Monumental: The most critical set of issues this century

Here is some related information which highlights the problem:

The US Financial Accounting Standards Board tried to address the problem of accountants unknowingly destroying companies´ capital and profits by applying the stable measuring unit assumption (which is fallaciously believed by everyone to be caused by inflation: inflation can only destroy the real value of money and other monetary items – nothing else.) in their Financial Accounting Standard FAS 33 Financial Reporting and Changing Prices which was completely superseded by FAS 89 with the same title.

FAS 89

This Statement supersedes FASB Statement No. 33, Financial Reporting and Changing Prices, and its subsequent amendments, and makes voluntary the supplementary disclosure of current cost/constant purchasing power information. The Statement is effective for financial reports issued after December 2, 1986.

This Statement was adopted by the affirmative vote of four members of the Financial

Accounting Standards Board. Messrs. Lauver, Mosso, and Swieringa dissented.

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

It is too important either to be dealt with inconclusively as in the original Statement 33 or to be written off as a lost cause as in this Statement. The basic proposition underlying Statement 33—that inflation causes historical cost financial statements to show illusory profits and mask erosion of capital — is virtually undisputed.

(My note: Erosion is the same as destruction of capital.)

Specific price changes are inextricably linked to general inflation, and the combination of general and specific price changes seriously reduces the relevance, the representational faithfulness, and the comparability of historical cost financial statements.

Although the current inflation rate in the United States is relatively low in the context of recent history, its compound effect through time is still highly significant.

Mr. Lauver:

Relative to most changes in financial reporting, the changes required by Statement 33 were monumental.

Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.

The measures set out in FAS 33 were the start of the process – definitely not the final solution. I do not agree with the specifics of FAS 33. I do agree with the broad principle that accountants unnecessarily destroy companies´ capital and profits when they choose to implement the stable measuring unit assumption - which is virtually undisputed as stated by the FASB.

The International Accounting Standards Board also attempted a similar standard: IAS 15 Information Reflection the Effect of Changing Prices. It was also withdrawn.

“At its meeting in October 1989, the Board of IASC approved the following statement to be added to IAS 15:

“The international consensus on the disclosure of information reflecting the effects of changing prices that was anticipated when IAS 15 was issued has not been reached. As a result, the Board of IASC has decided that enterprises need not disclose the information required by IAS 15 in order that their financial statements conform with International Accounting Standards.

However, the Board encourages enterprises to present such information and urges those that do to disclose the items required by IAS 15.”

Copyright © 2005 - 2010 Nicolaas J Smith

93.3% of internal financing unknowingly destroyed by SA accountants in banks and companies

It is generally the case that SA companies and banks do not invest 100% of the updated original real values of all contributions to their shareholders´ equity in fixed assets, e.g. land and buildings or other fixed property which are or can be revalued via the Revaluation Reserve to compensate for the real value shortfall in shareholders´ equity under Historical Cost Accounting rules during low inflation.

SA accountants thus generally unnecessarily, unknowingly and unintentionally destroy the real value of SA banks´ and companies´ reported retained earnings and other constant items never maintained at a rate equal to the annual rate of inflation (conservatively estimated at about R200 billion per annum) – all else being equal – when they choose to measure financial capital maintenance in nominal monetary units and implement their very destructive stable measuring unit assumption as part of the real value destroying traditional HCA model for an unlimited period of time during indefinite inflation.

SA accountants unnecessarily, unknowingly and unintentionally in this manner generally destroyed 93.3% of the real value of reported retained earnings that remained in SA banks and companies from January 1981 to Nov 2009 when they maintain their very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation.
Valuing the three economic items

Economic items are economic values. They are made up of monetary items, variable items and constant items. SA accountants value, record, classify, summarize and report transactions and events involving economic items in terms of the depreciating Rand.

(1) The real value of the Rand and all other monetary items in the SA monetary economy generally changes every month during low inflation. Months of zero annual inflation are rare and generally not sustained over a significant period of time.

(2) The real value of variable items may change all the time, e.g. the price of foreign exchange, precious metals, quoted shares, commodities, properties, goods, services, etc.

(3) The real values of constant items stay the same (or are suppose to stay the same) all the time – all else being equal; e.g. salaries, wages, rentals, issued share capital, reported retained profits, shareholders equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.

SA accountants have to take all three scenarios occurring simultaneously into account over time when they account economic activity and prepare and present financial reports.

Kindest regards,

Nicolaas Smith

Accountants value everything they account

Accountants value everything they account


"The debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail."

Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.

"Accounting is a measurement instrument."

David Mosso, Ex Member of the US Financial Accounting Standards Board

Economic items have economic value. Accountants deal with economic items all the time. They deal with economic values when they account economic items and prepare financial reports. Accountants value economic items when they account economic transactions and events. Financial reporting does not simply report on what took place. Accountants are not just scorekeepers of what happened in the past. Accountants value everything they account in the economy.

Many accountants still think that accounting is just a recording exercise during which they merely record past economic activity. That is not correct. Accountants value economic items when they account them. Accounting is the continuous maintenance of the constant purchasing power of capital and the provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users. It involves the valuing, recording, classifying, summarizing and reporting of an entity’s economic activity.

Accounting for inflation

In response to a letter to the editor of the Financial Mail, Accounting for Inflation published on 9th May, 2008 in which I stated:

“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.”

The IASB is dead right that financial capital maintenance can be measured in units of constant purchasing power during low inflation, hyperinflation and deflation. The IASB has my vote.
The statements that HC financial reporting does not destroy wealth and that there is no substance in my suggestion that value destruction would end if SA accountants abandon the stable measuring unit assumption have no substance as can be unequivocally proven in the case of SA banks´ and companies´ shareholders equity values never maintained in SA´s low inflationary economy.

The real values of SA banks´ and companies´ shareholders´ equity are unnecessarily, unknowingly and unintentionally being destroyed by their accountants at a rate equal to the annual rate of inflation when their boards of directors choose to apply the stable measuring unit assumption (one of the two very popular accounting fallacies authorized by the IASB) for an unlimited period of time during indefinite inflation when these entities do not own sufficient fixed assets that are or can be revalued via the Revaluation Reserve to compensate for the real value shortfall in these items under the HCA model.

Copyright © 2005 - 2010 Nicolaas J Smith

To be or not to be a constant item, that is the question

The specific choice of measuring financial capital maintenance in units of constant purchasing power (the Constant ITEM Purchasing Power Accounting model) at all levels of inflation and deflation as contained in the Framework for the Preparation and Presentation of Financial Statements Par 104 (a), was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."

IAS Plus, Deloitte. Date: 15 th January, 2010 http://www.iasplus.com/standard/framewk.htm

IAS 8 Par 11 states that managers, in exercising their judgement, have to first apply the rules and regulations in IFRS and interpretations by the International Financial Reporting Interpretations Committee which deal with similar and related items and, only secondly the measurement concepts, criteria for recognition and definitions for expenses, income, liabilities and assets as stated in the Framework.

There are no applicable IFRS or Interpretations regarding the valuation of the constant real value non-monetary items issued share capital, reported retained earnings, capital reserves, share premium account, share discount account, the concepts of capital, the capital maintenance concepts, the determination of profit/loss concept, etc. The measurement concepts and direct and indirect definitions in the Framework are thus applicable. There are Standards related to the constant items trade debtors, trade creditors, other non-monetary payables, other non-monetary receivables, deferred tax assets, deferred tax liabilities, taxes payable and taxes receivable. In terms of IAS 8.11 the Standards take precedence over the Framework in the case of these items.



Conflict

There is a conflict with the capital maintenance concept in the Framework where IFRS treat constant real value non-monetary items like monetary items or variable items. The only way the financial capital concept of continuously measuring financial capital maintenance in units of constant purchasing power in terms of the provisions in the Framework, Par 104 (a) can be correctly implemented, is with the correct treatment of all constant real value non-monetary items as constant items and not as monetary or variable items. The incorrect treatment of constant items as monetary or variable items may lead to the incorrect calculation of the Net Monetary Loss or Gain from holding monetary items as required when measuring financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a) and as required in IAS 29.

Examples

Examples of constant real value non-monetary items in today’s economy are income statement constant items, e.g. salaries, wages, rentals, all other items in the income statement as well as balance sheet constant items, e.g. reported retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, provisions, capital reserves, all other shareholder’s equity items, 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, all other non-monetary payables and receivables, etc.

Kindest regards,

Nicolaas Smith

IFRS authorize both destruction and maintenance of real value in SA

Maintaining the real values of all constant items in the SA economy where our accountants use the double entry accounting model to account economic activity is only possible with the real value maintaining Constant ITEM Purchasing Power Accounting (CIPPA) model as authorized by the IASB twenty years ago in the Framework, Par 104 (a) (which is applicable in the absence of specific IFRS) during non-hyperinflationary periods.

Maintaining the real values of all constant items stable in the SA economy is not possible, at present, while SA accountants implement the real value destroying traditional HCA model under which they apply the very destructive stable measuring unit assumption as authorized by the IASB in the Framework, Par 104 (a) in 1989. SA accountants unnecessarily, unknowingly and unintentionally destroy real value on a massive scale in the SA real economy when they measure financial capital maintenance in nominal monetary units as part of traditional HCA.

This unnecessary, unknowing and unintentional destruction by SA accountants in the real value of constant items not fully or never maintained amounts to about R200 billion per annum for as long as they choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. When they freely choose to measure financial capital maintenance in units of constant purchasing power, amazingly also authorized by the IASB in the Framework, Par 104 (a) in 1989 they will knowingly maintain that plus/minus R200 billion in real value per annum by not destroying existing reported constant item real value of, for example, reported retained profits, with their very destructive stable measuring unit assumption during low inflation.

The real value of reported retained profits can be maintained constant during low inflation and deflation under IFRS but not under HCA although the HC model is also authorized under IFRS. Both the destruction and the maintenance of the real value of reported retained profits and all other reported constant items never maintained during low inflation are, paradoxically, authorized under IFRS. Accountants are free to choose the one or the other. Both are compliant with IFRS.

Kindest regards,

Nicolaas Smith

SA accounting based on two popular accounting fallacies.

Today South African accountants unknowingly destroy the real value of existing reported constant items never maintained when they implement their very destructive stable measuring unit assumption during low inflation because they generally measure financial capital maintenance in SA banks and companies in nominal monetary units implementing the HCA model based on those two very popular IASB approved and authorized accounting fallacies.

Accountants at Johannesburg Stock Exchange listed companies as well as accountants at unlisted SA companies who prepare their financial statements in terms of International Financial Reporting Standards generally choose to measure financial capital maintenance in nominal monetary units, the accounting fallacy as approved by the International Accounting Standards Board in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a) which they apply in the absence of specific IFRS relating to the concept of capital, the concept of capital maintenance, the concept of profit /loss determination and in the absence of specific IFRS for the valuation of specific constants items, e.g. Shareholders´ Equity items, etc.

The Framework, Par 104 (a) states:

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

Astonishingly, the IASB approved and authorized both real value destroying HCA stated in terms of the very popular accounting fallacies as well as its only perfect antidote (the antidote is perfect, not the resulting values) during inflation, hyperinflation and deflation, in one and the same statement in 1989. It is impossible to maintain the real value of capital stable by measuring it in nominal monetary units per se during inflation, hyperinflation or deflation. The IFRS statement that financial capital maintenance can be measured in nominal monetary units is only true at sustainable zero inflation – a monetary mode never achieved in the past and maybe never to be achieved in the future. The IASB statement is a fallacy under the three general monetary modes: inflation, hyperinflation and deflation.

Accountants at JSE listed companies have to prepare financial reports in terms of IFRS and thus have to make the choice presented to them in the Framework, Par 104 (a) while accountants at unlisted SA companies can prepare financial statements either in terms of IFRS or South African Generally Accepted Accounting Practice. The boards of directors of SA companies listed on the JSE - which are all implementing IFRS - actually have to make the choice; their accountants being the accounting experts, obviously, advise them about the appropriate choice to make. Financial capital maintenance in nominal monetary units is a popular accounting fallacy authorized by the IASB in the Framework, Par 104 (a) in 1989. It is, however, not an appropriate accounting policy for SA companies during inflation, hyperinflation and deflation.

Unfortunately most, if not all, SA boards of directors choose financial capital maintenance in nominal monetary units as part of the real value destroying HCA model which includes the very destructive stable measuring unit assumption – another popular accounting fallacy authorized by the IASB in 1989 – in SA´s low inflationary economy. This results in their accountants unnecessarily, unknowingly and unintentionally destroying about R200 billion in the real value of existing reported constant items never or not fully maintained in the SA constant item economy each and every year.

Accountants preparing financial reports of unlisted SA companies in terms of SA GAAP generally also choose to measure financial capital maintenance in nominal monetary units and implement the very destructive HCA model since it is the generally accepted traditional accounting model.

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

No reproduction without permission.

IASB should not authorize IFRS based on massively destructive fallacies

There was only one systemic process of real value destruction operating only in the monetary economy before the invention of the Historical Cost Accounting model. The economic process of inflation only destroyed the real value of depreciating money and other depreciating monetary items equally throughout the monetary economy at that time as it does today in economies subject to inflation and hyperinflation.

There was no simultaneous second systemic process, as we experience it today, whereby Historical Cost accountants unknowingly, unnecessarily and unintentionally destroy massive amounts of real value of existing reported constant items never or not fully maintained, e.g. reported retained profits, only in the constant item economy because they implement their very destructive stable measuring unit assumption (one of the two IASB approved very popular accounting fallacies) during low inflation and hyperinflation.

This includes the unknowing destruction by HC accountants of the real values of issued share capital, share premium account and non-distributable reserves in companies without sufficient fixed assets that are or can be revalued via the Revaluation Reserve to maintain these items´ real values under HCA during low inflation. The reason was that the real value destroying traditional Historical Cost Accounting model which includes the very destructive stable measuring unit assumption and financial capital maintenance in nominal monetary units (the very popular accounting fallacies authorized by the IASB in the Framework, Par 104 a in 1989) was not yet invented at that time.

The International Accounting Standards Board is a private, independent accounting standards board. The mission of the IASB is to develop a single set of global accounting standards. The IASB cooperates with national accounting standard boards for international convergence of accounting standards. IASB should not authorize IFRS based on massively destructive accounting fallacies, e.g. financial capital maintenance in nominal monetary units per se and the stable measuring unit assumption during low inflation which cost the SA economy about R200 billion in real value unknowingly destroyed in constant items never maintained by SA accountants implementing HCA in the SA economy each and every year. Currently the IASB is doing that in the Framework, Par 104 (a) which states that financial capital maintenance can be measured in nominal monetary units.

Kindest regards,

Nicolaas Smith

Two accounting fallacies authorized by the IASB

Constant real value non-monetary items

"Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction makes no sense and leads to results that are void of meaning. (Massone, 1981a. p.6)"

The Taxation of Income from Business and Capital in Colombia: Fiscal Reform in the Developing World, By Charles E. McLure, John Mutti, Victor Thuronyi, George R. Zodrow, Contributor Charles E. McLure, Published by Duke University Press, 1990, ISBN 0822309254, 9780822309253, Page 259

Constant items are non-monetary items with constant real values over time.

The double entry accounting model was first comprehensively codified by the Italian Franciscan monk, Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.

SA accountants use the Consumer Price Index to maintain the real values of certain – not all - income statement constant items, e.g. salaries, wages, rentals, etc constant during low inflationary periods. They value them in units of constant purchasing power while they generally implement the real value destroying Historical Cost Accounting model which is based on two IASB authorized accounting fallacies, namely, financial capital maintenance in nominal monetary units and the very destructive stable measuring unit assumption during inflation.

Accountants are required by the International Accounting Standards Board to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. They have to restate their HC or current cost financial statements by applying the CPI during hyperinflation. They have to value all non-monetary items (both variable and constant items) in units of constant purchasing power by applying the CPI at the period end date. Companies in a hyperinflationary economy can only use IAS 29 to maintain the real value of non-monetary times stable when their tax authorities accept the restated values for the calculation of taxes due.

“Regarding to tax regulation, I want to emphasize that tax regulation required restatement of assets and liabilities according to inflation (in terms of IAS 29) for the date of 31.12.2003 but taxes were not taken according to restated values in 2003. In 2004, financial statements were restated and taxes were taken based on restated values.”

Cemal KÜÇÜKSÖZEN, Ph.D, Head of Accounting Standards Department, Capital Markets Board of Turkey

Constant Purchasing Power inflation accounting as defined in IAS 29 is a complete price-level inflation accounting model where under ALL variable and constant real value non-monetary items are inflation-adjusted by means of the CPI during hyperinflation.

Only the Constant ITEM Purchasing Power Accounting model, as approved by the IASB in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a) in 1989, enables accountants to maintain the real values of all income statement and balance sheet constant items constant during inflation and deflation.

The IASB´s Framework, Par 104 (a) states:

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

The IASB thus, amazingly, authorized and approved the two very popular accounting fallacies and their only and perfect antidote in the exact same statement in 1989. The antidote – financial capital maintenance in units of constant purchasing power – is perfect during inflation, hyperinflation and deflation; the values may not be.

Kindest regards,

Nicolaas Smith

Inflation has no effect on the real value of non-monetary items

Monetary items

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

1) Unstable medium of exchange
2) Unstable store of value
3) Unstable unit of account

Non-monetary items were only defined in unstable monetary terms after the invention of unstable money. The economy came to be divided in the unstable monetary economy and the non-monetary or real economy. There were only unstable monetary items and variable real value non-monetary items. There were no constant real value non-monetary items yet. The non-monetary or real economy consisted of only variable items.

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

Examples of monetary items in today’s economy are bank notes and coins, bank loans, bank savings, other monetary savings, bank account balances, treasury bills, commercial bonds, government bonds, mortgage bonds, student loans, car loans, consumer loans, credit card loans, notes payable, notes receivable, all monetary loans, etc.

Unstable money and other monetary items´ real values are continuously being destroyed by inflation. Inflation only destroys the real value of unstable money and other monetary items. Inflation has no effect on the real value of non-monetary items.

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

Non-monetary items in today’s economy are divided into two sub-groups:

a) Variable real value non-monetary items
b) Constant real value non-monetary items

There were still no units of constant purchasing power because there was still no CPI at that time. There were still no real value destroying Historical Cost Accounting model and very destructive stable measuring unit assumption accounting fallacy. There were still no price-level accounting, no Constant Purchasing Power inflation accounting model for hyperinflationary economies and no Constant ITEM Purchasing Power Accounting model for low inflationary and deflationary economies. There were still no financial reports. There were still no very popular accounting fallacies authorized by the IASB.

Inflation

Inflation is always and everywhere a monetary phenomenon: Milton Friedman.

Inflation is a sustained rise in the general price level of goods and services in an economy over a period of time. Prices are normally set in terms of the unstable money or unstable functional currency in an economy or economic region. Inflation always and everywhere destroys the real value of depreciating money and other depreciating monetary items over time. Inflation has no effect on the real value of non-monetary items. Disinflation is a decrease in the rate of increase of the general price level. Inflation still destroys the real value of depreciating money and other depreciating monetary items during disinflation; just at a slower rate than before.

Deflation is a sustained decrease in the general price level. Deflation creates real value in appreciating money and other appreciating monetary items over time, recently mainly seen in the Japanese economy.

Inflation reared its ugly head soon after the invention of money. It only destroyed the real value of depreciating money and other depreciating monetary items at that time as it does today. Inflation did not and can not destroy or erode (which is the same as destroy) the real value of non-monetary items – either variable or constant real value non-monetary items.

Inflation has no effect on the real value of non-monetary items.


“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.

Kindest regards,

Nicolaas Smith

Chávez is playing with fire

Venezuela is in hyperinflation since November 2009. PricewaterhouseCoopers published that on 17 December 2009. Everbody in Venezuela is still in denial about that.

Hugo Chávez is playing with fire when he thinks he can abuse sovereignty to create a fantasy economy where he can half his national debt overnight by presidential decree. Gideon Gono´s casino economy in Zimbabwe was also a fantasy economy created with the abuse of sovereignty. Then he single-handedly destroyed it by simply "printing money" continuously in 100 trillion Zimbabwe Dollar notes. There is no Zimbabwe Dollar today. Sovereignty in the wrong hands is like casting perls before swine.

Venezuealan companies now have to implement IAS 29. IAS 29 will make no difference and is not intended to make any difference to hyperinflation in a country. IAS 29 can be used to stabilize Venezuela´s entire non-monetary economy. Not by restating traditional Historical Cost year-end financial statements prepared in terms of the real value destroying HCA model at the end of 2010 applying the year-end CPI rate to make them "more useful", but, by updating all non-monetary items in the country daily at the daily parallel rate.

That would include trade debtors and trade creditors which the International Accounting Standards Board and PricewaterhouseCoopers mistakenly classify as monetary items. They are constant real value non-monetary items and have to be updated daily at the parallel rate in Venezuela.

Implementing IAS 29 by applying the daily parallel rate is, in principle, the same as Brazil´s daily indexation for 30 years from 1964 to 1994. They had a stable and sometimes growing non-monetary economy with up to 2700% annual hyperinflation in their monetary economy. This gave Gustavo Franco and his team a chance to work out a way of how to kill their hyperinflation. It took them 10 years, but, they had a more or less stable non-monetary economy because of daily updating of many if not all non-monetary items at daily rates supplied by the government. If Brazil could have done that for 30 year then Venezuela can do the same.

There is very little chance of this happening when Sir David Tweedie, the Chairman of the IASB, supports the two very popular accounting fallacies, namely the very destructive stable measuring unit assumption and financial capital maintenance in nominal monetary units (which is impossible per se during inflation) as authorized and approved by the IASB in the Framework, Par 104 (a) twenty years ago. The Framework, Par 104 (a) states: "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

The IASB thus authorized and approved the two very popular accounting fallacies and their only and perfect antidote in the exact same statement. The antidote is perfect during inflation, hyperinflation and deflation; the values may not be.

Kindest regards

Nicolaas Smith

PS And Julius Malema and his friends from the ANCYL want to visit Venezuela to see how to nationalize the mines??

Variable items

Variable real value non-monetary items

Variable items are non-monetary items with variable real values over time.

Examples of variable items in today’s economy are property, plant, equipment, inventories, quoted and unquoted shares, raw material stock, finished goods stock, patents, trademarks, foreign exchange, etc: all economic items you see around you except monetary and constant items.

The first economic items were variable real value items. Their values were not yet expressed in terms of money because money was not yet invented at that time.

There was no inflation at that time because there was no money. There was no unstable monetary medium of exchange. There was no unstable monetary unit of account. There was no unstable monetary store of value.

There was no double entry accounting model at that time.

There were no historical cost items, no stable measuring unit assumption, no Historical Cost Accounting model and no financial capital maintenance in nominal monetary units; that is to say: there were no accounting fallacies.

There was no value based accounting.

There was also no Consumer Price Index at that time. Consequently there were no units of constant purchasing power and no price-level accounting.

There was no inflation accounting. There was no Constant Purchasing Power inflation accounting model under which all non-monetary items (variable and constant items) in Historical Cost and Current Cost financial statements are required to be restated by means of the year end CPI during hyperinflation.

There was also no continuous financial capital maintenance option under which only constant items are continuously measured in units of constant purchasing power by applying the monthly CPI during non-hyperinflationary periods in order to implement a continuous financial capital concept of invested purchasing power by continuously measuring financial capital maintenance in units of constant purchasing power and determining profit/loss in constant purchasing power units while variable items are continuously valued in terms of specific International Financial Reporting Standards or South African Generally Accepted Accounting Practice rules at, for example, market value, fair value, present value, recoverable value or net realizable value and monetary items are valued at their always current original nominal monetary values during the reporting period.

There were no financial reports: e.g. no income statements, no balance sheets, no cash flow statements, no statements of changes in Shareholders´ Equity, etc.

There were no monetary items and no constant items. There were only variable real value items not yet expressed in monetary terms.

Kindest regards,

Nicolaas Smith

Three economic items

Science is simply common sense at its best - that is, rigidly accurate in observation, and merciless to fallacy in logic. Thomas Huxley

The economy consists of economic items and economic entities. Economic items have economic value. Accountants value economic items when they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value. The three fundamentally different basic economic items in the economy are

a) monetary items

b) variable real value non-monetary items

c) constant real value non-monetary items

The SA economy consequently consists of three parts:

1. Monetary economy

The SA monetary economy consists of the Rand money supply and other Rand monetary items, i.e. Rand money loans: e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans, etc.

2. Variable item non-monetary economy

Non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods products, etc. Variable items are all economic items you generally see around you except monetary and constant items.

3. Constant item non-monetary economy

Constant items are non-monetary items with constant real values over time: income statement items like salaries, wages, rentals, etc and balance sheet constant items like issued share capital, reported retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and receivables, etc.

The variable and constant item non-monetary economies in combination make up the non-monetary or real economy which together with the monetary economy constitute the SA economy.

Kindest regards,

Nicolaas Smith

Objective of general purpose financial reporting

The objectives of general purpose financial reporting are:

1) Maintenance of the constant purchasing power of capital


2) Provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users. (IFRS)

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

Nicolaas Smith

Copyright (c) 2012 Nicolaas Smith

Hyperinflation in Venezuela with the parallel rate on the internet

Hi,


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

Venezuela is currently in hyperinflation (scooped on this blog - see two posts back) with cumulative inflation over three years of 105.0% as at Dec 2009.

Their parallel rate is freely available on the internet which could make implementing IAS 29 at the daily parallel rate very possible in that country for whoever wishes to save the real values of their company´s non-monetary items from being unknowingly destroyed by their accountants with Historical Cost Accounting during hyperinflation.

Jan 8 parallel rate 6.25 compared to newly announced official pegs: "Oil Dollar" 4.30 and subsidized peg 2.60.

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


Kindest regards,

Nicolaas Smith

Parallel rate

The parallel rate is an unofficial or black market rate of exchange between the US Dollar and the local currency in a high inflationary or hyperinflationary economy. It is also called the street rate because unlicensed dealers trade US Dollars in the busy market streets for the local currency. This parallel rate is established for all the relatively stable or hard currencies used in that hyperinflationary economy. In Zimbabwe they used the US Dollar, the British Pound, the SA Rand and the Botswana Pula. As an economy starts moving into a hyperinflationary mode the central bank generally sets a fixed rate of exchange for the US Dollar and changes it not on a daily basis in concordance with what is happening in the foreign exchange market, but only as and when the central bank decides.

Credit sales and purchases are done at prices that allow for the expected loss of purchasing power in the local currency during the credit period, even if the period is very short. People start to state the real values (prices) of items in terms of the US Dollar, but, they do not use the official government rate of exchange for the local currency updated now and then. They start using their own generally accepted rate to protect their own real value in the products or services: the parallel rate.

The parallel rate is problematic in the real world. In the case of Zimbabwe the government did not recognize the parallel rate for most of the period of hyperinflation. They only recognized it right at the end when no-one wanted to accept the ZimDollar as payment for anything. Companies in hyperinflationary economies would save themselves when they start applying the parallel rate to all their non-monetary items as soon as it appears – if they could: they are often not allowed to do that by government. Company directors and owners are often arrested for increasing prices in hyperinflationary economies in terms of the parallel rate.

It happened in Angola too. There was a price freeze in Luanda while I was away in Portugal. The MD of our company phoned me and asked what we should do. I told him to tell my staff to carry on applying the current daily parallel rate to our selling prices and to our trade debtors. We could not start making losses not updating our prices and debtors daily with the parallel rate. I was not arrested when I arrived back in Luanda. I assumed it was because we most probably were the only company in Angola updating our workers´ salaries monthly at the parallel rate. Everybody knew what was going on in other companies. I am sure the government knew what we were doing at Auto-Sueco (Angola). We were the official agents for Volvo in Angola, but, we were controlled from our parent company in Portugal.

I did, however, order a halt to using the new daily parallel rate when I saw that the Angolan government was very serious about that price freeze. As usual it only lasted about a week. Then everybody started using the current parallel rate again. So did we.

Using the parallel rate would not be compliant with current IFRS, but, managers and owners would save their companies from going under. When all entities in a hyperinflationary economy apply the parallel rate on a daily basis to all non-monetary items (constant and variable items) they would save their country’s real economy – in a hyperinflationary economy. They would do nothing to hyperinflation in their currency. That problem has to be solved by the monetary authorities and the government. See How Brazil beat hyperinflation: Gustavo Franco. http://www.econ.puc-rio.br/gfranco/How%20Brazil%20Beat%20Hyperinflation.htm

But, they will not destroy their real economy at all. The problem is to determine one single official parallel rate because there are normally a number of rates that apply in different parts of the country. When the hyperinflation is created by the government as in the case of Zimbabwe and the government does not recognize the parallel rate companies would have to run their businesses at the parallel rate to save their companies as well as the real economy and do their official accounts in terms of meaningless IAS 29 using the year end CPI to comply with IFRS. The government obviously would collect proper and sufficient taxes and secure economic stability in the real economy if they would allow continuous financial capital maintenance in units of constant purchasing power by allowing the application of the daily parallel rate based on the basic principles in IAS 29 excluding applying the CPI.

Kindest regards,

Nicolaas Smith

Venezuela in hyperinflation

Julius Malema can visit Venezuela in hyperinflation


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

Venezuela officially entered into hyperinflation according to the IASB´s definition: 100% cumulative inflation over 3 years.

2007 22.5% inflation

2008 30.9% inflation

2009 26.9% inflation

Cumulative inflation over the last 3 years: 105.0% = hyperinflation. I predicted this in a joking way. Now it actually came about.

Julius and his friends from the ANCYL can now visit a country in hyperinflation and study how to get SA into the same situation by nationalizing the mines like Hugo Chavez did with many parts of the Venezuelan economy :-)

Actually, they can save some taxpayer money and fly over the border to Harare. At State House and the Reserve Bank of Zimbabwe they will be given a perfect plan of what to do :-)

On a serious note:

Venezuelan companies now have to implement the IASB´s IAS 29 Financial Reporting in Hyperinflationary Economies. The IASB encourages them to carry on doing business using the traditional real value destroying Historical Cost Accounting model implementing financial capital maintenance in nominal monetary units (one of the three popular IASB authorized accounting fallacies) and the stable measuring unit assumption (the second of the three popular IASB authorized accounting fallacies) during hyperinflation in this coming year.

At the end of 2010, after their accountants have unknowingly destroyed the real values of all their existing reported constant items (e.g. reported Retained Profits, capital, etc) never maintained with Historical Cost Accounting at the rate of most probably 25% this coming year, the IASB requires them to restate their year end results of what will be left of their very much destroyed companies at the year end Consumer Price Index to give them meaningless results that are suppose to make these results "more useful".

If all Venezuelan companies now immediately start valuing all non-monetary items at their black market parallel rate of exchange for the US Dollar on a daily basis - this rate already operates in Venezuela and is available in the streets on a daily basis - they would stop the destruction of real value in their real economy in its tracks: they would have zero inflation or value destruction in their real economy. It would be the only economy in the world operating like that. They could even grow their real economy this year.

This would give their government and monetary authorities a chance to work out a plan to stop hyperinflation in their money. Dollarization of the economy has already been suggested by one of their top bankers.

I do not think Hugo Chavez would be interested because this 100% secure plan comes from the west.

It may be possible to implement the above plan if he loses in the next election.

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


Kindest regards,

Nicolaas Smith

PS I think the ANC´s image will take a severe knock if they finance Julius and his mates with taxpayer money to visit a country that is well known for nationalizing left, right and centre and has just entered into hyperinflation, in search of viable economic policies for South Africa.

Gill Marcus can rid SA of 3% inertial inflation

From Wikipedia:

"In the medium-to-long term, economic agents begin to forecast inflation and to use those forecasts as de facto price indexes that can trigger price adjustments before the actual price indices are made known to the public. This cycle of forecast-price adjustment-forecast means current inflation becomes the basis for future inflation (more formally, economic agents start to adjust prices solely based on their expectations of future inflation)."

In my opinion, half of SA´s 6% inflation is simply unnecessarily destructive and economically destabilizing inertial or built-in inflation that can be done away with given sufficient "political will" from Gill Marcus and her team at the SARB. Marcus can eliminate that 3% inertial inflation by creating a lower, but still within the inflation target range, inflation expectation.

She and her team already have the necessary credibility that they stick to their word. It may simply be a matter of developing that 3% expectation in the economy and educating the population about the advantages of lower inflation.

I am convinced that SA can do with 3% inflation exactly the same as with 6% inflation. It is within the target range, is it not? So, what is wrong with 3%? All interest rates can come down by 3% too. Everybody gains.

Obviously, Eskom may be the fly in the ointment maybe being responsible for at least a 1% increase in inflation.

Kindest regards,

Nicolaas Smith

Constant items

There are three fundamentally different basic economic items in the economy: 1) monetary items 2) variable real value non-monetary items and 3) constant real value non-monetary items.

Variable items have variable values based on market demand and supply, and in companies their values are determined in terms of International Financial Reporting Standards if they are listed on the Johannesburg Stock Exchange and on SA Generally Accepted Accounting Practice if they are not listed on the JSE. Unlisted companies can also comply with IFRS if they so choose.

The second distinct economic item is a monetary item. That can be money and other monetary items like all money loans, capital amounts of mortages, etc. Money´s value is constant or stable in nominal value. The values on the notes and coins do not change.

Money and other monetary items´ real value has never ever been stable in the past and is not stable now. Money and other monetary items´ real value is determined by inflation and deflation. Inflation is always and everywhere the destruction of real value in money and other monetary values. 6% inflation in SA destroys about R120 billion in the real value of the Rand and other monetary items in the SA economy every year.

Now we come to the big surprise to you: there is a third distinctive basic fundamentally different economic item: constant real value non-monetary items. Examples are salaries, wages, rentals, issued share capital, reported retained profits, share premium account, capital reserves, all other items in shareholders´equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other payables and receivables, etc.

They all have constant real values - all else being equal. They have to be valued in units of constant purchasing power during inflation and deflation.

That is the ONLY way to keep their real values constant over time during inflation and deflation. When constant items are valued in nominal monetary units by SA accountants when they apply their very destructive stable measuring unit assumption (a very popular accounting fallacy approved by the International Accounting Standards Board) they destroy their real values at a rate equal to the rate of inflation because these constant items, like all other economic items in SA are expressed in the Rand which is a monetary medium of exchange and inflation destroys the real value of the Rand, not the real value of the constant items.

The real values of all constant items never maintained in the SA economy are unknowingly, unnecessarily and unintentionally being destroyed by SA accountants freely choosing the 700 year old generally accepted traditional Historical Cost Accounting model when they freely choose to measure financial capital maintenance in nominal monetary units (the second popular accounting fallacy approved by the IASB) in terms of the IASB´s Framework, Par 104 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

You can thus see that the IASB authorized the accounting fallacy of financial capital maintenance in nominal monetary units (it is impossible to maintain the real value of capital stable in nominal monetary units per se during inflation and deflation) and its ONLY and PERFECT antidote in one and the same IFRS statement. SA accountants unknowingly destroy about R200 billion each and every year in the real values of existing reported constant items never maintained when they freely choose traditional HCA implementing the stable measuring unit assumption when they measure financial capital maintenance in nominal monetary units in terms of the Framework, Par 104 (a) in SA companies.

They would stop that destruction and boost the SA real economy by about R200 billion per annum for an unlimited period of time in the future when they freely choose financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) twenty years ago in 1989. So, the SA constant item part of the SA real economy is full of millions of constant real value non-monetary items with constant real values.

When your salary is inflation-adjusted at least at the rate of inflation then its real value stays constant. The same should happen to all reported retained profits and capital in all SA banks and companies. Unfortunately it is not yet happening like that.

SA accountants blame inflation for the erosion of companies´ profits and capital, the third very popular accounting fallacy accepted by the IASB. They know and admit that this destruction - they always call it erosion - takes place: they and all other accountants world wide blame inflation instead of their own free choice of the traditional HCA model.

So, there are millions of constant items with stable or constant real values. The IASB proof is in Par 104 (a): Financial capital maintenance can be measured in units of CONSTANT purchasing power. Capital and all items in Shareholders´Equity are non-monetary items as defined by the IASB.

Since they can be measured in units of CONSTANT purchasing power to keep their real values CONSTANT, they are thus CONSTANT items.

Do you perhaps know any accountants? :-)

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

No reproduction without permission.

The failure of IAS 29

The combination of hyperinflation, accountants implementing HCA and inappropriate economic and monetary policies in a country destroy the real economy, because it is impossible for hyperinflation – per se – to destroy the real value of non-monetary items. For example: Salaries and wages: Salaries and wages are constant real value non-monetary items. Hyperinflation can not destroy their real values. Hyperinflation can only destroy the real value of the hyperinflationary currency and other monetary items. Salaries and wages are not monetary items. They are simply paid in money as the medium of exchange. They can be paid in Big Macs / beer / food supplies too. Hyperinflation destroys the real value of the monetary medium of exchange. They can also be paid in foreign exchange (e.g. in US Dollars) or in kind when their real values would not be destroyed no matter what the rate of hyperinflation. The real values of salaries and wages are destroyed in a hyperinflationary economy when they are fixed; i.e., they are valued in nominal monetary units.

Their real values are destroyed when they are not updated or they are updated at a rate lower than the rate of hyperinflation. Their real values are not updated because of an accounting practice: valuation in nominal monetary units. Their real values would be maintained when a different measurement basis is chosen, namely, units of constant purchasing power by applying the parallel rate in a hyperinflationary economy. So, it is the choice of measuring them in nominal monetary units which destroys their real value and not hyperinflation because when they are measured in units of constant purchasing power by applying the daily parallel rate their real values would be maintained no matter what the rate of hyperinflation.

The result of not updating salaries and wages in a hyperinflationary economy is that internal demand in the country contracts dramatically. Workers don’t receive enough money to make their normal monthly purchases because the goods they normally buy are variable items. These variable items´ prices are updated in terms of the daily parallel rate, but not their salaries.

There would be no destruction of real value in the real or non-monetary economy at all when all constant items (salaries, wages, rent, capital, retained profits, trade debtors, trade creditors, taxes payable, etc.) and variable items are updated daily in terms of the parallel rate – no matter what the hyperinflation rate is. That would be continuous financial capital maintenance in units of constant purchasing power: at the parallel rate in a hyperinflationary economy. This does not happen when IAS 29 is applied. IAS 29 simply requires simple financial statement restatement in terms of the CPI at the financial year end which produces meaningless results at a historic rate that is meaningless since the current parallel rate would make reading or analyzing those financial statements a complete waste of time in a hyperinflationary economy.

Some companies in Zimbabwe and elsewhere refused to implement IAS 29 for this reason. Towards the end of the hyperinflationary spiral created by the Zimbabwe government and central bank that wiped out all the real value of the Zimbabwe Dollar prices doubled every 24.7 hours according to Prof Steve Hanke from Cato Institute. http://www.cato.org/zimbabwe The Zimbabwe government did not even supply the CPI for a number of months. It is obviously impossible to apply IAS 29 in a scenario like that. The parallel rate (not always the same one) was available 24/7 throughout the country 365 days a year.

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

No reproduction without permission.

Accounting fallacy and antidote approved by IASB in the same statement

IAS 29 Financial Reporting in Hyperinflationary Economies was required to be implemented by all companies listed on the Zimbabwe Stock Exchange during hyperinflation in that country. That made no difference and could not make any difference to the hyperinflationary spiral of hyper-destruction of the real value of the ZimDollar because hyperinflation is always and everywhere a monetary phenomenon and can only destroy the real value of the hyperinflationary currency and other monetary items. Hyperinflation per se has no effect on the real value of non-monetary items in a hyperinflationary economy. See Gucenme and Arsoy.

However, if IAS29 was applied on a daily basis applying the daily parallel rate to all non-monetary items (not just most consumer products) in Zimbabwe, then the Zimbabwean real economy would not have unknowingly been destroyed to the extent it was destroyed by the implementation of the stable measuring unit assumption in the Zimbabwean real economy during hyperinflation.

The real values of constant real value non-monetary items in a hyperinflationary economy are destroyed by HC accountants´ choice of financial capital maintenance in nominal monetary units (one of the IASB-approved popular accounting fallacies) when they implement the HC model (see PricewaterhouseCoopers in Understanding IAS 29) which includes the stable measuring unit assumption (another IASB approved popular accounting fallacy) during hyperinflation.

Zimbabwe accountants then dutifully restated their HC financial statements at year end by applying the CPI at the year end date to give them meaningless results  after they had unknowingly destroyed the real value of constant real value non-monetary items in their companies by first implementing HCA during hyperinflation as encouraged by the IASB before applying IAS 29 restatement to what was left of their companies at year end as required by the IASB.

They also unknowingly played their full part in the destruction of their real economy in combination with hyperinflation, inappropriate government economic policies and inappropriate Reserve Bank of Zimbabwe monetary policies. The joke about an accountant being like a man who hides away in the hills during the battle and afterwards comes down and bayonets the wounded, comes to mind. :-)

Historical Cost Accounting should be banned by law during hyperinflation and low inflation. That would be the quikest and best way to solve many, many problems. That is going to be the end result, in any case. Not by law, but by general acceptance. The SA real economy would gain about R200 billion per annum for an unlimited period of time and SA accountants would - for the first time - properly fulfil their roles as guardians of constant real non-monetary value in the economy which should be the real objective of their training and their compensation.

It is the SARB´s job to lower the destruction of real value of the Rand and other monetary items in the SA monetary economy by lowering inflation. Accountants can do nothing with accounting about that. They can, however, ensure zero destruction of real value in the constant item economy for an unlimited period of time with continuous financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) twenty years ago. Instead, they currently unknowingly, unnecessarily and unintentionally destroy that about R200 billion each and every year in the real values of constant items (e.g. all reported Retained Profits in SA companies) never maintained with their implementation of financial capital maintenance in nominal monetary units - the very popular accounting fallacy also authorized by the IASB in the exact same Framework, Par 104 (a) in 1989.

The Framework, Par 104 (a) states:

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

A very long standing, very popular, very destructive accounting fallacy as well as its only and perfect antidote both approved by the IASB in the same statement. It is so strange it is hard to believe: but, it is true.


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

No reproduction without permission.

Sir David Tweedie does not understand the basic problem with IAS 29

A modified IAS 29 can, in fact, be used to stop this hyper-destruction by accountants´ choice of the HCA model of the real values of constant items never maintained during hyperinflation. Hyperinflation per se destroys the real value of the monetary unit directly, for example, the Zimbabwe Dollar in the recent past. There is no Zimbabwe Dollar today: the Reserve Bank of Zimbabwe over-printed it to oblivion. The Zimbabwean people en masse believed very strongly in the fallacy that printing money creates wealth. Hyperinflation did not and can not destroy the real value of any non-monetary item (constant or variable real value non-monetary item) in the Zimbabwean economy or any other economy.

The real values of some, mostly consumer, non-monetary items were maintained by the fact that their selling prices were adjusted every time the black market or parallel rate changed in Zimbabwe. These changes sometimes occurred twice or more often per day. Their real values were maintained, not by applying the CPI as officially required by the IASB in terms of IFRS, but, the daily parallel rate of exchange for the US Dollar to the ZimDollar. That was the real rate of exchange and real value rate in Zimbabwe. That is always the case in all hyperinflationary economies. Not the CPI that was announced a month after the month to which it related. The CPI that could be announced two months after the date of a transaction is useless as a real value index in a hyperinflationary economy when prices change every few hours.

This is the basic reason for IAS 29´s failure in hyperinflationary economies: requiring the CPI to be applied at the end of the year instead of the daily parallel rate to be applied daily. Sir David Tweedie, the Chairman of the IASB, never worked or lived in a hyperinflationary economy. If he had, he would understand the basic problem with IAS29. Obviously I agree that we cannot expect the Chairman of the IASB to experience every accounting problem personally. Sir David has a very busy schedule. He spends his time flying all over the world on IASB business (refining IASB approved accounting fallacies – I suppose) and did not have time to read my “voluminous manuscript” in the past. So he asked Geoffrey Whittington to inform me. (I do not actually expect Sir David to read my manuscripts. I thought the IASB had a basic research section.)

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

No reproduction without permission.

Vital function of accounting

Accountants were not aware in 1989 when IAS 29 Financial Reporting in Hyperinflationary Economies was authorized that they unknowingly destroy real value in existing reported constant items never maintained by implementing financial capital maintenance in nominal monetary units - traditional HCA - during inflation and hyperinflation. All destruction of the real value of constant items (e.g. the erosion of companies´ profits and capital) was and still is mistakenly blamed on inflation and hyperinflation.

Nor were accountants aware in 1989 that the only way to stop that destruction was with continuous financial capital maintenance in units of constant purchasing power during inflation and hyperinflation. Fortunately, this did not prevent the IASC Board from authorizing continuous financial capital maintenance in units of constant purchasing power as an alternative to traditional HCA in the Framework, Par 104 (a). Unfortunately no-one chooses continuous financial capital maintenance in units of constant purchasing power because of the predominance of HCA and the three popular accounting fallacies:

1) The stable measuring unit assumption - approved by the IASB.
2) Financial capital maintenance in nominal monetary units - approved by the IASB
3) The erosion of companies´ profits and capital caused by inflation - accepted by the IASB.

If the IASC Board in 1989 were aware of the fact that only continuous financial capital maintenance in units of constant purchasing power could stop forever accountants´ unknowing destruction of the real value of constant items never maintained because of their implementation of the HCA model during inflation and hyperinflation, they would have pointed that out to accountants and left it up to them to choose the alternative option to stop the destruction. The IASC Board stated in the Framework, Par 110 that it was not their intention to prescribe a specific accounting model except in the case of hyperinflation at that time.

They still did not prescribe continuous financial capital maintenance in units of constant purchasing power during hyperinflation, but simply restatement of all non-monetary items in HC and current cost financial statements by applying the CPI at the financial year end to make them more useful during hyperinflation. That clearly indicates that they were not aware of its permanent constant real value maintaining function at that time. It is an objective / function of accounting / general purpose financial reporting to maintain the real value of constant items stable by means of continuous financial capital maintenance in units of constant purchasing power during inflation, hyperinflation and deflation.

This is the reason for IAS 29´s failure in stopping the accounting based hyper-destruction of real value in constant items never maintained in hyperinflationary economies.

Kindest regards

Nicolaas Smith

Hyperinflation

Historical Cost accountants freely choosing to measure financial capital maintenance in nominal monetary units - a 700 year old generally accepted accounting practice (which is a popular accounting fallacy approved by the IASB) - in terms of the Framework, Par 104 (a) or as the traditional HCA model in terms of GAAP, unknowingly hyper-destroy the real value of reported constant items never maintained because they implement their very destructive stable measuring unit assumption (another IASB approved popular accounting fallacy) during hyperinflation. They know and admit that this destruction is occurring during inflation and hyperinflation and that it is especially evident during hyperinflation, but, they mistakenly blame inflation and hyperinflation (instead of their own choice of the HCA model) for the erosion of companies´ profits and capital - the third very popular accounting fallacy.

Hyperinflation is defined by the IASB in IAS 29 Financial Reporting in Hyperinflationary Economies as a rate of inflation approaching or surpassing 100% cumulative inflation over three years. 26% annual inflation for three years in a row would result in cumulative inflation of 100% over that period.

The IASB requires countries to implement IAS 29 during hyperinflation as defined above. IAS 29 requires companies to value all non-monetary items – both variable and constant items – in units of constant purchasing power by applying the CPI at the financial year end date.

Accountants freely choosing continuous financial capital maintenance in units of constant purchasing power would maintain the real value of all existing reported constant items stable in companies that at least break even during low inflation, hyperinflation and deflation per se for an unlimited period of time – all else being equal. Continuous financial capital maintenance in units of constant purchasing power (an IASB approved accounting model) is the only way to maintain the real value of constant items stable in companies that at least break even during low inflation, hyperinflation and deflation per se – ceteris paribus.

In short:

1.) Accountants unknowingly destroy massive amounts of real value in the real economy with traditional HCA during inflation and hyperinflation.

2.) The only way to stop that destruction is with another freely available accounting model also authorized by the IASB in 1989; namely, continuous financial capital maintenance in units of constant purchasing power during inflation and hyperinflation.

Unfortunately IAS 29, as it is currently formulated, does not incorporate continuous financial capital maintenance in units of constant purchasing power during hyperinflation. IAS 29 requires that all non-monetary items (variable and constant items) in HC or current cost financial statements are restated in terms of the CPI, generally at the year end date, to make the financial statements more useful during hyperinflation. IAS 29 is about the restatement of financial statements to make them more useful during hyperinflation. It is, unfortunately - currently, not the objective of IAS 29 to engender continuous financial capital maintenance in units of constant purchasing power and to continuously maintain the real values of non-monetary items during hyperinflation although it is almost correctly formulated to be used for this purpose. When it were to be used for this purpose it would stop the hyper-destruction of the real economy during hyperinflation. It would instead ensure economic stability in the real economy during hyperinflation. It is not currently the objective of IAS 29 to maintain the real value of constant items for an unlimited period of time by implementing continuous financial capital maintenance in units of constant purchasing power during hyperinflation because the IASC Board and accountants in general were not yet aware of this function of accounting during inflation and hyperinflation at the time of authorizing IAS 29 in 1989 for reasons explained before.

PricewaterhouseCoopers tell us very succinctly what happens under IAS 29:

"Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting. "

PricewaterhouseCoopers: International Financial Reporting Standards - Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, p. 3

Kindest regards,

Nicolaas Smith

Objective of general purpose financial reporting

The objectives of general purpose financial reporting are:

1) Automatic maintenance of the constant purchasing power of capital in all entities that at least break even - ceteris paribus.¹ ²


2) Provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users.

The objectives try to answer the question: what is accounting suppose to do?

Continuous financial capital maintenance to continuously maintain the real value of capital stable can only be measured in units of constant purchasing power during inflation, hyperinflation and deflation.

Financial capital maintenance in nominal monetary units per se is a complete fallacy, even though it is a very popular accounting fallacy, it is authorized by the IASB in the Framework, Par 104 (a) in 1989 and even though it is 700 years old, a SA Generally Accepted Accounting Practice and forms part of real value destroying generally accepted traditional Historical Cost Accounting used by everyone. It still is a fallacy that costs SA about R200 billion per annum in real value unknowingly, unnecessarily and unintentionally destroyed by SA accountants implementing their very destructive stable measuring unit assumption - the second of the three very popular accounting fallacies - two of which are authorized by the IASB in the exact same Framework, Par 104 (a).

A company has continuously maintained the real value of its capital stable if it has as much capital - expressed in units of constant purchasing power - at the end of the reporting period as it had at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Consequently: a profit is earned only if the constant purchasing power of the net assets at the end of the period exceeds the constant purchasing power of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

Continuous financial capital maintenance implies maintaining the constant purchasing power of constant items by continuously applying the monthly CPI during low inflation and deflation. The daily parallel rate is continuously applied during hyperinflation.

Variable items are continuously valued in terms of IFRS excluding the stable measuring unit assumption during low inflation and deflation. Variable items are continuously valued in units of constant purchasing power during hyperinflation by applying the daily parallel rate.

Monetary items are money held and items with an underlying monetary nature valued in nominal monetary units during the reporting period. The net monetary loss or gain from holding monetary items is included in net income.

¹ “It is the overall objective of reporting for price changes to ensure the maintenance of the business as an entity.”

Accounting for Price Changes: An Analysis of Current Developments in Germany, Adolf G Coenenberg and Klaus Macharzina, Journal of Business Finance & Accounting, 3.1 (1976), P 53.

² The Framework, Par 104 (a): "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Kindest regards,

Nicolaas Smith

Three popular accounting fallacies: two IFRS approved

SA accountants preparing their companies’ financial reports in compliance with IFRS are required, in terms of the IASB´s Framework, Par 104 (a), to choose between measuring financial capital maintenance in nominal monetary units or in units of constant purchasing power. They actually have to choose the one or the other measurement basis. The choice is not made for them like under GAAP where Historical Cost Accounting is the generally accepted accounting model.

The Framework, Par 104 states that the financial and physical concepts of capital stated in Par 102 give origin to the financial and physical capital maintenance concepts.

The Framework, Par 104 (a) states:

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

Consequently, it does not simply state that the economic item financial capital can be measured in nominal monetary units, but, financial capital maintenance can be measured in nominal monetary units. Generally stated financial capital maintenance implies maintaining the real value of financial capital stable – all else being equal. However, under the Historical Cost model it is assumed that the monetary unit of account is stable: the very destructive stable measuring unit assumption. Under the HC model it is thus assumed that the real value of financial capital is maintained stable with measurement in nominal monetary units. The statement that financial capital maintenance can be measured in nominal monetary units which implies that financial capital is maintained stable in real value is a very popular fallacy amongst accountants. It is mostly a deceptive, misleading and false statement. It is only true per se in theory at sustainable zero inflation. It is always false per se during inflation and deflation in real terms. It is only true during low inflation when qualified to the effect that it is required that a company invests 100% of its Issued Share Capital, Share Premium Account and Non-distributable Reserves in revaluable fixed assets which always have a revalued or not revalued total real value equal to the updated real value of the original real values of those items.

The IFRS statement “Financial capital maintenance can be measured … in nominal monetary units” would only be true – per se – in nominal and real value terms in one single theoretical instance: it would only be possible to maintain the nominal and real value of financial capital stable in nominal monetary units per se – all else being equal – at sustainable zero inflation: an economic environment that has never been achieved in monetary history and is not very likely to be achieved any time soon or in the distant future. The above IASB statement is not a fallacy at zero inflation. It is, however, a purely theoretical statement: we have never had, we do not have and we most probably will never have sustainable zero inflation anywhere in the monetary economy.

It is impossible to maintain the real value of financial capital stable with measurement in nominal monetary units per se during low inflation and deflation. The above IFRS statement is thus false in terms of real value during low inflation and deflation. The real value of financial capital measured in nominal monetary units is being destroyed at a rate equal to the inflation rate during low inflation when a SA company has no revaluable fixed assets by its accountant’s choice of the HCA model during low inflation. The nominal value of financial capital is maintained in nominal value by measuring it in nominal monetary units during low inflation and deflation. This is, however, a popular fallacy: a false, misleading, unsound, inappropriate and deceptive notion in real value terms. HCA is an inappropriate accounting model authorized by the IASB which adds to general economic instability in SA´s low inflationary economy. It causes massive destruction of reported constant items´ real values, e.g. the real value of all existing reported Retained Earnings, during low inflation in the SA economy. It causes economic instability in the real economy as the real value of companies´ profits and capital is destroyed in this manner. This is mistakenly blamed on inflation by accounting standard setters, accounting authorities, accounting professors and lecturers as well as accountants.

The above IFRS statement is true in nominal value, false in real value and a fallacy during deflation. It results in economic instability during deflation by creating real value in constant items valued in nominal monetary units.

The IASB approved fallacy of financial capital maintenance in nominal monetary units during low inflation leads to SA accountants unnecessarily, unknowingly and unintentionally destroying about R200 billion per year in the real value of SA companies´ existing reported constant items because of their implementation of the stable measuring unit assumption in SA´s low inflationary environment.

The above is one of the three popular accounting fallacies. They are the following:

1. The stable measuring unit assumption: IFRS approved
2. Inflation erodes companies´ profits and capital (The FASB loves this one)
3. Financial capital maintenance in nominal monetary units: IFRS approved (The IASB loves this one)

These three fallacies constitute the very destructive basis of the traditional generally accepted IFRS authorized Historical Cost Accounting model fully approved in most probably all SA companies.

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

No reproduction without permission.

IFRS statement mainly a destructive fallacy

SA accountants doing their companies’ accounting in compliance with IFRS are required, in terms of the IASB´s Framework, Par 104 (a), to choose between measuring financial capital maintenance in nominal monetary units or in units of constant purchasing power.

The IFRS statement “Financial capital maintenance can be measured … in nominal monetary units” in the Framework, Par 104 (a) is mainly a destructive fallacy.

It would only be true – per se – in nominal and real value terms in one single theoretical instance: It would only be possible to maintain the nominal and real value of financial capital constant in nominal monetary units per se at sustainable zero inflation – an economic environment that has never been achieved in all of monetary history and is not very likely to be achieved any time soon or even in the distant future.

The IASB statement is not a fallacy at zero inflation. It is, however, a purely theoretical statement at zero inflation: We have never had, we do not have and we most probably will never have sustainable zero inflation anywhere in the monetary economy.

Kindest regards,

Nicolaas Smith

Destructive GAAP

SA accountants consider their unknowing destruction of the real value of existing reported constant items in SA companies by their free choice of implementing the stable measuring unit assumption as part of the traditional Historical Cost Accounting model to be similar to the cost of inflation which is not accounted under HCA during low inflation. They are consequently satisfied when it is also not accounted. They do not see the destruction of real value in companies´ profits and capital as a separate item from inflation. To them it is all part of the “erosion” caused by inflation. They are dead wrong. Inflation has no effect on the real value of non-monetary items. Inflation can only destroy the real value of money and other non-monetary items which are items with an underlying monetary nature.

The IASB authorized an alternative basic accounting model, financial capital maintenance in units of constant purchasing power in the Framework, Par 104 (a) which SA accountants are free to choose which would allow them to stop their unknowing destruction caused by their choice of the stable measuring unit assumption during low inflation.

SA accountants do not know they are destroying about R200 billion in real value each and every year when they freely choose, in terms of the Framework, Par 104 (a), an IASB authorized 700 year old traditional, generally accepted accounting model complaint with IFRS; consequently, they do not look for a solution: they ignore the other option in Par 104 (a), namely, financial capital maintenance in units of constant purchasing power.

The cost of inflation, i.e., the net monetary loss from holding monetary items is not accounted under HCA during low inflation. This is not the same as the cost of the stable measuring unit assumption: the unknowing destruction of constant items´ real values by SA accountants´ choice of measuring them in nominal monetary units implementing the stable measuring unit assumption during low inflation, when inflation can only destroy the real value of the Rand, the monetary unit of account. This is the cost of a destructive Generally Accepted Accounting Practice (GAAP) by SA accountants. This cost is also not accounted under HCA during low inflation. It thus appears to be the same as the net monetary loss - the cost of inflation. However, it is not the same, even though the IASB, FASB and most people think it is.

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

No reproduction without permission.

Blind leading the blind

In 2008 I agreed with the statement that inflation destroys the value of non-monetary items which do not maintain their real values. I agreed at the time but later I realized that it is wrong. Inflation has no effect on the real value on non-monetary items. It was stated that SA accountants are not doing the destroying, but inflation. That is dead wrong. They unknowingly destroy about R200 billion per year in the real values of SA banks´ and companies´ reported constant items, e.g. reported Retained Profits, never maintained, either under SA GAAP or implementing the stable measuring unit assumption.

SA accountants, it was stated, simply do not record this destruction. So, SA accountants know and admit that there is real value being destroyed. It is dead right when it is stated that they do not record this destruction. Why? Because SA accountants also mistakenly think it is caused by inflation. They maintain that it is the monetary authorities´ task to contain inflation which would reduce this cost. They mistakenly regard the destruction caused by their choice to implement the stable measuring unit assumption as “the erosion of business profits and invested capital caused by inflation” (FASB). They consider it to be similar to the cost of inflation which is not accounted under HCA during low inflation. They are consequently satisfied when it is also not accounted. They do not see it as a separate item. To them it is all part of the “erosion” caused by inflation.

Inflation is the well known enemy number one. SA accountants´ choice of the stable measuring unit assumption is the unknown but real enemy number two camouflaged by the fact that it has been authorized by the International Accounting Standard Board in International Financial Reporting Standards with its statement in the Framework, Par 104 (a) in 1989 that financial capital maintenance can be measured in nominal monetary units. That statement is only theoretically true as an accounting principle. It is impossible to maintain capital in nominal monetary units - per se - in our low inflationary economies.


IFRS are principles-based standards. That statement is only, in fact, true at sustainable zero inflation, an economic environment that has never been achieved in the past and is not likely to be achieved any time soon in the future - if ever. The IASB´s statment is generally false: it is false for all of economic history as well as the current state of the world and SA economy: it is thus generally false and can even be considered a fantasy. It´s result is the destruction by SA accountants - who freely choose the stable measuring unit assumption - of about R200 billion in the real value of SA banks´ and companies´ constant items never maintained in SA´s low inflation environment each and every year.
Almost like the blind leading the blind. Everybody blinded by an IFRS fantasy principle which is part of SA GAAP and the basis of the 700 year old traditional Historical Cost Accounting model.

All this can be stopped when SA accountants freely choose the other option also authorized by the IASB twenty years ago in the Framework, Par 104 (a):

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

Copyright © 2005 - 2010 Nicolaas J Smith

SA´s second enemy camouflaged by IFRS approval

It was stated that inflation destroys the value of non-monetary items which do not maintain their real values. I agreed at the time but later understood that this is wrong. Inflation has no effect on the real value on non-monetary items. To that way of thinking SA accountants are not doing the destroying, but inflation. That is dead wrong. SA accountants unnecessarily and unknowingly destroy about R200 billion per year in the real values of SA banks´ and companies´ reported constant items, e.g. reported Retained Profits, never maintained either under SA GAAP or with their free choice of measuring financial capital maintenance in nominal monetary units implementing the stable measuring unit assumption in terms of the IASB´s Framework, Par. 104 (a) which states that financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units.

According to that view, SA accountants simply do not record this destruction. That is dead right: they do not record it because they also mistakenly think it is caused by inflation and they can do nothing about it as their actions do not affect inflation. They mistakenly think the cost of the stable measuring unit assumption is similar to the cost of inflation: the net monetary loss from holding monetary items, the only harm caused - and able to be caused - by inflation, which is not accounted under HCA during low inflation. It is not the same.

What SA accountants ignore is the fact that the IASB authorized an alternative basic accounting model, financial capital maintenance in units of constant purchasing power in the Framework, Par. 104 (a) twenty years ago which they are free to choose which will allow them to stop their unknowing destruction of about R200 billion in the real value of SA banks´ and companies´ constant items which they unknowingly destroy each and every year by measuring them in nominal monetary units implementing their very destructive stable measuring unit assumption under HCA in SA´s low inflationary economy.

The cost of inflation, i.e., the net monetary loss from holding monetary items is not accounted under HCA during low inflation. This is not the same as the cost of the stable measuring unit assumption: the unknowing destruction of constant items´ real values by SA accountants´ choice of measuring them in nominal monetary units implementing the stable measuring unit assumption during low inflation, when inflation can only destroy the real value of the Rand, the monetary unit of account. The latter is the cost of a destructive Generally Accepted Accounting Practice (GAAP) by SA accountants, namely, valuing constant items in nominal monetary units implementing the stable measuring unit assumption during low inflation. This cost is also not accounted under HCA during low inflation. It thus appears to be exactly the same as the net monetary loss - the cost of inflation. However, it is not the same, even though most people think it is.

The indisputable proof - from an accounting standards point of view - that inflation does not destroy the value of non-monetary items which do not maintain their real values is the fact that the cost of this destruction is not calculated as part of the net monetary loss in FAS 33: US Statement of Financial Accounting Standards No. 33 Financial Reporting and Changing Prices. It is thus a mistaken view. FAS 33 required the purchasing power gain or loss on net monetary items to be presented as supplementary information in published annual reports in companies using HCA during inflation.

IAS 29 also requires the calculation of the net monetary gain or loss from holding monetary items, but, during hyperinflation rejecting the stable measuring unit assumption; i.e. measuring all non-monetary items in units of constant purchasing power. There is no cost from the stable measuring unit assumption when it is not applied. In practice, it is normally exactly the opposite in hyperinflationary economies which do not follow the Brazilian example by indexing all non-monetary items. In practice, it is the stable measuring unit assumption that is applied even under hyperinflation which hyper-destroys the non-monetary or real economy together with hyperinflation in monetary items which hyper-destroys the monetary economy. The two enemies in the economy: the one seen as a monster, the other – wreaking maybe even more damage – a stealth enemy camouflaged by IFRS approval.

Copyright © 2005 - 2010 Nicolaas J Smith

Capital is a variable item or monetary item in SA

Capital is a constant real value non-monetary item.

However, there is no constant real value non-monetary item capital in South Africa under the Historical Cost Accounting model during low inflation.

Issued Share Capital and Share Premium Account values are, in fact, treated as variable items under HCA when a SA company owns revaluable fixed assets.

Issued Share Capital and Share Premium Account real values depend on the variable real non-monetary values of the fixed assets over time determined at fair value in terms of IFRS during low inflation.

When SA companies have no revaluable fixed assets under HCA, capital is, in principle, treated the same as a monetary item (money or cash) and SA accountants unknowingly destroy its real value at a rate equal to the rate of inflation because of their choice of the HCA model which include their very destructive stable measuring unit assumption in SA´s low inflationary environment.

Capital will only become a constant real value non-monetary item in the SA economy when SA accountants freely choose financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) twenty years ago. This is compliant with IFRS.

SA accountants are told that it is not them but inflation doing the destroying. That statement is dead wrong.  Most people think it is inflation doing the destroying. The US FASB sums up this view very well in its statement: “ the erosive impact of inflation on profits and capital ".

Copyright © 2005-2010 Nicolaas J Smith

Sticky salaries and wages

The constant real value non-monetary items salaries and wages are generally sticky downwards: it is not easy for firms to reduce them in nominal value.

It is, of course, very easy to reduce their real values during inflation: just keep them the same or increase them at a rate lower than the inflation rate.

It may happen that it could be some time before the concept of enhanced economic stability during deflation via financial capital maintenance in units of constant purchasing power is generally accepted.

Salaries and wages would then be automatically decreased in nominal value by means of measurement in units of constant purchasing power while their real values would stay the same during deflation. This would improve economic stability substantially and help central banks in their task of getting the economy into a low inflationary mode again. It would also reduce the level of the monetary effect of lower prices during deflation.

Salaries and wages are already being decreased in nominal value in the labour market during deflation, but, not yet by measuring them in units of constant purchasing power in terms of the negative change in the CPI.

There is a lot to be learned about how financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) as an alternative to the real value destroying traditional Historical Cost Accounting model would enhance general economic stability substantially during both low inflation and deflation. It would remove a great part of the distortion in the economy caused by SA accountants´ choice to implement their very destructive stable measuring unit assumption.

This is besides maintaining about R200 billion per annum in the SA constant item economy unnecessarily, unknowingly and unintentionally currently being destroyed by SA accountants´ choice of the stable measuring unit assumption during low inflation.

SA accountants mistakenly blame their unnecessary, unknowing and unintentional destruction of the real value of companies´ capital and profits on inflation since they do not value and account it the same way they do not value and account the net monetary gain or loss from holding monetary items during low inflation and deflation although this can be done according to Kapnick.

SA accountants can not stop the destruction of real value of monetary items in the SA monetary economy. The SARB with its monetary policy and the government with its economic policies have to reduce inflation which would reduce the amount of real value destruction in the monetary economy. The late Milton Friedman so famously stated "Inflation is always and everywhere a monetary phenomenon." Inflation can only destroy the real value of the Rand and other monetary items in the SA monetary economy - nothing else. Inflation has no effect on the real value of non-monetary items

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.

SA accountants can easily stop their about R200 billion annual destruction of the profits and capital of SA banks and companies and its negative effect on economic growth and employment during low inflation.

When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as the IASB authorized them 20 years ago, they would value and account the cost of inflation during low inflation as they are already required (forced) to do during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. They would also maintain about R200 billion in SA banks´ and companies´ existing profits and capital by not unknowingly destroying that amount each and every year as they are unknowingly doing right now in existing reported constant items, e.g. all reported Retained Profits in all SA banks and companies, never maintained in the SA non-monetary or real economy with their very destructive stable measuring unit assumption during low inflation. This would have a positive impact on economic growth and employment for an unlimited period of time.

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

No reproduction without permission.