Severe Hyperinflation: Comment Letter

Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

Submitter                        Organization                                                                    Date

 Nicolaas Smith              Constant ITEM Purchasing Power Accounting              2nd November, 2010 

International Accounting Standards Board 
30 Cannon Street 
London EC4M 6XH 
United Kingdom 

Second submission via “Create Comment Letter” page on www.ifrs.org. First submission on 22-10-2010 - confirmed by IASB email - not published after 10 days. This second submission is different from the first submission. I respectfully request that you publish this – updated – submission. Thank you. 

Dear Sirs/Mesdames, 

Request for comment on IASB Exposure Draft ED/2010/12: Severe Hyperinflation - Proposed Amendment to IFRS 1 

Thank you for the opportunity to comment on the IASB Exposure Draft: Severe Hyperinflation - Proposed Amendment to IFRS 1 

I agree with the IASB´s proposal to add an exemption to IFRS 1 to allow an entity which has been subject to severe hyperinflation to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position when the date of said opening IFRS statement of financial position is on, or after, the date when the reporting currency of the reporting entity ceases to be subject to severe hyperinflation or when the reporting currency is a relatively stable foreign currency in a newly dollarized economy after a period of severe hyperinflation. 

I disagree with the IASB´s definition of severe hyperinflation. Severe hyperinflation is impossible when there is no exchangeability. 

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 
Constant ITEM Purchasing Power Accounting 
http://realvalueaccounting.blogspot.com/ 

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Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

Appendix – Response to the questions asked in the Exposure Draft: Severe Hyperinflation 

Question 1 – Severe hyperinflation exemption 

The Board proposes adding an exemption to IFRS 1 that an entity can apply at the date of transition to IFRSs after being subject to severe hyperinflation. This exemption would allow an entity to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position. 

Do you agree that this exemption should apply when an entity prepares and presents an opening IFRS statement of financial position after being subject to severe hyperinflation? 

Why or why not? 

Yes, I agree with the IASB´s proposal to add an exemption to IFRS 1 to allow an entity which has been subject to severe hyperinflation to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position when the date of said opening IFRS statement of financial position is on, or after, the date when the reporting currency of the reporting entity ceases to be subject to severe hyperinflation or when the reporting currency is a relatively stable foreign currency in a newly dollarized economy after a period of severe hyperinflation. 

I agree because it is the only economically logical, correct and common sense solution. 

I suggest that the dollarization option – which can be in any relatively stable foreign currency - be specifically added to the wording of the amendment to IFRS 1. 

Question 2 – Other comments 

Do you have any other comments on the proposals? 

Yes, I suggest that the following changes (in bold and underlined) should be made to paragraph D28 (b): 

Paragraph D28: The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics: (a) a reliable general price index is not available to all entities with transactions and balances in the currency, (b) exchangeability between the currency and most relatively stable foreign currencies does not exist, 

 Rationale for my answers and suggestions above: 

 The IASB proposes to define severe hyperinflation as follows: 

 D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics: 

 (a) a reliable general price index is not available to all entities with 

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Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

transactions and balances in the currency, 

 (b) exchangeability between the currency and a relatively stable foreign currency does not exist, 

 In fact, it is exactly the opposite: severe hyperinflation stops when “(b) exchangeability between the currency and a relatively stable foreign currency does not exist.” (As stated in the singular it means it includes the plural since this is IFRS nomenclature.) 

 D28 (b) is thus not a definition of severe hyperinflation, but, a definition of when severe hyperinflation stops. 

 Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency. 

 The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR). 

 “The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate." p8  

 Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist. 

 “Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” p 9-10  

 There was severe hyperinflation in Zimbabwe while there was exchangeability with at least one relatively stable foreign currency – the British Pound in this case as made possible via the OMIR. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and severe hyperinflation stopped: no exchangeability means no severe hyperinflation. 

 I thus suggest that paragraph D28 (b) should be changed to: “(b) exchangeability between the currency and most relatively stable foreign currencies does not exist,” 

, Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation, Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-64 Available at http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf

No other issues noted.

 ______________________________________________________

This comment letter is available HERE on the IFRS.org website.

Severe hyperinflation comment letter available in the following book:

Buy the ebook 

Copyright ©  Nicolaas J Smith 2010

Definition of Severe Hyperinflation - Updated

      The IASB proposes to define severe hyperinflation as follows:
      D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
      (a) a reliable general price index is not available to all entities with transactions and balances in the currency,
      (b) exchangeability between the currency and a relatively stable foreign currency does not exist,
      In fact, it is exactly the opposite: severe hyperinflation stops when (b) “exchangeability between the currency and a relatively stable foreign currency does not exist.”
      D28 (b) is thus not a definition of severe hyperinflation, but, a definition of when severe hyperinflation stops.
      Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency.
      The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR).
      “The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate." p8
      Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist.
      “Zimbabwe ’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe . On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” p 9-10 
      There was severe hyperinflation in Zimbabwe while there was exchangeability with at least one relatively stable foreign currency – the British Pound in this case. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and severe hyperinflation stopped: no exchangeability means no severe hyperinflation.
      I thus suggest that D28 (b) should be changed to: “(b) exchangeability between the currency and most relatively stable foreign currencies does not exist,”
      1,2 Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation, Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-64 Available at http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf
      Copyright © 2010 Nicolaas J Smith

Severe Hyperinflation: Prof Steve Hanke´s opinion

I am of the opinion that hyperinflation - let alone severe hyperinflation - is impossible when exchangeability between the currency and a relatively stable foreign currency does not exist, as defined by the IASB in Par D28 (b) in their current Exposure Draft - Severe Hyperinflation:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
(a) a reliable general price index is not available to all entities with transactions and balances in the currency,
(b) exchangeability between the currency and a relatively stable foreign currency does not exist,

I asked Prof Steve Hanke who is a world authority on currency boards and hyperinflation for his opinion. Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University and a Senior Fellow at the Cato Institute.

This is his reply:

"The proposed amendment is to provide guidance on how an entity should resume presenting financial statements in a hyperinflationary economy. I don't have a problem with the substance of the proposal: it seems fair an entity should resume reporting after its functional currency has changed to one that is not hyperinflationary, or when the relative value of the hyperinflationary currency can be determined through a reliable price level or exchange rates.


I agree with you that the wording "severe hyperinflation" might not be most accurate in describing the situation where the relative value of the hyperinflationary currency is unrecognizable. Perhaps "unrecognizable currency value during hyperinflation" is a better name for the condition which is dubbed "severe hyperinflation" in the proposal. I see it as a nomenclature problem."

Copyright © 2010 Nicolaas J Smith

Three economic items

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

      The economy consists of economic items and economic entities.
      Economic items have economic value. Accountants do not simply record what happened in the past in Historical Cost terms. Accountants are not simply scorekeepers. Accountants value each and every economic item every time they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.
      It is generally accepted that there are only two basic, fundamentally different economic items in the economy, namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. That is an economic fallacy.
      The three fundamentally different basic economic items in the economy are:
1. Monetary items
2. Variable real value non-monetary items
3. Constant real value non-monetary items
      The economy consequently consists of not just two – the monetary and non-monetary economies, but, three parts:
1. Monetary economy
      The monetary economy consists of functional currency bank notes and coins and other functional currency monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds and other functional currency monetary items making up the money supply.
2. Variable item non-monetary economy
      The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, etc.
3. Constant item non-monetary economy
      The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.
      The variable and constant item non-monetary economies in combination make up the non-monetary or real economy. The real and monetary economies constitute the economy.
      The monetary economy can disappear completely or be totally destroyed like in the case of Zimbabwe as a result of hyperinflation. The real or non-monetary economy (houses, properties, buildings, infrastructure, inventories, finished goods, consumer goods, trademarks, goodwill, logos, copyright, trade debtors, trade creditors, royalties payable, royalties receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc,) can not be destroyed by hyperinflation: inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items.
      Trade debtors and trade creditors are constant real value non-monetary items and not monetary items as stated by the US Financial Accounting Standards Board, the International Accounting Standards Board, in International Financial Reporting Standards and by PricewaterhouseCoopers, amongst most probably all others.
      Under the current Historical Cost paradigm many constant items, e.g. trade debtors, trade creditors, other non-monetary payables, other non-monetary receivables, salaries, wages, etc are incorrectly treated as monetary items. The real values of these items are currently unnecessarily being destroyed by the implementation of the stable measuring unit assumption during low and high inflation. In a hyperinflationary monetary meltdown like in the case of Zimbabwe all these items are unnecessarily destroyed completely – because they are incorrectly treated as monetary items.
      Under financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) in 1989, these items are correctly treated as non-monetary items and their real values would not be destroyed at the rate of low or high inflation or they would not be completely destroyed in a hyperinflationary monetary meltdown like what happened in Zimbabwe. Their real values were not destroyed during 30 years of high and hyperinflation in Brazil from 1964 to 1994 because they were treated correctly as non-monetary items in Brazil and updated daily in terms of a daily index supplied by the government.
© Copyright 2010 Nicolaas J Smith

Our unsolved fundamental problems are the results of our inventions

In the begining before money and the double-entry accounting model were invented all items in the economy were variable real value non-monetary items not yet expressed in terms of money.

There was no International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies supplying us with the current definition of inflation accounting. There was thus no Constant Purchasing Power Accounting (CPPA) IFRS-approved inflation accounting model under which all non-monetary items (variable and constant real value non-monetary items) in Historical Cost and Current Cost financial statements were required to be restated by means of the period-end CPI to make these restated HC and CC financial statements more useful during hyperinflation.


There was also no real value maintaining financial capital maintenance in units of constant purchasing power accounting model – Constant ITEM Purchasing Power Accounting (CIPPA) – as an official IFRS-approved alternative basic accounting model to the traditional HCA model during low inflation and deflation. There was no IFRS compliant basic accounting option where under only constant items are continuously measured in units of constant purchasing power during low inflation and deflation. There was no option of continuously measuring only constant items in units of constant purchasing power by applying the monthly change in the CPI during low inflation and deflation in order to implement a constant purchasing power financial capital concept of invested purchasing power by continuously measuring financial capital maintenance in units of constant purchasing power and continuously determining profit/loss in units of constant purchasing power.

There were no financial reports: e.g. no income statements, no balance sheets, no cash flow statements, no statements of changes in shareholders´ equity, etc. There were no monetary items and no constant items. There were only variable real value items not yet expressed in monetary terms.

CIPPA stops the destruction caused by the stable measuring unit assumption in Historical Cost Accounting.

Copyright © 2010 Nicolaas J Smith

Definition of Severe Hyperinflation

I was of the opinion that severe hyperinflation was impossible if “exchangeability between the currency and a relatively stable foreign currency does not exist” as stated in Par D28 of the IASB Exposure Draft about Severe Hyperinflation.
I asked Dr Eric Bloch who is a Zimbabwean independent economist and commentator who experienced the complete hyperinflationary period in Zimbabwe whether he agreed with me. This is his reply:

"I respectfully differ with your view, for I consider that hyperinflation can exist even in an environment where :
a) No reliable/ authoritative Consumer Price Index or alternative general price index exists ; and
b) There is no exchangeability between the currency and a relative stable foreign currency ;
albeit that in the absence of the aforegoing, measurement of the extent of the hyperinflation is exceptionally difficult.
Despite the restricted ability to quantify the magnitude of inflation, in the absence of a reliable price index or authoritative exchange rates, if prices are escalating to an extent that consumer power progressively diminishes substantially, then hyperinflation exists e.g. if in one month a person’s total income will only purchase, say, one –half of the quantity of identical goods that that income would purchase in the preceding month, then clearly hyperinflation exists.
Further illustrative of the aforegoing, after Zimbabwe’s Central Statistical Office ceased computing the Consumer Price Index in July 2008, I sometimes applied as my measure of the extent of certain price movements the number of hours that I had to work in one month, as compared to previously, to purchase particular commodities."

I agree that as long as prices are being set in the local hyperinflationary currency, then there is hyperinflation. There is also exchangeability. What exchangeability? Not exchangeability between the local currency and relatively stable foreign currencies, but, exchangeability between the value of a very restricted range of goods and services in the economy and the local currency - to a very limited extent: only in some goods and services, for example the government will continue paying civil service salaries in the local currency. Locals can perhaps only use that money to pay for taxi fares because the taxi operators can buy petrol only from the government distributors paying with the local currency.
I would thus suggest that the following addition – underlined – should be made to Par D28:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
(a) a reliable general price index is not available to all entities with transactions and balances in the currency,
(b) exchangeability between the currency and a relatively stable foreign currency does not exist,
as long as some prices are still being set in the local hyperinflationary currency.

Copyright © 2010 Nicolaas J Smith

Greenspan and Historical Cost Accounting

U.S. companies may be holding back on investment because of the rising federal deficit, which causes uncertainty about future tax policies, Greenspan said in an opinion article for the Financial Times this week. Weak investment by businesses in capital equipment and fixed assets has helped to crimp the U.S. economic recovery, he said.

Historical Cost accountants unknowingly, unintentionally and unnecessarily destroy the real value of that portion of shareholders´ equity (which is a constant real value non-monetary item) never maintained constant with sufficient revaluable fixed assets (revalued or not) at a rate equal to the annual rate of inflation each and every year with their very destructive stable measuring unit assumption: they simply assume there is no such thing as inflation – only for this purpose and only during low inflation.

Shareholders´ equity forms an important part of the financial resources available for fixed investment in a modern economy. Historical Cost accountants unknowingly destroy that permanent capital base with traditional Historical Cost Accounting as described above. This destruction amounts to about USD 280 billion per annum in the case of the US economy and about R134 billion in the SA economy at current levels of inflation.

Accountants would stop this annual unknowing destruction and instead boost the US economy by about USD 280 billion and the SA economy by about R134 billion per annum for an indefinite period of time when inflation in these two economies remains at current levels when they freely change over to financial capital maintenance in units of constant purchasing power (Constant ITEM Purchasing Power Accounting) as authorized in International Financial Reporting Standards 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.”

US accountants unknowingly destroy US companies´ shareholders´ equity´s real value resulting in these companies not having sufficient financial resources for capital equipment and fixed asset investments as described by Alan Greenspan.

Constant ITEM Purchasing Power Accounting as authorized in IFRS twenty one years ago would stop this destruction automatically (accounting is double-entry: for every already existing credit there is an equivalent already existing debit; real values of variable real value non-monetary items are maintained at mainly market prices in terms of IFRS while the constant real non-monetary values of all already existing constant items would be maintained constant forever by measurement in units of constant purchasing power plus the net monetary gain or loss would be accounted) when accountants maintain the existing constant real value of existing constant real value non-monetary items, e.g. already existing shareholders´s equity, forever - ceteris paribus - in all entities that at least break even whether these entities own any revaluable fixed assets or not when accountants freely reject their very destructive stable measuring unit assumption which is based on the fallacy that money always was, always is and always will be perfectly stable.

CIPPA is not my original idea: the IASB authorized it 21 years ago in IFRS in the Framework, Par 104 (a) as an alternative to HCA during low inflation and deflation.

Copyright © 2010 Nicolaas J Smith

Variable items

Variable items


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

Examples of variable items in today’s economy are property, plant, equipment, inventories, quoted and unquoted shares, raw material stock, finished goods stock, patents, trademarks, foreign exchange, etc.

The first economic items were variable real value items. Their values were not yet expressed in terms of money because money was not yet invented at that time. There was no inflation because there was no money. Inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items. There was no unstable monetary medium of exchange. There was no unstable monetary unit of account. There was no unstable monetary store of value.

There was no double entry accounting model at that time. There were no historical cost items. There was no very destructive stable measuring unit assumption approved by the International Accounting Standards Board whereby accountants assume the unit of measure is stable, i.e., they consider that changes in the general purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. The stable measuring unit assumption is based on a very popular accounting fallacy since the real value of money is never absolutely stable on a sustainable basis during inflation and deflation. There was no Historical Cost Accounting model and no financial capital maintenance in nominal monetary units per se (another very popular IFRS-authorized accounting fallacy) during inflation; that is to say: there were no Historical Cost accounting fallacies. There was no value based accounting. There was also no Consumer Price Index at that time. Consequently there were no units of constant purchasing power and no price-level accounting.

Copyright © 2010 Nicolaas J Smith

Three economic items

The economy consists of economic items and economic entities.

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

It is generally accepted that there are only two basic, fundamentally different economic items in the economy, namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. This is an economic fallacy.

The three fundamentally different basic economic items in the economy are:
a) Monetary items

b) Variable real value non-monetary items

c) Constant real value non-monetary items

The SA economy consequently consists of not just two – the monetary and non-monetary economy, but, three parts:

1. Monetary economy

The SA monetary economy consists of Rand bank notes and coins and other Rand monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans and other monetary items making up the money supply in SA.

2. Variable item non-monetary economy

The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, etc.

3. Constant item non-monetary economy

The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.

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

The monetary economy can disappear or be totally destroyed like in the case of Zimbabwe as a result of hyperinflation. The real or non-monetary economy (houses, properties, buildings, infrastructure, inventories, finished goods, consumer goods, trademarks, goodwill, logos, copyright, trade debtors, trade creditors, royalties payable, royalties receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc,) can not be destroyed by hyperinflation: inflation is always and everywhere a monetary phenomenon - inflation has no effect on the real value of non-monetary items.

Trade debtors and trade creditors are constant real value non-monetary items and not monetary items as stated by the US Financial Accounting Standards Board, the International Accounting Standards Board, in International Financial Reporting Standards and by PricewaterhouseCoopers, amongst others



Copyright © 2010 Nicolaas J Smith

There is no such thing as "severe hyperinflation" as defined by the IASB.

The IASB published for public comment an exposure draft Severe Hyperinflation, a proposed amendment to IFRS 1 First-time Adoption of IFRS on 30th September, 2010.

The IASB proposes to define "severe hyperinflation" in the ED as follows:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:

(a) a reliable general price index is not available to all entities with

transactions and balances in the currency.

(b) exchangeability between the currency and a relatively stable

foreign currency does not exist.

I am of the opinion that there is no such thing as "severe hyperinflation" as the IASB defined it. To have hyperinflation you need two different sets of prices: one at time A and another at time B - a different time, e.g. one month or one year later, or other time periods (hours or days or months during hyperinflation) later. I worked for 2 ½ years in Angola´s hyperinflationary economy in the 1990´s and have studied the effect of the stable measuring unit assumption ever since. I also followed Zimbabwe´s monetary meltdown on a day by day basis during the last two years of your hyperinflation.

When characteristic (b) exists – no exchangeability - then it is not possible to have two different sets of prices: so, you cannot have hyperinflation or "severe hyperinflation" when you do not de facto have a currency any more: there is no hyperinflation because there is, in fact, no currency used as a medium of exchange in the market although the government may have not yet stated officially that the currency does not have legal tender in the economy any more.

When (b) exists – no exchangeability – then transactions are impossible. (a) uses the term “transactions”. Transactions are impossible when (b) exists. A general price index is also impossible when (b) exists because there are no prices being set in the previously hyperinflationary currency any more.

Once a currency loses its exchangeability with relatively stable currencies, it is de facto dead. It is not exchangeable for stable currencies or any item: thus, it is not a currency any more: it is de facto dead – although the government has not yet officially removed it as legal tender.

So, in my opinion, it is wrong to propose that there was a period of hyperinflation in Zimbabwe , while there was a parallel rate for the USD and then at the end there was a period of this so-called "severe hyperinflation" when there was no CPI and no parallel rate for the USD. There was no hyperinflation during that period. The market already de facto Dollarized the economy although the ZimDollar still, officially, had legal tender: in the market it did not. The fact is there was no hyperinflation: the market was already Dollarized.

As soon as there was no parallel rate for the USD the ZimDollar was de facto dead: it stopped being money and a currency. It does not matter that the notes were still around: absolutely no-one would accept them as payment for items/goods/property/assets/anything.

It is wrong to me to name a period with no hyperinflation as a period of "severe hyperinflation". There was no hyperinflation, because there were no prices being set in ZimDollars. People stopped accepting the ZimDollar for any payment for goods at all.

It is misleading to state that there was a period of "severe hyperinflation" different from hyperinflation. Hyperinflation ended the moment the ZimDollar was not accepted as payment for items anymore. There was no more hyperinflation and it is wrong to call the period after that "severe hyperinflation" when there was, in fact, no hyperinflation.

As an article in the SA Mail and Guardian states:

“Inflation, identified by central bank governor Dr Gideon Gono as "the number one enemy", was stopped dead in its tracks.”

http://www.mg.co.za/article/2010-02-05-in-god-we-trust

So, it is better for the IASB to state that when a currency, after a period of hyperinflation, loses its monetary function of exchangeability, then the rules of this Exposure Draft apply and companies can fairvalue assets and use that fair value as deemed cost for IFRS 1 purposes without giving this period a name, especially not “severe hyperinflation” when, in fact, there was no hyperinflation anymore.

(b) excludes transactions as stated in (a): when there is no exchangeablity, there are no transactions.

So, (a) is logically wrong: the term transactions should be removed from (a)

I am concerned about the fact that the IASB now wants to invent this new phrase "severe hyperinflation" for the period immediately after hyperinflation when the currency is not accepted in the economy any more, although the government has not yet officially withdrawn its legal tender status: de facto the currency does not exist as a currency any more: so, setting prices in it is impossible, thus, there is no more hyperinflation. The IASB wants to call this period just after the exchangeability of the currency ended and there is no actual hyperinflation because no prices are set in the de facto dead currency, the IASB wants to call this period "severe hyperinflation". I oppose this move.

What is wrong is the actual misleading name the IASB wants to give to this period: namely "severe hyperinflation". I am against using the term for that period because there were no prices quoted in the ZimDollar during that period, thus, there was no hyperinflation.

I agree that the economy was still in the same state that caused actual hyperinflation. But, to have hyperinflation you needed prices in ZimDollars, but, there were no new prices set in ZimDollars.

It is important to get the technicalities right too if we really want to understand what actually happened.

I am of the opinion that the introduction of this new term "severe hyperinflation" should be stopped.

Once it is in the final International Financial Reporting Standard it will be in accounting and economic literature. Then hyperinflation will be, incorrectly, divided in hyperinflation and this "severe hyperinflation" as incorrectly defined by the IASB. I don´t agree with that.

I think the IASB should not introduce this new term "severe hyperinflation" into economic and accounting terminology. They should remove their definition since the term “severe hyperinflation” is used in the hyperinflation literature for periods of actual extreme hyperinflation when prices are still being set in the hyperinflationary currency. The IASB should simply state that after a currency failed or lost its exchangeability then the new ED applies: they should not give that period a misleading name. They should not give it any name.

Naming a period with no hyperinflation as "severe hyperinflation" is obviously wrong.

Someone in Zimbabwe suggested that the period immediately after the currency lost its exchangeability in the market although the government has not yet officially withdrawn its characteristic as legal tender could be called the Zimbabwean Syndrome. This person agreed that the term “severe hyperinflation” is misleading for that period of no hyperinflation.

This period is a period when the currency has no exchangeability. It should just be described as that. It should not be called a period of “severe hyperinflation” when there is no actual hyperinflation. It is obviously a mistake.

Copyright © 2010 Nicolaas J Smith

IASB proposes Severe Hyperinflation amendment to IFRS 1

IASB proposes Severe Hyperinflation amendment to IFRS 1
30 September 2010

The International Accounting Standards Board (IASB) today published for public comment an exposure draft Severe Hyperinflation, a proposed amendment to IFRS 1 First-time Adoption of International Financial Reporting Standards.

The amendment proposes guidance on how an entity should resume presenting financial statements in accordance with International Financial Reporting Standards (IFRSs) after a period when the entity was unable to comply with IFRSs because its functional currency was subject to severe hyperinflation.

The exposure draft, Severe Hyperinflation, is open for comment until 30 November 2010 and can be accessed via the ‘Comment on a Proposal’section of www.ifrs.org.

Press enquiries

•Mark Byatt, Director of Communications, IFRS Foundation

Telephone: +44 (0)20 7246 6472

Email: mbyatt@ifrs.org

Technical enquiries

•David Humphreys, Practice Fellow, IASB

Telephone: +44 (0)20 7246 6916

Email: dhumphreys@ifrs.org

Related information

¦Click here for a print-friendly version of this press release [PDF 31 KB]

¦Go to the exposure draft Severe Hyperinflation

¦Go to the IFRS 1 project page

Copyright © IASB

Verbatim copy of IASB statement.

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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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