Value does not always exist independently of how we measure it

Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.” As quoted in FAS 33 p. 29.

Shareholder’s equity forms part of an entity’s financial resources.

“Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity.” IASB Exposure Draft: Management Commentary, June 2009, Par 29.

Shareholders´ equity is a financial resource with a constant real non-monetary value expressed in terms of monetary unit of measure. The IASB statement in the Framework, Par 104 (a) that “financial capital maintenance can be measured in nominal monetary units” is a fallacy.

There is no substance in the claim that the existence and value of economic resources, for example shareholders´ equity items, exist independently of how we measure them - and that the choice of the measuring unit does not affect their fundamental values, only how we choose to represent that value – and that we can use Rands, Rands of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced. See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices SA accountants make will not change that value and will not affect the SA economy.

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 constant item economy, they would have called for its rejection by now.
Copyright © 2010 Nicolaas J Smith

The Historical Cost Mistake

Constant ITEM Purchasing Power Accounting, the financial capital maintenance in units of constant purchasing power model is, unfortunately, not chosen by a single SA accountant in SA to measure financial capital maintenance in real value maintaining units of constant purchasing power despite the fact that it is authorized in the IASB´s Framework, Par 104 (a) since 1989 as an alternative to the very destructive traditional HC model at all levels of low inflation and deflation. SA accountants value balance sheet constant real value non-monetary items using the traditional HC model in terms of which they implement the stable measuring unit assumption. SA accountants unknowingly destroy the real values of constant items never maintained at a rate equal to the rate of inflation because they, unfortunately, choose to measure financial capital maintenance in nominal monetary units when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. They unknowingly make the wrong choice. Since they all do it, since it is the traditional choice and since it is also authorized in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS, they unknowingly make the Historical Cost Mistake.

In the same breath, SA accountants do exactly the opposite: they acknowledge that inflation is destroying the real value of the depreciating Rand used as a depreciating monetary medium of exchange and they index or inflation-adjust by means of the CPI constant real value non-monetary income statement items like salaries, wages, rentals, etc by increasing their nominal values at a rate at least equal to the rate of inflation thus keeping their non-monetary real values constant over the time period in question.

On the one hand they acknowledge that the nominal values of income statement items like salaries and wages have to be indexed or inflation-adjusted by means of the CPI because inflation is destroying the real value of the Rand and on the other hand they assume - at exactly the same time and during exactly the same period - that the constantly depreciating Rand is perfectly stable, but, only for the valuation of balance sheet constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, provisions, other shareholder equity items, etc as well as for the other income statement items not inflation adjusted. SA accountants thus, unknowingly, destroy their real values at a rate equal to the rate of inflation to the amount of about R200 billion (Date 2010), year in year out, decade after decade when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

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

Inflation cannot erode or destroy the real value of non-monetary items. Erode is in the case of the functional currency, in fact, the same as destroy – there is absolutely no difference. Inflation can only destroy the real value of the unstable monetary medium of exchange (the unstable functional currency - the unstable Rand) used to transfer the constant real non-monetary values of salaries and wages from the employer to the employee.

“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.

The destruction at a rate equal to the rate of inflation of all constant real value non-monetary items never maintained during inflation stops the very moment the Boards of Directors of SA companies and SA accountants choose to implement the IASB-approved financial capital maintenance in units of constant purchasing power model no matter what the level of inflation in the SA economy. The choice is theirs. The power to stop killing the real economy is in their hands - as authorized since 1989 in the IASB´s Framework, Par 104 (a) which is applicable in the absence of specific IFRS. It is SA accountants´ choice of accounting model and not inflation that maintains or destroys the real value of constant real value non-monetary items in SA´s low inflationary economy.

The constant real non-monetary values of salaries and wages expressed in terms of the depreciating unstable Rand as the depreciating unstable monetary unit of account are presently being maintained at the actual levels currently being achieved in SA when their nominal monetary values are indexed or inflation-adjusted by means of the CPI in SA´s low inflationary environment. This happens not because of a lowering of inflation, but because of SA accountants and SA trade unions valuing salaries and wages in units of constant purchasing power - inflation-adjusting them - instead of the Historical Cost measurement basis for this particular purpose.

If the parties to the salary and wage determination process were to agree to value salaries and wages at fixed Historical Cost – like Iceland recently decided to freeze salaries because of their financial crisis - then their constant real non-monetary values would be destroyed at a rate equal to the rate of inflation since constant real value non-monetary salaries and wages are expressed in term of the depreciating monetary unit of account in SA, namely, in depreciating Rands and are normally paid in depreciating Rands. Salaries and wages are not depreciating monetary items. They are constant real value non-monetary items. They are, however, normally paid in depreciating Rands which are depreciating monetary items during inflation.

“Income Statement

This standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date.” IAS 29, Par 26.

All items in the income statement are constant real value non-monetary items to be expressed or maintained or inflation-adjusted in terms of the measuring unit current (normally the CPI) at the balance sheet date in the case of IAS 29 and CIPPA models. Salaries and wages, being income statement items, are constant real value non-monetary items.

The real values of salaries and wages would thus not be destroyed by inflation if they were valued in nominal monetary units, but by the choice of the measurement basis, namely, Historical Cost which means the implementation of the very destructive stable measuring unit assumption whereby SA accountants consider that the continuous destruction of the purchasing power of the Rand – currently at 6.2% p.a. - is not sufficiently important to index or inflation-adjust the nominal values of constant real value non-monetary salaries and wages by means of the CPI in order to maintain their real values constant. What SA accountants do, in essence, is they assume the constantly depreciating monetary unit of account – the depreciating Rand – is perfectly stable when they implement the stable measuring unit assumption. SA accountants assume the depreciating Rand is perfectly stable, but, only for this particular purpose.

Constant purchasing power indexation or inflation-adjustment or measurement in units of constant purchasing power as authorized in the Framework, Par 104 (a) is thus applicable for financial capital maintenance in units of constant purchasing power since there is no particular IFRS which deals with it. It is a SA Generally Accepted Accounting Practice and well understood in SA´s low inflationary economy, but, currently, only for some - not all - constant real value non-monetary items in the income statement, e.g. salaries, wages, rentals, etc.
Copyright © 2010 Nicolaas J Smith

SA accountants are unknowingly doing the destroying - not inflation

We commonly find that SA companies state in their opening notes to their balance sheet that their financial reports have been prepared based on the traditional Historical Cost model. We normally find that they use different measurement bases to different degrees and in different combinations including constant items in the income statement that are indexed or inflation-adjusted or valued in units of constant purchasing power by applying the CPI in SA´s low inflationary economy: e.g. salaries, wages, rentals, utility fees, transport fees, etc. Indexation or inflation-adjustment or valuing in units of constant purchasing power is thus already a generally accepted accounting practice in SA´s low inflationary economy, but, only for some, not all, income statement items and not at all for balance sheet constant items. SA accountants generally choose financial capital maintenance in nominal monetary units implementing their very destructive stable measuring unit assumption unknowingly destroying about R200 billion per annum in the SA real economy.
The annual indexation or inflation-adjustment of salaries and wages in SA´s low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages during inflation. This involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating Rand payment values for constant real value non-monetary salaries and wages to maintain their purchasing power constant in the low inflationary SA economy where the real value of the Rand is continuously being destroyed by inflation of about 6% per annum which is the SARB´s definition of "price stability". The nominal values of constant real value non-monetary salaries and wages are thus increased or indexed or inflation-adjusted by means of the CPI to cover or compensate for at least the expected rate of destruction in the real value of the depreciating Rand which is the depreciating unstable monetary unit of account for accounting purposes as well as the depreciating unstable monetary medium of exchange for payment purposes in the SA economy. The period is normally for the year ahead. They normally agree on an additional percentage increase for increases in productivity or for social reasons.

Both parties to the salary and wage negotiations agree that constant real value non-monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very destructive stable measuring unit assumption whereby SA accountants simply assume that the depreciating Rand is perfectly stable in SA´s low inflationary economy. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated Rands whose real values are continuously being destroyed by inflation. They would not receive their full real values of their salaries and wages.

“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman.

Inflation can only destroy the real value of the depreciating unstable monetary medium of exchange (depreciating unstable money, i.e. the depreciating unstable functional currency inside an inflationary economy) - the depreciating unstable Rand in South Africa’s case - and other depreciating unstable monetary items.

Inflation has no effect on the real values of salaries and wages which are constant real value non-monetary items. Inflation can only destroy the real value of money and other monetary items. Accountants implementing the very destructive stable measuring unit assumption as part of the traditional HCA model unknowingly destroy the real value of salaries and wages when they do not inflation-adjust them by means of the CPI when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation; i.e. when they keep salaries fixed.

SA accountants are unknowingly doing the destroying - not inflation (as they so mistakenly believe) - and that inflation has no effect on the real value of any non-monetary item. Also inform them that SA accountants - with their full support - unknowingly destroy about R200 billion per annum in the SA constant item economy with financial capital maintenance in nominal monetary units per se - a complete fallacy - as authorized by the IASB in 1989. It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

Although, I am sure they realize that by now.
Copyright © 2010 Nicolaas J Smith

CIPPA during low inflation authorized by the IASB 21 years ago

Monetary Items

Current period monetary item accounts cannot be indexed or inflation-adjusted or valued in units of constant purchasing power under any accounting model because the real value of money cannot be maintained constant during inflation or deflation.

Variable items

It is not proposed on this blog that the historical costs of variable real value non-monetary items are to be value in units of constant purchasing power or to be consistently indexed or inflation-adjusted by SA accountants by means of the CPI for the purpose of valuation during the current accounting period, for financial capital maintenance and for calculating the period-end profit or loss during low inflation. I have never advocated inflation accounting during low inflation in SA.

Variable items are valued by SA accountants in terms of IFRS or SA Generally Accepted Accounting Practice. The IASB specifically requires the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. Variable items are required to be valued in units of constant purchasing power during hyperinflation in terms of IAS 29. SA has never experienced hyperinflation like, for example, Germany, Brazil and Turkey. That may explain a possible lack of profound analysis of price-level accounting in SA.

I believe SA will never experience hyperinflation. The culture of relatively low inflation and the understanding by the public in SA that low inflation is what long term sustainable economic growth is based upon are already solid parts of the SA economic identity.

It is very clear from the IASB´s Framework, Par 104 (a) that measuring financial capital maintenance in real value maintaining units of constant purchasing power is authorized by the IASB as the basis for a Constant ITEM Purchasing Power Accounting (CIPPA) model at any level of inflation and deflation. The IASB does not state that financial capital maintenance can be measured in nominal monetary units (the traditional HCA model) only during low inflation and that it can be measured in units of constant purchasing power only during high and hyperinflation. In typical international accounting standard fashion it simply states that either the one or the other can be used. That means at all levels of inflation and deflation.

The IASB does, however, specifically require the implementation of IAS 29 during hyperinflation. IAS 29 is based on the CPP inflation accounting model requiring all non-monetary items to be inflation-adjusted by means of the CPI during hyperinflation. This results in most accountants, accounting authorities, accounting professors and lecturers assuming that price-level accounting always refers only to inflation accounting. They thus ignore the CIPPA model authorised by the IASB in the Framework, Par 104 (a) in 1989 for financial capital maintenance in units of constant purchasing power during low inflation.

In the Framework, Par 101 the IASB states that companies most commonly use the traditional HC model to prepare their financial reports and that other measurement bases are used in combination with HC. The IASB does, however, specifically require entities only in hyperinflationary economies – being exceptional circumstances - to implement IAS 29.

The IASB - as far as measurement bases are concerned - specifically deals with historical cost, current cost, realizable (settlement) value, present value, market value, recoverable value and fair value, all of which SA accountants, in fact, use to value variable items in terms of IFRS or SA GAAP during low inflation in SA.

In the Framework, Par 104 (a) the IASB authorizes SA accountants to measure financial capital maintenance in real value maintaining units of constant purchasing power at all levels of inflation and deflation – including low inflation. Whenever they choose to do that, it would indicate that they choose the CIPPA model instead of their current choice, the very destructive traditional Historical Cost model.

Although SA accountants choose to measure financial capital maintenance in nominal monetary units, that is, they choose the very destructive HC model, they do, in fact, also use the real value maintaining constant purchasing power measurement basis to index or inflation-adjust some - not all - income statement constant real value non-monetary items like salaries, wages, rentals, transport fees, utility fees, etc by means of the CPI. They measure them in units of constant purchasing power instead of in nominal monetary units. SA accountants can also use real value maintaining units of constant purchasing power, in terms of the Framework, Par 104 (a), to value balance sheet constant items like Retained Earnings, Issued Share capital, other shareholder equity items, etc to implement a constant purchasing power concept of financial capital maintenance. The IASB notes that entities use various different measurement bases in varying combinations and to different degrees in their financial reports.

Copyright © 2010 Nicolaas J Smith

How to kill the stable measuring unit assumption

Non-monetary items are subdivided in variable and constant items. Only constant items have to be inflation-adjusted in terms of the Framework, Par 104 (a) to maintain their real values constant during low inflation in order to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units. That is what this blog is about. Variable items are valued in terms of IFRS or SA GAAP in a manner that takes into account all elements - including inflation - which determine the variable item’s real value at the date of valuation during low inflation and deflation. Monetary items are always valued at their original nominal monetary values under all accounting models and under all economic environments.

This blog is about SA accountants maintaining the real values of all constant real value non-monetary items - e.g., SA banks´ and companies´ Shareholders´ Equity – constant during low inflationary conditions for an unlimited period of time – ceteris paribus - by implementing the real value maintaining financial capital maintenance in units of constant purchasing power model as approved in the IASB´s Framework, Par 104 (a) in 1989.

This blog is about SA accountants indexing or inflation-adjusting only constant items by implementing the Constant ITEM Purchasing Power Accounting model as approved in the IASB´s Framework, instead of unknowingly and unintentionally destroying their real values on a massive scale with their implementation of the very destructive stable measuring unit assumption as it forms part of the traditional HCA model when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

This blog is about SA accountants choosing to measure financial capital maintenance in SA banks and companies in real value maintaining units of constant purchasing power during low inflation as approved in the IASB´s Framework, Par 104 (a) instead of in nominal monetary units as a result of their choice to implement the very destructive stable measuring unit assumption during low inflation also authorized by the IASB in the Framework, Par 104 (a) twenty one years ago.

This blog is about SA accountants rejecting the stable measuring unit assumption and instead adopting IASB-approved real value maintaining constant purchasing power units as the measurement basis for only constant items including SA banks´ and companies´ Shareholders´ Equity and not only for income statement constant items, e.g. salaries, wages, rentals, etc during non-hyperinflationary conditions.

This blog is about stopping SA accountants unknowingly destroying about R200 billion per annum in real value in the SA real economy because they choose to implement the traditional HCA model when they maintain the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation instead of the IASB-approved real value maintaining CIPPA model.

SA accountants make the Historical Cost Mistake by implementing the very destructive stable measuring unit assumption during inflation as part of the traditional HCA model for an unlimited period of time during indefinite inflation.

This blog is about SA accountants being able to maintain about R200 billion per annum of real value in the SA real economy for an unlimited period of time complying with IFRS instead of unknowingly destroying that value year in year out as they unknowingly do at the moment when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

This blog is about SA accountants abandoning the very destructive traditional HCA model and adopting the real value maintaining CIPPA model in SA´s low inflationary economy as authorized in 1989 in the IASB´s Framework, Par 104 (a).

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

SA accounting profession clueless about CIPPA

The statement that financial capital maintenance can be measured in either constant purchasing power units or in nominal monetary units in the IASB´s Framework, Par 104 (a) means that Constant ITEM Purchasing Power Accounting has been authorized by the IASB since 1989 as an alternative to the traditional HCA model during periods of low inflation. This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of constant purchasing power during low inflation since 1989.

Income statement constant real value non-monetary items like salaries, wages, rentals, utilities, transport fees, etc are normally valued by accountants in units of constant purchasing power during low inflation in most economies including South Africa. Payments in money for these items are normally inflation-adjusted by means of the CPI to compensate for the destruction of the real value of the unstable monetary medium of exchange by inflation. Inflation is always and everywhere a monetary phenomenon and can only destroy the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not destroy the real value of non-monetary items. See GUCENME and ARSOY.

Constant real value non-monetary items´ real values can be maintained by accountants choosing the CIPPA model as per the IASB´s Framework during low inflation as authorized since 1989 instead of currently unknowingly being destroyed by them by the implementation of the traditional HCA model when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. It is thus accountants´ choice of accounting model and not inflation that maintains or destroys the real value of constant real value non-monetary items like Retained Earnings, Issued Share capital, capital reserves, other shareholder equity items, etc when accountants choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Implementing the low inflation CIPPA model as approved in the Framework, Par 104 (a) means accountants choose to reject the stable measuring unit assumption which they implement when they choose to measure financial capital maintenance in nominal monetary units – also in terms of the Framework, Par 104 (a).

SA accountants do not select financial capital maintenance in units of constant purchasing power and SA accounting professors and lecturers do not teach SA accounting students to select the real value maintaining IASB approved alternative to the 700 year old very destructive generally accepted traditional Historical Cost Accounting model because

(1) they automatically assume that any price-level accounting model always refers to the CPP inflation accounting model,

(2) they do not understand the fact that they unknowingly destroy real value on a massive scale (at least R200 billion per annum) in the SA real economy when they select to measure financial capital maintenance in nominal monetary units, and

(3) they do not understand the fact that they can stop that by simply selecting the alternative approved by the IASB predecessor body, the IASC Board, 21 years ago, namely, the measurement of financial capital maintenance in units of constant purchasing power as approved in the Framework, Par 104 (a) which is compliant with IFRS and was adopted by the IASB in 2001.

(4) they believe and implement the IASB´s authorization of the fallacy that "Financial capital maintenance can be measured in nominal monetary units."

(5) they believe and implement the stable measuring unit assumption that is based on a fallacy.

(6) they believe the fallacy that "the erosion of business profits and capital is caused by inflation."

If they understood it, they would have stopped the stable measuring unit by now.
Copyright © 2010 Nicolaas J Smith

I support Greta Steyn

Hi,

Greta Steyn recently stated that she would be happy if the government controlled all the shares in the South African Reserve Bank.

In simple terms, abandoning monetary prudence at the SARB can only destroy the SA monetary economy – period. Example: Zimbabwe. Inflation is only a monetary phenomenon and can only destroy the real value of the Rand and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. SA accountants would destroy the SA constant real value non-monetary economy (like Zimbabwean accountants did) with their very destructive stable measuring unit assumption – even during hyperinflation – if hyperinflation was ever created by the SARB in SA.

SA accountants currently destroy the real value of SA banks´ and companies´ capital and profits never maintained with sufficient revaluable fixed assets under the HCA model at the rate of 6.2% per annum amounting to about R200 billion each and every year. PricewaterhouseCoopers state very clearly in their publication Understanding IAS 29: “Inflation adjusted financial statements are an extension to and not a departure from historic cost accounting.” Accountants – unbelievably supported by PricewaterhouseCoopers – still apply the stable measuring unit assumption during hyperinflation and then only restate the year-end Historical Cost financial statements of their hyper-destroyed businesses at the year end CPI rate – after they have hyper-destroyed all constant real value non-monetary items never maintained or never updated during the financial year with their stable measuring unit assumption – during hyperinflation.

This is prevented with either financial capital maintenance in units of constant purchasing power during low inflation as authorized by the IASB in the Framework, Par 104 (a) twenty one years ago or with indexation – which is in principle the same process – as Brazil did for 30 years from 1964 to 1994.

Destroying SA´s economy like it happened in Zimbabwe is a political act. The SARB having some private shareholders who have no influence will not stop a Zimbabwe style destruction of the SA monetary economy. Either SA has the right political leaders or not.

Contrary to what some people state and believe, the government already owns the majority of shares in the SARB. It is not privately controlled. It has some private shareholders - a minority. The Bank´s independence from government interference in monetary policy is stated in the constitution.

I support Greta’s position.

Obviously, for the government to hold all the shares in the SARB is not the same as nationalizing the mining industry or banks or the economy as a whole as Malema wants.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

The IASB may be to blame

The IASB may be to blame since 1989 for financial capital maintenance in nominal monetary units which is a complete fallacy during inflation and deflation by simply stating in the Framework, Par 104 (a) that financial capital maintenance can be measured in nominal monetary units without qualifying that statement. It is only possible per se during zero inflation. We have never had sustainable zero inflation in the past and we are not likely to have sustainable zero inflation any time soon in the future. It is, in fact, only possible under the HCA model during low inflation and deflation when an entity invests 100% of the real value of all contributions to Shareholders´ Equity in revaluable fixed assets. It is impossible to maintain the real value of capital constant with financial capital maintenance per se during inflation and deflation.

All economic items are valued by accountants and the values are stated in terms of the functional currency (money) as the unit of account. All functional currencies are unstable in real value: either their real values are being destroyed by inflation or, in the case of Japan lately, the Yen’s real value is being increased internally by deflation. It is thus impossible to maintain the real value of financial capital constant in nominal monetary units – per se – during low inflation and deflation - unless qualified as above.

The IASB did not approve financial capital maintenance in units of constant purchasing power in the Framework, Par 104 (a) in 1989 as an inflation accounting model. They did that with the CPP inflation accounting model in IAS 29 – also in 1989. Constant ITEM Purchasing Power Accounting as approved in the Framework, Par 104 (a), by measuring financial capital maintenance in units of constant purchasing power constitutes an IASB authorized alternative to the Historical Cost financial capital concept, HC financial capital maintenance concept and HC profit or loss determination concept, namely a constant purchasing power financial capital concept, constant purchasing power financial capital maintenance concept and constant purchasing power profit or loss determination concept during low inflation and deflation.

CIPPA as approved in the Framework only requires all constant real value non-monetary items to be valued in units of constant purchasing power. Variable real value non-monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS or SA GAAP and are not required in terms of the Framework, Par 104 (a) to be valued in units of constant purchasing power to determine their values during the accounting period during non-hyperinflationary periods.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Capital maintenance ignored by IASB and FASB

Inflation-adjusted balance sheet constant real value non-monetary items, e.g. Issued Share capital, Retained Earnings, Share premiums, Capital Reserves, General Reserves, all other items in Shareholders´ Equity, trade debtors, trade creditors, taxes payable, taxes receivable, salaries payable, salaries receivable, all other non-monetary payables, all other non-monetary receivables, etc in SA´s low inflation economy would be a blessing to everyone in SA when our accountants simply decide to change from their current implementation of their very destructive stable measuring unit assumption – which is based on a fallacy – and their financial capital maintenance in nominal monetary units per se which is impossible during inflation and another fallacy and freely choose to implement the real value maintaining financial capital maintenance in units of constant purchasing power model as approved by the IASB in the Framework, Par 104 (a) twenty one years ago. They would knowingly maintain - instead of currently unknowingly, unnecessarily and unintentionally destroy as they also did last year and all the years before and will do next year if they do not stop with their very destructive stable measuring unit assumption - at least R200 billion annually in constant item real value in the SA real economy for an unlimited period of time – all else being equal.
Financial capital maintenance in units of constant purchasing power authorized during low inflation

Financial capital maintenance in units of constant purchasing power during low inflation, despite being approved by the IASB in the Framework twenty one years ago, is completely ignored by accountants in non-hyperinflationary economies even though it would maintain instead of destroy the real values of not only all income statement constant items but also all balance sheet constant items in all companies that at least break even for an unlimited period of time during low inflation and deflation. Financial capital maintenance in units of constant purchasing power would stop SA accountants unknowingly destroying about R200 billion in the real value of constant items never maintained in the SA real economy each and every year. It would result in SA accountants knowingly boosting the SA real economy by at least R200 billion per annum for an unlimited period – all else being equal.

The reason accountants ignore financial capital maintenance in units of constant purchasing power is because any price-level accounting model is generally viewed by almost all accountants and accounting authorities as a 1970-style failed and discredited inflation accounting model that required all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) to be inflation-adjusted by means of the CPI during high inflation. They, inexplicably and unbelievably, seemed not to understand, at all, the implications of the Framework, Par 104 (a) which the IASB authorized 21 years ago and which states:

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


Deloitte, one of the Big Four accounting and auditing multi-nationals, also ignore the paragraphs in the Framework that deal with the concepts of capital, capital maintenance and the determination of profit or loss in their presentation of the Framework on their site IAS Plus as at 13th February, 2010. http://www.iasplus.com/standard/framewk.htm

Deloitte do not even mention one word in their presentation of the Framework about the fact that companies can measure financial capital maintenance in units of constant purchasing power. This appears to be another example of the lack of understanding by accountants in general that an essential function of accounting is continuous maintenance of the constant purchasing power of capital by continuously maintaining the real value of all constant items at all levels of inflation and deflation which can only be achieved with the IASB approved financial capital maintenance in units of constant purchasing power model in the Framework, Par 104 (a) and IAS 29 with valuation of all non-monetary items at the daily parallel rate during hyperinflation.

Similarly the paragraphs in the Framework dealing with the concepts of capital, the concepts of financial capital maintenance and units of constant purchasing power were also omitted from the presentation of the Framework in the Wikipedia article on IFRS till they were added very recently. The whole of the Framework was summarized in the Wikipedia article, except those paragraphs.

The IASB and FASB are currently working on a joint project called Conceptual Framework. “The project's overall objective is to create a sound foundation for future accounting standards that are principles-based, internally consistent and internationally converged.” (IASB site). All items in the IASB´s current Framework are covered in this project, except the concepts of capital and capital maintenance. In response to a request for information about when the concepts of capital and capital maintenance would be covered in the current project the FASB project leader, who is not a spokesman for the Boards, stated: “I can only say that early on in the measurement phase the staff suggested that capital and capital maintenance be discussed in the measurement phase, as it was in the original FASB Conceptual Framework. However, to date the Boards have not taken a decision on where, or even whether, those topics will be included in the converged framework.”

The concept of financial capital maintenance in units of constant purchasing power during low inflation and deflation seems to have been correctly treated by the IASC Board twenty one years ago – and then simply just ignored by everyone.
Copyright © 2010 Nicolaas J Smith

Constant items

As a result of a lack of understanding the destructive nature of their implementation of the very destructive stable measuring unit assumption, 1970-style CPP inflation accounting was not an accounting system implemented by accountants to correct or eliminate the destruction of the real value of constant items by the use of the stable measuring unit assumption, but, a failed attempt to simply make financial reports more understandable and more comparable with previous year statements during periods of high inflation by inflation-adjusting all non-monetary items equally in terms of the CPI.

Accountants simply do not understand that they unknowingly destroy real value on a massive scale in all constant items never maintained when they choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. In many cases they do not even know that they make that choice. Neither do they understand that they will stop that destruction by freely choosing to measure financial capital maintenance in units of constant purchasing power, as approved in the IASB Framework, Par 104 (a) in 1989.

Prof Geoffrey Whittington in his definitive work on inflation accounting in the beginning of the 1980´s, Inflation Accounting - An Introduction to the Debate, published in 1983, clearly indicated that with 1970-style CPP inflation accounting all non-monetary accounts (with no distinction being made between variable and constant real value non-monetary item accounts) were updated by means of the CPI.

"Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."

This eventually led to the failure of 1970-style CPP accounting as an inflation accounting model.

The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never maintained.
Copyright © 2010 Nicolaas J Smith

Generally accepted fact and fiction

The IASB approved Framework, Par 104 (a) which is applicable in the absence of specific IFRS relating to the concepts of capital, the capital maintenance concepts, the valuation of constant items, e.g. Issued Share Capital, Retained Earnings and other items in Shareholders´ Equity, etc during non-hyperinflationary periods, allows accountants to reject the stable measuring unit assumption during all levels of inflation and deflation when they choose to measure financial capital maintenance in units of constant purchasing power as an alternative to measurement in nominal monetary units as applied in the traditional HCA model.

It is not generally understood by SA accountants that they are unknowingly and unintentionally responsible for the unnecessary destruction of the real value of constant items never maintained with sufficient revaluable fixed assets when they implement the traditional HCA model: more specifically, their very destructive stable measuring unit assumption during periods of low inflation when they maintain it for an unlimited period of time during indefinite inflation. This lack of understanding also applies to economists, business people and the public in general.

It is also not generally understood by SA accountants that they can stop this destruction by selecting financial capital maintenance in units of constant purchasing power as authorized by the IASB 21 years ago in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS. If they understood it, they would have stopped the stable measuring unit assumption by now.

It is generally accepted and a fact that inflation destroys the real value of money (the internal functional currency) and other monetary items over time. It is also a fact that hyperinflation can destroy the real value of a country’s entire monetary base as happened in Zimbabwe recently. That was the result of a massive increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, with an equivalent extreme rate of destruction of the real value of the Zimbabwe Dollar since the massive nominal increase in the ZimDollar money supply was not in response to an equal increase in real value in the real or non-monetary economy of Zimbabwe. Gono was actually "printing money" in the popular belief that you can create wealth by simply printing pretty pictures on paper. When the German company from which he was buying the special bank note paper was pressurized to stop supplying him, he started printing the 100 trillion ZimDollar notes on normal A4 photostat paper.


“There is no subtler, no surer means of overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”The Economic Consequences of the Peace by John Maynard Keynes, 1919http://socserv2.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace

This certainly was true in the case of Zimbabwe.

It is generally accepted and a fact that inflation destroys the real value of money and the original real value of monetary savings and money lent over time. It is generally accepted, but not a fact, that inflation erodes, which is the same as destroys, the real value of constant real value non-monetary items with fixed nominal payments over time, e.g. fixed salary, wage, rental payments, etc.

The constant real non-monetary values of salaries, wages, rentals, etc are generally maintained, i.e. not destroyed, when accountants choose to measure the real value of these constant real value non-monetary items in units of constant purchasing power in terms of the CPI in most economies with payment in depreciating money during inflation.

It is not generally accepted, but a fact, that SA accountants unknowingly destroy the real value of constant items never maintained, e.g. Retained Earnings, of all SA companies and banks over time when they choose to measure financial capital maintenance in nominal monetary units in terms of the traditional HCA model during low inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

World Institute of Research and Publication

World Institute of Research and Publication

World Institute for Research and Publication Accounting Annual Meeting


June 4 - 6, 2010

In 2010, we will be meeting online for the first time. As result of the effort of researchers all around the world, accounting researchers are going to make a more sustainable conference. WIRP Accounting saves travel costs and can avoid tons of CO2 from airline emissions.

Also, without sacrificing the communication efficiency by allowing the participation of researchers of every part of the globe thru our platform, academicians and practitioners can present new research and discussing current issues. WIRP is divided in thematic areas and the participants can at any time attend the previously available presentations during the event.

The debates occur in our virtual rooms with resources of audio and video, making possible all the interactions between the participants without costs of locomotion and lodging. Likewise, making possible and viable the participation of any researcher, independent of its place of origin.

Direct text copy of WIRP Accounting site
__________________________________________________________

I have been invited to submit a paper for possible selection to be presented at the World Institute for Research and Publication Accounting Annual Meeting.

Nicolaas Smith

100 Questions (and Answers) about IFRS: Prof Rachel Baskerville

Prof Baskerville: "There is much to be gained from moving away from reporting on the basis Financial Capital Maintenance in Nominal Monetary Units."

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

Nicolaas Smith

Copyright © 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Comment letter to the IASB Exposure Draft: Management Commentary

Submitter.............Organization..................Date

Nicolaas Smith........Real Value Accounting.........25th February, 2010

Ms Amy Schmidt
Project Manager: Management Commentary
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
United Kingdom

Attempted submission Via “Open to comment” page on www.iasb.org

This comment letter is published HERE on the IFRS Foundation website with ID CL32.


Dear Ms Schmidt

Request for comment on IASB Exposure Draft: Management Commentary

Thank you for the opportunity to comment on the IASB Exposure Draft: Management Commentary.

In my opinion the Board should develop an IFRS for the preparation and presentation of management commentary to make it binding.

I suggest changes in the content elements related to the analysis of the adequacy of the entity’s capital structure requiring details about real value unnecessarily being destroyed because of the implementation of the stable measuring unit assumption; real value to be gained by its rejection; related to plans to address this inadequacy and useful disclosure regarding the entity’s justification for choosing financial capital maintenance in nominal monetary units instead of in units of constant purchasing power during low inflation and deflation as authorized by the IASB.

I do not agree with the Board’s decision not to include detailed application guidance and illustrative examples in the final management commentary document. I suggest specific guidance regarding management’s obligation to supply details about real value unnecessarily destroyed as a result of their implementation of financial capital maintenance in nominal monetary units and real value to be gained when they change over to financial capital maintenance in units of constant purchasing power during low inflation.

My detailed answers to the questions in the Exposure Draft and my suggestions are contained in the attached appendix.

If you have any questions regarding this submission, please do not hesitate to contact me at realvalueaccounting@yahoo.com

Yours sincerely

Nicolaas Smith


Appendix – Response to the questions asked in the Exposure Draft: Management Commentary

Status of the Final Work Product

Question 1

Do you agree with the Board’s decision to develop a guidance document for the preparation and presentation of management commentary instead of an IFRS? If not, why?

No, I do not agree. It should be an IFRS to make it binding. Optional implementation has in the past meant “Keep the status quo” as far as IFRS are concerned. Financial capital maintenance in units of constant purchasing power is a good example: The IASB approved financial capital maintenance in units of constant purchasing power during low inflation and deflation in the Framework, Par 104 (a) twenty one years ago. Its implementation would stop the unnecessary destruction of hundreds of billions of Euros (probably much more) per annum in the world economy in the real value of entities´ capital and profits never maintained constant during low inflation. Its implementation would mean automatically maintaining instead of destroying hundreds of billions of Euros (probably much more) per annum in the real value of entities´ capital and profits in entities that at least break even whether they own revaluable fixed assets or not - without extra money or additional retained profits required to maintain existing capital - in the world economy during low inflation. No-one chooses it during low inflation or deflation because it is not a binding IFRS: it is an option. It is nullified as our Taiwanese friends so eloquently state. I would also point to the waste of IASB resources in producing a document simply to be nullified by making it optional as in the case of financial capital maintenance in units of constant purchasing power during low inflation and deflation over the last 21 years.


Content elements of a decision-useful management commentary

Question 2

Do you agree that the content elements described in paragraphs 24–39 are necessary for the preparation of a decision-useful management commentary? If not, how should those content elements be changed to provide decision-useful information to users of financial reports?

Yes, I agree, but, I suggest that the following (in italics) should be added to paragraphs 29 and 33:

Paragraph 29

Disclosure about resources depends on the nature of the entity and the industry in which the entity operates. Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity. Analysis of the adequacy of the entity’s capital structure,


“with reference to the concept of capital maintenance: in particular

(1) supplying details of the real value destroyed in shareholders´ equity never maintained constant in real value as a result of insufficient revaluable fixed assets under Historical Cost Accounting when the entity has chosen financial capital maintenance in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a) and

(2) supplying details of the gain to the entity if it should choose continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation also authorized by the IASB in the Framework, Par 104 (a). ”

“Analysis of” financial arrangements (whether or not recognised in the statement of financial position), liquidity and cash flows, as well as plans to address any identified inadequacies

“- specifically the identified inadequacy of financial capital maintenance in nominal monetary units per se to maintain the real value of shareholders´ equity and other constant items constant during inflation and deflation taking into account the fact that its remedy, namely, continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation has been authorized by the IASB 21 years ago” - or surplus resources, are examples of disclosures that can provide useful information.

Paragraph 33

Management commentary should include a clear description of the entity’s financial and non-financial performance, the extent to which
that performance may be indicative of future performance and management’s assessment of the entity’s prospects. Useful disclosure in
that area can help users to make their own assessments about the assumptions and judgements used by management in preparing the financial statements

“specifically management’s justification in entities implementing the HCA model for their choice to measure financial capital maintenance in nominal monetary units during low inflation and deflation instead of in units of constant purchasing power in terms of the IASB´s Framework, Par 104 (a).”


Application guidance and illustrative examples

Question 3

Do you agree with the Board’s decision not to include detailed application guidance and illustrative examples in the final management commentary guidance document? If not, what specific guidance would you include and why?

No, I do not agree. The Board should include detailed application guidance to cover the items detailed in paragraphs 24-39 in the Exposure Draft as to be amended as suggested above and specifically include the following:

Management have to:

(1) state in the Management Commentary that their choice of the traditional Historical Cost basis which includes the stable measuring unit assumption, destroys the real value of constant real value non-monetary items never maintained, at a rate equal to the annual rate of inflation;

(2) state that this includes the destruction of the real value of Shareholders´ Equity when the entity does not have sufficient fixed assets that are or can be revalued via the Revaluation Reserve equal to the updated original real value of all contributions to Shareholders’ Equity under the HC basis;

(3) state the percentage and amount of Shareholders´ Equity that are not being maintained; i.e., the percentage and amount of Shareholders´ Equity that are subject to real value destruction at a rate equal to the annual inflation rate because of management’s choice, in terms of the Framework, Par 104 (a), to maintain financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – both practices being compliant with IFRS;

(4) state the amount of real value destroyed during the last and previous financial years in Shareholders´ Equity and all other constant items never maintained because of management’s choice to implement the Historical Cost Accounting model;

(5) state the updated total amount of real value destroyed from the entity’s inception to date in this manner in at least Shareholders´ Equity never maintained as described above;

(6) state the change in the updated real value of Shareholders´ Equity if management should decide – as they are freely allowed to do at any time - to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a);

(7) state management’s estimate of the amount of real value to be destroyed by their implementation of the stable measuring unit assumption during the following accounting year under the HC basis;

(8) state that the real value calculated in (7) represents the amount of real value the entity would gain during the following accounting year and every year there after for an unlimited period of time – ceteris paribus – when management choose to measure financial capital maintenance in units of constant purchasing power – which is compliant with IFRS – as authorized by the IASB in the Framework, Par 104 (a) in 1989 which they are free to choose any time they decide;

(9) state management’s reason(s) for choosing financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par 104 (a).

Rationale for my answers and suggestions above:

It is relevant information for existing and potential capital providers that the real value of the capital they provided - or are about to provide - to an entity as well as their share of other items in shareholders´ equity, e.g. retained profits which are possible dividends to them, are unnecessarily being destroyed - or would unnecessarily, be destroyed - at a rate equal to the annual rate of inflation as a result of the implementation of the Historical Cost Accounting model during low inflation for the portion of the real value of shareholders´ equity which is not maintained constant as a result of insufficient revaluable fixed assets under HCA.

It is equally relevant information for existing and potential capital providers that continuous financial capital maintenance in units of constant purchasing power which has also been authorized by the IASB 21 years ago in the Framework, Par 104 (a) would maintain the real value of shareholders´ equity and all other constant real value non-monetary items constant at all levels of inflation and deflation for an unlimited period of time in all entities that at least break even – ceteris paribus - irrespective of whether an entity owns revaluable fixed assets or not. This would happen automatically as a result of a correct IASB-authorized basic accounting model approved in 1989 at all levels of inflation and deflation without requiring more money from capital providers for additional capital contributions or additional retained profits to simply maintain existing equity’s existing real value.

The Framework, Par 104 (a) states:

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

Constant items are one of the three fundamentally different basic economic items in the economy. The other two are monetary items and variable real value non-monetary items. Variable items are non-monetary items with variable real values over time. Examples are property, plant, equipment, inventory, finished goods, foreign exchange, etc. Constant items are non-monetary items with constant real values over time. Examples are all items in the income statement, all items in shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, provisions, all non-monetary payables, all non-monetary receivables, etc. Constant items have to be continuously valued in units of constant purchasing power in order to maintain their real values constant during inflation and deflation.

The generally accepted view under the HC paradigm that economic items consist of only monetary and non-monetary items avoids the proper split of non-monetary items in variable and constant items because of the implementation of the stable measuring unit assumption. This results in variable items valued at HC (e.g. fixed assets, inventory, etc.) and constant items currently also valued at HC (e.g. shareholders´ equity and most items in the income statement – excluding salaries, wages, rentals and other items normally inflation-adjusted) being classified as simply non-monetary items under HCA.

The real value of shareholders´ equity currently being valued at HC is only 100% maintained constant in the rare cases where 100% of the updated original real values of all contributions to shareholders´ equity are invested in revaluable fixed assets. It is hardly ever the case that even 100% of the updated original real values of all contributions to shareholders´ equity excluding retained profits are invested in revaluable fixed assets. Retained profits in most entities are thus treated the same as monetary items (cash) and their real values are being destroyed at a rate equal to the annual rate of inflation when financial capital maintenance is measured in nominal monetary units in low inflationary economies.

The stable measuring unit assumption is based on the fallacy that changes in the purchasing power of money are not sufficiently important for entities to choose to continuously measure financial capital maintenance in units of constant purchasing power
during low inflation and deflation as authorized by the IASB in the Framework, Par 104(a). Hyperinflation is defined by the IASB as 100% cumulative inflation over three years, i.e. 26% annual inflation for 3 years in a row. Financial capital maintenance in units of
constant purchasing power is required by the IASB in IAS 29 during hyperinflation: it is thus required at 26% annual inflation for 3 years in a row. It is, however, left as an option at 20% or 15% or 6% or 2% for three years in a row or any number of years. Real value destruction in constant items never maintained constant by the implementation of the stable measuring unit assumption at continuous 20% inflation (which would wipe out 100% of the real value of shareholders´ equity never maintained constant in 4 years) is currently considered as not sufficiently important for the implementation of continuous financial capital maintenance in units of constant purchasing power. Financial capital maintenance in nominal monetary units per se currently unknowingly, unnecessarily and
unintentionally destroy 51% of the real value of shareholders´ equity and all other constant items never maintained constant over 35 years in all economies with continuous 2% annual inflation.

Financial capital maintenance in nominal monetary units per se as authorized by the IASB in the Framework, Par 104 (a) is a fallacy during low inflation and deflation. IFRS should not be based on fallacies as they currently are. It is impossible to maintain the real value of entities´ capital and profits constant with financial capital maintenance in nominal monetary units per se during inflation and deflation. The only way to maintain the real value of capital and profits constant for an unlimited period of time in entities that at least
break even during low inflation and deflation – all else being equal - is with continuous financial capital maintenance in units of constant purchasing power per se irrespective of whether those entities own fixed assets or not. There is no other way.

“The erosion of business profits and invested capital caused by inflation” is generally accepted.

“In Mr. Mosso's view, conventional accounting measurements fail to capture the erosion of business profits and invested capital caused by inflation.” FAS 33, 1979, P 24 (superseded by FAS 89)

There is absolutely no doubt in the accounting profession that real value is being destroyed in entities´ capital and profits and there is equally absolutely no doubt in the accounting profession that it is caused by inflation. In fact, “the erosion of business profits and invested capital caused by inflation” is a fallacy. Inflation is always and everywhere a monetary phenomenon as per the late American Nobel Laureate Milton Friedman. Inflation destroys the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. It is impossible for inflation per se to destroy 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.
http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

It is not inflation doing the destroying: it is unnecessary, unknowing and unintentional destruction by the implementation of the stable measuring unit assumption under financial capital maintenance in nominal monetary units (the HCA model) during low inflation - as authorized by the IASB in the Framework, Par 104 (a) - of the real value of constant items never maintained constant amounting to hundreds of billions of Euros (probably much more) in the world economy each and every year. It is relatively easy for individual entities to calculate the amount of real value unnecessarily, unknowingly and unintentionally being destroyed as indicated above during the current year in low inflationary economies. That would give an estimate of the annual value to be gained from changing over to continuous financial capital maintenance in units of constant purchasing power as authorized by the IASB twenty one years ago. Basically it is Retained Earnings times the average rate of annual inflation in most entities.

The real values of all constant items, e.g. shareholders´ equity, will knowingly be maintained constant for an unlimited period of time in all entities that at least break even with continuous financial capital maintenance in units of constant purchasing power – ceteris paribus – amounting to hundreds of billions of Euros (probably much more) in the world economy each and every year, no matter what the rate of inflation without requiring more money for additional capital or additional retained profits to maintain the existing real values of existing constant items constant - whether entities own revaluable fixed assets or not. It is simply a matter of maintaining existing real value as indicated above instead of currently unnecessarily, unknowingly and unintentionally destroying existing real value.

Continuous financial capital maintenance in units of constant purchasing power only results in zero destruction of real value in constant items for an unlimited period of time at any level of inflation or deflation in entities that at least break even – ceteris paribus. It has no direct effect on the rate of inflation or deflation.

The removal of the 5 words “either nominal monetary units or” from the IASB Framework, Par 104 (a) would make this comment letter and appendix superfluous.

No other issues noted.

_____________________________________________________________________________________

This comment letter is published HERE on the IFRS Foundation website with ID CL32.

Copyright © 2010 Nicolaas J Smith

SA accountants confused

SA accountants and accounting lecturers at SA universities do not understand that they can stop this unknowing destruction by SA accountants of about R200 billion per annum in the real value of SA companies´ constant items never maintained by simply rejecting the stable measuring unit assumption when they freely choose the IFRS compliant financial capital maintenance in units of constant purchasing power model at all levels of inflation and deflation.

IFRS do, however, already – 21 years ago – allow the rejection of the stable measuring unit assumption as an alternative to HCA at all levels of inflation and deflation. The IASB´s Framework, Par 104 (a) states:

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

Par 104 (a) was authorized by the IASB predecessor body, the International Accounting Standards Committee Board in April, 1989 and adopted by the IASB in 2001.

The stable measuring unit assumption is also rejected in IAS 29 Financial Reporting in Hyperinflationary Economies.

The Standards already reject the stable measuring unit assumption under the above two circumstances.
Copyright © 2010 Nicolaas J Smith

HCA abdicates one of its main functions

1970-style Constant Purchasing Power (CPP) inflation accounting was a popular but failed attempt at inflation accounting at the time. It was a form of inflation accounting which tried unsuccessfully to make corporate accounts more informative when comparing current transactions with previous transactions by updating all non-monetary items (without distinguishing between variable and constant real value non-monetary items) equally by means of the Consumer Price Index during high and hyperinflation. 1970-style CPP inflation accounting was abandoned as a failed and discredited inflation accounting model for reasons explained below when general inflation decreased to low levels thereafter.


The function of financial accounting is not just “to convey value information about the economic resources of a business” as Harvey Kapnick stated in the 1976 Sax Lecture.

http://newman.baruch.cuny.edu/DIGITAL/saxe/saxe_1975/kapnick_76.htm

The objectives of general purpose financial reporting are:

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


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

This can only be achieved by valuing constant items in units of constant purchasing power, i.e., by inflation-adjusting all constant items by means of the monthly CPI during low inflation and deflation, namely, by measuring financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, Par 104 (a) twenty one years ago and by valuing both variable and constant items at the daily parallel rate in terms of IAS 29 during hyperinflation.

HCA has unknowingly abdicated the essential financial capital maintenance function of accounting to the fiction that money is stable in real value during inflation and deflation. In so doing, they have in the past unknowingly destroyed and currently unknowingly destroy real value on a massive scale (at least R200 billion per annum) in the SA real economy when they implement their very destructive stable measuring unit assumption as part of the IASB approved traditional Historical Cost Accounting model for an unlimited period of time during indefinite inflation.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Inflation: two definitions

Variable real value non-monetary items do not need to be and are not valued in units of constant purchasing power during low inflation because they are valued in terms of SA GAAP or IFRS at, for example, fair value, market value, present value, recoverable value, net realizable value, etc which always automatically take inflation - amongst many other things - into account. Variable items are only valued in units of constant purchasing power during hyperinflation as required by the IASB in IAS 29 since the board regards hyperinflation as an exceptional circumstance.

There is a school of thought that 2% inflation is completely unharmful and that it has no disadvantages compared to absolute price stability. That is not correct. 2% inflation will destroy, for example, 51% of the real value of all monetary items and all constant items never maintained, e.g. Retained Profits, over 35 years – all else being equal – when the stable measuring unit assumption is implemented for an indefinite period of time during indefinite inflation.

It is not necessary for accountants to inflation-adjust by means of the CPI, which is a general price index, variable real value non-monetary items (e.g. properties, shares, raw material, etc.) which are subject to product specific price increases for the purpose of valuing these variable items during the accounting period on a primary valuation basis during non-hyperinflationary periods. These variable items are generally subject to market based real value changes determined by supply and demand.

They incorporate product specific price changes or product specific inflation where the word inflation is, very unfortunately, also used to simply mean a product or product group price increase instead of the general use of the word in economics to mean the destruction of the real value of money over time, i.e. a destruction of the general purchasing power of money which is caused by/results in an increase in the general price level over time. The word inflation thus has two totally different but generally accepted meanings in economics: (1) inflation meaning the destruction of the real value of money and other monetary items over time and (2) inflation meaning any price increase.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

The Rand is an unstable monetary unit of account

SA accountants unknowingly destroy or maintain (please note: not create) the real value of constant real value non-monetary items (please note: not variable real value non-monetary items) depending on whether they choose the IASB approved traditional HCA model under which they implement their very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation or the IASB approved real value maintaining financial capital maintenance in units of constant purchasing power model under which they select to reject the stable measuring unit assumption at all levels of inflation and deflation for an unlimited period of time.

Inflation is a uniquely monetary phenomenon and can only destroy the real value of money and other monetary items over time. It has no effect on the real value of non-monetary items. See GUCENME and ARSOY above. SA accountants unknowingly, unintentionally and unwittingly do the destroying of the real value of constant items never maintained over time, e.g. Retained Earnings, Issued Share capital, other items in Shareholder’s Equity, etc when they choose the traditional HCA model during low inflationary periods.

It is correct, essential and compliant with IFRS to inflation-adjust or update constant real value non-monetary items by means of the CPI which is a general price index at all levels of inflation and deflation. The reason for this is that constant items are expressed in terms of money, i.e. in terms of an unstable monetary unit of account which is the same as the unstable monetary medium of exchange. Inflation destroys the real value of the unstable monetary medium of exchange - which is also the unstable monetary unit of account in accounting and the economy in general.

Constant items thus have to be updated or inflation-adjusted at a rate equal to the rate of inflation or deflation, i.e. valued in units of constant purchasing power, in order to maintain their real values constant during inflation and deflation because the unit of measure in accounting is an unstable monetary unit of account and consequently hardly ever absolutely stable during periods of inflation and deflation. Months of zero annual inflation are very few and far between. Sustainable zero inflation has never been achieved before and it does not seem very likely that it will be achieved any time soon in the future.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

Capital maintenance

Capital maintenance is the continuous maintenance of the real value of capital over time; i.e. the constant purchasing power of capital.

Financial capital maintenance in nominal monetary units per se is a fallacy: it is impossible to maintain the real value of capital constant over time in nominal monetary units per se during inflation and deflation.

There are two ways of looking at capital maintenance:

1. In terms of fact
2. In terms of IFRS

1. In terms of fact

The fact that capital maintenance is the continuous maintenance of the constant purchasing power of capital means that there are only two concepts of capital maintenance:

a) Physical capital maintenance as defined in the Framework
b) Continuous financial capital maintenance in units of constant purchasing power as defined in the Framework, Par 104 (a) which states:

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

2. In terms of IFRS

There are 3 concept of capital maintenance in terms of IFRS:

a) Physical capital maintenance as defined in the Framework.

b) Financial capital maintenance in nominal monetary units as authorized by the IASB in the Framework, Par 104 (a) which is a fallacy, but, is implemented by 99.99% of entities in the world economy and results in their accountants (not inflation as the FASB, IASB and most accountants believe) unknowingly, unnecessarily and unintentionally destroying the real value of their companies´ shareholder’s equity (never maintained by sufficient revaluable fixed assets) with the implementation of their very destructive stable measuring units assumption during low inflation at a rate equal to the annual rate of inflation in all countries with low inflation amounting to hundreds of billions of Euros in the world economy each and every year.

c) Continuous financial capital maintenance in units of constant purchasing power which the IASB authorized in the Framework, Par 104 (a) in 1989 for implementation during low inflation and deflation as an alternative to the globally implemented generally accepted traditional Historical Cost Accounting model, but, it is ignored by almost everyone. Financial capital maintenance in units of constant purchasing power during low inflation would stop the unknowing destruction by accountants of the real value of companies´ capital and profits never maintained amounting to hundreds of billions of Euros in the world economy per annum implementing their very destructive stable measuring unit assumption under HCA during low inflation.

Accountants would knowingly maintain hundreds of billions of Euros in the real value of companies´ capital and profits per annum without extra money in new capital contributions or extra retained profits when they measure financial capital maintenance in units of constant purchasing power during low inflation as authorized by the IASB in the Framework, Par 104 (a) in 1989. This is not understood by the IASB, FASB, other accounting authorities and most accountants and accounting lecturers and professors. If they understood it, they would have stopped the stable measuring unit assumption by now. Financial capital maintenance in units of constant purchasing power units is only required by the IASB in IAS 29 Financial Reporting in Hyperinflationary Economies.

The legal requirements for satisfying the liquidity and solvency tests do not constitute a fourth concept of capital maintenance, but, are simply the legal basis for either financial capital maintenance in nominal monetary units – when you assume the that the stable measuring unit assumption satisfies the requirement for “fairly valued” as 99.99% of entities currently incorrectly assume - as well as financial capital maintenance in units of constant purchasing power where under the very destructive stable measuring unit assumption is rejected in terms of the Framework, Par 104 (a). Unfortunately no-one chooses this option.

In most jurisdictions the legal requirements of “liquidity” and “solvency” have to be satisfied in the case of

• payment of dividends to shareholders
• reduction of a company’s share capital or reserves
• a company’s purchase of its own shares

A company is prohibited from making any payment in whatever form from shareholders´ equity if there are reasonable grounds for believing:

(a) that the company is or would after the payment be unable to pay its debts as they become due in the ordinary course of business (this is known as the “liquidity” test); or

(b) the consolidated assets of the company fairly valued would after the payment be less than the consolidated liabilities of the company (this is known as the “solvency” test) The Capital Maintenance Concept and Share Repurchases in South African Law - By F.H.I. Cassim and Rehana Cassim
Copyright © 2010 Nicolaas J Smith

Inflation Accounting

One of the inflation accounting models that was tried unsuccessfully in the 1970´s and 1980´s was Constant Purchasing Power Accounting (CPPA).

The Financial Accounting Standards Board issued an exposure draft in the United States in January, 1975, that required supplemental financial reports on a Constant Purchasing Power inflation accounting price-level basis. The Securities and Exchange Commission in the USA proposed in 1976 the disclosure of the current replacement cost of amortizable, depletable and depreciable assets used for production as well as most inventories at the financial year-end. It also proposed the disclosure of the approximate value of amortization, depletion and depreciation as well as the approximate value of cost of sales that would have been accounted in terms of the current replacement cost of productive capacity and inventories.

Both supplemental Constant Purchasing Power inflation accounting financial statements and value accounting were experimented with in Canada. Australia tried both replacement-cost inflation accounting and CPP price-level inflation accounting. Netherland companies experimented with value accounting. Replacement-cost disclosures for equity capital financed items were considered in Germany. CPP inflation accounting supplemental financial statements were tried in Argentina. Brazil successfully used various indexes to update constant and variable non-monetary items for the 30 years from 1964 to 1994. In the United Kingdom an original proposal of supplementary CPP financial accounting financial reports was replaced by the Sandilands Committee proposal for a value accounting approach for inventories, marketable securities and productive property. South Africa had published a discussion paper on value accounting at the time.

The FASB issued FAS 33 Financial Reporting and Changing Prices in 1979. It only applied to certain large, publicly held enterprises. No changes were to be made in the primary financial statements; the information required by FAS 33 was to be presented as supplementary information in published annual reports.

These companies were required to calculate and report:

a. Income from continuing operations reflecting the effects of general inflation
b. The purchasing power loss or gain on net monetary items.
c. Calculate income from continuing operations on a current cost basis
d. Calculate the current cost amounts of property, plant, equipment and inventory at the end of the fiscal year
e. Report increases or decreases in current cost amounts of property, plant, equipment and inventory, net of inflation.

FAS 89 Financial Reporting and Changing Prices superseded FASB Statement No. 33 in 1986 and made voluntary the supplementary disclosure of constant purchasing power/current cost information.

Presently, inflation accounting describes a complete price-level inflation accounting model, namely the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies required to be implemented only during hyperinflation which is an exceptional circumstance according to the IASB. It serves to make HC and CC financial statements more useful at the period end by restating all non-monetary items – variable and constant real value non-monetary items - by inflation-adjusting them by applying the period-end CPI during hyperinflation.

“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses value at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2.

The fallacy that inflation destroys the real value of non-monetary items is currently still generally accepted. It is still mistakenly accepted as a fact that the erosion or destruction of companies´ capital and profits is caused by inflation.
It became very clear to me during 2008 that inflation has no effect on the real value of non-monetary items over time. The understanding of the real value destroying effect of the stable measuring unit assumption on constant items never maintained is an ongoing process. Not inflation, per se, but SA accountants´ implementation of the very destructive stable measuring unit assumption during low inflation as it forms part of the HCA model, destroys the real value of constant real value non-monetary items never maintained over time. There is no substance in the statement that inflation destroys the real value of non-monetary items which do not hold their real value over time. 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.


Copyright © 2010 Nicolaas J Smith

The accusation that I suggest inflation-accounting in SA is not true.

The IASB approved financial capital maintenance in nominal monetary units fallacy led SA accountants to choose to implement the traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation. They value both variable items stated at Historical Cost in terms of IFRS or SA GAAP, as well as constant items also stated at Historical Cost in terms of the Historical Cost Accounting model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant real value non-monetary items are thus considered by SA accountants to be simply HC non-monetary items.

There is a fixation in accounting that constant purchasing power inflation-adjustment simply means adjusting company financial statements mainly to make current year statements more comparable with previous year statements. Inflation-adjustment is not automatically thought of as affecting the fundamental values of the underlying resources although that is what is done with world wide annual inflation-adjustment of salaries, wages, rentals, etc. The two processes are seen as different processes.


The high inflation 1970´s

During the period of high inflation in the 1970´s accountants and accounting authorities tried various inflation accounting models in an attempt to reflect in company financial reports the effect of high inflation on monetary and – mistakenly - non-monetary items too. Inflation has no effect on the real value of non-monetary items.

They did not realize that it was simply their choice of the stable measuring unit assumption that was destroying the real value of constant real value non-monetary items never maintained although the FASB did mention the stable measuring unit assumption in FAS 89. The IASB never mentioned it in either IAS 6 or IAS 15. “The erosion of business profits and invested capital caused by inflation” was clearly stated in FAS 33 and “the erosive impact of inflation on profits and capital” was stated in both FAS 33 and FAS 89. The FASB did, however, realize that “Relative to most changes in financial reporting, the changes required by Statement 33 were monumental.” Their implementation was eventually made voluntary.

During that period inflation accounting described a range of accounting models designed to reflect the effect of changing prices on financial reporting. Changing prices included changes in specific prices as well as changes in the general price level which resulted in the destruction of the purchasing power of money, i.e. inflation. It was and still is generally accepted that inflation affects the real value of non-monetary items. That is not true. Inflation has no effect on the real value of non-monetary items.

Inflation is a uniquely monetary phenomenon. It is not inflation, but, SA accountants´ selection of the HCA model and implementing the very destructive stable measuring unit assumption and financial capital maintenance in nominal monetary units (the first based on a fallacy and the second being a very popular accounting fallacy) which unknowingly destroy the real value of constant real value non-monetary items never maintained during low inflationary periods in the SA real economy.

Copyright © 2010 Nicolaas J Smith

What price stability?

“The South African Reserve Bank is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as the achievement and maintenance of price stability.

The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.” SARB.

Absolute price stability is a year-on-year increase in the Consumer Price Index of zero percent. A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.

“The ECB´s Governing Council has announced a quantitative definition of price stability:

Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.” European Central Bank

http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html

A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. Theoretically, the SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”. In fact, the SARB´s chosen definition of price stability is for inflation to be 6% per annum on a continuous basis because when inflation targeting is implemented inflation generally trends to the upper limit.

SA accountants, on the other hand, simply assume that the Rand is perfectly stable in SA´s low inflationary economy, but, only for the purpose of valuing balance sheet constant real value non-monetary items which they account as Historical Cost items. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant items, namely salaries, wages, rentals, etc. They value other income statement items in nominal monetary units, i.e. at HC. SA accountants do not regard changes in the general purchasing power or real value of the Rand to be sufficiently important to measure financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) in 1989.

They generally choose to implement financial capital maintenance in nominal monetary units, also authorized by the IASB in the Framework, Par 104 (a) in 1989. It is impossible to maintain the real value of capital stable by measuring financial capital maintenance in nominal monetary units per se during low inflation or deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

No fundamental constant

One of the basic principles in accounting is “The Measuring Unit principle:

The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”

Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.

However, non-monetary items are not all fundamentally the same. Non-monetary items are, in fact, subdivided into variable real value non-monetary items and constant real value non-monetary items. The three fundamentally different basic economic items are monetary items, variable items and constant items although it is generally accepted under the HC paradigm that there are only two basic economic items, namely, monetary and non-monetary items.

HC accountants regard all non-monetary items stated at HC, whether they are variable real value non-monetary HC items or constant real value non-monetary HC items to be fundamentally the same, namely, simply non-monetary items when they implement their very destructive stable measuring unit assumption as part of the traditional HCA model during low inflationary periods.

This is the result of money illusion. People make the mistake of thinking that money is stable in real value in a low inflationary environment. Inflation always and everywhere destroys the real value of money over time. It is thus impossible for money to be stable in real value during inflation. On the other hand, inflation has no effect on the real value of non-monetary items over time.
The unit of measure in accounting is the base money unit of the most relevant currency. Money is not stable in real value during inflation.

This means that the monetary unit of measure in accounting is not a stable monetary unit of measure during inflation and deflation. Accountants´ unstable monetary unit of measure or unstable monetary unit of account is the only generally accepted unit of measurement that is not an absolute value. It does not contain a fundamental constant. All other generally accepted units of measurement of time, distance, velocity, mass, momentum, energy, weight, etc are absolute values, e.g. second, minute, hour, metre, yard, litre, kilogram, pound, mile, kilometre, inch, centimetre, gallon, ounce, etc.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith