Fundamental flaws in IFRS and US GAAP

 The stable measuring unit assumption’s rejection during hyperinflation has already been authorized in IAS 29 in 1989 and its rejection during low inflation and deflation has been authorized as an option in the Framework, Par 104 (a), also in 1989.

Bruce Pounder, a highly respected American academic and commentator on IFRS and US GAAP, states that there are various inherent (fundamental) flaws in current IFRS and US GAAP.

Constant items, with the exception of some income statement items, namely salaries, wages, rentals, etc which are, in fact, inflation-adjusted, are valued in nominal monetary units under HCA applying the very destructive stable measuring unit assumption when measuring financial capital maintenance in nominal monetary units during low inflation and deflation. SA accountants unknowingly destroy the real values of constant items never maintained at a rate equal to the annual rate of inflation when they implement their very destructive stable measuring unit assumption during low inflation. This amounts to about R134 billion per annum.
Copyright © 2010 Nicolaas J Smith

The stable measuring unit assumption

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

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

The IASB manages to side-step the appropriate split between variable and constant items in IFRS with the stable measuring unit assumption which it authorized as part of HCA in the Framework, Par 104 (a). The IASB-authorized both the implementation of the stable measuring unit assumption as well as its rejection in Par 104 (a). SA accountants have to choose the one or the other. Most probably all SA accountants choose financial capital maintenance in nominal monetary units which is a complete fallacy during inflation and deflation: it is impossible to maintain the real value of financial capital constant during inflation and deflation. This means they implement the stable measuring unit assumption during non-hyperinflationary periods.
Copyright © 2010 Nicolaas J Smith

Examples of constant real value non-monetary items

All income statement items once they are accounted.


All balance sheet constant items.


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

Stable measuring unit assumption rejected twice in IFRS

SA accountants at Johannesburg Stock Exchange listed companies as well as at non-listed companies doing their accounts in terms of IFRS generally choose, in terms of Par 104 (a), to measure financial capital maintenance in nominal monetary units implementing the traditional HCA model which includes their very destructive stable measuring unit assumption during low inflation.

Issued Share Capital, Share Premium Account, Capital Reserves, Retained Earnings, all other items in Shareholders´ Equity, all items in the Income Statement, Provisions, etc. are non-monetary items. The IASB confirms this by clearly defining them as such in IAS 29. These non-monetary items are obviously constant items with constant real values since they can be measured in units of constant purchasing power in terms of the Framework, Par 104 (a) in order to implement a constant purchasing power financial capital maintenance concept at all levels of inflation and deflation.

This is done as follows: The monthly change in the annual CPI is continuously applied to the measurement of all constant items in a double entry accounting model during low inflation and deflation. It includes calculating and accounting the net monetary loss or gain from holding monetary items during the accounting period. Net monetary losses and gains are constant items once calculated and accounted in the Income Statement. Variable items are valued in terms of IFRS during low inflation and deflation while monetary items are stated at their original monetary values during the current accounting period under all accounting models and at all levels of inflation and deflation. Both constant and variable items are valued in units of constant purchasing power during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies.
Copyright © 2010 Nicolaas J Smith

Constant items defined in IFRS

The definition of constant items is confirmed by the IASB in the Framework by implication.

The fact that certain non-monetary items have constant real non-monetary values is implied by the IASB in the Framework for the Preparation and Presentation of Financial Statements.

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

IAS Plus, Deloitte. Date: 21st March, 2010 http://www.iasplus.com/standard/framewk.htm

There are no applicable IFRS or Interpretations regarding the capital concepts, the capital maintenance concepts and the valuation of constant items. The explicit and implied definitions of these items in the Framework are thus applicable.

The Framework, Par 102 states that most companies choose a financial concept of capital to prepare their financial reports. An entity’s capital is the same as its shareholders´ equity or net assets when it adopts a financial concept of capital, for example, invested purchasing power or invested money.

Par 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.

Par 104 states that the concepts of capital stated in Par 102 give origin to the financial capital maintenance concept. Par 104 (a) states:

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

Constant items are non-monetary items with constant purchasing power values.

“It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.”

US Financial Accounting Standard FAS 33 p. 24
Copyright © 2010 Nicolaas J Smith

Basel III maintains the financial-capital-maintenance-in-nominal-monetary-units fallacy

Banking regulation is about banks having sufficient capital and maintaining that capital adequacy ratio during inflation and deflation.

However, the basic financial capital maintenance concept is a fallacy, namely, financial capital maintenance in nominal monetary units (the traditional global generally accepted Historical Cost Accounting model): it is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

The IASB foresaw this 21 years ago and authorized financial capital maintenance in units of constant purchasing power during low inflation and deflation in IFRS in the Framework, Par 104 (a) in 1989 which states:

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

See Constant ITEM Purchasing Power Accounting - CIPPA (NOT Constant Purchasing Power Accounting - CPPA)

US GAAP do not provide for financial capital maintenance in units of constant purchasing power – only IFRS do.

Accountants implementing IFRS can freely change over to financial capital maintenance in units of constant purchasing power any time they wish.



Copyright © 2010 Nicolaas J Smith

Basel is nominal

Bank capital requirements are increased in NOMINAL TERMS as per new Basel rules.

Result: their capital is always declining in REAL TERMS during inflation; i.e. their accountants unknowingly destroy the real value of their capital with their very destructive stable measuring unit assumption.

In 1989 the International Accounting Standards Board authorized the Framework, Par 104 (a). It states:

"Financial capital maintenance can be measured in either nominal monetary units OR UNITS OF CONSTANT PURCHASING POWER." (my capitals)

Simply stated: All banks (and all companies) would maintain the REAL VALUE of their capital (equity) CONSTANT FOREVER as long as they break even - all else being even - under any level of inflation or deflation with financial capital maintenance in units of constant purchasing power whether they own any revaluable fixed assets or not.

US GAAP does not even allow financial capital maintenance in units of constant purchasing power.

No-one implements it because:

1. Very few people understand the real value maintaining effect of financial capital maintenance in units of constant purchasing power.

2. Very few people understand the destruction caused by accoutants´ stable measuring unit assumption where under accountants simply assume there is no such thing as inflation and deflation: they simply assume money was, is and always will be perfectly stable ONLY for the purpose of valuing/measuring ALL balance sheet constant real value non-monetary items as well as most - not all - income statement items: accountants (very smartly) look after their own very good salaries: they inflation-adjust them as well as rental payments, etc. But, only these items: nothing else.
3. Financial capital maintenance in nominal monetary units per se - logically and mathematically impossible during inflation and deflation - is the paradigm since the invention of money: i.e. at least for the last 3000 years.
Copyright © 2010 Nicolaas J Smith

Constant real value non-monetary items

"One can say that capital, as a category, did not exist before double-entry bookkeeping". Sombart

Lane, Frederic C; Riemersma, Jelle, eds (1953). Enterprise and Secular Change: Readings in Economic History. R. D. Irwin. p. 38. (quoted in "Accounting and rationality")

Definition

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

Measurement of Constant Items in the Financial Statements

Measurement of constant items is the generally accepted accounting practice of determining the monetary amounts at which constant real value non-monetary items are to be recognised/accounted and carried in the financial reports. This involves the selection of the particular basis of primary measurement. Constant real value non-monetary items are valued in terms of IFRS in units of constant purchasing power by applying the CPI under the financial capital maintenance in units of constant purchasing power model, i.e. Constant ITEM Purchasing Power Accounting, as authorized in IFRS in the Framework, Par 104 (a) in 1989 where under only constant real value non-monetary items are inflation-adjusted during low inflation and deflation.

Hyperinflation is described as an exceptional circumstance by the IASB. All non-monetary items – both variable real value non-monetary items and constant real value non-monetary items - are required to be valued in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation.

Financial capital maintenance in nominal monetary units and its IFRS-authorized alternative - financial capital maintenance in units of constant purchasing power - would be one and the same basic accounting model at permanently sustainable zero inflation – something that has never been achieved in the past and is not likely to be achieve any time soon in the future.

The IASB defined monetary items in IAS 29 incorrectly as money on hand and items to be paid in money or to be received in money. Most variable real value non-monetary items and constant real value non-monetary items are generally received or paid in money as the monetary medium of exchange. The fact that the IASB defines non-monetary items as all items in the income statement and all other assets and liabilities in the balance sheet that are not monetary items, after having defined monetary items incorrectly, leads to the wrong classification of some constant items, notably trade debtors and trade creditors, as monetary items by, for example,

PricewaterhouseCoopers in their publication Understanding IAS 29. This results in the net monetary gain or loss generally being calculated incorrectly by companies implementing IAS 29 in hyperinflationary economies.

The definition of non-monetary items as being all items that are not monetary items is a generic definition. It is thus premised by the IASB that there are only two fundamentally distinct items in the economy: monetary and non-monetary items and that the economy is divided into two parts: the monetary and non-monetary economy. IAS 29 and other IFRS are based on this premise of only two fundamentally different items in the economy. This is a false premise.

It is not true that there are only two basic economic items as defined in IFRS. There are three fundamentally different basic economic items in the economy:

1. Monetary items
2. Variable real value non-monetary items
3. Constant real value non-monetary items
Copyright © 2010 Nicolaas J Smith

The world cup of debt

The world cup of debt

The safest 10 countries are:

1.Hong Kong
2.Singapore
3.Korea
4.Chile
5.Taiwan
6.Germany
7.South Africa
8.Czech Republic
9.Malaysia
10.Uruguay.

Not bad!!

Congratulations!!

The strength of the Rand bears testimony to this.

The US Dollar and the Euro are not money in SA

Foreign exchange

A foreign currency is not the functional currency in South Africa since it is not the generally accepted national monetary unit of account. The Rand is the monetary measuring unit in SA. The SA economy is not a Dollarized economy. The Rand is the functional currency.

Money has three functions:

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

A foreign currency like the US Dollar or the Euro is, however, a medium of exchange in SA. Most businesses and individuals would accept the USD or the Euro as a means of payment; that is, as a medium of exchange because they can easily sell the foreign currency amounts they would receive in transactions at their local banks for Rands.

A hard currency is also a store of value in SA. The USD and the Euro are hard currencies with daily changing market values. They are generally accepted world wide as a relatively stable store of value. People know there are normal daily small changes in their exchange values.

The USD and the Euro are, however, not national units of account in SA. You cannot normally do your SA accounts in US Dollars or Euros for tax purposes during low inflation and deflation. You have to do your accounting in Rand values in the SA economy during low inflation and deflation. The USD and the Euro are not functional currencies in SA since they do not fulfil all three functions of a functional currency within the SA economy. A foreign currency like the USD or the Euro only fulfils two functions of money, namely, unstable medium of exchange and unstable store of value. They therefore are not money or the functional currency in SA from a strictly technical point of view. They are not monetary items in SA.

Foreign currencies are variable real value non-monetary items in the SA economy. They have variable real values which are determined in the foreign exchange markets daily.

The US Dollar is only a functional currency outside the United States of America in countries like Ecuador, Panama and Zimbabwe which have Dollarized their economies. They use the US Dollar as their functional currency. They do not have their own national currencies. That is not the case in SA.

It just appears very strange to say that the US Dollar or the Euro is not money in SA. Technically speaking that is correct because an economic item can only be money if it fulfils all three functions of money. The Euro is only money in the European Monetary Union (EMU) and the USD is only money in the US and in countries which have Dollarized their economies.

The man and woman in the street, however, regard anything that is a medium of exchange as “money” in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.

The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. Accountants would, however, classify foreign exchange as a variable real value non-monetary item stated at its current market value and not the same as the SA Rand, that is, not as a monetary item when they choose to implement financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a) during low inflation and deflation, i.e. when they implement Constant ITEM Purchasing Power Accounting (CIPPA).


Copyright © 2010 Nicolaas J Smith

Valuing properties at HC does not destroy their real values

Valuing properties at HC does not destroy their real values

The real values of land and buildings are not destroyed by accountants when they value these fixed assets at their original nominal HC values before the date that they are actually sold during low inflation. They would be valued at their current market values on the date of exchange in an open economy. During hyperinflation all non-monetary items (variable and constant items) are required to be valued in units of constant purchasing power to make restated HC financial reports more useful by applying the CPI at period-end or a hard currency parallel rate – normally the US Dollar daily parallel rate – on a daily basis if the country wishes to stabilize its real economy.

This is not the case with reported constant items with real values never maintained constant during low inflation and deflation under the HCA model. SA accountants unknowingly destroy the real values of reported constant items never maintained at a rate equal to the rate of inflation in a low inflationary environment with their stable measuring unit assumption under HCA.

Land and buildings´ real values are not being unknowingly destroyed by SA accountants as a result of their implementation of IFRS or SA GAAP since they exist independently of how we value them. Accountants can value land and buildings in the balance sheet at their HC 50 years ago, but, when they are sold in the market today they would be transacted at the current market price. The real values of variable items are also not being destroyed uniformly at, e.g., a rate equal to the inflation rate because of valuing them at original nominal HC. Inflation has no effect on the real values of non-monetary items.

Where real losses are made in dealing with variable items in SA, these losses are the result of supply and demand or business or private decisions, e.g. selling at a bad price, obsolescence, stock market crashes, credit crunches, etc. They do not result from the implementation by SA accountants of the HC accounting model.

A house is a variable real value non-monetary item. Let us assume a house in Port Elizabeth is fairly valued in the PE market at say R 2 million on 1st January in year one. With no change in the market a year later but with inflation at 6% in SA, the seller would increase his or her price to R2.12 million - all else being equal. The house’s real value remained the same. The depreciating monetary price for the house expressed in the depreciating Rand medium of exchange – all else being equal - was inflation-adjusted to compensate for the destruction of the real value of the depreciating Rand in the internal SA market by 6% annual inflation. It is clear that inflation does not affect the house’s variable non-monetary real value – all else being equal.

However much inflation rises, it can only make the Rand more worthless at a higher rate and over a shorter period of time. Heaven forbid that what happened in Zimbabwe recently would ever happen in SA. As inflation rises the price of the house would rise to keep pace with inflation or value destruction in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non-monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.

When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 29 years since January, 1981 in the company’s balance sheet. When it is eventually sold today for R 1.4 million we can see that inflation did not destroy the property’s variable real non-monetary value – all else being equal. Inflation only destroyed the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 29 year period - all else being equal. This was taken into account by the buyer and seller at the time of the sale. The selling price in Rand was increased to compensate for the destruction of the real value of the Rand by inflation. R1.4 million today (2010) is the same as R100 000 in January, 1981 – all else being equal.

As the two lady academics from Turkey state: “Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Copyright © 2010 Nicolaas J Smith

The Historical Cost Debate

The Historical Cost Debate

The Historical Cost Debate is the debate over the last 100 years or so about the exclusive use of Historical Cost for all accounting purposes. The accounting profession has realized for a very long time that financial reports based on Historical Cost for all economic items do not fairly represent a company’s results and operations. As a result of this debate the pure Historical Cost Accounting model has been improved and changed dramatically during this time, so much so, that today we have a huge volume of IFRS where under variable items are not all valued at HC but at, e.g. fair value or the lower of cost and net realizable value or market value or recoverable value or present value, etc. This debate has thus been a very valid and successful debate regarding the valuation of variable real value non-monetary items.

Unfortunately, the stable measuring unit assumption is still an IASB-approved option that everyone uses for the valuation of most constant items (excluding salaries, wages, rents, etc) during low inflation and deflation. Fortunately, the option of measuring financial capital maintenance in units of constant purchasing power during low inflation has been approved by the IASB in the Framework, Par 104 (a) in 1989. Unfortunately, no-one uses it during low inflation or deflation for the various reasons explained on this blog.

Copyright © 2010 Nicolaas J Smith

IAS 29 fundamentally flawed

Hyperinflation is defined as an exceptional circumstance by the IASB in IAS 29. All non-monetary items – variable real value non-monetary items and constant real value non-monetary items - are required to be valued in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation by applying the period-end Consumer Price Index to make restated Historical Cost or Current Cost financial reports more useful.

This normally does nothing to the real values of the restated constant items unless they are accepted by the tax authorities as the new real values for these companies. International Financial Reporting Standards only have legal effect once their implementation has been formally legalized by individual countries. The same is true for indexation or inflation-accounting during very high and hyperinflation.

Brazil, Argentina, other South American countries and Turkey are examples of countries where inflation-accounting was used during very high and hyperinflation.

The only way a country in hyperinflation can stabilize its real or non-monetary economy is by applying the daily parallel rate in the valuing of all non-monetary items instead of the year-end CPI as required in IAS 29. This was not done in Zimbabwe with obvious results. It was done in Brazil during 30 years from 1964 to 1994 where the whole economy updated all non-monetary items daily in terms of a daily index value supplied by the various governments over those 30 years. That was financial capital maintenance in units of constant purchasing power during high and hyperinflation by daily updating in terms of the parallel rate. IAS 29 Financial Reporting in Hyperinflationary Economies is fundamentally flawed in this respect.

Copyright © 2010 Nicolaas J Smith

CIPPA implements financial capital maintenance in units of constant purchasing power

Constant ITEM Purchasing Power Accounting - CIPPA - is not an inflation accounting model the same as 1970-style Constant Purchasing Power Accounting (CPPA) under which all non-montary items (variable and constant items) are inflation adjusted during very high and hyperinflation. CIPPA is an alternative basic accounting model to HCA under which only constant items (not variable items) are inflation adjusted during low inflation and deflation.

The specific choice of measuring financial capital maintenance in units of constant purchasing power (the CIPPA model) during non-hyperinflationary periods as authorized in the Framework, Par 104 (a), was approved by the IASB’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

Deloitte states:

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

IAS8, 11:

“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

There is no applicable IFRS or Interpretation regarding the capital concept, the capital maintenance concept and the valuation of constant real value non-monetary items. The Framework is thus applicable.

The IASB did not approve CIPPA in 1989 as an inflation accounting model. It did that with CPPA in IAS 29 also in 1989. CIPPA by measuring financial capital maintenance in units of constant purchasing power incorporates an alternative constant purchasing power capital concept, constant purchasing power financial capital maintenance concept and constant purchasing power profit determination concept to the HC capital concept, HC financial capital maintenance concept and HC profit determination concept.

CIPPA only requires all constant real value non-monetary items to be valued in units of constant purchasing power - not variable items. Variable items are valued in terms of IFRS or GAAP and are not required in terms of the Framework, Par 104 (a) to be valued in units of constant purchasing power during low inflation or deflation.

Copyright © 2010 Nicolaas J Smith

Constant ITEM Purchasing Power Accounting - CIPPA.

Constant purchasing power accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the International Accounting Standards Board´s inflation accounting model required to be implemented only during hyperinflation which the IASB describes as an exceptional circumstance.

Constant item purchasing power accounting (CIPPA) is the IASB's basic accounting alternative authorized in IFRS in 1989 as an alternative to traditional historical cost accounting whereunder only constant real value non-monetary items, e.g., all items in the income statement, shareholders´ equity, trade debtors, trade creditors, provisions, all non-monetary payables, all non-monetary receivables, etc. (not variable real value non-monetary items, e.g., property, plant, equipment, inventories, foreign exchange, etc) are measured in units of constant purchasing power (inflation-adjusted) during low inflation and deflation.

Both CPPA (authorized in IFRS for implementation only during hyperinflation) and CIPPA (authorized in IFRS for implementation during low inflation and deflation) are price-level accounting models which use the principle of financial capital maintenance in units of constant purchasing power. CPPA uses it to maintain the real value of all non-monetary items during hyperinflation. Under CIPPA only constant real value non-monetary items (not variable real value non-monetary items) are measured in units of constant purchasing power during low inflation and deflation respectively. IAS 29 (CPPA) requires the updating of all non-monetary items (both variable and constant real value non-monetary items) by means of the Consumer Price Index during hyperinflation. CIPPA as authorized in IFRS in the IASB´s Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a) in 1989 requires the inflation-adjustment (measurement in units of constant purchasing power) of only constant real value non-monetary items by means of the CPI during non-hyperinflationary periods.

In terms of the Framework, Par 104 (a) accountants can choose CIPPA to implement a financial capital concept of invested purchasing power, i.e. financial capital maintenance in units of constant purchasing power during low inflation and deflation instead of the traditional HC concept of invested money. They will thus implement a Constant Purchasing Power financial capital maintenance concept by measuring financial capital maintenance in units of Constant Purchasig Power instead of the traditional HC nominal monetary units and they will implement a Constant Purchasing Power profit/loss determination concept in units of constant purchasing power instead of in real value destroying nominal monetary units during low inflation. CIPPA simply means inflation-adjusting only constant real value non-monetary items, e.g., issued share capital, retained income, capital reserves, all other items in shareholders´ equity, trade debtors, trade creditors, provisions, deferred tax assets and liabilities, all other non-monetary payable, all other non-monetary receivables, salaries, wages, rentals, all other items in the income statement, etc, by means of the consumer price index (CPI) while valuing variable real value non-monetary items, e.g., property, plant, equipment, listed and unlisted shares, inventory, foreign exchange, etc., in terms of International Financial Reporting Standards (IFRS) at for example fair value, market value, recoverable value, present value, net realizable value, etc. or Generally Accepted Accounting Principles (GAAP) during non-hyperinflationary periods.

Monetary items are always valued at their original nominal HC monetary values in nominal monetary units during the current accounting period under all accounting and economic models because it is impossible to inflation adjust money and other monetary items, monetary items being money held and other items with an underlying monetary nature.

Monetary items, variable real value non-monetary items and constant real value non-monetary items are the three fundamentally different basic economic items in the economy.

CIPPA would maintain the real value of all constant real value non-monetary items constant in all entities that at least break even - ceteris paribus - including banks´ and companies´ capital base, for an unlimited period of time (forever) - all else being equal, whether these entities own revaluable fixed assets or not and without the requirement of additional capital from capital providers in the form of extra money or extra retained profits simply to maintain the existing constant real non-monetary value of existing constant items constant. This is opposed to the traditional HCA model under which HC accountants are unknowingly, unnecessarily and unintentionally destroying the real value of that portion of shareholders´equity never maintained constant as a result of insufficient revaluable fixed assets (revalued or not) under HCA during low inflation. CIPPA was authorized by the IASB in 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation in the Framework and is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of constant real value non-monetary items.

•The Framework, Par. 104 (a) states:

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

It does not state "during hyperinflation." That is stated in IAS 29 Financial Reporting in Hyperinflationary Economies. The Framework, Par 104 (a) is thus applicable at all levels of inflation and defltion: low inflation too.

Discredited 1970-style CPPA was a form of inflation accounting which tried unsuccessfully - by updating all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) equally by means of the CPI during high inflation (but not yet hyperinflation) - to allow for the effect of the stable measuring unit assumption in an attempt to make corporate accounts more informative when comparing current transactions with previous transactions. It was a total failure during low inflation. CPPA is not the same as CIPPA. Under CIPPA only constant items are inflation-adjusted only during low inflation and deflation. Under CPPA all non-monetary items - constant and variable real value non-monetary items - are inflation adjusted only during hyper inflation.

Many accountants and accounting authorities - excluding the IFRS Foundation and the IASB - still mistakenly regard CIPPA as the same as the discredited and failed 1970-style CPPA inflation accounting model. They ignore CIPPA's substantial benefits, for example, automatically maintaining the real value of banks´ and companies´ equity constant instead of destroying it in all entities that at least break even during low inflation when accountants choose to inflation-adjust only constant real value non-monary items by means of the CPI thus maintaining instead of continuously destroying their real values at a rate equal to the annual rate of inflation while they value variable items in terms of IFRS or GAAP. Monetary items cannot be inflation-adjusted or updated and accountants value them at their original nominal HC values during the actual accounting period under all accounting and economic models.

Certain income statement constant real value non-monetary items, most notably salaries, wages, rentals, etc. are inflation-adjusted by means of the CPI, that is, valued or measured in units of constant purchasing power during low inflation, in most economies implementing the traditional HCA model.

IFRS specifically require the CPPA inflation accounting model to be used only during hyperinflation as per IAS 29.

Copyright © 2010 Nicolaas J Smith

Underlying assumptions in IFRS

Underlying assumptions in IFRS

The stable measuring unit assumption is the underlying assumption in IFRS under the HC paradigm and measurement in units of constant purchasing power is the underlying assumption in IFRS under the Constant Item Purchasing Power paradigm.
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Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Only daily parallel rate indexing can do the trick in a hyperinflationary economy

Hyperinflation is defined as an exceptional circumstance by the IASB. All non-monetary items – variable and constant items - are required to be valued in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation by applying the period-end CPI to make restated HC or Current Cost financial reports more useful. This normally does nothing to the real values of the restated constant items unless they are accepted by the tax authorities as the new real values for these companies. The only way a country in hyperinflation can stabilize its real or non-monetary economy is by applying the daily parallel rate in the valuing of all non-monetary items instead of the year-end CPI.

Only daily parallel rate indexing can do the trick in a hypeirnflationary economy.


Copyright © 2010 Nicolaas J Smith

Variable items

Variable items hold their values in terms of purchasing power as a result of the ways in which they are valued in terms of IFRS, SA GAAP or just simply in the market, in which their nominal values are adjusted to allow for the many factors that determine their values - including - amongst many factors - inflation. For example: fair value, market value, net realizable value, present value and recoverable value all adjust for inflation in the real value of the Rand as part of the specific valuation process.
Valuation values

Values used in the valuation of variable items on a primary valuation basis include the following:

Market value

Fair value

Net realisable value

Present value

Recoverable value

Current cost

Carrying value

Residual value

Value in use

Settlement value

Book value

Replacement cost

Historical cost

Copyright © 2010 Nicolaas J Smith

Accounts Payable and Accounts Receivable under CIPPA

"2 - When I settle the Accounts Payable and receive the Accounts Receivable, what am I receiving/paying? The adjusted amount or the original invoice amount?"

You receive the adjusted amount.

You receive the constant real non-monetary value (the sale has been made and the AP/AR amount is fixed in real value at the date of sale) measured in units of constant purchasing power – inflation-adjusted.

All original nominal (HC) invoiced amounts that are not settled on the spot (on the date of sale) have to be updated every month the CPI changes as an AP/AR amount, BUT, the original REAL VALUE stays the same: the nominal values are inflation-adjusted; i.e. they are measured in units of constant purchasing power over time. An invoice is stated in terms of money. When the real value of that money is destroyed by inflation over time and there is no stable measuring unit assumption made by accountants and implemented in accounting, then the nominal value of the invoice has to be adjusted over time in order to keep the real value the same – under CIPPA: because there is no stable measuring unit assumption under CIPPA: you are implementing financial capital maintenance in units of constant purchasing power which requires you to inflation-adjust all constant items; e.g. AR, AP, equity, etc.

You receive/pay the original real value; i.e. the nominal value adjusted for inflation (the destruction in the real value of the medium of exchange) over time. Street vendors who have never been to school know this instinctively in a hyperinflationary economy. They adjust all their prices for all the products they sell in the streets daily as the black market rate changes. Obviously, the same has to be done to invoice values, trade debtors, capital, profit and all other constant real value non-monetary items.

When I told them in Angola that I was going to update debtors they immediately understood. In hyperinflation it is also done for all variable real value non-monetary items; i.e. for all non-monetary items. We were the only firm who inflation-adjusted their salaries monthly: they got the same in USD but fantastic “increases” in Kwanzas. There were no real increases. Ben Bernanke stated that in pure hyperinflation there are no price increases. He is correct.

Copyright © 2010 Nicolaas J Smith

Why is inventory inflation-adjusted under CIPPA? Is this not against IAS 2?

IAS 2 (Technical Summary) states:
Inventories shall be measured at the lower of cost and net realisable value.

The Historical Cost of inventories is inflation-adjusted during low inflation because there is no stable measuring unit assumption under Constant ITEM Purchasing Power Accounting. Implementing CIPPA means an entity is applying financial capital maintenance in units of constant purchasing power during low inflation and deflation.

That means

Firstly that all constant real value non-monetary items (all items in the income statement, equity, trade debtors, trade creditors, etc.) are measured in units of constant purchasing power (inflation-adjusted every time the CPI changes);

Secondly that variable real value non-monetary items (property, plant, equipment, inventories, foreign exchange, etc.) are valued in terms of IFRS or GAAP on a primary basis and

Thirdly that monetary items are measured in nominal monetary units during the current financial period which includes the calculation and accounting of the net monetary gain or loss for the financial period.

Variable items, e.g. inventories, that are valued on a primary basis at HC in terms of IFRS are inflation-adjusted every time the CPI changes because there is no stable measuring unit assumption.

Measurement at HC does not mean or imply that the stable measuring unit assumption is applied. The stable measuring unit assumption is rejected under CIPPA. HC valuation is simply the measurement of an item at its original nominal historical cost in terms of IFRS or GAAP which is then inflation-adjusted every time the CPI changes: i.e. monthly.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Two methods to calculate the net monetary loss or gain

Accountants have to calculate the net monetary loss or gain from holding monetary items when they choose the Constant Purchasing Power Accounting (CIPPA) model where under they measure financial capital maintenance in units of constant purchasing power in the same way as the IASB requires its calculation and accounting during hyperinflation. There are net monetary losses and net monetary gains during low inflation too, but they are not required to be calculated when accountants choose the traditional HCA model.


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Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Value does not exist independently of how we measure it.

Hi,

CA007 stated in our mother of all debates:

"I state: Value DOES exist independently of how we ACCOUNTING measure it."

My reply was:

I spent a lot of time and I have prepared an excellent concise response to your statement that "value exist independently of how we accounting measure it".

I then realized that we first have to agree what the concept of a unit of constant purchasing power is, what the effect of applying it is, whether it is part of IFRS, whether it is generally accepted, does it work, does it not work, is there something like it, is it just a theoretical concept and no-one ever uses it, or is it used every day by billions of people - or not, is it never ever used, does no-one use it ever, has it ever been used in the past, does it appear in IFRS, how many times is it applied in IFRS - if at all, is it junk, is it real, does it affect the economy, does it have any effect, yes or no, what exactly is it, is there such a thing, or is it just my imagination, who supports it, etc, etc.

I will prepare a stament - with references to reliable third party source - although I am a bit worried that you may not accept them since you wish to regard what happened in Brazil during 30 years as "irrelevant".

We will have to agree that Brazil did exist during those 30 years from 1964 to 1994 and that 185 million people did measure all their non-monetary items DAILY in units of constant purchasing power and we will have to agree that it kept their internal non-monetary real market more or less stable while hyperinflation destroyed ONLY the real value of their money - not the real value of their non-monetary items. We also will have to agree that the reason why hyperinflation did not destroy the real value of all their non-monetary items was because they remeasured them DAILY in units of constant purchasing power. We will have to agree that it is impossible for hyperinflation to destroy any non-monetary item. We will have to agree that hyperinflation like inflation can only destroy the real value of money and other monetary items - nothing esle. We will have to agree that it was because they implemented measurement in units of constant purchasing power. We will have to agree that the Brazilian economy was not a barter economy during those 30 years as you claim. There may have been barter here and there on a miniscule scale, but the economy was not a barter economy. The whole economy remeasured all non-monetary items DAILY in units of constant purchasing power.

We will have to agree that this is not irrelevant as you say.

We did the same in Auto-Sueco (Angola) in 1996 where I worked in Luanda, Angola. I implemented it. It is not theory to me.

I know that various other South-American countries also used indexation during about the same period as Brazil - and even later.

If you are not prepared to agree that Brazil used the measurement of all non-monetary items during 30 years by means of units of constant purchasing power and that it had a real effect on their economy - totally different from the stable measuring unit assumption that you apply in your accounting - then I am prepared to research other cases of indexation - especially in South American countries.

This is all about units of constant purchasing power.

We will have to agree that it was because they rejected the stable measuring unit assumption - the basis of your accounting model, namely, HCA. We will have to agree that they did not apply HCA. We will have to agree that they rejected the stable measuring unit assumption - the fundamental basis of Historical Cost Accounting. We will have to agree that they maintained their NON-MONETARY OR REAL economy more or less stable BECAUSE they applied measurement in units of constant purchasing power. We will have to agree that they applied inflation-accounting and that it worked - that measurement in units of constant purchasing power did and does make a difference to the economy.

This is all about measurement in units of constant purchasing power and whether it makes a difference to the eonomy or not (for those who do not accept historical facts from the recent economic history of Brazil).

CA007, I wish to ask you: do you accept that there is a concept of units of constant purchasing power?

Yes or no?

Or do you regard the whole concept of units of contant purchasing power as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago (how long have you been an accountant?) as irrelevant as you regard 30 years of economic history in Brazil?

Par 104 (a) states: "Financial capital maintenance can be measured either in nominal monetary units OR UNITS OF CONSTANT PURCHASING POWER". (my capitals)

Par 104 (a) does not state "during hyperinflation". That is stated in IAS 29. Par 104 (a) thus applies under all levels of inflation and deflation - LOW inflation too.

CA007, do you accept measurement in units constant purchasing power during LOW inflation as authorized in IFRS?

Or, do you regard it as irrelevant?

During low inflation ONLY constant real value non-monetary items (NOT variable real value non-monetary items) are measured in units of constant purchasing power.

During hyperinflation ALL non-monetary items - both constant and variable items - are measured in units of constant purchasing power.

I do not wish to implement inflation-accounting in SA.

I wish SA accountants to measure ONLY constant items during LOW inflation as authorized in IFRS.

CA007, do you accept measurement in units constant purchasing power during LOW inflation as authorized in IFRS?

Or, do you regard it as irrelevant?

After I have your view about measurement in units of constant purchasing power, then I will be able to respond fully to your statement that value exist independently of how we accounting measure it. I am not running away from your statement. I will answer it in detail. You know already that I disagree with you. I intend to prove my point with historical facts and other facts.

You see, stating that what happened in Brazil during 30 years when an important country like Brazil as a whole maintained its whole non-monetary or real economy more or less stable - they even GREW economically - they had positive GDP growth - DURING hyperinflation of 2000 % per annum - by means of measuring all non-monetary items (variable and constant items - variable items too because they were in hyperinflation - this is not necessary during low inflation) by the accounting practice (authorized in IFRS) of measuring all non-monetary items in units of constant purchasing power which affected their economy in a massive way - they kept their non-monetary economy more or less stable during hyperinflation - by you stating that is irrelevant makes it very difficult to agree anything with you.

You can similarly state any fundamental fact is "irrelevant." It is difficult to agree on anything when one participant in the debate assumes the right to state proven historical facts are irrelevant.

What happened in Brazil during those 30 years is relevant to our discussion.

They did maintain the real value of all non-monetary items - variable and constant items - by measuring them in units of constant purchasing power - for 30 years: something they could not have done if they had implemented HCA, i.e. the stable measuring unit assumption during those 30 years. Value existed, yes, and they maintained those real values by means of measurement in units of constant purchasing power. If they had chosen HCA during those 30 years they would not have been able to maintain their real values: their choice of accounting model, not inflation, would have destroyed the real value.

Value thus does not simply exist irrespective of the ACCOUNTING measure we choose to implement over a period of time: during the financial year. When we choose HCA, we destroy the real value of constant items NEVER MAINTAINED during low inflation and hyperinflation - over the period of time of the financial year.

Measuring an item in units of constant purchasing power does maintain its real value - over time: the accounting period. As such it does affect the economy. The real value first has to exist. Measuring it in units of constant purchasing power (inflation-adjusting it) does maintain its existing real value during the accounting period during inflation. It is the choice of the accounting method, the choice of the measuring unit, namely, actually choosing measurement in units of constant purchasing power during inflation (rejecting the 3000 year old stable measuring unit assumption) that maintains the real value of the item - over time. By maintaining the real value - over time - by choosing the accounting method or measuring unit namely units of constant purchasing power, the existing real value is not destroyed - over time: the accounting period. It is not inflation doing the destroying in the non-monetary item. The real value of the non-monetary item is destroyed when the accountant chooses to measure its value in nominal monetary units during inflation - over a period of time: the accounting period. So, it is the choice of the accounting model or accounting method or measuring unit that is doing the destroying because when the accountant chooses measurement in units of constant purchasing power, the non-monetary item´s real value is maintained irrespective of the rate of inflation - always over time.

It is not inflation doing the destroying: it is the choice of applying the stable measuring unit assumption - over time during inflation. Measurement in units of constant purchasing power does affect the economy when it is applied over time. Measurement in units of constant purchasing power does not create real value over time where it NEVER existed. It simply MAINTAINS EXISTING real value in constant real value non-monetary items during low inflation - applied over time.

CA007,

Brazil was in high and hyperinflation for 30 years. Brazil was not a barter economy - as you believe - during those 30 years.

Venezuela is in hyperinflation now. Venezuela is not a barter economy now.

Zimbabwe was in hyperinflation for 18 or 19 years - Zimbabwe was not a barter economy.

The issue here is: does measuring a constant real value non-monetary item in units of constant purchasing power during low inflation affect the economy?

The answer is: yes.

It maintains the real value of the constant real value non-monetary item. It does not create new real value. It maintains it. It is the choice of measurement unit that maintains the real value: when the accountants chooses measurement in units of constant purchasing power during low inflation as authorized in IFRS in the Framework, Par 104 (a) DURING LOW INFLATION, then the real value of the non-monetary item is maintained, i.e. it is not destroyed. It is not inflation doing the destroying.

When the accountant chooses to measure the value of a constant real value non-monetary item in nominal monetary units, i.e. the accountant chooses to apply the stable measuring unit assumption during low inflation, i.e. the accountant chooses to assume there is no inflation DURING LOW INFLATION, then the implementation of that choice of measurement destroys the real value of the constant real value non-monetary item DURING INFLATION.

It is able to prove that measurement in units of constant purchasing power during low inflation maintains the real value of constant items in many ways.

It is able to prove that the accountant´s choice to implement the stable measuring unit assumption and not inflation is doing the destroying in many ways.

CA007´s reply was:

"You certainly know what you are talking about and I will need time to think it over.

I will concede: the Brazil example is not irrelevant to our debate.

Your question:

“ CA007, do you accept measurement in units constant purchasing power during LOW inflation as authorized in IFRS? “

My answer: Yes. I accept for both economic and financial reporting purposes

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

"Is the process of financial reporting the same as a process of wealth creation?"

That was the question asked by CA007 after he came to accept financial capital maintenance in units of constant purchasing power during LOW inflation as authorized in IFRS in the Framework, Par 104 (a) in 1989 on our Mother of all Debates

This was my answer:

This one is easy to answer immediately:

The answer is NO.

I emphatically always state that accountants do not and can not create wealth or real value out of nothing: out of thin air: by simply passing some update or inflation-adjustment accounting entries. They never do.

Accountants can only MAINTAIN EXISTING real value, BUT, ONLY with measurement in units of constant purchasing power during low inflation and hyperinflation.

(OR - ONLY in the case of the real value of SHAREHOLDERS´ EQUITY - not the real value of any other constant real value non-monetary item under HCA - under HCA during low inflation - when 100% of all contributions to the equity balance is continuously invested in revaluable fixed assets with an equivalent updated real value (revalued or not) - something that is only generally the case with property, hospital and hotel companies. This is where the unknowing destruction of real value by accountants choosing to implement the stable measuring unit assumption, i.e. assuming that inflation is zero percent during actual low inflation of up to 25% during three years in a row - enters the picture: they unknowingly destroy real value in that portion of equity that is never backed or maintained by investment in revaluable fixed assets with an equivalent updated real value under HCA during low inflation.)

How do accountants maintain EXISTING constant real non-monetary value during low inflation?

By NOT DESTROYING IT: i.e by measuring it in units of constant purchasing power: i.e. the OPPOSITE of what they do under HCA when they assume that there is no inflation even if inflation is 25% per annum forever. They destroy the real value by measuring the constant real value non-monetary items in nominal montary units: exactly the same as monetary units: treating constant real value non-monetary items the same as cash.

The constant real non-monetary value must first legally exist, then, accountants can MAINTAIN (instead of destroy with applying the stable measuring unit assumption; i.e ASSUMING there is no inflation and measuring it in nominal monetary units during low inflation) its real value ONLY with measurement in units of constant purchasing power during low inflation and hyperinflation.

We must remember that accounting has that little-understood magic: it is double entry: for every debit there is an equivalent credit.

The existing constant real non-monetary value of all constant real value non-monetary items is only maintained constant in all entities that at least break even when all constant real value non-monetary items are measured in units of constant purchasing power, all variable items are correctly valued in terms of IFRS and the net monetary gain or loss from holding monetary items is accounted in the income statement during low inflation.

This requires the CORRECT definition of monetary items.

Why?

Because both I and the IASB agree that non-monetary items are all items that are not monetary items.

Thus: define monetary items wrongly - as it is defined incorrectly in IFRS and US GAAP and by PricewaterhouseCoopers, and, we have the wrong split (classification) of monetary and non-monetary items - as we do have at the moment.

Here is the correct definition of monetary items:

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

Here is the IFRS (wrong) definition of monetary items:

Monetery items are money held and items to be received of paid in money. IAS 29, Par 12

Almost all non-monetary items are also received or paid in money.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

9 Fundamental flaws in IFRS and US GAAP

There are nine Fundamental flaws in IFRS and US GAAP

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Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Four accounting models authorized in IFRS.

A: Financial capital maintenance in nominal monetary units during low inflation and deflation: traditional Historical Cost Accounting (see the Framework, Par 104 (a))

B: Financial capital maintenance in units of constant purchasing power; i.e. Constant ITEM Purchasing Power Accounting under which ONLY constant real value non-monetary items (NOT variable items) are inflation-adjusted during low inflation and deflation. This is NOT Constant Purchasing Power Accounting which is an inflation-accounting model required ONLY during hyperinflation under which ALL non-monetary items – BOTH variable and constant items – are inflation-adjusted. (see the Framework, Par 104 (a)). This accounting model is unique to IFRS. It is not authorized under US GAAP.

IFRS also specifically requires

C: Current Cost Accounting when an entity selects physical capital maintenance in terms of the Framework, Par 102 and 104 (b).

IAS 29 Financial Reporting in Hyperinflationary Economies requires

D: Constant Purchasing Power Accounting, i.e. inflation-accounting under which all non-monetary items – both variable and constant items – are inflation-adjusted ONLY during hyperinflation (different from the above Constant ITEM Purchasing Power Accounting authorized in Par 104 (a) during LOW inflation and deflation under which ONLY constant items – NOT variable items – are inflation-adjusted during LOW inflation and deflation).

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Value does not exist independently of how we measure it.

The best example is a salary: when it is measured at Historical Cost, it has one value and when it is inflation-adjusted, i.e. measured in units of constant purchasing power, it has another - totally different - value.

This is also true for wages, rentals, etc.

Salaries, wages, rentals, etc are constant real value non-monetary items.

The same is true for all constant real value non-monetary items. Other examples are trade debtors, trade creditors, taxes payable, taxes receivable, etc.

Trade debtors, trade creditors and other non-monetary payables and receivables are mostly incorrectly defined by PricewaterhouseCoopers, the FASB, the IASB and others as monetary items and measured at Historical Cost in today´s economy.

185 million Brazilians measured all trade debtors, trade creditors, all other non-monetary payables and receivables daily in units of constant purchasing power by indexing them daily during 30 years from 1964 to 1994 with reference to a daily index supplied by the various governments during that period in the entire Brazilian economy.

This is totally ignored by PricewaterhouseCoopers, the FASB and the IASB today.

PricewaterhouseCoopers´auditors must have audited many Brazilian companies doing that during those 30 years. The message never got through to the PwC accountants who wrote their publication: Understanding IAS 29 - Financial Reporting In Hyperinflationary Economies in which PwC define trade debtors and trade creditors as monetary items. The FASB also specifically define trade debtors and trade creditors as monetary items.

Dr Gustavo Franco was the Governor of the Central Bank of Brazil during the last few years of that period of indexation. He was the head of the team that famously killed hyperinflation in Brazil in 1994 (they took 10 years to do it) with their Unidade Real de Valor (URV) or Real Value Unit.

I sent him the following email:

Dear Dr Franco,
>
> I would appreciate it very much if you could perhaps clear up a point for me regarding trade debtors and trade creditors under the URV.
>
> Were trade debtors and trade creditors treated as monetary items under the URV and not updated or were they treated as non-monetary items an updated in terms of the URV?
>
> What are trade debtors and trade creditors in your opinion? Are they monetary or non-monetary items?

He answered as follows:

"Dear Mr. Smith


Two observations are in order. First, for spot transactions the existence of the URV is immaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enters the picture only when at least one leg of a commercial transaction is deferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantities of URVs are to be paid at the payment day, though this should represent LARGER QUANTITIES OF WHATEVER MEANS OF PAYMENT IS USED. (my capitals)


It was essential, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denominated obligations had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetized.


Att


GF"

So: there it is from the best possible source: trade debtors and trade creditors are non-monetary items.

PricewaterhouseCoopers, the IASB and the FASB and all of us can be educated about financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) from what Dr Franco confirmed.

Equity is measured at Historical Cost during low inflation and deflation in all economies world wide.

Equity is measured, not at Historical Cost, but, in units of constant purchasing power in terms of IAS 29 in Venezuela today by all Venezuelan companies which implement IFRS as well as foreign holding companies (applying IFRS) of Venezuelan subsidiaries and in all hyperinflationary economies

So, it is very clear that the value of any economic resource does not exist independently of how it is measured.

That statement is ONLY true in the case of

(1) variable real value non-monetary items, e.g. property, plant, equipment, inventory, etc. and monetary items - per se - under all accounting and economic models

and
(2) ONLY equity (not all constant items) during low inflation and deflation under Historical Cost Accounting ONLY when 100% of the updated original real value of all contributions to the equity balance are continuously invested in revaluable fixed assets (revalued or not) with an equivalent updated real value. This is – generally – rarely the case. It is most probably the case in property, hospital and hotel companies.

The statement that “value exists irrespective of how it is accounted” is thus the fourth accounting fallacy not yet extinct.

The four accounting fallacies not yet extinct are:

1.Financial capital maintenance in nominal monetary units: it is impossible to maintain the real value of financial capital constant - per se - with measurement in nominal monetary units during inflation and deflation.

2.The stable measuring unit assumption that is based on the fallacy that changes (up to 25% annual inflation for three years in a row) in the real value of the monetary unit of account are not sufficiently important for accountants to choose financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized in IFRS in the Framework, Par 104 (a).

3.The erosion of business profits and invested capital is caused by inflation as wrongly stated by the FASB in FAS 33 in 1979. This is believed by almost all accountants and economists. In fact: “inflation is always and everywhere a monetary phenomenon” as so famously stated by Milton Friedman, the late Noble Laureate. Inflation has no effect on the real value of any nonmonetary item ever. It is impossible for inflation – per se - to erode, distort or destroy any non-monetary item ever. This is confirmed by two top Turkish academics who state:

“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.

4. “Value exists irrespective of how it is accounted.” This is only true in the case of variable and monetary items per se under all accounting and economic models and only equity during HCA during low inflation and deflation if the 100% investment requirement of the updated original real value of all contributions to the equity balance in revaluable fixed assets with an equivalent updated real value is met.

Copyright © 2010 Nicolaas J Smith

f

Statement regarding inflation destroying the real value of non-monetary items have no substance at all.

After 2008 it became very clear to me that inflation is only a monetary phenomenon and can only destroy the real value of money and other monetary items.

It is very clear that inflation has no effect on the real value of non-monetary items as Milton Friedman, the late American Noble Laureate stated so famously: "Inflation is always and everywhere a monetary phenomenon." It is impossible for inflation per se to destroy the real value of any non-monetary item ever.

I am not the only person stating and understanding that. This is what two Turkish academics state:

“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

The statement that inflation destroys the real value of non-monetary items that do not hold their real value has no substance at all. Just like the statement that valuing items in units of constant purchasing power makes no difference to the economy as well as the statement that inflation does the destroying in companies´capital and profits and not accountants.

The statement correctly confirms that there are two types of non-monetary items. Those that hold their real values in terms of purchasing power and those that do not hold their real values in terms of purchasing power under HCA during low inflation; i.e., as a result of the stable measuring unit assumption. These are constant real value non-monetary items incorrectly measured in nominal monetary units instead of in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) in 1989 which states:

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

The IASB only makes a distinction between monetary and non-monetary items. The stable measuring unit assumption allows the IASB to side-step the split between variable and constant real value non-monetary items.

Copyright © 2010 Nicolaas J Smith

Variable items exist independently of how SA accountants value them

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

Measurement is the process of determining the monetary amounts at which variable items are to be accounted/recognised and carried in the financial reports. This involves the selection of a particular basis of measurement. SA accountants value variable items in terms of IFRS or SA GAAP.

Variable items in the SA non-monetary or real economy are valued at, for example, fair value or the lower of cost and net realizable value or recoverable value or market value or present value in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

SA accountants value variable items correctly in terms of IFRS or SA GAAP at the financial report date – excluding those variable items valued at original nominal Historical Cost when that original date is not the financial report date on a primary valuation basis. The fundamental real values of variable items exist independently of being valued at their original nominal HC values after the original date they came about or were acquired by the entity. Valuing a variable item at its original nominal HC during its lifetime does not destroy its real value because it would be valued at its current market value whenever it is finally exchanged or sold or disposed of in the future.

All items in financial statements - monetary, variable and constant items - were valued at Historical Cost before there were any GAAPs and IFRS, since money – the monetary unit of account – was generally assumed to be stable in real value over time: the infamous stable measuring unit assumption. Today, SA accountants maintain this very destructive and very economically destabilizing assumption only for the valuation of the majority of income statement items (excluding salaries, wages, rents, etc which SA accountants generally value in units of constant purchasing power) and all balance sheet constant items during low inflation and deflation.

SA accountants implement the HC model when they choose to measure financial capital maintenance in nominal monetary units per se (which is a fallacy during inflation and deflation) in terms of the IASB´s Framework, Par 104 (a). They implement their very destructive stable measuring unit assumption. In so doing, they- and not inflation - are unknowingly destroying the real value of constant items never maintained during low inflation.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

Salaries and wages would never be decreased in line with monthly deflation.

Salaries and wages would never be decreased in line with monthly deflation.
Effects of rejecting the current 3000-year-old Historical Cost paradigm and changing over to a Constant Item Purchasing Power paradigm:

All non-monetary receivables and payables would be updated monthly with the change in the CPI. E.g. trade debtors, trade creditors, taxes payable, taxes receivable, etc would be updated monthly.

Salaries and wages would be updated monthly.

Result: a law would be rushed through parliament in the first month of monthly deflation (as already happened in one American state very recently) to prevent salaries from being decreased in line with monthly deflation (as they should be in order to maintain economic stability).

This would result in an increase in the real value of salaries and wages when they are kept the same during a month of monthly deflation.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

PricewaterhouseCoopers, the IASB and the FASB bamboozled by accountants´ notorious stable measuring unit assumption

Most accountants and economists will confirm that real value is being destroyed in banks´ and companies´ capital over time. The banking crisis – remember?

Most of them blame inflation – except two Turkish academics, the head of the Turkish Accounting Standards Department, the late Milton Friedman – and I.

It is not inflation doing the destroying as someone stated. It is them assuming there is no inflation when they never update companies´ and banks´ capital when they implement their very destructive stable measuring unit assumption.

Most of them believe the FASB when it tells them that the erosion of business profits and invested capital is caused by inflation.

They are all dead wrong: Friedman was right: inflation is always and everywhere a monetary phenomenon: inflation per se has no effect on any non-monetary item ever – as confirmed by the two Turkish academics.

What will happen when we change the global 3000 year old Historical Cost paradigm to the IFRS approved units of constant purchasing power regime?

First of all: accountants´ brains get filled by one word when they read or hear the term units of constant purchasing power:

INFLATION-ACCOUNTING!!!

Accountants forget that most of them inflation-adjust salaries, wages, rentals, etc annually.

However, IFRS authorized financial capital maintenance in units of constant purchasing power at ALL levels of inflation and deflation in the Framework, Par 104 (a) twenty one years ago.

Inflation-adjusting ONLY constant real value non-monetary items during low inflation (not all non-monetary items as required by inflation-accounting during hyperinflation) would mean that SA accountants would knowingly maintain about R167 billion in the constant real value of existing constant items currently unknowingly and unnecessarily being destroyed by them PER ANNUM in the SA real economy in, for example, that portion of companies´ capital not backed by sufficient revaluable fixed assets as a result of them implementing the stable measuring unit assumption.

The magic of accounting is that it is double entry: for every debit there is an equivalent credit.

So, if companies´ equity is to be inflation-adjusted (an increase in nominal credit values to maintain real values constant during low inflation) where does the opposite increase in nominal debit values come from?

For example from trade debtors: currently trade debtors are incorrectly classified by the IASB, the FASB, PricewaterhouseCoopers, etc, as monetary items. They are constant real value non-monetary items.
Copyright © 2010 Nicolaas J Smith

Would we be able to borrow more?

Bertie: Nicholaas, how would business be different in SA if that value was not being destroyed? In practical terms. I now buy into your point. But blog for us on what difference the opposite approach would have for everyday business in SA. Would we be able to borrow more? Lend more? Produce more? Market more lavishly?

Would we be able to borrow more?

Yes.

With all capital and retained profits revalued monthly, it means that the real value of the part of SA´s investment capital base represented by companies´ equity will be maintained constant in real value terms on a national and company by company basis: in units of constant purchasing power.

The company with R1 million in capital on 1st Jan 1981 still has R1 million today under the current 3000-year-old Historical Cost paradigm and is able to borrow accordingly from the banks today as well as in 29 years time from today if inflation is exactly the same over the next 29 years as it was over the last 29 years and we maintain the Historical Cost paradigm. In 29 years´ time the company will still have R1 million capital - but at the 2039 price level; i.e. 1/14th of today´s real value exactly the same when today´s R1 million is 1/14th of the real value of what it was on 1st Jan 1981.

Under the Constant Item Constant Purchasing Power (CICPP) paradigm, the company with R14 million in capital on 1st Jan 1981 (today´s price level; R1 million at 1981 price level: the 1981 value simply being a Historical Cost reference item, not a value in terms of today´s price level) would still have R14 million at today´s price level and would be able to borrow accordingly from the banks today as well a in 29 years time from today when the nominal value would be 14 X 14 million at the 2039 price level but still R14 million for us at today´s price level. We live today. Our minds can only evaluate the value of the Rand at today´s price level. We cannot put our minds (value evaluation mind processes) back or forward – although we imagine that we are doing that today and did in the past.

The multiplier effect would come into play and the economy as a whole would benefit.

We would have fewer banking crises as a result of insufficient bank capital. Banks´ capital would be automatically maintained at its constant real value over time - not like today when that portion of banks´ (and companies´) capital NEVER backed by sufficient revaluable fixed assets is unknowingly and unnecessarily being destroyed by the banks´ accountants implementing the stable measuring unit assumption as part of the Historical Cost Accounting model.

The CICPP paradigm would be the same as zero inflation ONLY for constant real value non-monetary items, e.g. companies´ shareholders´ equity, salaries, wages, rentals, all other items in the income statement, trade debtors, trade creditors, taxes payable, taxes receivable, all non-montary payables, all non-monetary receivables, provisions, etc.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith

How would business be different in SA? - Part 1

Bertie: Nicholaas, how would business be different in SA if that value was not being destroyed? In practical terms. I now buy into your point. But blog for us on what difference the opposite approach would have for everyday business in SA. Would we be able to borrow more? Lend more? Produce more? Market more lavishly?

The opposite approach means a once-in-3000-year paradigm change. Everything used to be accounted at historical cost. It could also be seen as the last step in a 100 year process of changing this global 3000 year old Historical Cost paradigm.

Over the last 100 years or so, accountants have realized that variable real value non-monetary items, e.g. property, plant, equipment, shares, inventories, etc cannot be accounted/valued/measured at their 200 year old or 20 year old or 1 year old or any historic price that is not the price/fair value at the balance sheet date.

IFRS and US GAAP are really about defining rules for the measurement of the above mentioned variable items.

Both US GAAP and IFRS value constant real value non-monetary items, e.g. issued share capital, retained profits, capital reserves, equity and most items in the profit and loss account still at Historical Cost as they have been for the last 3000 years: they ASSUME there was no inflation, there is no inflation and there never will be inflation ONLY as far as these items are concerned: they, in principle, ASSUME all monetary units are perfectly stable during low inflation and deflation ONLY for this purpose.

By doing this SA accountants unknowingly, unnecessarily and unintentionally destroy about R167 billion per annum in the real value of SA companies´ equity never backed by sufficient revaluable fixed assets (revalued or not) as well as other constant items never maintained PER ANNUM under HCA as long as annual inflation stays at more or less 5%.

Luckily for workers, they do change their minds for the constant items salaries, wages, rentals, etc. They value them in units of constant purchasing power: i.e. they inflation-adjust them annually. But, ONLY for a selected few profit and loss account items: no balance sheet constant items at all.

Only IFRS, not US GAAP, authorized accountants 21 years ago already, to inflation-adjust all constant items: all profit and loss account and all balance sheet constant items during low inflation and deflation. SA accountants would knowingly maintain instead of destroy about R167 billion PER ANNUM in the real value of all constant items of all SA companies´ that at least break even whether they own any revaluable fixed assets or not – ceteris paribus – forever, when they freely change over to financial capital maintenance in units of constant purchasing power during low inflation: inflation-adjusting ONLY constant items (NOT variable items) during low inflation (this is not inflation-accounting required to be implemented only during hyperinflation).

No-one does it.

Why?

Because they all believe that inflation is doing the destroying because they have been taught like that and everyone “knows” that to be a “fact”. In SA someone stated that in so many words and someone else  confirmed that: accountants have no control over inflation; so, it has nothing to do with them: they can not fix it: they can not stop the destruction.

However, inflation is always and everywhere a monetary phenomenon: it is impossible for inflation per se to destroy the real value of any non-monetary item ever. All items in shareholders´ equity are constant real value non-monetary items: all accountants would confirm that. So, it is not inflation doing the destroying: it is accountants´ free choice of implementing the stable measuring unit assumption as part of traditional HCA. When they reject the stable measuring unit assumption and implement financial capital maintnenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago, the destruction stops - in all entities that at least break even.

How would business in SA be different when SA accountants implement financial capital maintenance in units of constant purchasing power during low inflation: inflation-adjusting ONLY constant items as authorized in IFRS in the Framework, Par 104 (a) in 1989: the opposite approach?

There are obviously two aspects to the change-over from the current Historical Cost paradigm to a units of constant purchasing power paradigm or Constant Purchasing Power (CPP) paradigm: (1) the actual change-over which would be a once-in-3000-year event and then (2) the actual effects of the change. Bertie´s questions are about Nº 2: the actual effects of the change-over. The US regards changing from US GAAP to IFRS as a once-in-a-100-year event. Imagine when they then have to change again in this once-in-a-3000-year event? Accounting, auditing and consulting companies are going to make billions in extra retraining fees.

In general

Everybody will have to get used to think in real terms or CPP terms instead of Historical Cost terms. Everybody in SA will have to get used to the fact that the value of the Rand changes once a month: that the Rand is not perfectly stable as all SA accountants ASSUME only for this ONE purpose and that all EXISTING constant items´ nominal values would be revalued/remeasured/updated correctly and automatically in businesses (in the whole real or non-monetary economy) to maintain their EXISTING CONSTANT real values constant forever in all entities that at least break even and that all financial statements would show this monthly - once all financial statements are updated automatically digitally on a montly basis: no real value would be destroyed any more by accountants simply in the way they do accounting. But, the EXISTING CONSTANT real value of EXISTING CONSTANT REAL VALUE ITEMS would be maintained automatically by the way accountants do accounting in a better way.

Hard copy printed financial statements would be correct only for the first month after the year-end or period-end – in general - and only if the first set of statements were produced within the first month after the year-end or period-end: during the month of the year-end or period-end CPI. Sometimes SA has two or even three months of zero MONTHLY inflation (I remember that): the CPI stays the same for two or even three months in a row. No change would be made to financial statements only during those zero MONTHLY inflation months. Otherwise all financial statements would change monthly: i.e. every time the CPI changes.

It would be best for companies to keep their financial statements only in digital form so they can be updated monthly with the change in the CPI. Companies would end up with a digital set of financial statements only in digital form that would automatically be updated monthly. Only the latest updated version would be correct. There will always only be one set of financial statements that are correct, namely, the latest ones updated at the latest CPI. No copies of statements at previous CPI levels will be kept - ever - because it is not possible for us to put our minds and thinking and evaluating processes back in time: it is impossible to do that - although that is how we have been doing accounting (wrongly) for the last 3000 years.

I will answer more of Bertie´s questions tomorrow. This blog is getting rather long.
Copyright © 2010 Nicolaas J Smith

It´s the stable measuring unit assumption, stupid!

We have seen so far that accountants implement the Historical Cost Accounting model because it is the traditional model for the last 3000 years – or more.

Historical Cost Accounting is based on the fallacy of financial capital maintenance in nominal monetary units: it is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

They accept and admit that companies´ capital and retained profits are constantly being eroded (which is the same as destroyed). They all believe and are taught that this erosion is caused by inflation. They are told as much by the FASB and the IASB.

However:

It´s the stable measuring unit assumption, stupid! as Bill Clinton would have said.

Accountants unknowingly, unnecessarily and unintentionally destroy the real value of that portion of companies´ equity never maintained constant by sufficient revaluable fixed assets under HCA during inflation because they implement the stable measuring unit assumption.

They would stop this destruction when they freely change over to financial capital maintenance in units of constant purchasing power as they have been authorized in IFRS in the Framework, Par 104 (a) in 1989. It states:

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

When SA accountants do that they will knowingly maintain about R167 billion per annum in the SA real economy for as long as annual inflation stays at about 5%.
Copyright © 2010 Nicolaas J Smith

Accountants do not understand what they are doing.

So, we have seen so far that accountants don’t really understand what they are doing: they simply just keep on doing what all accountants before them have been doing and what all accountants currently are doing: Historical Cost Accounting.

Naturally, they state that they do accounting in terms of IFRS and that IFRS pass through a very rigorous due process before they are approved. Well, the IASB and the FASB have been discussing Measurement for the last 6 years in their joint Conceptual Framework project and have not once discussed units of constant purchasing power as a primary measurement basis: very clear proof that they do not understand what they are doing.

If you knew what you were doing in basic accounting with the stable measuring unit assumption and if you understood the effects of measuring items in units of constant purchasing power, you would discuss units of constant purchasing power at least once during six years of high-level discussions about the concepts of measurement, wouldn´t you?

Measuring constant items, e.g. salaries, wages, rentals, equity, etc, in units of constant purchasing power does affect the nature of the underlying resources and does affect the economy.
Accountants are completely inconsistent: they measure salaries, wages, rentals, etc (constant items) in units of constant purchasing power, but they measure capital and retained profits (also constant items) in nominal monetary units.

Very inconsistent and very destructive.

Accountants ignore the whole problem by stating that this destruction of value is caused by inflation: they all believe that. The FASB, the IASB and everyone tell them that. They must be right.

They are dead wrong – as I have proved in the previous blogs.

How is this value destroyed: I have shown how in an example in a previous blog.

Basically, SA accountants unknowingly destroy the real value of all SA companies´ equity never covered or backed by revaluable fixed assets under HCA during inflation at a rate equal to the annual rate of inflation.

They all believe it is inflation doing the destroying.

We know now very clearly – confirmed by the two Turkish academics and Milton Friedman – that inflation can only destroy the real value of money and other monetary items – nothing else.

So that is settled then: accountants destroy real value with normal traditional Historical Cost Accounting to the tune of about R167 billion per annum in the SA real economy.

How can this be stopped?

See my next blog.
Copyright © 2010 Nicolaas J Smith