Accounting for non-accountants: stable measuring unit assumption

For accountants

Accountants today still apply their stable measuring unit assumption to the valuation of companies´ capital and profits.

Under the current global Historical Cost Accounting model you can keep your capital and profits at nominal value if you always buy fixed property or land for the exact original real value of the capital and profits you keep in your company. The real value of your capital and profits - stated at nominal value - would generally be maintained by sufficient unrecorded or hidden holding gains in the revaluable fixed property assets. Only maybe hotel companies and perhaps also property companies buying properties and making money from the rent can generally maintain the real value of their capital and profits (I don’t really think so) by stating them in nominal values in their books. Most other companies do not do that.

For non-accountants

The three basic economic items in the economy are valued as follows:

1. Monetary items

Examples: Rands, bank loans, car loans, housing loans, student loans, any money loan or savings in Rand.

You can only value and account or state them at their original nominal values during the current financial period. No other way because you cannot update money.

2. Variable real value non-monetary items

Examples: property, plant, equipment, stock, shares, foreign exchange, etc.

They are valued by accountants in terms of International Financial Reporting Standards or SA Generally Accepted Accounting Practice.

3. Constant real value non-monetary items

Examples: capital, retained profits, capital reserves, trade debtors, trade creditors, taxes payable, taxes receivable, etc.

They have constant real values, but, accountants value them at historical cost: i.e. they treat them the same as money.

Now, we all know inflation destroys the real value of money.

Accountants think that inflation also destroys the real value of capital, retained profits, debtor, creditors, etc.

Obviously it is not inflation destroying these items´ real values: it is their choice of valuing these items in nominal monetary units. They can also value them in units of constant purchasing power; i.e. they can inflation-adjust them during low inflation. The IASB authorized them 21 years ago to do that.

Accountants do not do this because they are not taught to do that and because they and all accounting authorities think it is inflation doing the destroying. It is not inflation. Inflation can only destroy the real value of money. Nothing else. Inflation can not destroy the real value of non-monetary items. When accountants inflation-adjust these items, they never lose their real values, no matter what the rate of inflation.

All accountants and accounting authorities believe absolutely that the erosion of capital and profits is caused by inflation. They have absolutely no doubt about it. They are wrong. Inflation cannot destroy the real value of non-monetary items. When they inflation adjust these items, they maintain their real values forever in companies that at least break even.

What is so good about financial capital maintenance in units of constant purchasing power is that it has been authorized by the IASB 21 years ago and that it does not require any more new money or new capital to maintain companies´ capital and profits. Accountants unknowingly destroy companies´ capital and profits by treating capital and profits like money when they implement their stable measuring unit assumption.

So, they can maintain capital and profits´ real values by not destroying these existing real values. As simple as that.

How is this done? By inflation-adjusting all constant items in a company and by accounting the loss of real value in money caused by inflation. No extra new money needed.

This has been authorized by the IASB in 1989 and is compliant with International Financial Reporting Standards. So, there is nothing to worry about: it is all legal and IASB-approved.
Copyright © 2010 Nicolaas J Smith

Accounting for Non-CA´s: Monetary items

For CA´s

“Monetary items have to be stated at their original nominal values because money cannot be updated. Inflation destroys the real value of money, but accountants ignore this real value destruction during low inflation, but, account it during hyperinflation. Obviously, if you account it under hyperinflation, you also have to account it under low inflation.”

For Non-CA´s

There are three fundamentally different basic economic items in the economy:

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

Monetary items

The R100 notes in your pocket do not magically change to R94 notes after a year of 6% inflation. They keep their nominal value of R100, but, they are only worth R94 in real value.

So, in your business, if you have R100 000 in your company bank account on 1st January and you keep the money in the bank for the whole year, then your accountant will state that R100 000 as R100 000 in your year end accounts. It is only worth R94 000 in real value, but, because the R100 note in your pocket cannot change, your accountant has to state the money as R100 000 in your accounts.

Compare this to stock: if you had R100 000 stock for resale in your company on 1st January and you have the same stock on 31st December and the stock´s net realizable value was only R94 000 your accountant will account it at R94 000 with R6 000 written off as a loss in your profit and loss account. But, he is not allowed to do that with the real value loss in money - not under low inflation. Under hyperinflation, yes, but not under low inflation. Crazy, isn´t it? This gets fixed under financial capital maintenance in units of constant purchasing power during low inflation which was authorized by the IASB in 1989 and which I promote for SA accountants. I am actually an unofficial agent for the IASB - doing what they should have been doing for the last 21 years - but, they don´t like me either because I state that accountants unknowingly destroy real value doing traditional historical cost accounting and they base International Financial Reporting Standards on fallacies - which is true.

Inflation, in very simple terms, means there are too many Rands in the economy in relation to the actual real value in the economy. Zero inflation would mean, for example, that there are R100 billion of real value in the economy and R100 billion of Rands in the economy and it stays like that over a year. What does actually happen is that there are R100 billion real value in the economy and R106 billion of Rands in the economy. Now there are too many Rands and every Rand, after a year, is only worth 100/106 = R0.94 in real value. So, the simple fact of having too many Rands in the economy destroyed the real value of each and every Rand by 6%: each and every Rand is now only worth 94 cents. This is inflation in simple terms. So, it is thus a fact that inflation always and everywhere destroys the real value of money and monetary items like bank loans over time.

The International Accounting Standards Board, the highest accounting authority in the world, forces companies do show this loss or cost of inflation as an actual business cost, but, only during hyperinflation. The IASB defines hyperinflation as 100% cumulative inflation over 3 years. 26% annual inflation for 3 years in a row will equal 100% cumulative inflation. So, the IASB forces companies to account the cost of inflation as a business cost being deducted from profits before tax, but, only during hyperinflation and not during low inflation. This is obviously wrong. If companies have to do it at 26% annual inflation for 3 years in a row they obviously have to do it at 20% annual inflation for 3 years in a row too and at 6% annual inflation and 2% annual inflation and 1% annual inflation, etc. A cost is a cost under all circumstances. But, not according to the IASB. That is obviously a mistake.

When SA accountants stop Historical Cost Accounting during low inflation, as I am promoting, they will change to financial capital maintenance in units of constant purchasing power and they will account the cost of inflation during low inflation as they are required by the IASB to do under hyperinflation. Financial capital maintenance in units of constant purchasing power has also been authorized by the IASB twenty-one years ago. So, it is fine for SA accountants to change over and do that.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Historical Cost Accounting erodes companies´ equity

Boerseun, Thank you for your visits. You know I appreciate your comments.

Today you stated:

"I always come to read your posts and then get even more confused. I try my best and the little bit that I do grasp does at least show me something is seriously wrong."

It is really easy to understand.

People think money keeps its real value. That is not true, as you know and as we all know.

A long time ago, let´s say 200 years ago, accountants did all accounting at the original historical values of all items.

They assumed money was perfectly stable in real value; i.e. they assumed there was no inflation and there never will be inflation. They applied their stable measuring unit assumption. We all know there is inflation and money loses its real value.

Over the last 100 years they have realized that you cannot value everything at its original historical cost. You cannot value shares you bought at R1 per share in 1951 which are selling on the JSE today at R1000 per share at the original R1 per share, for example. You have to show them in your accounts at their current value.

So, accountants have rules (International Financial Reporting Standards) to value variable real value non-monetary items.

Monetary items have to be stated at their original nominal values because money cannot be updated. Inflation destroys the real value of money, but accountants ignore this real value destruction during low inflation, but, account it during hyperinflation. Obviously, if you account it under hyperinflation, you also have to account it under low inflation.

Accountants today still apply their stable measuring unit assumption to the valuation of companies´ capital and profits.

Under the current global Historical Cost Accounting model you can keep your capital and profits at nominal value if you always buy fixed property or land for the exact original real value of the capital and profits you keep in your company. The real value of your capital and profits - stated at nominal value - would generally be maintained by sufficient unrecorded or hidden holding gains in the revaluable fixed property assets. Only maybe hotel companies and perhaps also property companies buying properties and making money from the rent can generally maintain the real value of their capital and profits (I don’t really think so) by stating them in nominal values in their books. Most other companies do not do that.

Because they do not update their capital and profits, their accountants are unknowingly destroying capital and profits´ real values at the rate of inflation. When they do not update the constant real value non-monetary items capital and retained profits, then they are the same as monetary items and we all know money and monetary items lose their real values because of inflation. The same happens to capital and profits not updated. They all think for a very long time that it is inflation doing this destroying. Capital and profits are constant real value non-monetary items. They are not monetary items. If they value capital and profits in units of constant purchasing power (inflation-adjust them) then they will always maintain their real values, no matter what the inflation rate is. So, it is not inflation doing the destroying, it is their choice of the stable measuring unit assumption which they can stop any time they want to.

However, under hyperinflation they update capital and profits, but, not under low inflation. So, they admit and agree that capital and profits must be updated under hyperinflation, but, they refuse to do it under low inflation. They admit that capital and profits´ real values are destroyed under hyperinflation, i.e. 26% inflation for 3 years in a row equalling 100% cumulative inflation (the IASB´s definition of hyperinflation) but they do not consider that, say, 20% inflation forever will require them to update capital and profits. They claim that there is no destruction of the real value of capital and profits at 20% inflation – or if there is, then it is inflation´s fault: it has nothing to do with their decision to choose the stable measuring unit assumption and to implement it. A decision they can change to financial capital maintenance in units of constant purchasing power today, if they want to: but, no, it is inflation doing the destroying – according to the IASB, the US FASB and all accountants.

They thus unknowingly destroy the real value of capital and profits under low inflation.

That is all I am stating. Very easy to understand. They are all very upset with me because I say they do this unknowingly, unnecessarily and unintentionally.
The International Accounting Standards Board authorized them to update capital and profits during low inflation in the Framework, Par 104 (a) in 1989. It states:

“Financial capital maintenance can be measured either in nominal monetary units OR IN UNITS OF CONSTANT PURCHASING POWER.”

So, accountants can stop this destruction any time they want to. I am just promoting that idea. That´s all. It is not my idea. It is the IASB´s idea.

Because accounting is double entry, it means that they can maintain the real value of capital and profits in all companies that at least break even FOREVER, by just updating all constant items equally and correctly. There is no extra money required to do this. They must just stop destroying existing real value. It is a matter of maintaining existing real value. No extra money required at all. Just stop destroying real value that already exists.

The IASB forces them to do this under hyperinflation, but, under low inflation it gives them a choice. Because all accountants have been applying the stable measuring unit assumption for the last 700 years and all the accountants in the world are doing it today, except in hyperinflationary economies, no-one wants to change.

The truth is that they do not realize it is happening. They all think it is inflation doing the destroying and that they as accountants can do nothing about it. It is not true. The IASB forces them to do it correctly under hyperinflation.

Accountants and all accounting authorities state very firmly and very, very confidently that the erosion (destruction) of companies´ capital and profits is caused by inflation. The IASB, the US FASB, everybody agree with that statement. So they all agree that companies´ capital and profits are being destroyed. There is no problem with that. They all admit it. There is destruction of real value. But, they all blame inflation.

However, it is impossible for inflation to destroy companies´ capital and profits because inflation is always and everywhere a monetary phenomenon, as Milton Friedman stated. Inflation has no effect on the real value on 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.

So, Boerseun, it is not so difficult to understand. Quite easy actually.

My estimate of the real value unknowingly destroyed by SA acountants in constant items never maintained is about R200 billion per annum. That is quite a lot of real value that is destroyed each and every year in the SA real economy. All SA accountants have to do to stop that and to boost the SA real economy with about R200 billion each and every year forever is freely choose financial capital maintenance in units of constant purchasing power; i.e. they must choose to update capital and profits instead of unkowingly destroy their real values year in year out.


Copyright © 2010 Nicolaas J Smith

The world only goes round by misunderstanding

The world only goes round by misunderstanding. Charles Baudelaire

It is generally accepted under the current Historical Cost paradigm that the economy is divided in only two parts: the monetary economy and the non-monetary or real economy. It is also generally accepted that there are only two basic economic items in the economy: monetary items and non-monetary items. Monetary items are money held and items with an underlying monetary nature. Non-monetary items are all items that are not monetary items.

No distinction is generally made between the valuation of variable real value non-monetary items, e.g. property, plant, equipment, inventory, etc valued at Historical Cost under the Historical Cost Accounting model and constant real value non-monetary items, e.g. Issued Share capital, retained Earnings, other items in Shareholders´ Equity and most items in the income statement (excluding items like salaries, wages, rentals, etc. valued in units of constant purchasing power) also valued at Historical Cost under the HCA model.

This is the result of the fact that the economy is based on the Historical Cost paradigm. Historical Cost is the traditional measurement basis in accounting. It is thus generally accepted for accountants to choose to implement the very destructive stable measuring unit assumption (based on a fallacy) and measure financial capital maintenance in nominal monetary units (another complete fallacy) as authorized by the IASB in the Framework, Par 104 (a) during low inflationary periods.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Value date December 2009

South African Consumer Price Index 109.2 December 2009

Base year 2008 = 100 Table A – All Urban Areas

All items in financial reports dated December 2009 have to be updated or restated or inflation-adjusted in terms of the December 2009 CPI in order to reflect their correct and valid nominal or updated or inflation-adjusted values at the date they are read. Unadjusted December 2009 financial reports are out of date or wrong as from the date the January 2010 CPI is published - if it is different from the December 2009 CPI value. All financial reports not updated or restated or inflation-adjusted every time the CPI changes are - in principle - wrong. They certainly are out of date. Since most financial reports are not published during the period of the CPI for their period-end date, most financial reports are always published, in principle, with wrong values at first publication.

All SA financial reports of SA companies with December year ends published after the January 2010 CPI (with a different value from the 109.2 December 2009 value) is published and these financial reports are not inflation adjusted or restated or updated in terms of the January 2010 CPI value, will be published with wrong values on first publication.

Values in electronic copies will be updated automatically with Real Value Enabler™ - US Patent Applied For - when the necessary technology becomes available.

Example

Assumption: Inflation assumed to remain at 6% per annum in SA for an indefinite period of time.

..............................................Nominal Value........Real Value
.....................................................................at Dec 2009
CPI as at Dec 2009..............109.2.........R100.00.............R100.00

Assumed values for the CPI

Dec 2010........................115.8.........R106.00.............R100.00
Dec 2011........................122.7.........R112.36.............R100.00
Dec 2012........................130.1.........R119.10.............R100.00
Dec 2013........................137.9.........R126.25.............R100.00
Dec 2014........................146.1.........R133.82.............R100.00
Dec 2015........................154.9.........R141.85.............R100.00
Dec 2020........................207.3.........R189.83.............R100.00
Dec 2030........................371.2.........R339.96.............R100.00
Dec 2080......................6 838.2.......R6 262.05.............R100.00


All financial reports, e.g. income statements and balance sheets, dated December 2009 have to be restated as above to be able to be read correctly at the above future dates.

The restated values will not be the assumed real values of the items at the above future dates, but, the real values of the items at December 2009 restated at the assumed future CPI values.

All items in historical financial reports have to be restated every time the CPI changes, not to value them correctly, but, to reflect their real values correctly at the original date of the financial report.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Price-level accounting does not prevail for balance sheet constant items

Price-level accounting as Harvey Kapnick hoped for in 1976 clearly does not prevail for balance sheet constant items and most income statement items, except during rare instances of hyperinflation (e.g., Turkey’s latest period of hyperinflation) when companies are required to implement IAS 29 which is the IASB´s Constant Purchasing Power inflation accounting model and the tax authorities accept the restated amounts as the new real values of those items as happened in the case of Turkey.

Price-level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when they indexed many variable and constant items in their non-monetary or real economy with daily indexation with a daily index value supplied by their government. They stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They stopped daily indexation which is, in principle, the same as continuous financial capital maintenance in units of constant purchasing power.

Price-level accounting does prevail in the valuation of certain income statement items, e.g. salaries, wages, rentals, etc. which are inflation-adjusted annually by means of the CPI in most economies.

If SA accountants understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional destruction by SA accountants of massive amounts of real value in constant items never maintained in the SA economy, they would have called for its rejection by now.


Copyright © 2010 Nicolaas J Smith

IASB clueless about destruction by stable measuring unit assumption

The International Accounting Standards Board confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 Financial Reporting in Hyperinflationary Economies and in the Framework that companies´ primary financial reports are prepared in most economies based on the traditional Historical Cost Accounting model without taking changes in the general level of prices (here it is clear that the IASB blames inflation and not the stable measuring unit assumption) or specific price changes of assets into account, with the exception that investments, equipment, plant and properties can be revalued. The IASB does not mention the destruction of the real value of balance sheet constant items never maintained when accountants implement the stable measuring unit assumption during low inflationary periods because it is not generally understood: the IASB, like the US Financial Accounting Standards Board and most accountants mistakenly believe that the destruction (erosion) of companies´ capital and profits is caused by inflation.

They all support the stable measuring unit assumption (based on a fallacy) and the actual fallacy of financial capital maintenance in nominal monetary units during low inflation and deflation. The destruction of real value in constant items by implementing the stable measuring unit assumption is very well understood - and compensated for by inflation-adjusting them by applying the annual CPI - in the case of the income statement constant items salaries, wages, rentals, etc.

Neither is the real value maintaining effect on balance sheet constant items understood of freely choosing to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved by the IASB in the Framework, Par 104 (a).

The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position. Whereas the FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89, the IASB never mentioned it in either IAS 6 Accounting Response to Changing Prices or IAS 15. IAS 15 completely superseded IAS 6. IAS 15 was eventually withdrawn.

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. FAS 89, Par 4, 1986

The integrity of the historical cost/nominal dollar system relies on a stable monetary system. FAS 33, 1979.
Copyright © 2010 Nicolaas J Smith

Accounting can not and does not create real value out of thin air

It must be clearly understood, however, that accounting per se can not and does not create real value out of thin air – out of nothing.

Accountants can not and do not create real value or wealth by simply passing some update accounting entries when no real value already exists.

Constant real value non-monetary items, e.g. Issued Share Capital, Share Premium, Retained Profits, Capital Reserves, other items in Shareholders´ Equity, Trade Debtors, Trade Creditors, Taxes Payable, Taxes Receivable, etc first have to exist for accountants to be able to maintain the real values of those existing constant real value non-monetary items stable by continuously measuring financial capital maintenance in units of constant purchasing power as approved by the IASB and by continuously valuing income statement constant items in terms of units of constant purchasing power in order to determine profit or loss in units of constant purchasing power during low inflation and deflation.

Accountants can maintain the existing real values of existing balance sheet constant items, e.g. Issued Share capital, Retained Earnings, etc stable in companies at least breaking even for an unlimited period of time, ceteris paribus, when they choose to measure financial capital maintenance in units of constant purchasing power during low inflation and deflation as approved by the IASCB in the Framework, Par 104 (a) in 1989 and adopted by the IASB in 2001.

The Framework, Par 104 (a) states:

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

Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy. It is impossible to maintain the real value of capital stable in nominal monetary units per se during inflation and deflation. The only way to maintain the real value of capital constant during inflation and deflation per se in companies that at least break even - all else being even - is with financial capital maintenance in units of constant purchasing power.

The IASB has thus, amazingly, authorized the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation as well as its only and perfect antidote during inflation and deflation in one and the same statement in 1989. The antidote is perfect during inflation and deflation; the values may not be perfect as a result of the way the CPI is calculated.

Obviously, at sustainable zero inflation constant items will maintain their real values stable in all companies that at least break even. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Capital deficiency during sub-prime crisis

The world economy would be more robust today if only financial capital maintenance in units of constant purchasing power had been authorized in the Framework, Par 104 (a) in 1989. Accountants would today maintain the real values of all companies´ and banks´ Issued Share Capital, Retained Earnings and all other items in Shareholders´ Equity since then in companies and banks that at least break even, instead of unknowingly destroying their real values never maintained at a rate equal to the rate of inflation year in year out during low inflationary periods when they implement their very destructive stable measuring unit assumption based on a fallacy, but, approved by the IASB – for an unlimited period of time during indefinite inflation. They unknowingly do this because they are authorized to choose to measure financial capital maintenance in nominal monetary units – another complete fallacy also approved by the IASB – implementing the traditional HCA model authorized by the IASB in the exact same Framework, Par 104 (a) 21 years ago.

Had only real value maintaining financial capital maintenance in units of constant purchasing power been approved in 1989 it would have made a significant difference over this period as verified by the huge capital injections required as a result of the capital deficiency problems caused by the continuous unknowing, unnecessary and unintentional destruction by accountants´ implementation of the stable measuring unit assumption in the valuation of banks´ and companies´ Shareholders´ Equity values never maintained under the HCA model as evidenced during the recent sub-prime financial crisis.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Financial capital maintenance in units of constant purchasing power

Financial capital maintenance in units of constant purchasing power, i.e. the inflation-adjustment by means of the CPI of only constant items - not inflation accounting complete price-level adjustment of all (variable and constant) non-monetary items - during low inflation and deflation has also been authorized by the IASC Board thirteen years after Harvey Kapnick´s 1976 prediction. The IASC Board approved the Framework, Par 104 (a) in 1989 stating that

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

However, the enormous real value destroying function of the very destructive stable measuring unit assumption when accountants choose, also in terms of Par 104 (a), the IASB approved very popular accounting fallacy of financial capital maintenance in nominal monetary units and apply it in the valuing of constant items never maintained, e.g. reported retained earnings, in low inflationary economies when the stable measuring unit assumption is maintained for an unlimited period of time during indefinite inflation, is not generally understood by the IASB and SA accountants, at all. This is clearly verified by the fact that both financial capital maintenance in nominal monetary units as well as real value maintaining financial capital maintenance in units of constant purchasing power during inflation and deflation were approved by the IASB in the Framework, Par 104 (a) in 1989. Accountants can choose the one or the other and state that they have prepared primary financial statements in terms of IFRS.

However, when they choose the traditional HCA model they unknowingly destroy real value on a massive scale in the real or non-monetary economy during low inflation when the very destructive stable measuring unit assumption is maintained for an unlimited period of time during indefinite inflation. When they choose IASB approved financial capital maintenance in units of constant purchasing power they would maintain the real values of all constant items during inflation and deflation in companies which at least break even, empowering and enriching those companies, their shareholders and the economy in general with the accompanying benefits to workers and employment for an unlimited period of time – all else being equal.

As the Deutsche Bundesbank stated:

“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”

Deutsche Bundesbank, 1996 Annual Report, P 83.

Financial capital maintenance in units of constant purchasing power during inflation and deflation would result in absolute price stability only in constant items for an unlimited period of time in companies that at least break even – all else being equal. The IASB predecessor body, the IASC Board, approved absolute price stability in income statement and balance sheet constant items when they authorized the Framework, Par 104 (a) in 1989 approving the option of measuring financial capital maintenance in units of constant purchasing power during low inflation and deflation.

HCA is very destructive during inflation

Also approving the traditional HCA model in the Framework, Par 104 (a), on the other hand, has been very costly for the world economy as amply illustrated by the deficiency in bank and company capital during the recent sub-prime financial crisis. This clearly illustrates the lack of understanding the very destructive effect of the stable measuring unit assumption on balance sheet constant items during low inflationary periods.
Copyright © 2010 Nicolaas J Smith

Historical Cost Accounting is based on popular IASB-approved accounting fallacies

Price-level accounting

SA accountants generally choose to measure financial capital maintenance in nominal monetary units (one of the three very popular accounting fallacies not yet extinct) and thus apply their very destructive stable measuring unit assumption (another of the three accounting fallacies) as part of the traditional HCA model based on these fallacies. They generally value balance sheet constant items as well as most income statement items – which are all constant items - at Historical Cost because they value them in nominal monetary units as a result of the fact that they assume the Rand is perfectly stable for this purpose. They only value certain income statement items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and inflation-adjust them by means of the annual CPI during low inflation.

Complete price-level accounting

Complete price-level accounting also called Constant Purchasing Power Accounting (CPPA) was developed as an inflation accounting model whereby all non-monetary items – variable and constant items – are inflation-adjusted by means of the period-end CPI in order to make financial statements more comparable with previous year statements during periods of high and hyperinflation. The non-monetary or real economy of a hyperinflationary economy can only be maintained stable by applying the daily parallel US Dollar exchange rate to the valuation of all non-monetary items instead of the period-end CPI as required by IAS 29.

The Framework is applicable

The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non-hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Framework, Par 102 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11. The valuation of the constant items Issued Share capital, reported retained earnings, other items in Shareholders´ Equity and other constant items is thus covered in 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” authorized in 1989.

Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:

“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”

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

Kindest regards,

Nicolaas Smith

© Copyright 2010 Nicolaas J Smith

Value accounting prevails for monetary and variable items

The accounting model SA accountants choose determines whether they unknowingly destroy massive amounts annually in the real value of reported constant items never maintained or knowingly would maintain massive amounts of real value every year in reported constant items in the constant item economy depending on whether they choose the IASB-approved traditional HCA model when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation or IASB-approved financial capital maintenance in units of constant purchasing power during inflationary and deflationary periods – both models amazingly approved in the Framework, Par 104 (a) in 1989. It is not inflation doing the destroying in reported constant real value non-monetary items never maintained, e.g. in companies´ capital and profits, as the IASB, the FASB and most accountants believe. SA accountants are unnecessarily, unknowingly and unintentionally doing the destroying when they implement the stable measuring unit assumption during indefinite inflation. Inflation has no effect on the real value of non-monetary items.

Value accounting

There is, on the other hand, also strong awareness in the accounting profession that accounting is really about value and not simply about Historical Cost.

"...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions”

Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.

Most SA accountants agree that accounting should be value based. By value based they mean that variable real value non-monetary items can not always be valued at Historical Cost and are to be valued in terms of specific standards formulated in IFRS or SA GAAP at, for example, market value, net realizable value, fair value, present value or recoverable value, etc.

Value accounting has been specifically defined in International Standards since 1976 via IAS and IFRS relating to variable items. Value accounting thus prevails in the valuation and accounting of variable items in terms of IAS and IFRS.

Value accounting also prevails as far as the accounting and valuing of monetary items during the current accounting period are concerned. Monetary items are measured in nominal monetary units no matter which accounting model is used. The real values of monetary items are kept always current by inflation and deflation since the nominal values of monetary items are normally not updated or inflation-adjusted during the current accounting period in any inflationary or deflationary economy. The real value of money and other monetary items generally changes monthly during inflation and deflation. It is destroyed during inflation and increased during deflation.

The nominal values of monetary items stay the same during the current financial period under any accounting model, but, their real values are automatically adjusted by inflation and deflation. The real value of money and other monetary items can be halved every 24.7 hours as has happened recently during hyperinflation in Zimbabwe. According to Prof Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.

The net monetary loss or net monetary gain resulting from holding an excess of either monetary item assets or monetary item liabilities is currently only calculated and accounted during the implementation of Constant Purchasing Power inflation accounting as defined in IAS 29 in hyperinflationary economies. Net monetary gains and losses would also be calculated and accounted during low inflation and deflation when companies start measuring financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a). They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick. See Saxe Lecture, 1976.

Copyright (c) 2005-2010 Nicolaas J Smith

SA accountants clueless about destruction by stable measuring unit assumption

The real values of many reported constant real value non-monetary items, for example, reported retained earnings never maintained, in the SA economy are currently not being maintained stable during low inflation. To the contrary: they are unnecessarily, unknowingly and unintentionally being destroyed at a rate equal to the annual rate of inflation by SA accountants implementing their very destructive stable measuring unit assumption when they measure financial capital maintenance in nominal monetary units – the accounting fallacy as authorized by the IASB in the Framework, Par 104 (a) in 1989 - for an unlimited period of time during indefinite inflation.

Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items stable during inflation and deflation is a basic objective of accounting. This is the result of:

(1) the three popular accounting fallacies; namely,

(a) the stable measuring unit assumption (authorized by the IASB) ,
(b) financial capital maintenance in nominal monetary units (authorized by the IASB) and
(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB, the FASB);

(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very destructive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied for an unlimited period of time during indefinite inflation and

(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant items of continuously measuring financial capital maintenance in units of constant purchasing power during low inflation as approved by the IASB in the Framework, Par 104 (a).

If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units by now.


This is what the International Accounting Standards Committee Board authorized 21 years ago in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a):

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

It was adopted by the IASB in 2001.

Amazingly the very popular accounting fallacy of financial capital maintenance in nominal monetary units and its perfect antidote are both authorized in the exact same IASB statement in 1989.

There are no specific IFRS relating to the concepts of capital or the concepts of capital maintenance. The Framework thus applies.

“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 December 2009

Copyright © 2005 - 2010 Nicolaas J Smith

It is not inflation doing the destroying

The understanding of the difference between the generally accepted accounting practice whereby SA accountants unnecessarily, unknowingly and unintentionally destroy the real values of only existing reported constant items never maintained only in the SA constant item economy with their free choice of implementing their very destructive stable measuring unit assumption during low inflation as authorized by the IASB when it approved the very popular accounting fallacy of financial capital maintenance in nominal monetary units during low inflation in the Framework, Par 104 (a) in 1989 and the destruction by the economic process of inflation of the real value of only money and other monetary items only in the monetary economy is an ongoing process. It has become clear to me, since September 2008, that inflation and hyperinflation only destroy the real value of money and other monetary items. Inflation and hyperinflation only have one – a monetary – component. It is clear to me now that it is not inflation that is causing (or hyperinflation that could cause) the destruction of the SA real economy or the real value of reported constant items never maintained in the SA real economy. It is clear to me now that inflation does not have a non-monetary component.

Copyright © 2005 - 2010 Nicolaas J Smith

Economic fallacies not yet extinct

Economic history is replete with fallacies which became extinct with the developement of economic understanding.

The three economic fallacies not yet extinct are:

1. The stable measuring unit assumption.

2. Financial capital maintenance in nominal monetary units.

3. The erosion of companies´ profits and capital caused by inflation.

We all know that money is not perfectly stable and that it is impossible to maintain the real value of capital with financial capital maintenance in nominal monetary units per se during inflation and deflation.

SA accountants unknowingly destroy the real value of companies´ profits and capital never maintained with their free choice of implementing the stable measuring unit assumption during inflation. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.

The erosion of companies´ capital and profits by inflation is a very popular accounting fallacy stated by, for example, the US Financial Accounting Standards Board:

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. Financial Accounting Standard FAS 89 (voluntary disclosure), Par 4, P 5, 1986

and

Mr. Mosso dissents because he believes that the Statement does not bring the basic problem it addresses — measuring the effect of inflation on business operations — into focus. Because of that he doubts that it will effectively communicate the erosive impact of inflation on profits and capital and the significance of that erosion on all who have an investment stake in business enterprises. FAS 33 (superseded by FAS 89), Par 67, P 22, 1979.

The FASB blamed inflation for the erosion – which is the same as destruction – of companies´ capital and profits, but, in the same paragraph carried on to admit that the traditional Historical Cost Accounting model or, specifically, the stable measuring unit assumption does the destroying:

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. FAS 89, Par 4, P6, 1986.

The International Accounting Standards Board also blamed inflation in IAS 15 Information Reflecting the Effects of Changing Prices (withdrawn):

The information required by this standard is designed to make users of an enterprise’s financial statements aware of the effects of changing prices on the results of its operations. IAS 15, Par 7, 1983.

Both shareholders´ equity being a company’s capital as well as retained profits are 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.

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

No reproduction without permission.

Hegemony of Historical Cost Accounting

Monetary items

SA accountants value and account monetary items during the current accounting period at their original nominal monetary values under all accounting models during low inflation, hyperinflation and deflation. Inflation determines the always current real value of the Rand and other monetary items in the SA monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period.

The real value of the Rand and other monetary items in the SA monetary economy changes equally normally every month with the publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in SA´s low inflationary economy. The daily parallel rate is generally constantly available in a hyperinflationary economy. The CPI is the internal exchange rate between the value of the Rand and real value in the SA economy. The parallel rate fulfils this role in a hyperinflationary economy.

Variable items

Variable items in SA are continuously valued and accounted in terms of IFRS or SA GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc.

Constant items

Real values of constant real value non-monetary items in the SA constant item economy have to be continuously maintained stable during low inflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation by means of the CPI as authorized in the IASB´s Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in South Africa as well as in most other non-hyperinflationary economies.

Harvey Kapnick was correct when he stated in 1976: In the long run both value accounting and price-level accounting should prevail.
Saxe Lecture, 1976


Meanwhile the standards, twenty years ago, already provided the option to reject the stable measuring unit assumption in the Framework, Par 104 (a) which states:

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

I want the International Accounting Standards Board to remove the accounting fallacy "financial capital maintenance can be measured in nominal monetary units" from the Framework, Par 104 (a). International Financial Reporting Standards should not be based on very popular accounting fallacies.
Hyperinflation

Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a country can maintain its non-monetary or real economy stable during hyperinflation is by measuring all non-monetary items in units of constant purchasing power; however, not by restating HC or current cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done, in principle, in Brazil - with indexation during the 30 years from 1964 to 1994.

IAS 29 was implemented by Zimbabwean companies listed on their stock exchange by applying the CPI at year-end as required by the IASB. Zimbabwean accountants unnecessarily, unknowingly and unintentionally destroyed their country’s real economy by implementing Historical Cost Accounting during the financial year, as supported by the IASB in IAS 29, and then restated their year-end Historical Cost financial statements in terms of the year-end CPI to make them more useful. That did not stop them from unknowingly destroying their real economy with HCA during hyperinflation.

PricewaterhouseCoopers state:

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

Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006.

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

No reproduction without permission.

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