far as salary increases and product price increase are concerned.

I am sure you agree. So this will not cause massive inflation and spiral out of control. So, that sort out salaries. Now updating issued share capital, retained income, trade debtors, trade creditors, taxes etc will maintain all these items´ real values instead of destroying hundreds of billions of Rand in SA´s real economy each and every year. This will increase GDP, economic growth and job creation

Ben on 2008/05/29 11:53:46 PM - Nicolaas

Ben on 2008/05/29 11:53:46 PM - Nicolaas

Finweek


Are you serious? This would worsen inflation like you have no idea. Inflation targeting hinges CRITICALLY on the extent to which players in the economy believe the target will be maintained and sought after. If wages are increased in line with inflation, or possibly above inflation, this causes what economists call a "wage spiral".

Costs like salaries - what you term contant items - will need to be covered by way of higher prices from the firm. Isnt this obvious? If people demand higher wages, this worsens inflation. So if the accountant raises your salary by 1.2% every month, and this cost is passed on to the consumer as a 1.2% increase in the price of that company's product every month, can you see that this causes inflation? It all well and good to "maintain a persons real salary" but this will cause massive inflation that will spiral out of control.

A better tactic is to aggressively tackle inflation, to make everyone aware that the government is ADAMANT that they are sticking to it, lest workers demand increases in wages above inflation. It simply isnt possible to keep inflation at 3-6% if people demand wage increases of 10% a year...

Nicolaas Smith on 2008/05/29 11:23:50 PM - Re: Logan

Nicolaas Smith on 2008/05/29 11:23:50 PM - Re: Logan

Buy the ebook for $2.99 or £1.53 or €2.68

"Isn't the monthly inflation taken care of by the annual wage increase if based on annualised inflation rate?" Yes. That is one constant item. That is only salaries and wages. What about retained income, issued share capital, personal taxes, company taxes, VAT, trade debtors, trade creditors, profit and loss items, shareholders equity, etc? I always state: Historical Cost Accounting inflation destroys the real value of constant items never or not fully updated. Retained earnings, issued share capital of companies with no non-monetary items to revalue, etc, are never updated in non-hyperinflationary economies. Their values are destroyed and have always been destroyed at the full rate of inflation. The real values of salaries, wages, taxes, rents, etc are, only where they are not fully updated, destroyed at a lower rate than the full inflation rate.

Logan on 2008/05/29 10:54:06 PM - Maybe we need change

Logan on 2008/05/29 10:54:06 PM - Maybe we need change !


If the aNC does decide to relax the inflation targets a bit that won't be a problem, economists are fiercely divided anyway over what level of inflation is ok. To deny that is contested terrain would be silly, the research papers are all over the place. The problem is that we have to be flexible enough to maintain social stability. Economic policy purity is for lecture halls, not the real world. Anyway, where is all this so-called investment? Years of low inflation and very little FDI, a few biggies and that's it, compared to Brazil, India etc. Investors want growth, not policy purity. p.s. Nicolaas, interesting points! Isn't the monthly inflation taken care of by the annual wage increase if based on annualised inflation rate?

"OK, so what measure of inflation do we use?"

Nicolaas Smith on 2008/05/29 11:15:17 PM - Re: Neelsie Naamloos

Finweek


"OK, so what measure of inflation do we use"

CPI which is 11.1% at the moment.

"should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement?"

When all accountants decide to abandon the stable measuring unit assumption it will apply throughout SA. It will be an automatic monthly adjustment to all constant items [salaries, wages, rents, fees, retainers, royalties, issued share capital, retained income, personal taxes, trade debtors, trade creditors, company taxes, value added taxes, all items in the profit and loss account, etc] in terms of the monthly inflation rate (CPI). Computer accounting programs will have to be upgraded for this purpose. Any individual company or economic entity can do this.

"How will such a system be administrated so that it is equitable to everyone,"

It is equitable since all constant items are updated monthly in a non-hyperinflationary economy at the monthly inflation rate and daily in a hyperinflationary economy at the daily parallel rate of daily index rate. It is simply an admittance that the Rand´s real value is being destroyed by inflation. So, only all constant items have to be adjusted at the monthly rate of inflation. It is simply a matter of maintaining all constant items´ real values, because, when any constant item is never updated, eg. retained income, then its real value is destroyed at the rate of infaltion

See this peer reviewed article in  Accountancy SA


"and what will the costs be?"

The cost of upgrading accounting programs and training accounting staff in updating constant items.

"And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case?"

Inflation is the destruction of value. When constant items are never or not fully updated at the monthly rate of inflation then their real values are being destroyed at the rate of inflation when they are never updated (retained income) or at a lower rate when they are not fully updated (salaries, wages). When accountants abandon the stable measuring unit assumption and update all constant items monthy then no real value will be destroyed in constant items for an indefinite period of time. That is thus zero destruction of real value in constant items, that is 0% inflation in constant items only.

We will still have 11.1% cash inflation in monetary items, that is in the Rand and in all monetary items. The real economy will be stabilized, internal demand will be stabilized. The destruction of the real economy will stop for an indefinite period of time. Accountants will maintain billions of Rand in constant item real value in the real economy instead of destroying billions of Rand in the real economy each and every year

© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

Neelsie Naamloos on 2008/05/29 10:43:07 PM - Nicolaas Smith

Neelsie Naamloos on 2008/05/29 10:43:07 PM - Nicolaas Smith


OK, so what measure of inflation do we use, should it be a one-sided decision by the company, or will they consult labour on the monthly salary adjustement? How will such a system be administrated so that it is equitable to everyone, and what will the costs be? And why will inflation stabilize if everyone's avaialable cash keeps growing at the rate of inflation in any case? Just asking. Everyone's Friend Neelsie

"where is TITO? In the "real economy" or in the "monetary economy"?"

Nicolaas Smith on 2008/05/29 10:19:37 PM - Re: Benzo

Finweek


"where is TITO? In the "real economy" or in the "monetary economy"?"

Tito is in the monetary economy. 11.1% inflation (Tito?) is destroying R194 billion in the real value of all monetary items (M3 = R1751.361 billion) in SA. At 3% inflation Tito would only destroy R52 billion of the real value of all money in SA. His job is thus worth R142 billion at the moment. If he can bring inflation down to 3% he will not destroy - or maintain R142 billion in the real value of all money and monetary items in SA. It would be wonderful if he can bring inflation down to 3% and maintain R142 billion in the SA economy. We can pay him a big bonus for that - when he achieves that.

"Where am I? in the "real economy" or in the "monetary economy"?"

You are in both.

Where you own money or montary items your are in the monetary economy and Tito destroys the real value of your money at 11.1% instead of 3% at the moment. You can make your own calculations how much Tito is destroying in the real value of your average cash balance you keep over a year. Where you own or use or buy or sell things that are not money or monetary items and these things are variable items, e.g. your house, car, mobile phone, clothes, food, energy, fuel, clothes, consumer goods, etc your are in the variable item part of the real economy. You are simply in the market for these things: you are paying market prices for these items in the variable part fo the real economy.

You are in the constant items part of the real economy with your salary you receive, the taxes you pay, the rent you pay or receive, the issued share capital of your company, the retained income in your company, etc.

Here your company accountant makes as if he is very dumb and assumes that there is no inflation at all. All company accountants do this. Your company accountant assumes that there is no inflation in SA only for this purpose. He assumes the Rand is perfectly stable. But we all know it is not. Your salary is a constant item. Your company accountant should increase your salary by about 1.2% per month at the moment.

He does not do that. He assumes there is no inflation - only for this purpose and nothing else. So he pays you out the same salary every month end. So he destroys the real value of your salary at 1.2% per month or 11.1% per annum. So to the retained income and the issued share capital of your company and the taxes he pays over to the government.

In total all accountants in SA destroy billions of constant item real value every year in SA. No-one forces them to do that. They can stop assuming there is no inflation in SA only for this purpose anytime they want to. When they do they will maintain b billions and billions of real value in the SA economy, increase economic growth and create more jobs in SA.

"Will the two ever meet? If so; when? If not, who should care?"

The two are always there together.

Benzo on 2008/05/29 09:36:42 PM - Nic Smith

Benzo on 2008/05/29 09:36:42 PM - Nic Smith


"South African's sound economic policies" ???? where is TITO? In the "real economy" or in the "monetary economy"? Where am I? in the "real economy" or in the "monetary economy"? Will the two ever meet? If so; when? If not, who should care?

Nicolaas Smith on 2008/05/29 09:28:26 PM - Re: Viparo

Nicolaas Smith on 2008/05/29 09:28:26 PM - Re: Viparo

Finweek

Viparo, For example: cars are variable items - their prices vary in the car market: there is a market for cars. Their prices depend on demand and supply. But, salaries and wages are constant items: there is no market for salaries. You cannot sell your salary in a market. Or you cannot buy someone else´s salary in a market. They are constant items.

The value of your salary - a constant real value - is paid over to you in Rands. But, cash inflation destroys the real value of the Rand. So the Rand is always worth less. So, your constant value salary must be updated at the monthly inflation rate to maintain its constant value. It is not done anywhere.

The company accountant ignores the fact that the Rand is losing value every month. The company accountant assumes that there is no inflation in the Rand as far as your salary is concerned. So the company accountant pays you out in Rands that are always worth less. So, your salary should be increased every month that inflation increases. Now at about the rate of 1.2% per month. This is not done. So the real value of your salary is being destroyed by the accountant at 1.2% per month. This is easy to change.

The company accountant can update your salary and all other constant items in the company every month. All accountants in SA are assuming that there is no inflation in the Rand for this purpose. So they are destroying billions of Rand in real value every year in SA. The real vlaue of your salary and all salaries, all taxes, all retained income, all companies´ capital etc.

We can stop this. This will increase economic growth in SA and create more jobs.

Viparo on 2008/05/29 09:10:40 PM - Nicolaas

Viparo on 2008/05/29 09:10:40 PM - Nicolaas

Finweek 29 May 2008

Nope, lost you after "when"

CAs please drop the stable measuring unit assumption

Nicolaas Smith on 2008/05/29 09:01:15 PM - CAs please drop the stable measuring unit assumpti

Finweek 29 May 2008

When CAs drop their assumption that there is no inflation when they account constant items like salaries, wages, taxes, retained income, issued share capital, etc they will guarantee the achievement of a 0% inflation target in the real economy for an indefinite period of time. http://realvalueaccounting.blogspot.com/

0% inflation in the real economy = value stability

Nicolaas Smith on 2008/05/29 08:53:53 PM - 0% inflation in the real economy = value stability

Finweek 29 May 2008


0% inflation in the real economy is value stability in the real economy when SA Chartered Accountants abondon their stable measuring unit assumption. CAs assume that there is no inflation (they just simply ignore the 11.1% current inflation - can you believe that!!!!!!) when they account constant items like salaries, wages, rents, taxes, retained income, issued share capital etc.

They thus destroy billions of Rand in constant item real value this year and every year as long as they keep on assuming there is not inflation only for this purpose. When they abondon the stable measuring unit assumption they will maintain billions of Rand in the SA real economy instead of destroying it.

By abondoning the stable measuring unit assumption - no one stops them from doing that - SA Chartered Accountants will guarantee 0% inflation in the real economy. We will still have 11.1% cash inflation in the monetary economy.

Accounting for Inflation

Financial Mail 09 May 2008


Accounting for inflation

Nicolaas Smith, Lisbon

DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).


SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.


There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.


We have to remember that inflation is the destruction of value in monetary and constant items over time.


Inflation has two components: a monetary component - cash inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.


The 10,6% (March) cash inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.


Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.


The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.


We will still have 10,6% cash inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.


Inflation would then have only a monetary component, namely, cash inflation.


No-one stops us from revoking the stable measuring unit assumption.


The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.

Inflation value destruction in South Africa

March 2008 CPI 153.9 Annual inflation 10.6%

Real value destroyed in 2008

1. By 10.6% cash inflation in monetary items, that is, in M3: 10.6% of R1.751361 trillion = R185 billion per annum

2. Unwittingly by SA Chartered Accountants: 10.6% Historical Cost Accounting inflation in the real value of Retained Income of companies listed on the Johannesburg Stock Exchange = Billions per annum. Actual amount in the process of being calculated.

3. Unwittingly by SA Chartered Accountants in other constant items never or not fully updated = Billions per annum. Value unknown.

Accountants eroding real value

Accountants are eroding real value in South Africa each and every day with their assumption that the Rand is perfectly stable only when they account constant items like salaries, wages, taxes, retained income, issued share capital, etc in SA.

That is, they assume that changes in the Rand´s general purchasing power are not sufficiently important to require adjustments to the basic financial statements with regard to these constant items.

Accountants thus destroy hundreds of billions of Rand in real value in SA each and every year.
That will benefit everyone in SA for an indefinite period of time.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Congratulations Mr Mboweni

I wish to congratulate Mr Mboweni for admitting that 10.6% inflation is not consistent with price stability. Price stability is a year-on-year increase in the CPI of 0%. A high degree of price stability is a year-on-year increase in the CPI of 2%.

10.6% South African inflation destroys R185 billion per annum in the real value of M3 valued at R1.751 trillion. 6% inflation will destroy R105 billion in M3 while 3% inflation will destroy R52.5 billion in M3 real value per annum. I support an upper limit of 2% inflation in SA that will destroy R35 billion in M3 real value per annum.

When SA Chartered Accountants stop assuming that the Rand is perfectly stable only when they account constant items (e.g. retained income) they will guarantee 0% inflation in the real economy for an indefinite period of time.

The benefits of 0% inflation in the real economy can scarcely be overstimated, especially as these are, in principle, unlimited in duration and accrue year after year.

Instead CAs are currently destroying billions of Rand each and every year in retained income real value in all SA companies.

IAS 29 doubly flawed

It is not only flawed in it´s definition of monetary items as being money held and "items to be received or paid in money" (everything is received or paid in money - both monetary and non-monetary items) but also when it states that Retained Income in the first period of restatement is the balancing figure after restatement of all other balance sheet items.

This is a very serious mistake by the IASB.

Retained Income is a constant real value non-monetary item like Issued Share Capital and should be restated at the daily parallel rate or daily index rate in hyperinflationary economies and at the monthly inflation rate in non-hyperinflationary economies from the date it came about to today´s date.

The book "RealValueAccounting.Com - The next step in our fundamental model of accounting" which is available as a free download from a link on this blog, followed the flawed IASB approach.

This will be corrected in the new book: "Killing the real economy - South African Chartered Accountants unwittingly destroy real value on a massive scale." Unpublished.

Historical Cost Accounting versus revoking the stable measuring unit assumption in SA

Under HCA


1. Variable items are valued correctly in terms of SA Generally Accepted Accounting Practice and International Financial Reporting Standards. No value is being destroyed by SA Chartered Accountants implementing the above or automatically by the combination of inflation and the HCA model.

2. 10.6% inflation destroys R185 billion per annum in R1.751 trillion M3 real value. 2% inflation would have only destroyed R35 billion. Think about that Mr Mboweni. [Tito, your job is most probably worth R150 billion per annum at the moment - and rising. :) ]


3. Chartered Accountants most probably (actual value in the process of being calculated) destroy another R60 billion (estimate) per annum in constant item real value because they assume the Rand is stable (a very silly and a very costly assumption) only when they account constant items never of not fully updated. At 2% inflation they would only destroy R35 billion per annum.

Buy the ebook for $2.99 or £1.53 or €2.68

Revoking the stable measuring unit assumption


A. Variable items would be valued correctly by CA´s exactly as in 1 above.

B. 10.6% inflation will destroy R185 billion per annum in R1.751 trillion M3 real value exactly the same as in 2 above.

C. Chartered Accountants will not destroy any real value in constant items. They will maintain R185 billion (estimated value) per annum in constant items real value in the case of 10.6% cash inflation instead of destroying it. This is the same as investing R60 billion per annum in constant items in the SA economy for an indefinite period of time - all else being equal. There will be 0% inflation in the real economy. The benefits to GDP and the economic growth rate will be unlimited in duration and accrue year after year.

It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in South Africa´s high inflationary economy.

The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy like Zimbabwe´s - as it was done for 30 years by Brazil.


Buy the ebook for $2.99 or £1.53 or €2.68

It will be completely impossible for SA Chartered Accountants to unwittingly carry on with their current destruction of the SA real economy.

IAS 29 versus revoking the stable measuring unit assumption.

Restatement in terms of the hyperinflation rate as required by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is simply the restatement of Historical Cost Accounting financial reports with the intention of making them more meaningful in a hyperinflationary economy like Zimbabwe.

Restated values become the actual new real values when the restated financial reports are accepted by a country´s tax authorities for the purpose of calculating annual taxes due.

The restated values will not be actual real values when the tax authorities do not accept them for the purpose of calculating annual taxes due.

IAS 29 has no effect at all on the hyper destruction of the real economy in a hyperinflationary country because restatement is not done on a daily basis in terms of a dialy index rate or a daily parallel hard currency rate. IAS 29 is almost a complete failure. It can stop the hyper destruction of the real economy in a country with hyperinflation if it required the daily restatement of all non-monetary items.


Revoking the stable measuring unit assumption will change the current accounting and economic paradigm from the Historical Cost paradigm to the Real Value paradigm in low, high and hyperinflationary economies.

The stable measuring unit assumption can be revoked in a single company, group of companies, single economy, economic region or world wide.

It will replace the Historical Cost Accounting model with the Real Value Accounting model. The current HCA model automatically becomes the RVA model only at zero inflation.

It will stop the perennial destruction of hundreds of billions of Euros of real value in the real economy world wide.

It will result in the automatic monthly updating in terms of the Consumer Price Index of salaries, wages, rents, fees, royalties, retainers, issued share capital, retained income, share premium and share discount account balances, trade debtors, trade creditors, income taxes, company taxes, value added taxes and all profit and loss account items, etc in non-hyperinflationary economies.

The above items will be updated on a daily basis in terms of a daily index rate or a daily parallel hard currency rate in a hyperinflationary economy.

It will result in 0% inflation only in the real economy with continued cash inflation in the cash economy.

The stable measuring unit assumption is a Historical Cost Accounting principle implemented by Chartered Accountants only for the purpose of valuing the above constant value items never or not fully updated.

Chartered Accountants unwittingly destroy the real economy in this manner.

Stop Chartered Accountants from destroying the real economy and everyone will gain.

Get Chartered Accountants to admit that the Rand is not stable and that changes in its general purchasing power are sufficiently important to require adjustments to the basic financial statements and the following will happen automatically:

1. Salaries, wages, taxes, issued share capital, retained income and all constant items will be updated monthly with the change in the CPI;

2. CA´s will stop destroying hundreds of billions of Rand in real value in the real economy each and every year(how can they sleep at night?);

3. GDP and sustainable economic growth will increase;

4. It will be IMPOSSIBLE for inflation and hyperinflation to destroy the SA real economy like it did in Zimbabwe.

Higher interest rates

"The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year." Deutsche Bundesbank 1996 Annual Report, Page 83.

Only if higher interest rates bring down inflation will it benefit the man in the street - and also attract foreign investment.

Price stability is a year on year increase in the CPI of 0%. A HIGH DEGREE of price stability is a year on year increase in the CPI of 2%.

SA should have an upper limit for cash or monetary inflation of 2% like the Euro and the USD - AND SA should stop the stable measuring unit assumption by an act of parliament which will result in 0% inflation ONLY in the REAL economy and prevent the destruction of the SA real economy by inflation or hyperinflation.

One of the basic principles in accounting is “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency.

This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.” Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.

The man in the street

The man in the street´s salary or wage is a constant real value non-monetary item.

When SA Chartered Accountants stop their assumption that the Rand is PERFECTLY stable (can you believe that!!) ONLY for the purpose of accounting CONSTANT items NEVER or NOT FULLY updated, namely their stable measuring unit assumption, then salaries will be automatically updated every month when the new CPI value is announced.

Salaries will automatically be maintained at their real values, that is, they will currently be updated at about 1.2% per month, every month. The man in the street will thus have more money to pay the higher installments on his house and car and higher prices for fuel, food and electricity. In economic terms: total internal demand will be maintained in the economy.

At the same time taxes will be updated monthly too. In economic terms: government´s tax receipts will maintain their real value over time.

At the same time companies´ issued share capital and retained income balances will be updated monthly too. In economic terms: the capital and investment base in the country will be maintained at its real value all the time:

In overall economic terms: probably hundreds of billions of Rand in real value will be maintianed in the SA REAL economy - instead of being destroyed by Chartered Accountants each and every year.

Result: 0% inflation or 0% destruction of REAL value in the REAL economy.

We will still have 10.6% inflation in money (the Rand).

For the man in the street: the real value of his salary will be maintained month after month - no matter what the rate of cash inflation. Internal demand in the economy will be maintained - no matter what the rate of cash inflation.

Brazil did that for 30 years from 1964 to 1994 with a DAILY index under hyperinflation. Their economy grew UNDER HYPERINFLATION.

For the man in the street: it will be IMPOSSIBLE for the SA REAL economy to be destroyed under inflation or HYPERINFLATION (see Brazil) no matter what the rate of inflation or hyperinflation in the Rand.