The function of financial accounting is not just “to convey value information about the economic resources of a business” as Harvey Kapnick stated in the 1976 Sax Lecture.
http://newman.baruch.cuny.edu/DIGITAL/saxe/saxe_1975/kapnick_76.htm
The objectives of general purpose financial reporting are:
1) Automatic maintenance of the constant purchasing power of capital in all entities that at least break even - ceteris paribus.
2) Provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users.
This can only be achieved by continuously valuing all constant real value non-monetary items in units of constant purchasing power, i.e., by continuously inflation-adjusting all constant real value non-monetary items by means of the monthly change in the annual CPI during low inflation and deflation, namely, by continuously measuring financial capital maintenance in units of constant purchasing power during inflation and deflation. Valuing both variable real value non-monetary items and all constant real value non-monetary items at the daily parallel rate in terms of IAS 29 (or Brazilian-style daily indexation) during hyperinflation will result in the real economy being maintained relatively stable during hyper inflation (see Brazil 1964 to 1994) with real value hyper-erosion in only monetary items.
Accountants have unknowingly abdicated the essential continuous financial capital maintenance in units of constant purchasing power function of accounting/financial reporting to their fiction that money is stable in real value during low inflation and deflation. In so doing, the Historical Cost Accounting model has in the past unknowingly eroded and currently unknowingly, unintentionally and unnecessarily erodes real value on a significant scale (hundreds of billions of US Dollars per annum) in the real economy when accountants implement their very erosive stable measuring unit assumption as part of the IASB-approved traditional HCA model for an unlimited period of time during indefinite inflation.
Accountants and accounting authorities do not realize that they can stop this unknowing, unintentional and unnecessary erosion by simply rejecting the stable measuring unit assumption when they freely choose the IFRS-compliant continuous financial capital maintenance in units of constant purchasing power model (Constant Item Purchasing Power Accounting) at all levels of inflation and deflation.
IFRS do – 21 years ago – allow the rejection of the stable measuring unit assumption as an alternative to HCA at all levels of inflation and deflation. The IASB´s Framework, Par 104 (a) states:
Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.
Par 104 (a) was authorized by the IASB predecessor body, the International Accounting Standards Committee Board in April, 1989 and adopted by the IASB in 2001.
The stable measuring unit assumption is also rejected in IAS 29 Financial Reporting in Hyperinflationary Economies for restatement of Historical Cost or Current Cost financial statements at the period-end CPI to make them more useful.
The Standards already reject the stable measuring unit assumption under the above two circumstances.
The IASB-approved Framework(1989), Par 104 (a) which is applicable since there are no specific IFRS relating to the concepts of capital, the capital maintenance concepts, the valuation of constant real value non-monetary items, e.g. Issued Share Capital, Retained Earnings and other items in Shareholders´ Equity, etc during non-hyperinflationary periods, allows accountants to reject the stable measuring unit assumption during all levels of inflation and deflation when they choose to continuously measure financial capital maintenance in units of constant purchasing power as an alternative to measurement in nominal monetary units as applied in the traditional HCA model.
It is not generally realized by accountants and accounting authorities that the traditional Historical Cost Accounting model is unknowingly, unintentionally and unnecessarily responsible for the erosion of the real value of constant real value non-monetary items never maintained constant when they implement the traditional HCA model: more specifically, the very erosive stable measuring unit assumption during periods of low inflation when accountants maintain it for an unlimited period of time during indefinite inflation. Accounting professors, accounting lecturers, economists, business people and the public in general equally do not realize the above.
It is also not generally realized by accountants and accounting authorities that they can stop this erosion by selecting financial capital maintenance in units of constant purchasing power as authorized by the IASB 21 years ago in the Framework, Par 104 (a) which is applicable in the absence of specific IFRS.
It is generally accepted and a fact that inflation erodes the real value of money (the internal functional currency) and other monetary items over time. It is also generally accepted and a fact that hyperinflation can erode all the real value of a country’s entire monetary base as happened in Zimbabwe in 2008. That was the result of a significant increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, with an equivalent extreme rate of erosion of the real value of the Zimbabwe Dollar since the significant nominal increase in ZimDollar money supply was not in response to an equal increase in real value in the real or non-monetary economy of Zimbabwe.
“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction.”
The Economic Consequences of the Peace by John Maynard Keynes 1919
http://socserv2.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace
That certainly was true in the case of Zimbabwe.
It is generally accepted and a fact that inflation erodes the real value of money and the capital amounts of monetary savings and money lent over time (amongst other monetary items). It is generally accepted, but not a fact, that inflation erodes the real value of constant real value non-monetary items with fixed nominal payments over time, e.g. fixed salary, wage, rental payments.
The constant real non-monetary values of salaries, wages, rentals, etc are generally maintained constant, i.e. not eroded, when accountants choose to measure the existing constant real non-monetary values of these constant real value non-monetary items in units of constant purchasing power in terms of the CPI in most economies with payment in depreciating money during inflation: they inflation-adjust them during low inflation.
It is not yet generally accepted, but a fact, that the traditional Historical Cost Accounting model unknowingly, unintentionally and unnecessarily erodes the real value of existing constant real value non-monetary items never maintained constant, e.g. equity never maintained constant, of companies and banks over time as a result of insufficient revaluable fixed assets when accountants choose to measure financial capital maintenance in nominal monetary units in terms of the traditional HCA model during low inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.
As a result of this lack of realizing the erosive nature of the implementation of the stable measuring unit assumption, 1970-style CPPA inflation accounting was also not an accounting system implemented by accountants to correct or eliminate the erosion of the constant real value of existing constant real value non-monetary items never maintained constant by the use of the stable measuring unit assumption, but, a failed attempt to simply make financial reports more understandable and more comparable with previous year statements during periods of high inflation by inflation-adjusting all non-monetary items in year-end financial statements equally in terms of the CPI.
Accountants simply do not realize that the HCA model unknowingly erodes real value on a significant scale in all existing constant real value non-monetary items never maintained constant when accountants choose to implement the very erosive stable measuring unit assumption for an unlimited period of time during indefinite inflation. In most cases accountants do not even know that they make that choice. Neither do they realize that they will knowingly stop that erosion by freely choosing to measure financial capital maintenance in units of constant purchasing power, as approved in the IASB Framework, Par 104 (a) in 1989.
Prof Geoffrey Whittington in his definitive work on inflation accounting in the beginning of the 1980´s, Inflation Accounting - An Introduction to the Debate, published in 1983, clearly indicated that with 1970-style CPP inflation accounting all non-monetary accounts (with no distinction being made between variable real value non-monetary items and constant real value non-monetary item accounts) were updated by means of the CPI.
"Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Saturday, 26 February 2011
Current inflation accounting
Presently, inflation accounting describes a complete price-level inflation accounting model, namely the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies required to be implemented only during hyperinflation which is an exceptional circumstance according to the IASB. It serves to make Historical Cost and Current Cost financial statements more useful at the period end by restating all non-monetary items – variable real value non-monetary items and constant real value non-monetary items - by inflation-adjusting them by applying the period-end Consumer Price Index during hyperinflation.
“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses value at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29.2
The fallacy that inflation erodes the real value of non-monetary items is currently still generally accepted. It is still mistakenly accepted as a fact that the erosion of companies´ capital and profits is caused by inflation. “The erosion of business profits and invested capital caused by inflation” was clearly stated in FAS 33 and “the erosive impact of inflation on profits and capital” was stated in both FAS 33 and FAS 89.
Since 2008 it became very clear to me that inflation has no effect on the real value of non-monetary items over time. The understanding of the real value eroding effect of the stable measuring unit assumption on constant real value non-monetary items never maintained during inflation is an on-going process. Not inflation, per se, but the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model erodes the real value of constant real value non-monetary items never maintained constant over time as a result of insufficient revaluable fixed assets during low inflation. There is no substance in the statement that inflation destroys the real value of non-monetary items which do not hold their real value over time. Inflation has no effect on the real value on non-monetary items.
The late Milton Friedman, Nobel Laureate and US economist, clearly stated that “inflation is always and everywhere a monetary phenomenon.” Friedman was not the only economist who realized that.
“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
Accountants unknowingly, unintentionally and unnecessarily erode or knowingly maintain (please note: not create) the real value of constant real value non-monetary items (please note: not variable real value non-monetary items) depending on whether they choose the IASB-approved traditional Historical Cost Accounting model under which they implement their very erosive stable measuring unit assumption for an unlimited period of time during indefinite inflation or the IASB-approved constant item real value maintaining financial capital maintenance in units of constant purchasing power model (Constant Item Purchasing Power Accounting) under which they select to reject the stable measuring unit assumption at all levels of inflation and deflation for an unlimited period of time.
Inflation is a uniquely monetary phenomenon and can only erode the real value of money and other monetary items over time. It has no effect on the real value of non-monetary items. The traditional Historical Cost Accounting model unknowingly, unintentionally and unnecessarily do the eroding of the real value of constant real value non-monetary items never maintained constant over time, e.g. Retained Earnings, Issued Share capital, other items in Shareholder’s Equity, etc when accountants choose financial capital maintenance in nominal monetary units as authorized in IFRS in the Framework (1989), Par 104 (a) during low inflationary periods.
It is correct, essential and compliant with IFRS to inflation-adjust or update constant real value non-monetary items by means of the monthly change in the CPI which is a general price index during low inflation and deflation. The reason for this is that constant real value non-monetary items are expressed in terms of money, i.e. in terms of an unstable monetary unit of account which is the same as the unstable monetary medium of exchange within an economy or monetary union. Inflation erodes the real value of the unstable monetary medium of exchange - which is also the unstable monetary unit of account in accounting and the economy in general. Constant real value non-monetary items thus have to be updated or inflation-adjusted at a rate equal to the rate of low inflation or deflation, i.e. valued or measured in units of constant purchasing power, in order to maintain their real values constant during low inflation and deflation because the unit of measure in accounting is an unstable monetary unit of account and consequently hardly ever absolutely stable during periods of low inflation and deflation. Months of zero annual inflation are very few and far between. Sustainable zero annual inflation has never been achieved before and it does not seem very likely that it will be achieved any time soon in the future.
Variable real value non-monetary items do not need to be and are not valued in units of constant purchasing power during low inflation because they are valued in terms of GAAP or IFRS at, for example, fair value, market value, present value, recoverable value, net realizable value, etc which always automatically take inflation - amongst many other things - into account. Variable real value non-monetary items are only valued in units of constant purchasing power during hyperinflation as required by the IASB in IAS 29 since the Board regards hyperinflation as an exceptional circumstance.
There is a school of thought that 2% inflation is completely unharmful and that it has no disadvantages compared to absolute price stability (sustainable zero inflation). That is not correct. 2% inflation will erode, for example, 51% of the real value of all monetary items and all constant real value non-monetary items never maintained constant, e.g. Retained Profits never maintained constant, over 35 years – all else being equal – when the stable measuring unit assumption is implemented for an indefinite period of time during indefinite low inflation.
It is not necessary for accountants to inflation-adjust by means of the CPI, which is a general price index, variable real value non-monetary items (e.g. properties, plant, equipment, shares, raw material, etc.) which are subject to product specific price increases for the purpose of valuing these variable real value non-monetary items during the accounting period on a primary valuation basis during non-hyperinflationary periods. These variable real value non-monetary items are generally subject to market-based real value changes determined by supply and demand. They incorporate product specific price changes or product specific inflation where the word inflation is, very unfortunately, also used to simply mean a product or product group price increase instead of the general use of the word in economics to mean the erosion of the real value of money and other monetary items over time, i.e. an erosion of the general purchasing power of money which is caused by/results in an increase in the general price level over time. It is thus generally accepted in economics that the word inflation has two different meanings:
(1) inflation meaning the erosion of the real value of only money and other monetary items over time and
(2) inflation meaning any price increase.
1970-style Constant Purchasing Power Accounting (CPPA) inflation accounting was a popular but failed attempt at inflation accounting at the time. It was a form of inflation accounting which tried unsuccessfully to make corporate accounts more informative when comparing current transactions with previous transactions by updating all non-monetary items (without distinguishing between variable real value non-monetary items and constant real value non-monetary items) equally by means of the Consumer Price Index during high and hyperinflation. 1970-style CPPA inflation accounting was abandoned as a failed and discredited inflation accounting model when general inflation decreased to low levels thereafter.
Constant Item Purchasing Power Accounting (CIPPA) is not an inflation accounting model to be used during high and hyperinflation. IAS 29 requires CPPA for that. CIPPA is the IASB´s alternative to Historical Cost Accounting during low inflation and deflation . CIPPA implements financial capital maintenance in units of constant purchasing power to be used during low inflation and deflation which was authorized in IFRS in the Framework (1989), Par 104 (a).
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses value at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29.2
The fallacy that inflation erodes the real value of non-monetary items is currently still generally accepted. It is still mistakenly accepted as a fact that the erosion of companies´ capital and profits is caused by inflation. “The erosion of business profits and invested capital caused by inflation” was clearly stated in FAS 33 and “the erosive impact of inflation on profits and capital” was stated in both FAS 33 and FAS 89.
Since 2008 it became very clear to me that inflation has no effect on the real value of non-monetary items over time. The understanding of the real value eroding effect of the stable measuring unit assumption on constant real value non-monetary items never maintained during inflation is an on-going process. Not inflation, per se, but the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model erodes the real value of constant real value non-monetary items never maintained constant over time as a result of insufficient revaluable fixed assets during low inflation. There is no substance in the statement that inflation destroys the real value of non-monetary items which do not hold their real value over time. Inflation has no effect on the real value on non-monetary items.
The late Milton Friedman, Nobel Laureate and US economist, clearly stated that “inflation is always and everywhere a monetary phenomenon.” Friedman was not the only economist who realized that.
“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
Accountants unknowingly, unintentionally and unnecessarily erode or knowingly maintain (please note: not create) the real value of constant real value non-monetary items (please note: not variable real value non-monetary items) depending on whether they choose the IASB-approved traditional Historical Cost Accounting model under which they implement their very erosive stable measuring unit assumption for an unlimited period of time during indefinite inflation or the IASB-approved constant item real value maintaining financial capital maintenance in units of constant purchasing power model (Constant Item Purchasing Power Accounting) under which they select to reject the stable measuring unit assumption at all levels of inflation and deflation for an unlimited period of time.
Inflation is a uniquely monetary phenomenon and can only erode the real value of money and other monetary items over time. It has no effect on the real value of non-monetary items. The traditional Historical Cost Accounting model unknowingly, unintentionally and unnecessarily do the eroding of the real value of constant real value non-monetary items never maintained constant over time, e.g. Retained Earnings, Issued Share capital, other items in Shareholder’s Equity, etc when accountants choose financial capital maintenance in nominal monetary units as authorized in IFRS in the Framework (1989), Par 104 (a) during low inflationary periods.
It is correct, essential and compliant with IFRS to inflation-adjust or update constant real value non-monetary items by means of the monthly change in the CPI which is a general price index during low inflation and deflation. The reason for this is that constant real value non-monetary items are expressed in terms of money, i.e. in terms of an unstable monetary unit of account which is the same as the unstable monetary medium of exchange within an economy or monetary union. Inflation erodes the real value of the unstable monetary medium of exchange - which is also the unstable monetary unit of account in accounting and the economy in general. Constant real value non-monetary items thus have to be updated or inflation-adjusted at a rate equal to the rate of low inflation or deflation, i.e. valued or measured in units of constant purchasing power, in order to maintain their real values constant during low inflation and deflation because the unit of measure in accounting is an unstable monetary unit of account and consequently hardly ever absolutely stable during periods of low inflation and deflation. Months of zero annual inflation are very few and far between. Sustainable zero annual inflation has never been achieved before and it does not seem very likely that it will be achieved any time soon in the future.
Variable real value non-monetary items do not need to be and are not valued in units of constant purchasing power during low inflation because they are valued in terms of GAAP or IFRS at, for example, fair value, market value, present value, recoverable value, net realizable value, etc which always automatically take inflation - amongst many other things - into account. Variable real value non-monetary items are only valued in units of constant purchasing power during hyperinflation as required by the IASB in IAS 29 since the Board regards hyperinflation as an exceptional circumstance.
There is a school of thought that 2% inflation is completely unharmful and that it has no disadvantages compared to absolute price stability (sustainable zero inflation). That is not correct. 2% inflation will erode, for example, 51% of the real value of all monetary items and all constant real value non-monetary items never maintained constant, e.g. Retained Profits never maintained constant, over 35 years – all else being equal – when the stable measuring unit assumption is implemented for an indefinite period of time during indefinite low inflation.
It is not necessary for accountants to inflation-adjust by means of the CPI, which is a general price index, variable real value non-monetary items (e.g. properties, plant, equipment, shares, raw material, etc.) which are subject to product specific price increases for the purpose of valuing these variable real value non-monetary items during the accounting period on a primary valuation basis during non-hyperinflationary periods. These variable real value non-monetary items are generally subject to market-based real value changes determined by supply and demand. They incorporate product specific price changes or product specific inflation where the word inflation is, very unfortunately, also used to simply mean a product or product group price increase instead of the general use of the word in economics to mean the erosion of the real value of money and other monetary items over time, i.e. an erosion of the general purchasing power of money which is caused by/results in an increase in the general price level over time. It is thus generally accepted in economics that the word inflation has two different meanings:
(1) inflation meaning the erosion of the real value of only money and other monetary items over time and
(2) inflation meaning any price increase.
1970-style Constant Purchasing Power Accounting (CPPA) inflation accounting was a popular but failed attempt at inflation accounting at the time. It was a form of inflation accounting which tried unsuccessfully to make corporate accounts more informative when comparing current transactions with previous transactions by updating all non-monetary items (without distinguishing between variable real value non-monetary items and constant real value non-monetary items) equally by means of the Consumer Price Index during high and hyperinflation. 1970-style CPPA inflation accounting was abandoned as a failed and discredited inflation accounting model when general inflation decreased to low levels thereafter.
Constant Item Purchasing Power Accounting (CIPPA) is not an inflation accounting model to be used during high and hyperinflation. IAS 29 requires CPPA for that. CIPPA is the IASB´s alternative to Historical Cost Accounting during low inflation and deflation . CIPPA implements financial capital maintenance in units of constant purchasing power to be used during low inflation and deflation which was authorized in IFRS in the Framework (1989), Par 104 (a).
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The high inflation 1970´s
During the period of high inflation in the 1970´s accountants and accounting authorities tried various inflation accounting models in an attempt to reflect in company financial reports the effect of high inflation on monetary and – mistakenly by them – constant real value non-monetary items too. Inflation has no effect on the real value of non-monetary items. They did not realize that it was simply their choice of the stable measuring unit assumption that was eroding the real value of existing constant real value non-monetary items never maintained constant as a result of insufficient revaluable fixed assets during low inflation although the FASB did mention the stable measuring unit assumption in FAS 89. The IASB never mentioned it in either IAS 6 or IAS 15. They all blamed inflation. “The erosion of business profits and invested capital caused by inflation” was clearly stated in FAS 33 and “the erosive impact of inflation on profits and capital” was stated in both FAS 33 and FAS 89.
“Relative to most changes in financial reporting, the changes required by Statement 33 were monumental. Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.” FAS 89, 1986, p 6.
The implementation of these changes was eventually made voluntary and the “monumental” changes only materialized as far as the valuation of variable real value non-monetary items in terms of the requirements stipulated in International Financial Reporting Standards and US GAAP were concerned. They were developed and implemented by the IASB in the form of IAS and IFRS related to the valuing of variable real value non-monetary items in the years that followed. The “monumental” changes envisaged in FAS 33 with regard to the valuation of existing constant real value non-monetary items never happened although they were authorized in IFRS in the Framework, Par 104 (a) since 1989. They were attempted in IAS 29 but with very little success to date. See the implementation of IAS 29 in Zimbabwe.
During the high inflation 1970´s inflation accounting described a range of accounting models designed to reflect the effect of changing prices on financial reporting. Changing prices included changes in specific prices (of variable real value non-monetary items) as well as changes in the general price level (CPI) which ONLY resulted in the erosion of the purchasing power of monetary items (money and other monetary items) and nothing else. It was and still is generally accepted that inflation affects the real value of non-monetary items. That is not true. Inflation has no effect on the real value of non-monetary items. Inflation is a uniquely monetary phenomenon. It is not inflation, but, accountants´ selection of the HCA model and implementing their very erosive stable measuring unit assumption and financial capital maintenance in nominal monetary units (the first based on the fallacy that money is perfectly stable and the second being a very popular IASB-approved accounting fallacy) which unknowingly, unintentionally and unnecessarily erodes the real value of existing constant real value non-monetary items never maintained constant during low inflationary periods in the world´s constant item economy. One of the inflation accounting models that was tried unsuccessfully in the 1970´s and 1980´s was Constant Purchasing Power Accounting (CPPA).
The Financial Accounting Standards Board issued an exposure draft in the United States in January, 1975, that required supplemental financial reports on a Constant Purchasing Power Accounting inflation accounting price-level basis. The Securities and Exchange Commission in the USA proposed in 1976 the disclosure of the current replacement cost of amortizable, depletable and depreciable assets used for production as well as most inventories at the financial year-end. It also proposed the disclosure of the approximate value of amortization, depletion and depreciation as well as the approximate value of cost of sales that would have been accounted in terms of the current replacement cost of productive capacity and inventories.
Both supplemental Constant Purchasing Power Accounting inflation accounting financial statements and value accounting were experimented with in Canada. Australia tried both replacement-cost inflation accounting and CPP price-level inflation accounting. Netherland companies experimented with value accounting. Replacement-cost disclosures for equity capital financed items were considered in Germany. CPP inflation accounting supplemental financial statements were tried in Argentina. Brazil successfully used non-monetary indexes to update constant real value non-monetary items and variable real value non-monetary items for the 30 years from 1964 to 1994. In the United Kingdom an original proposal of supplementary CPP financial accounting financial reports was replaced by the Sandilands Committee proposal for a value accounting approach for inventories, marketable securities and productive property. South Africa had published a discussion paper on value accounting at the time.
The FASB issued FAS 33 Financial Reporting and Changing Prices in 1979. It only applied to certain large, publicly held enterprises. No changes were to be made in the primary financial statements; the information required by FAS 33 was to be presented as supplementary information in published annual reports.
These companies were required to calculate and report:
a. Income from continuing operations reflecting the effects of general inflation
b. The purchasing power loss or gain on net monetary items.
c. Calculate income from continuing operations on a current cost basis
d. Calculate the current cost amounts of property, plant, equipment and inventory at the end of the fiscal year
e. Report increases or decreases in current cost amounts of property, plant, equipment and inventory, net of inflation.
FAS 89 Financial Reporting and Changing Prices superseded FASB Statement No. 33 in 1986 and made voluntary the supplementary disclosure of constant purchasing power/current cost information.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
“Relative to most changes in financial reporting, the changes required by Statement 33 were monumental. Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.” FAS 89, 1986, p 6.
The implementation of these changes was eventually made voluntary and the “monumental” changes only materialized as far as the valuation of variable real value non-monetary items in terms of the requirements stipulated in International Financial Reporting Standards and US GAAP were concerned. They were developed and implemented by the IASB in the form of IAS and IFRS related to the valuing of variable real value non-monetary items in the years that followed. The “monumental” changes envisaged in FAS 33 with regard to the valuation of existing constant real value non-monetary items never happened although they were authorized in IFRS in the Framework, Par 104 (a) since 1989. They were attempted in IAS 29 but with very little success to date. See the implementation of IAS 29 in Zimbabwe.
During the high inflation 1970´s inflation accounting described a range of accounting models designed to reflect the effect of changing prices on financial reporting. Changing prices included changes in specific prices (of variable real value non-monetary items) as well as changes in the general price level (CPI) which ONLY resulted in the erosion of the purchasing power of monetary items (money and other monetary items) and nothing else. It was and still is generally accepted that inflation affects the real value of non-monetary items. That is not true. Inflation has no effect on the real value of non-monetary items. Inflation is a uniquely monetary phenomenon. It is not inflation, but, accountants´ selection of the HCA model and implementing their very erosive stable measuring unit assumption and financial capital maintenance in nominal monetary units (the first based on the fallacy that money is perfectly stable and the second being a very popular IASB-approved accounting fallacy) which unknowingly, unintentionally and unnecessarily erodes the real value of existing constant real value non-monetary items never maintained constant during low inflationary periods in the world´s constant item economy. One of the inflation accounting models that was tried unsuccessfully in the 1970´s and 1980´s was Constant Purchasing Power Accounting (CPPA).
The Financial Accounting Standards Board issued an exposure draft in the United States in January, 1975, that required supplemental financial reports on a Constant Purchasing Power Accounting inflation accounting price-level basis. The Securities and Exchange Commission in the USA proposed in 1976 the disclosure of the current replacement cost of amortizable, depletable and depreciable assets used for production as well as most inventories at the financial year-end. It also proposed the disclosure of the approximate value of amortization, depletion and depreciation as well as the approximate value of cost of sales that would have been accounted in terms of the current replacement cost of productive capacity and inventories.
Both supplemental Constant Purchasing Power Accounting inflation accounting financial statements and value accounting were experimented with in Canada. Australia tried both replacement-cost inflation accounting and CPP price-level inflation accounting. Netherland companies experimented with value accounting. Replacement-cost disclosures for equity capital financed items were considered in Germany. CPP inflation accounting supplemental financial statements were tried in Argentina. Brazil successfully used non-monetary indexes to update constant real value non-monetary items and variable real value non-monetary items for the 30 years from 1964 to 1994. In the United Kingdom an original proposal of supplementary CPP financial accounting financial reports was replaced by the Sandilands Committee proposal for a value accounting approach for inventories, marketable securities and productive property. South Africa had published a discussion paper on value accounting at the time.
The FASB issued FAS 33 Financial Reporting and Changing Prices in 1979. It only applied to certain large, publicly held enterprises. No changes were to be made in the primary financial statements; the information required by FAS 33 was to be presented as supplementary information in published annual reports.
These companies were required to calculate and report:
a. Income from continuing operations reflecting the effects of general inflation
b. The purchasing power loss or gain on net monetary items.
c. Calculate income from continuing operations on a current cost basis
d. Calculate the current cost amounts of property, plant, equipment and inventory at the end of the fiscal year
e. Report increases or decreases in current cost amounts of property, plant, equipment and inventory, net of inflation.
FAS 89 Financial Reporting and Changing Prices superseded FASB Statement No. 33 in 1986 and made voluntary the supplementary disclosure of constant purchasing power/current cost information.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
What price stability?
“The South African Reserve Bank is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as the achievement and maintenance of price stability.
The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.” SARB.
Absolute price stability is a year-on-year increase in the Consumer Price Index of zero percent. Alan Greenspan defines price stability as follows:
“Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making.”
http://www.kansascityfed.org/PUBLICAT/SYMPOS/1996/pdf/s96green.pdf
, Page 1.
It can be deduced from Mr Greenspan´s excellent definition that price stability can be defined as permanently sustainable zero per cent per annum inflation.
A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.
“The ECB´s Governing Council has announced a quantitative definition of price stability:
Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.
The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.” European Central Bank
http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html
A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. Theoretically, the SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”.
Accountants, on the other hand, solve the problem of the fact that the monetary unit is never perfectly stable on a sustainable basis by simply assuming that the monetary unit is perfectly stable in the world´s low inflationary economies, but, only for the purpose of valuing balance sheet constant real value non-monetary items and most income statement items which they account as Historical Cost items: they measure them in nominal monetary units. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant real value non-monetary items, namely salaries, wages, rentals, etc. which they inflation-adjust annually in terms of the CPI. They value other income statement items in nominal monetary units, i.e. at HC.
Accountants do not regard changes in the general purchasing power or real value of the monetary unit to be sufficiently important to continuously measure financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) in 1989. They generally choose to implement financial capital maintenance in nominal monetary units, also authorized by the IASB in the Framework, Par 104 (a). It is impossible to maintain the real value of existing constant real value capital constant by measuring financial capital maintenance in nominal monetary units per se during low inflation or deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy.
This led accountants to choose to implement the traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption (also IASB-approved and also based on a fallacy) for an unlimited period of time during indefinite inflation. They value both variable real value non-monetary items stated at HC in terms of IFRS or GAAP, as well as constant real value non-monetary items also stated at HC in terms of the HCA model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant items are thus considered by accountants to be simply HC non-monetary items.
There is a fixation in accounting that measurement in units of constant purchasing power (restatement) simply means adjusting company financial statements mainly to make current year statements more comparable with previous year statements. Measurement in units of constant purchasing power is not automatically thought of as affecting the fundamental values of the underlying resources although that is what is done with world wide annual measurement in units of constant purchasing power of salaries, wages, rentals, etc. The two processes are seen as different processes - when they are not.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.” SARB.
Absolute price stability is a year-on-year increase in the Consumer Price Index of zero percent. Alan Greenspan defines price stability as follows:
“Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making.”
http://www.kansascityfed.org/PUBLICAT/SYMPOS/1996/pdf/s96green.pdf
, Page 1.
It can be deduced from Mr Greenspan´s excellent definition that price stability can be defined as permanently sustainable zero per cent per annum inflation.
A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.
“The ECB´s Governing Council has announced a quantitative definition of price stability:
Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.
The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.” European Central Bank
http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html
A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. Theoretically, the SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”.
Accountants, on the other hand, solve the problem of the fact that the monetary unit is never perfectly stable on a sustainable basis by simply assuming that the monetary unit is perfectly stable in the world´s low inflationary economies, but, only for the purpose of valuing balance sheet constant real value non-monetary items and most income statement items which they account as Historical Cost items: they measure them in nominal monetary units. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant real value non-monetary items, namely salaries, wages, rentals, etc. which they inflation-adjust annually in terms of the CPI. They value other income statement items in nominal monetary units, i.e. at HC.
Accountants do not regard changes in the general purchasing power or real value of the monetary unit to be sufficiently important to continuously measure financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) in 1989. They generally choose to implement financial capital maintenance in nominal monetary units, also authorized by the IASB in the Framework, Par 104 (a). It is impossible to maintain the real value of existing constant real value capital constant by measuring financial capital maintenance in nominal monetary units per se during low inflation or deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy.
This led accountants to choose to implement the traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption (also IASB-approved and also based on a fallacy) for an unlimited period of time during indefinite inflation. They value both variable real value non-monetary items stated at HC in terms of IFRS or GAAP, as well as constant real value non-monetary items also stated at HC in terms of the HCA model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant items are thus considered by accountants to be simply HC non-monetary items.
There is a fixation in accounting that measurement in units of constant purchasing power (restatement) simply means adjusting company financial statements mainly to make current year statements more comparable with previous year statements. Measurement in units of constant purchasing power is not automatically thought of as affecting the fundamental values of the underlying resources although that is what is done with world wide annual measurement in units of constant purchasing power of salaries, wages, rentals, etc. The two processes are seen as different processes - when they are not.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Money illusion
Historical Cost accountants regard all non-monetary items stated at HC, whether they are variable real value non-monetary HC items or constant real value non-monetary HC items to be fundamentally the same, namely, simply non-monetary items when they implement their very erosive stable measuring unit assumption as part of the traditional HCA model during low inflationary periods.
This is the result of money illusion. People make the mistake of thinking that money is stable in real value in a low inflationary environment. Inflation always and everywhere erodes the real value of money and other monetary items over time. It is thus impossible for money to be stable in real value during inflation. On the other hand, inflation has no effect on the real value of non-monetary items over time.
The monetary unit of measure in accounting is the base money unit of the most relevant currency. Money is not stable in real value during inflation. This means that the monetary unit of measure in accounting is not a stable monetary unit of measure during inflation and deflation. Accountants´ unstable monetary unit of measure or unstable monetary unit of account is the only generally accepted unit of measure that is not an absolute value. It does not contain a fundamental constant. All other generally accepted units of measure of time, distance, velocity, mass, momentum, energy, weight, etc are absolute values, e.g. second, minute, hour, metre, yard, litre, kilogram, pound, mile, kilometre, inch, centimetre, gallon, ounce, etc.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
This is the result of money illusion. People make the mistake of thinking that money is stable in real value in a low inflationary environment. Inflation always and everywhere erodes the real value of money and other monetary items over time. It is thus impossible for money to be stable in real value during inflation. On the other hand, inflation has no effect on the real value of non-monetary items over time.
The monetary unit of measure in accounting is the base money unit of the most relevant currency. Money is not stable in real value during inflation. This means that the monetary unit of measure in accounting is not a stable monetary unit of measure during inflation and deflation. Accountants´ unstable monetary unit of measure or unstable monetary unit of account is the only generally accepted unit of measure that is not an absolute value. It does not contain a fundamental constant. All other generally accepted units of measure of time, distance, velocity, mass, momentum, energy, weight, etc are absolute values, e.g. second, minute, hour, metre, yard, litre, kilogram, pound, mile, kilometre, inch, centimetre, gallon, ounce, etc.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Three instead of two basic eonomic items
The world only goes round by misunderstanding. Charles Baudelaire
It is generally accepted under the current Historical Cost paradigm that the economy is divided in two parts: the monetary economy and the non-monetary or real economy. It is also generally accepted that there are only two basic economic items in the economy: monetary items and non-monetary items. Monetary items are money held and items with an underlying monetary nature. Non-monetary items are all items that are not monetary items.
No distinction is generally made between the valuation of variable real value non-monetary items, e.g. property, plant, equipment, inventory, etc, valued at Historical Cost under the Historical Cost Accounting model and constant real value non-monetary items, e.g. Issued Share capital, Retained Earnings, other items in Shareholders´ Equity and most items in the income statement (excluding items like salaries, wages, rentals, etc. valued in units of constant purchasing power) also valued at Historical Cost under the HCA model.
This is the result of the fact that the economy is based on the Historical Cost paradigm. Historical Cost is the traditional measurement basis in accounting. It is thus generally accepted for accountants to choose to implement their very erosive stable measuring unit assumption (based on a fallacy) and measure financial capital maintenance in nominal monetary units (another complete fallacy) as authorized by the IASB in the Framework, Par 104 (a) during low inflationary periods.
One of the basic principles in accounting is “The Measuring Unit principle:
The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”
Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.
However, non-monetary items are not all fundamentally the same. Non-monetary items are, in fact, subdivided into variable real value non-monetary items and constant real value non-monetary items. The three fundamentally different basic economic items are monetary items, variable real value non-monetary items and constant real value non-monetary items although it is generally accepted under the HC paradigm that there are only two basic economic items, namely, monetary and non-monetary items.
HC accountants regard all non-monetary items stated at HC, whether they are variable real value non-monetary HC items or constant real value non-monetary HC items to be fundamentally the same, namely, simply non-monetary items when they implement their very erosive stable measuring unit assumption as part of the traditional HCA model during low inflationary periods.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Price-level accounting does not prevail for balance sheet constant items during low inflation
Price-level accounting as Harvey Kapnick hoped for in 1976 clearly does not prevail for balance sheet constant real value non-monetary items (e.g. equity) and most income statement items. Income statement items are all constant real value non-monetary items. Price-level accounting does prevail as far as the income statement constant real value non-monetary items salaries, wages, rentals, etc are concerned since accountants update them annually in units of constant purchasing power in terms of the change in the Consumer Price Index. Accountants unfortunately choose the Historical Cost Accounting model and implement the stable measuring unit assumption under which they value balance sheet constant real value non-monetary items at historical cost, i.e. in nominal monetary units thus eroding these constant real value non-monetary items when their existing constant real non-monetary values are never maintained as a result of insufficient revaluable fixed assets (revalued or not) during low inflation.
Price-level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when they indexed many variable real value non-monetary items and constant real value non-monetary items in their non-monetary or real economy with daily indexation with a daily index value supplied by the different governments during that period. They stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They stopped daily indexation which is, in principle, the same as continuous financial capital maintenance in units of constant purchasing power, i.e. Constant Item Purchasing Power Accounting.
US Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.” As quoted in FAS 33 p. 29.
Shareholder’s equity forms part of an entity’s financial resources.
“Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity.” IASB Exposure Draft: Management Commentary, June 2009, Par 29.
Shareholders´ equity is a financial resource with a constant real non-monetary value expressed in terms of an unstable monetary unit of measure. The IASB statement in the Framework, Par 104 (a) that “financial capital maintenance can be measured in nominal monetary units” is clearly a fallacy since it is impossible to maintain the existing constant real non-monetary value of capital constant “in nominal monetary units” during inflation and deflation.
There is no substance in the claim that the existence and value of economic resources, for example shareholders´ equity items, exist independently of how we measure them - and that the choice of the measuring unit does not affect their fundamental values, only how we choose to represent that value – and that we can use Rands, Rands of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced. See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices accountants make will not change that value and will not affect the economy.
If accountants and accounting authorities generally understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional destruction by the implementation of the Historical Cost Accounting model of hundreds of billions of US Dollars of real value in constant real value non-monetary items (e.g. banks´ and companies´ equity) never maintained in the world´s constant item economy, they would have called for its rejection by now.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Price-level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when they indexed many variable real value non-monetary items and constant real value non-monetary items in their non-monetary or real economy with daily indexation with a daily index value supplied by the different governments during that period. They stopped that with the full implementation of the traditional HCA model, financial capital maintenance in nominal monetary units and the stable measuring unit assumption when they changed the Unidade Real de Valor into their latest currency, the Real, in 1994. They stopped daily indexation which is, in principle, the same as continuous financial capital maintenance in units of constant purchasing power, i.e. Constant Item Purchasing Power Accounting.
US Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.” As quoted in FAS 33 p. 29.
Shareholder’s equity forms part of an entity’s financial resources.
“Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity.” IASB Exposure Draft: Management Commentary, June 2009, Par 29.
Shareholders´ equity is a financial resource with a constant real non-monetary value expressed in terms of an unstable monetary unit of measure. The IASB statement in the Framework, Par 104 (a) that “financial capital maintenance can be measured in nominal monetary units” is clearly a fallacy since it is impossible to maintain the existing constant real non-monetary value of capital constant “in nominal monetary units” during inflation and deflation.
There is no substance in the claim that the existence and value of economic resources, for example shareholders´ equity items, exist independently of how we measure them - and that the choice of the measuring unit does not affect their fundamental values, only how we choose to represent that value – and that we can use Rands, Rands of constant purchasing power, US Dollars, whatever we think best represents that value and will make sense to whoever is using the information produced. See Paton above. There is no substance in the claim that it is fine to represent value in terms of constant purchasing power and to argue that that would be a better method than using historic cost and maintaining a fiction as to the stability of the measuring unit - but that doesn't affect the nature of the underlying resources. There is no substance in the claim that the choices accountants make will not change that value and will not affect the economy.
If accountants and accounting authorities generally understood that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional destruction by the implementation of the Historical Cost Accounting model of hundreds of billions of US Dollars of real value in constant real value non-monetary items (e.g. banks´ and companies´ equity) never maintained in the world´s constant item economy, they would have called for its rejection by now.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Saturday, 19 February 2011
Accounting per se can not and does not create real value out of nothing
It must be clearly understood, however, that accounting per se can not and does not create real value out of thin air – out of nothing. Accountants can not and do not create real value or wealth by simply passing some update or inflation-adjustment accounting entries when no real value actually exists. Constant real value non-monetary items, e.g. Issued Share Capital, Share Premium, Retained Profits, Capital Reserves, other items in Shareholders´ Equity, Trade Debtors, Trade Creditors, Provisions, Taxes Payable, Taxes Receivable, etc first have to actually exist for accountants to be able to maintain the real values of those existing constant real value non-monetary items constant by continuously measuring financial capital maintenance in units of constant purchasing power as authorized by the IASB and by continuously valuing income statement constant items in terms of units of constant purchasing power in order to determine profit or loss in units of constant purchasing power during low inflation and deflation.
The IASB has, amazingly, authorized the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation as well as its only and perfect remedy during inflation and deflation in one and the same statement in 1989. The remedy is perfect during inflation and deflation; the values may not be perfect as a result of the way the CPI is calculated.
Obviously, at sustainable zero inflation constant real value non-monetary items will maintain their real values constant in all companies that at least break even. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.
The IASB confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 and in the Framework that companies´ primary financial reports are prepared in most economies based on the traditional Historical Cost Accounting model without taking changes in the general level of prices or specific price changes of assets into account, with the exception that investments, equipment, plant and properties can be revalued. The IASB does not mention the erosion of the real value of balance sheet constant real value non-monetary items never maintained constant when accountants implement the stable measuring unit assumption during low inflationary periods because this process of erosion of the real value of constant real value non-monetary items never maintained is not generally understood. The IASB, like the FASB and most accountants, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation as specifically stated by the FASB and IASB. They all also support the stable measuring unit assumption which is based on the fallacy that money is perfectly stable as well as the fallacy of financial capital maintenance in nominal monetary units during low inflation and deflation. The erosion of real value of constant real value non-monetary items by implementation of the stable measuring unit assumption is very well understood - and compensated for by updating them by applying the annual CPI - in the case of the income statement constant real value non-monetary items salaries, wages, rentals, etc. Neither is the real value maintaining effect on balance sheet constant items understood of freely choosing to continuously measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved by the IASB in the Framework, Par 104 (a).
The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position. Whereas the FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89, the IASB never mentioned it in either IAS 6 Accounting Response to Changing Prices or IAS 15. IAS 15 completely superseded IAS 6. IAS 15 was eventually withdrawn.
“Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.” FAS 89, Par 4, 1986
“The integrity of the historical cost/nominal dollar system relies on a stable monetary system.” FAS 33, 1979
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The IASB has, amazingly, authorized the fallacy of financial capital maintenance in nominal monetary units per se during inflation and deflation as well as its only and perfect remedy during inflation and deflation in one and the same statement in 1989. The remedy is perfect during inflation and deflation; the values may not be perfect as a result of the way the CPI is calculated.
Obviously, at sustainable zero inflation constant real value non-monetary items will maintain their real values constant in all companies that at least break even. Sustainable zero inflation has never been achieved in the past and is not likely soon to be achieved in the future. Sustainable zero inflation is thus simply a theoretical option.
The IASB confirms the fact that the Historical Cost paradigm is firmly in place when it states in IAS 29 and in the Framework that companies´ primary financial reports are prepared in most economies based on the traditional Historical Cost Accounting model without taking changes in the general level of prices or specific price changes of assets into account, with the exception that investments, equipment, plant and properties can be revalued. The IASB does not mention the erosion of the real value of balance sheet constant real value non-monetary items never maintained constant when accountants implement the stable measuring unit assumption during low inflationary periods because this process of erosion of the real value of constant real value non-monetary items never maintained is not generally understood. The IASB, like the FASB and most accountants, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation as specifically stated by the FASB and IASB. They all also support the stable measuring unit assumption which is based on the fallacy that money is perfectly stable as well as the fallacy of financial capital maintenance in nominal monetary units during low inflation and deflation. The erosion of real value of constant real value non-monetary items by implementation of the stable measuring unit assumption is very well understood - and compensated for by updating them by applying the annual CPI - in the case of the income statement constant real value non-monetary items salaries, wages, rentals, etc. Neither is the real value maintaining effect on balance sheet constant items understood of freely choosing to continuously measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units – both models being approved by the IASB in the Framework, Par 104 (a).
The International Accounting Standards Committee (the IASB predecessor body) blamed changing prices in IAS 15 Information Reflecting the Effects of Changing Prices for affecting an enterprise’s results of operation and financial position. They defined changing prices as (1) specific price changes and (2) changes in the general price level which changed the general purchasing power of money, i.e. they blamed specific price changes and inflation for affecting companies´ results and financial position. Whereas the FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89, the IASB never mentioned it in either IAS 6 Accounting Response to Changing Prices or IAS 15. IAS 15 completely superseded IAS 6. IAS 15 was eventually withdrawn.
“Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.” FAS 89, Par 4, 1986
“The integrity of the historical cost/nominal dollar system relies on a stable monetary system.” FAS 33, 1979
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday, 17 February 2011
Capital deficiency during sub-prime crisis
The world economy would be more robust today if only continuous financial capital maintenance in units of constant purchasing power had been authorized in the Framework (1989), Par 104 (a). The implementation of the Constant Item Purchasing Power Accounting model would today maintain the real values of all companies´ and banks´ Issued Share capital, Retained Earnings and all other items in Shareholders´ Equity since then in companies and banks that at least break even, instead of unknowingly, unintentionally and unnecessarily eroding their real values never maintained with traditional Historical Cost Accounting at a rate equal to the rate of inflation year in year out during low inflationary periods when accountants implement the very erosive stable measuring unit assumption which is based on the fallacy that the erosion of the real value of the functional currency (money) during low inflation is not sufficiently important for them to implement continuous financial capital maintenance in units of constant purchasing power. Accountants unknowingly do this because they are authorized to choose to measure financial capital maintenance in nominal monetary units – a complete fallacy also approved by the IASB – implementing the traditional HCA model authorized by the IASB in the exact same Framework, Par 104 (a) 22 years ago.
Had only real value maintaining financial capital maintenance in units of constant purchasing power (CIPPA) been approved in 1989 it would have made a significant difference over this period as verified by the huge capital injections required as a result of the capital deficiency problems caused by the continuous unknowing, unnecessary and unintentional erosion by accountants´ implementation of the very erosive stable measuring unit assumption in the valuation of banks´ and companies´ Shareholders´ Equity values never maintained constant under the HCA model as evidenced during the recent sub-prime financial crisis.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Had only real value maintaining financial capital maintenance in units of constant purchasing power (CIPPA) been approved in 1989 it would have made a significant difference over this period as verified by the huge capital injections required as a result of the capital deficiency problems caused by the continuous unknowing, unnecessary and unintentional erosion by accountants´ implementation of the very erosive stable measuring unit assumption in the valuation of banks´ and companies´ Shareholders´ Equity values never maintained constant under the HCA model as evidenced during the recent sub-prime financial crisis.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Saturday, 12 February 2011
Historical Cost Accounting is very erosive during inflation
Also approving the traditional Historical Cost Accounting model in the Framework(1989), Par 104 (a) has been very costly for the world economy as amply illustrated by the deficiency in bank and company capital during the recent financial crisis. This clearly illustrates the lack of understanding the very erosive effect of the stable measuring unit assumption on balance sheet constant real value non-monetary items (e.g. shareholders´ equity) during low inflationary periods.
The school of thought that the effects of 2% inflation are not more harmful than zero per cent inflation may have contributed to this. This school of thought is wrong in two of the three valuation processes in our current HC economy and would also be wrong in one of the three valuation processes under continuous financial capital maintenance in units of constant purchasing power, i.e. a constant item purchasing power paradigm during low inflation. The three valuation processes in our economy under both the HC and constant item purchasing power paradigms are the valuation of monetary items, variable real value non-monetary items and constant real value non-monetary items.
Variable items are valued in terms of International Financial Reporting Standards under both the Historical Cost and constant item purchasing power paradigms with the stable measuring unit assumption being applied under HCA. The stable measuring unit assumption is rejected under the Constant Item Purchasing Power Accounting option.
In the first instance, the view that a high degree of price stability of a positive inflation rate of up to two per cent per annum is completely unharmful and that it has no disadvantages compared to absolute price stability is never true in the case of monetary items under any accounting model – either the HCA model or the Constant Item Purchasing Power Accounting model – since monetary items are incapable of being updated as a result of the current nature of fiat money. A high degree of price stability of two per cent per annum in this case erodes two per cent per annum of the real value of all money and other monetary items that cannot be updated in any way or form; that equates to the erosion of 51 per cent of real value in all current monetary items over the next 35 years and will over a long enough time period lead to all current monetary items arriving at the point of being completely worthless. See the Real Value Table for some other levels of value erosion over the respective time periods involved. In the case of monetary items we can thus confidently disagree completely with those who assume that a high degree of price stability of above zero and up to two per cent per annum is unharmful in all respects and that it has absolutely no disadvantages compared to absolute price stability or zero inflation.
The assumption that 2% inflation is unharmful and that it has no disadvantages compared to zero inflation is acceptable in the case of variable real value non-monetary items valued continuously in terms of IFRS under both the HC model and the Constant Item Purchasing Power Accounting model. The nature of the valuing processes in valuing variable real value non-monetary items continuously, for example, at fair value or net realizable value or market value, as applicable, in terms IFRS, allows this idea to be justifiable under both models. The above view is acceptable in this instance, because, in principle, any level of inflation or deflation – high or low – is automatically adjusted for in determining the price of a variable real value non-monetary item in terms of IFRS excluding, of course, the stable measuring unit assumption.
2% inflation erodes 2% per annum - i.e. 51% over 35 years - of the real value of constant real value non-monetary items never maintained, e.g. retained profits and issued share capital, under the current HC paradigm. All existing constant real value non-monetary items´ real values would be maintained constant with continuous measurement in units of constant purchasing power at any level of inflation or deflation under the Constant Item Purchasing Power Accounting paradigm for an unlimited period of time in companies at least breaking even – all else except inflation and deflation being equal. We can thus safely disagree in the instance of constant real value non-monetary items under the HC paradigm too, that the effects of 2% inflation is completely unharmful. 2% inflation – in fact, any level of inflation or deflation - would be the same as zero inflation as far as the valuation of constant real value non-monetary items under the Constant Item Purchasing Power Accounting paradigm is concerned.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The school of thought that the effects of 2% inflation are not more harmful than zero per cent inflation may have contributed to this. This school of thought is wrong in two of the three valuation processes in our current HC economy and would also be wrong in one of the three valuation processes under continuous financial capital maintenance in units of constant purchasing power, i.e. a constant item purchasing power paradigm during low inflation. The three valuation processes in our economy under both the HC and constant item purchasing power paradigms are the valuation of monetary items, variable real value non-monetary items and constant real value non-monetary items.
Variable items are valued in terms of International Financial Reporting Standards under both the Historical Cost and constant item purchasing power paradigms with the stable measuring unit assumption being applied under HCA. The stable measuring unit assumption is rejected under the Constant Item Purchasing Power Accounting option.
In the first instance, the view that a high degree of price stability of a positive inflation rate of up to two per cent per annum is completely unharmful and that it has no disadvantages compared to absolute price stability is never true in the case of monetary items under any accounting model – either the HCA model or the Constant Item Purchasing Power Accounting model – since monetary items are incapable of being updated as a result of the current nature of fiat money. A high degree of price stability of two per cent per annum in this case erodes two per cent per annum of the real value of all money and other monetary items that cannot be updated in any way or form; that equates to the erosion of 51 per cent of real value in all current monetary items over the next 35 years and will over a long enough time period lead to all current monetary items arriving at the point of being completely worthless. See the Real Value Table for some other levels of value erosion over the respective time periods involved. In the case of monetary items we can thus confidently disagree completely with those who assume that a high degree of price stability of above zero and up to two per cent per annum is unharmful in all respects and that it has absolutely no disadvantages compared to absolute price stability or zero inflation.
The assumption that 2% inflation is unharmful and that it has no disadvantages compared to zero inflation is acceptable in the case of variable real value non-monetary items valued continuously in terms of IFRS under both the HC model and the Constant Item Purchasing Power Accounting model. The nature of the valuing processes in valuing variable real value non-monetary items continuously, for example, at fair value or net realizable value or market value, as applicable, in terms IFRS, allows this idea to be justifiable under both models. The above view is acceptable in this instance, because, in principle, any level of inflation or deflation – high or low – is automatically adjusted for in determining the price of a variable real value non-monetary item in terms of IFRS excluding, of course, the stable measuring unit assumption.
2% inflation erodes 2% per annum - i.e. 51% over 35 years - of the real value of constant real value non-monetary items never maintained, e.g. retained profits and issued share capital, under the current HC paradigm. All existing constant real value non-monetary items´ real values would be maintained constant with continuous measurement in units of constant purchasing power at any level of inflation or deflation under the Constant Item Purchasing Power Accounting paradigm for an unlimited period of time in companies at least breaking even – all else except inflation and deflation being equal. We can thus safely disagree in the instance of constant real value non-monetary items under the HC paradigm too, that the effects of 2% inflation is completely unharmful. 2% inflation – in fact, any level of inflation or deflation - would be the same as zero inflation as far as the valuation of constant real value non-monetary items under the Constant Item Purchasing Power Accounting paradigm is concerned.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monday, 7 February 2011
Price-level accounting
Accountants generally choose to measure financial capital maintenance in nominal monetary units (one of the three very popular accounting fallacies not yet extinct) and thus apply their very erosive stable measuring unit assumption (another of the three accounting fallacies) as part of the traditional HCA model based on these fallacies. They generally value balance sheet constant real value non-monetary items (e.g. equity) as well as most income statement items – which are all constant real value non-monetary items - at Historical Cost because they value them in nominal monetary units as a result of the fact that they assume that money (the functional currency) is perfectly stable for this purpose. Accountants do not regard changes in the real value of money during low inflation as important enough for them to maintain the real value of capital constant with financial capital maintenance in units of constant purchasing power as they have been authorized in IFRS in the Framework (1989) Par 104 (a). Accountants basically assume there has never ever been inflation or deflation in the past, there is no inflation and deflation in the present and there never will be inflation and deflation in the future as far as the valuation of most constant real value non-monetary is concerned. They only value certain income statement items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and inflation-adjust them by means of the annual CPI during low inflation.
Complete price-level accounting also called Constant Purchasing Power Accounting (CPPA) was developed as an inflation accounting model whereby all non-monetary items – variable real value non-monetary items and constant constant real value non-monetary items – are inflation-adjusted by means of the period-end CPI in order to make financial statements more useful during periods of very high and hyperinflation. The non-monetary or real economy of a hyperinflationary economy can only be maintained relatively stable by applying the daily parallel US Dollar exchange rate or a Brazilian-style daily index to the valuation of all non-monetary items instead of the period-end CPI as required by IAS 29.
The Framework is applicable
The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non-hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Framework (1989), Par 102 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11.
Deloitte state:
"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 Par. 11 states:
“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.”
The valuation of the constant real value non-monetary items Issued Share capital, Retained Earnings, other items in Shareholders´ Equity and other constant real value non-monetary items is thus covered by the IASB´S Framework, Par 104 (a) which states “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” authorized in 1989.
Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:
“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”
Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.
Financial capital maintenance in units of constant purchasing power
Constant Item Purchasing Power Accounting is a price-level accounting model implemented during low inflation and deflation where under only constant real value non-monetary items ( not variable real value non-monetary items) are continuously inflation-adjusted every time the CPI changes, i.e. month after month.
Continuous financial capital maintenance in units of constant purchasing power, i.e. the monthly inflation-adjustment by means of the CPI of only constant real value non-monetary items - not inflation accounting complete price-level adjustment of all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) - during low inflation and deflation has also been authorized by the IASC Board thirteen years after Harvey Kapnick´s 1976 prediction. The IASC Board approved the Framework, Par 104 (a) in 1989 stating that “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” However, the enormous real value eroding function of the very erosive stable measuring unit assumption when accountants choose, also in terms of the Framework, Par 104 (a), the IASB-approved very popular accounting fallacy of financial capital maintenance in nominal monetary units and apply it in the valuing of constant real value non-monetary items never maintained, e.g. retained earnings never maintained, in low inflationary economies when the stable measuring unit assumption is maintained for an unlimited period of time during indefinite inflation, is not generally understood at all. This is clearly verified by the fact that both financial capital maintenance in nominal monetary units (an accounting fallacy) as well as real value maintaining continuous financial capital maintenance in units of constant purchasing power during inflation and deflation were approved by the IASB in the Framework, Par 104 (a) in 1989. Accountants can choose the one or the other and state that they have prepared primary financial statements in terms of IFRS. However, when they choose the traditional HCA model they unknowingly, unintentionally and unnecessarily erode real value on a significant scale in the real or non-monetary economy during low inflation when they implement the very erosive stable measuring unit assumption. When they choose IASB-approved continuous financial capital maintenance in units of constant purchasing power they maintain the real values of all constant real value non-monetary items during inflation and deflation in companies which at least break even, empowering and enriching those companies, their shareholders and the economy in general with the accompanying benefits to workers and employment for an unlimited period of time – all else except inflation or deflation being equal.
As the Deutsche Bundesbank stated:
“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”
Deutsche Bundesbank, 1996 Annual Report, P 83.
Financial capital maintenance in units of constant purchasing power during inflation and deflation results in absolute price stability only in constant real value non-monetary items for an unlimited period of time in companies that at least break even – all else except inflation and deflation being equal – without the need for extra capital from capital providers or more retained earnings simply to maintain the existing constant real value of existing constant items constant. The IASB predecessor body, the IASC Board, approved absolute price stability in income statement and balance sheet constant items when they authorized the Framework, Par 104 (a) in 1989 approving the option of continuously measuring financial capital maintenance in units of constant purchasing power during low inflation and deflation.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Complete price-level accounting also called Constant Purchasing Power Accounting (CPPA) was developed as an inflation accounting model whereby all non-monetary items – variable real value non-monetary items and constant constant real value non-monetary items – are inflation-adjusted by means of the period-end CPI in order to make financial statements more useful during periods of very high and hyperinflation. The non-monetary or real economy of a hyperinflationary economy can only be maintained relatively stable by applying the daily parallel US Dollar exchange rate or a Brazilian-style daily index to the valuation of all non-monetary items instead of the period-end CPI as required by IAS 29.
The Framework is applicable
The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non-hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Framework (1989), Par 102 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11.
Deloitte state:
"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 Par. 11 states:
“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.”
The valuation of the constant real value non-monetary items Issued Share capital, Retained Earnings, other items in Shareholders´ Equity and other constant real value non-monetary items is thus covered by the IASB´S Framework, Par 104 (a) which states “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” authorized in 1989.
Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:
“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”
Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.
Financial capital maintenance in units of constant purchasing power
Constant Item Purchasing Power Accounting is a price-level accounting model implemented during low inflation and deflation where under only constant real value non-monetary items ( not variable real value non-monetary items) are continuously inflation-adjusted every time the CPI changes, i.e. month after month.
Continuous financial capital maintenance in units of constant purchasing power, i.e. the monthly inflation-adjustment by means of the CPI of only constant real value non-monetary items - not inflation accounting complete price-level adjustment of all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) - during low inflation and deflation has also been authorized by the IASC Board thirteen years after Harvey Kapnick´s 1976 prediction. The IASC Board approved the Framework, Par 104 (a) in 1989 stating that “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” However, the enormous real value eroding function of the very erosive stable measuring unit assumption when accountants choose, also in terms of the Framework, Par 104 (a), the IASB-approved very popular accounting fallacy of financial capital maintenance in nominal monetary units and apply it in the valuing of constant real value non-monetary items never maintained, e.g. retained earnings never maintained, in low inflationary economies when the stable measuring unit assumption is maintained for an unlimited period of time during indefinite inflation, is not generally understood at all. This is clearly verified by the fact that both financial capital maintenance in nominal monetary units (an accounting fallacy) as well as real value maintaining continuous financial capital maintenance in units of constant purchasing power during inflation and deflation were approved by the IASB in the Framework, Par 104 (a) in 1989. Accountants can choose the one or the other and state that they have prepared primary financial statements in terms of IFRS. However, when they choose the traditional HCA model they unknowingly, unintentionally and unnecessarily erode real value on a significant scale in the real or non-monetary economy during low inflation when they implement the very erosive stable measuring unit assumption. When they choose IASB-approved continuous financial capital maintenance in units of constant purchasing power they maintain the real values of all constant real value non-monetary items during inflation and deflation in companies which at least break even, empowering and enriching those companies, their shareholders and the economy in general with the accompanying benefits to workers and employment for an unlimited period of time – all else except inflation or deflation being equal.
As the Deutsche Bundesbank stated:
“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”
Deutsche Bundesbank, 1996 Annual Report, P 83.
Financial capital maintenance in units of constant purchasing power during inflation and deflation results in absolute price stability only in constant real value non-monetary items for an unlimited period of time in companies that at least break even – all else except inflation and deflation being equal – without the need for extra capital from capital providers or more retained earnings simply to maintain the existing constant real value of existing constant items constant. The IASB predecessor body, the IASC Board, approved absolute price stability in income statement and balance sheet constant items when they authorized the Framework, Par 104 (a) in 1989 approving the option of continuously measuring financial capital maintenance in units of constant purchasing power during low inflation and deflation.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Value accounting
There is strong awareness in the accounting profession that accounting is really about value and not simply about Historical Cost.
"...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions”
Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.
Most accountants agree that accounting should be value based. By value based they mean that variable real value non-monetary items can not always be valued at Historical Cost and are to be valued in terms of specific standards formulated in IFRS or GAAP at, for example, market value, net realizable value, fair value, present value or recoverable value, etc.
Value accounting has been specifically defined in International Standards since 1976 via IAS and IFRS relating to variable items. Value accounting thus prevails in the valuation and accounting of variable items in terms of IAS and IFRS.
Value accounting also prevails as far as the accounting and valuing of monetary items during the current accounting period are concerned. Monetary items are measured in nominal monetary units no matter which accounting model is used. The real values of monetary items are kept always current by inflation, deflation and hyperinflation since the nominal values of monetary items are not updated or inflation-adjusted during the current accounting period in any inflationary, deflationary or hyperinflationary economy. The real value of money and other monetary items generally changes monthly during inflation and deflation while it normally changes daily or even every 8 hours during hyperinflation. The real value of money is eroded during inflation, increased during deflation and hyper-eroded during hyperinflation. The nominal values of monetary items stay the same during the current financial period under any accounting model, but, their real values are automatically adjusted by inflation, deflation and hyperinflation. The real value of money and other monetary items can be halved every 24.7 hours as has happened recently during hyperinflation in Zimbabwe. According to Prof Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.
The net monetary loss or net monetary gain resulting from holding an excess of either monetary item assets or monetary item liabilities is currently only calculated and accounted during the implementation of the IASB´s inflation accounting model Constant Purchasing Power Accounting (CPPA) as defined in IAS 29 in hyperinflationary economies. Net monetary gains and losses are required to be calculated and accounted during low inflation and deflation when companies measure financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a) - the Constant Item Purchasing Power Accounting model - during low inflation and deflation. They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick. See Saxe Lecture, 1976.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without premission.
"...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions”
Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.
Most accountants agree that accounting should be value based. By value based they mean that variable real value non-monetary items can not always be valued at Historical Cost and are to be valued in terms of specific standards formulated in IFRS or GAAP at, for example, market value, net realizable value, fair value, present value or recoverable value, etc.
Value accounting has been specifically defined in International Standards since 1976 via IAS and IFRS relating to variable items. Value accounting thus prevails in the valuation and accounting of variable items in terms of IAS and IFRS.
Value accounting also prevails as far as the accounting and valuing of monetary items during the current accounting period are concerned. Monetary items are measured in nominal monetary units no matter which accounting model is used. The real values of monetary items are kept always current by inflation, deflation and hyperinflation since the nominal values of monetary items are not updated or inflation-adjusted during the current accounting period in any inflationary, deflationary or hyperinflationary economy. The real value of money and other monetary items generally changes monthly during inflation and deflation while it normally changes daily or even every 8 hours during hyperinflation. The real value of money is eroded during inflation, increased during deflation and hyper-eroded during hyperinflation. The nominal values of monetary items stay the same during the current financial period under any accounting model, but, their real values are automatically adjusted by inflation, deflation and hyperinflation. The real value of money and other monetary items can be halved every 24.7 hours as has happened recently during hyperinflation in Zimbabwe. According to Prof Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.
The net monetary loss or net monetary gain resulting from holding an excess of either monetary item assets or monetary item liabilities is currently only calculated and accounted during the implementation of the IASB´s inflation accounting model Constant Purchasing Power Accounting (CPPA) as defined in IAS 29 in hyperinflationary economies. Net monetary gains and losses are required to be calculated and accounted during low inflation and deflation when companies measure financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a) - the Constant Item Purchasing Power Accounting model - during low inflation and deflation. They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick. See Saxe Lecture, 1976.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without premission.
Friday, 4 February 2011
Historical Cost Accounting is to blame
The real values of many constant real value non-monetary items, for example, retained earnings never maintained, are currently not being maintained constant in the world´s low inflation economies. To the contrary: they are unnecessarily, unknowingly and unintentionally being eroded at a rate equal to the annual rate of inflation by the implementation of the traditional HCA model where under accountants apply the very erosive stable measuring unit assumption when they measure financial capital maintenance in nominal monetary units – the accounting fallacy as authorized by the IASB in the Framework, Par 104 (a) in 1989 – during low inflation.
Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items constant during inflation and deflation is a basic objective of accounting.
This is the result of:
(1) the three popular accounting fallacies; namely,
(a) the stable measuring unit assumption based on the fallacy that changes in the purchasing power of the functional currently are not sufficiently important for accountants to measure financial capital maintenance in units of constant purchasing power during low inflation (authorized by the IASB) ,
(b) financial capital maintenance in nominal monetary units per se during low inflation (authorized by the IASB) and
(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB and the FASB);
(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very erosive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied, and
(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant real value non-monetary items of continuously measuring financial capital maintenance in units of constant purchasing power during inflation as approved by the IASB in the Framework, Par 104 (a).
If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units, i.e. the HCA model, during low inflation by now.
The accounting model accountants choose determines whether they unknowingly erode significant amounts annually in the real value of existing constant real value non-monetary items never maintained constant or knowingly would maintain significant amounts of real value every year in existing constant real value non-monetary items in the constant item economy depending on whether they choose the IASB-approved traditional HCA model when they apply the very erosive stable measuring unit assumption during low inflation or IASB-approved financial capital maintenance in units of constant purchasing power during inflationary and deflationary periods – both models amazingly approved in the Framework, Par 104 (a) in 1989. It is not inflation doing the eroding in real value of existing constant real value non-monetary items never maintained, e.g. in companies´ capital and profits, as the IASB, the FASB and most accountants believe. Implementing the HCA model is unnecessarily, unknowingly and unintentionally doing the eroding when accountants apply the stable measuring unit assumption during low inflation. Inflation has no effect on the real value of non-monetary items.
Copyright (c) Nicolaas J Smith. All rights reserved. No reproduction without permission.
Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items constant during inflation and deflation is a basic objective of accounting.
This is the result of:
(1) the three popular accounting fallacies; namely,
(a) the stable measuring unit assumption based on the fallacy that changes in the purchasing power of the functional currently are not sufficiently important for accountants to measure financial capital maintenance in units of constant purchasing power during low inflation (authorized by the IASB) ,
(b) financial capital maintenance in nominal monetary units per se during low inflation (authorized by the IASB) and
(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB and the FASB);
(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very erosive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied, and
(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant real value non-monetary items of continuously measuring financial capital maintenance in units of constant purchasing power during inflation as approved by the IASB in the Framework, Par 104 (a).
If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units, i.e. the HCA model, during low inflation by now.
The accounting model accountants choose determines whether they unknowingly erode significant amounts annually in the real value of existing constant real value non-monetary items never maintained constant or knowingly would maintain significant amounts of real value every year in existing constant real value non-monetary items in the constant item economy depending on whether they choose the IASB-approved traditional HCA model when they apply the very erosive stable measuring unit assumption during low inflation or IASB-approved financial capital maintenance in units of constant purchasing power during inflationary and deflationary periods – both models amazingly approved in the Framework, Par 104 (a) in 1989. It is not inflation doing the eroding in real value of existing constant real value non-monetary items never maintained, e.g. in companies´ capital and profits, as the IASB, the FASB and most accountants believe. Implementing the HCA model is unnecessarily, unknowingly and unintentionally doing the eroding when accountants apply the stable measuring unit assumption during low inflation. Inflation has no effect on the real value of non-monetary items.
Copyright (c) Nicolaas J Smith. All rights reserved. No reproduction without permission.
IAS 29 impossible during hyperinflation
The implementation of IAS 29 Financial Reporting in Hyperinflationary Economies by Zimbabwean listed companies as required by the Zimbabwean Stock Exchange made no difference to the Zimbabwean economy during the final stages of the hyperinflationary erosion of the monetary unit in Zimbabwe, i.e. the Zimbabwe Dollar. The IASB has agreed that it was not possible to implement IAS 29 during severe hyperinflation at the end of the hyperinflationary period in Zimbabwe since there was no CPI available. The daily Old Mutual Implied Rate (OMIR) was, however, available till 20th November, 2008, the day Gideon Gono, the governor of the Reserve Bank of Zimbabwe issued regulations that closed down the Zimbabwe Stock Exchange and effectively led to the end of the Zimbabwe Dollar.
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." P 8 ¹
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 ²
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
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.
Valuing all non-monetary items as required by the IAS 29 inflation accounting model in terms of the period-end Consumer Price Index which was published a month or more after the month to which it related when the real value of the Zimbabwe Dollar halved every day, obviously, had no effect at all.
“The Zimbabwe government last published an official Zimbabwe dollar inflation index in July 2008. This, combined with the complexities of not having a stable currency due to the phenomenon described above, meant that there were severe limitations to accurate financial reporting in the period from August 2008 to when the Zimbabwe dollar was abandoned in early 2009. During this period the Institute of Chartered Accountants in Zimbabwe set up a technical subcommittee to address these challenges, as it was impossible to apply IAS 29 “Financial Reporting in Hyperinflationary Economies” without a general price index, or IAS 21 “Exchange Rates” without a single spot rate.” Inflation Gone Wild, Gordon Whiley, Accountancy SA, March 2010.
http://www.accountancysa.org.za/resources/ShowItemArticle.asp?ArticleId=1885&Issue=1090
Zimbabwean accountants unnecessarily, unknowingly and unintentionally eroded their country’s real economy by implementing HCA during the financial year, as required by the IASB in IAS 29, and then restated their year-end HC financial statements of their very much hyper-eroded companies in terms of the year-end CPI (while the CPI was made available in Zimbabwe) to make them more useful for comparison purposes. That did not stop them from unknowingly eroding their real or non-monetary economy with HCA - as supported by the IASB and PricewaterhouseCoopers - during the course of the financial year in a period of hyperinflation.
PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:
"Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting."
Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006.
How anyone can use or recommend the use of the HCA model during hyperinflation is completely incomprehensible. The use of the HCA model during hyperinflation should be banned by law.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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." P 8 ¹
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 ²
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
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.
Valuing all non-monetary items as required by the IAS 29 inflation accounting model in terms of the period-end Consumer Price Index which was published a month or more after the month to which it related when the real value of the Zimbabwe Dollar halved every day, obviously, had no effect at all.
“The Zimbabwe government last published an official Zimbabwe dollar inflation index in July 2008. This, combined with the complexities of not having a stable currency due to the phenomenon described above, meant that there were severe limitations to accurate financial reporting in the period from August 2008 to when the Zimbabwe dollar was abandoned in early 2009. During this period the Institute of Chartered Accountants in Zimbabwe set up a technical subcommittee to address these challenges, as it was impossible to apply IAS 29 “Financial Reporting in Hyperinflationary Economies” without a general price index, or IAS 21 “Exchange Rates” without a single spot rate.” Inflation Gone Wild, Gordon Whiley, Accountancy SA, March 2010.
http://www.accountancysa.org.za/resources/ShowItemArticle.asp?ArticleId=1885&Issue=1090
Zimbabwean accountants unnecessarily, unknowingly and unintentionally eroded their country’s real economy by implementing HCA during the financial year, as required by the IASB in IAS 29, and then restated their year-end HC financial statements of their very much hyper-eroded companies in terms of the year-end CPI (while the CPI was made available in Zimbabwe) to make them more useful for comparison purposes. That did not stop them from unknowingly eroding their real or non-monetary economy with HCA - as supported by the IASB and PricewaterhouseCoopers - during the course of the financial year in a period of hyperinflation.
PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:
"Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting."
Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006.
How anyone can use or recommend the use of the HCA model during hyperinflation is completely incomprehensible. The use of the HCA model during hyperinflation should be banned by law.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday, 3 February 2011
Valuing the three economic items
Economic items are made up of monetary items, variable items and constant items. Accountants value, record, classify, summarize and report transactions and events involving economic items in terms of depreciating functional currencies during inflation and appreciating functional currencies during deflation.
Monetary items
(1) The real value of the functional currency and all other monetary items in the monetary economy generally changes every month during low inflation. Months of zero annual inflation are rare and not sustained over a significant period of time.
Variable items
(2) The real value of variable items may change all the time, e.g. the price of foreign currencies, precious metals, quoted shares, commodities, properties, finished goods, services, raw materials, etc.
Constant items
(3) The real values of constant items stay the same (or are supposed to stay the same) all the time – all else except inflation and deflation being equal – e.g. salaries, wages, rentals, issued share capital, retained profits, shareholders equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.
Accountants have to take all three scenarios - occurring simultaneously - into account over time when they account economic activity and prepare and present financial reports.
Monetary items
(1) Accountants value and account monetary items at their original historical cost nominal values in nominal monetary units during the current accounting period under all accounting models during low inflation, hyperinflation and deflation. Inflation, deflation and hyperinflation determine the always current real value of the functional currency (US Dollar, Bolívar, Euro, Yen, Yuan, etc.) and other monetary items within a monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period. The real value of the functional currency and other monetary items in the monetary economy changes equally (all monetary units are affected evenly) normally on a monthly basis during low inflation and deflation. The change is confirmed or quantified with the monthly publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in many low inflationary economies. The daily black market or parallel US Dollar exchange rate or street rate is generally constantly (24/7, 365 days a year) available in a hyperinflationary economy. The CPI is the internal exchange rate between the real value of a unit of the functional currency and a unit of real value in an economy. The parallel US Dollar exchange rate fulfils this role in a hyperinflationary economy.
Variable items
(2) Variable items in a national economy are valued and accounted in terms of IFRS or GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc. These prices change all the time: even minute by minute in many markets.
Constant items
(3) The real values of constant real value non-monetary items in the constant item economy have to be continuously maintained constant during low inflation and deflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation and deflation by means of the CPI as authorized by the IASB in the Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done, generally in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in non-hyperinflationary economies.
Harvey Kapnick was correct when he stated in the Saxe Lecture in 1976: “In the long run both value accounting and price-level accounting should prevail.”
Valuation of all non-monetary items during Hyperinflation
Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a hyperinflationary country can maintain its non-monetary or real economy relatively stable (at a rate of real value erosion in constant items never maintained limited to the inflation rate of the hard currency used for determining the parallel rate) during hyperinflation is by continuously measuring all non-monetary items (variable and constant items) in units of constant purchasing power; however, not by restating HC and Current Cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done in Brazil during the 30 years from 1964 to 1994 - with daily indexation which is, in principle, the same as measurement in units of constant purchasing power by applying the daily parallel rate.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monetary items
(1) The real value of the functional currency and all other monetary items in the monetary economy generally changes every month during low inflation. Months of zero annual inflation are rare and not sustained over a significant period of time.
Variable items
(2) The real value of variable items may change all the time, e.g. the price of foreign currencies, precious metals, quoted shares, commodities, properties, finished goods, services, raw materials, etc.
Constant items
(3) The real values of constant items stay the same (or are supposed to stay the same) all the time – all else except inflation and deflation being equal – e.g. salaries, wages, rentals, issued share capital, retained profits, shareholders equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.
Accountants have to take all three scenarios - occurring simultaneously - into account over time when they account economic activity and prepare and present financial reports.
Monetary items
(1) Accountants value and account monetary items at their original historical cost nominal values in nominal monetary units during the current accounting period under all accounting models during low inflation, hyperinflation and deflation. Inflation, deflation and hyperinflation determine the always current real value of the functional currency (US Dollar, Bolívar, Euro, Yen, Yuan, etc.) and other monetary items within a monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period. The real value of the functional currency and other monetary items in the monetary economy changes equally (all monetary units are affected evenly) normally on a monthly basis during low inflation and deflation. The change is confirmed or quantified with the monthly publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in many low inflationary economies. The daily black market or parallel US Dollar exchange rate or street rate is generally constantly (24/7, 365 days a year) available in a hyperinflationary economy. The CPI is the internal exchange rate between the real value of a unit of the functional currency and a unit of real value in an economy. The parallel US Dollar exchange rate fulfils this role in a hyperinflationary economy.
Variable items
(2) Variable items in a national economy are valued and accounted in terms of IFRS or GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc. These prices change all the time: even minute by minute in many markets.
Constant items
(3) The real values of constant real value non-monetary items in the constant item economy have to be continuously maintained constant during low inflation and deflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation and deflation by means of the CPI as authorized by the IASB in the Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done, generally in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in non-hyperinflationary economies.
Harvey Kapnick was correct when he stated in the Saxe Lecture in 1976: “In the long run both value accounting and price-level accounting should prevail.”
Valuation of all non-monetary items during Hyperinflation
Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a hyperinflationary country can maintain its non-monetary or real economy relatively stable (at a rate of real value erosion in constant items never maintained limited to the inflation rate of the hard currency used for determining the parallel rate) during hyperinflation is by continuously measuring all non-monetary items (variable and constant items) in units of constant purchasing power; however, not by restating HC and Current Cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done in Brazil during the 30 years from 1964 to 1994 - with daily indexation which is, in principle, the same as measurement in units of constant purchasing power by applying the daily parallel rate.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday, 2 February 2011
Accountants do not simply report on what took place
There is no substance in the statement that financial reporting simply reports on what took place. It can be correctly stated that the above statement has no substance when we refer to the IASB-approved basic accounting option of continuous financial capital maintenance in units of constant purchasing power which requires the valuing of only constant items in units of constant purchasing power during low inflation and deflation as authorized 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.”
The first option in Par 104, namely, financial capital maintenance in nominal monetary units during inflation and deflation is a fallacy: it is impossible to maintain the real value of capital stable in nominal monetary units per se during inflation and deflation. Continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation is generally applicable in the economy as a result of the absence of specific IFRS as per IAS8.11. However, that is not the same as comprehensive CPI-based adjustment of accounts themselves as accountants and accounting authorities automatically assume when financial capital maintenance in units of constant purchasing power during low inflation and deflation is suggested. Only constant items (not variable items) are continuously valued in units of constant purchasing power by continuously applying the CPI on a monthly basis during low inflation and deflation to implement a constant purchasing power capital concept of invested constant purchasing power and a constant purchasing power financial capital maintenance concept with measurement in units of constant purchasing power which includes a constant purchasing power profit or loss determination concept with the continuous valuation of only constant items in units of constant purchasing power during low inflation and deflation. The IASB is dead right that financial capital maintenance can be measured in units of constant purchasing power during low inflation and deflation as authorized in the Framework (1989), Par 104 (a) twenty two years.
The real values of banks´ and companies´ existing constant real value non-monetary items never maintained, e.g. retained profits, are unnecessarily, unknowingly and unintentionally being eroded by the implementation of the traditional HCA model at a rate equal to the annual rate of inflation when companies´ boards of directors choose to apply the stable measuring unit assumption during low inflation.
It is a simple fact that continuous financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) in 1989, i.e. inflation-adjusting all constant items in the economy during low inflation, would remedy this unknowing, unintentional and unnecessary erosion by the application of the HCA model in companies that at least break even whether they own revaluable fixed assets or not and without extra money or retained profits to maintain the constant real value of existing constant real value equity constant
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The first option in Par 104, namely, financial capital maintenance in nominal monetary units during inflation and deflation is a fallacy: it is impossible to maintain the real value of capital stable in nominal monetary units per se during inflation and deflation. Continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation is generally applicable in the economy as a result of the absence of specific IFRS as per IAS8.11. However, that is not the same as comprehensive CPI-based adjustment of accounts themselves as accountants and accounting authorities automatically assume when financial capital maintenance in units of constant purchasing power during low inflation and deflation is suggested. Only constant items (not variable items) are continuously valued in units of constant purchasing power by continuously applying the CPI on a monthly basis during low inflation and deflation to implement a constant purchasing power capital concept of invested constant purchasing power and a constant purchasing power financial capital maintenance concept with measurement in units of constant purchasing power which includes a constant purchasing power profit or loss determination concept with the continuous valuation of only constant items in units of constant purchasing power during low inflation and deflation. The IASB is dead right that financial capital maintenance can be measured in units of constant purchasing power during low inflation and deflation as authorized in the Framework (1989), Par 104 (a) twenty two years.
The real values of banks´ and companies´ existing constant real value non-monetary items never maintained, e.g. retained profits, are unnecessarily, unknowingly and unintentionally being eroded by the implementation of the traditional HCA model at a rate equal to the annual rate of inflation when companies´ boards of directors choose to apply the stable measuring unit assumption during low inflation.
It is a simple fact that continuous financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) in 1989, i.e. inflation-adjusting all constant items in the economy during low inflation, would remedy this unknowing, unintentional and unnecessary erosion by the application of the HCA model in companies that at least break even whether they own revaluable fixed assets or not and without extra money or retained profits to maintain the constant real value of existing constant real value equity constant
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monday, 31 January 2011
Accounting dollarization compared to Brazilian-style indexation
Brazil indexed all non-monetary items during the 30 years from 1964 to 1994 by means of a daily non-monetary index supplied by the various governments over that period for everybody in the economy to use daily. Although the Brazilian indexes used during those 30 years were almost entirely based on the daily US Dollar exchange rate with the Brazilian currency, it was not a parallel rate used parallel to another “official” US Dollar exchange rate arbitrarily set by the government as happens in most cases where a parallel market for the US Dollar develops in hyperinflationary economies. However, the daily index supplied by the government was not the actual daily US Dollar exchange rate. Thus, although the Brazilian indexation was financial capital maintenance in units of constant purchasing power during those 30 years, and very similar to accounting dollarization, it was not exactly the same.
Brazilian indexation theoretically maintained the constant item economy perfectly stable whereas there is still real value erosion in the constant item economy as a result of the stable measuring unit assumption at a rate equal to the inflation rate in the US Dollar when accounting dollarization is employed. Brazilian-style indexation is thus better than accounting dollarization since real value erosion because of the use of the stable measuring unit assumption is completely eliminated with financial capital maintenance in units of constant purchasing power in terms of the daily index rate.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Brazilian indexation theoretically maintained the constant item economy perfectly stable whereas there is still real value erosion in the constant item economy as a result of the stable measuring unit assumption at a rate equal to the inflation rate in the US Dollar when accounting dollarization is employed. Brazilian-style indexation is thus better than accounting dollarization since real value erosion because of the use of the stable measuring unit assumption is completely eliminated with financial capital maintenance in units of constant purchasing power in terms of the daily index rate.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Accounting dollarization
Updated on 2 October 2013
Accounting dollarization is not the same as normal dollarization of an economy. An economy is dollarized when the national functional currency is physically substituted with a relative stable foreign currency, normally the US Dollar. That is how the phrase “dollarization” originated. The national currency is not used anymore. Its legal tender is legally terminated. Dollarization is generally adopted after a period of severe hyperinflation, e.g. in Zimbabwe in 2008.
Accounting dollarization is doing all your daily accounting in US Dollars or in any other relatively stable foreign currency during hyperinflation in your national functional currency in an economy that does not use the US Dollar as functional currency. It does not necessarily mean that you do all your actual business transactions in US Dollars. You normally do some business in US Dollars and some in the local hyperinflationary currency. You may even do no business in US Dollars.
You simply note down the daily parallel US Dollar rate and use it in all your daily business transactions and daily accounting. The existence of a US Dollar foreign exchange rate, official or unofficial, is essential for the application of accounting dollarization. When there is only one US Dollar rate the economy will normally not be in hyperinflation and accounting dollarization will not be required. Sometimes the US Dollar parallel rate changes more than the normal once per day. It can change every 8 hours, for example, during severe hyperinflation.
Accounting dollarization is the same as Capital Maintenance in Units of Constant Purchasing Power as defined in IAS 29 which requires financial capital maintenance in units of constant purchasing power during hyperinflation, but, not at the period-end monthly published CPI, as required in IAS 29, but at the DAILY US Dollar parallel rate.
I implemented it for the first time in Auto-Sueco (Angola), the Volvo agents in Angola, starting in January, 1996. Auto-Sueco (Angola) is the subsidiary of Auto-Sueco in Portugal.
Accounting dollarization is also not the same as the US GAAP requirement that US companies with subsidiaries in hyperinflationary economies simply translate their year-end HCA financial statements prepared in the hyperinflationary local currency into US Dollars at the year-end rate before consolidation into the controlling US company´s consolidated accounts. Accounting dollarization is running any local business in a hyperinflationary economy in US Dollars on a daily basis applying the daily parallel rate. This eliminates the hyper-eroding effect of
(1) the stable measuring unit assumption as implemented under HCA on the real value of all non-monetary items (variable and constant real value non-monetary items) in a hyperinflationary economy as well as the hyper-eroding effect of
(2) hyperinflation on monetary items inflation-indexed daily in terms of the daily US Dollar parallel rate.
Accounting dollarization is a daily price-level accounting model or daily indexation or daily monetary correction applying financial capital maintenance in units of constant purchasing power in terms of a Daily Index as authorized in IFRS in the original Framework (1989), Par. 104 (a), now the Conceptual Framework (2010), Par. 4.59 (a).
Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproducation without permission.
Accounting dollarization is not the same as normal dollarization of an economy. An economy is dollarized when the national functional currency is physically substituted with a relative stable foreign currency, normally the US Dollar. That is how the phrase “dollarization” originated. The national currency is not used anymore. Its legal tender is legally terminated. Dollarization is generally adopted after a period of severe hyperinflation, e.g. in Zimbabwe in 2008.
Accounting dollarization is doing all your daily accounting in US Dollars or in any other relatively stable foreign currency during hyperinflation in your national functional currency in an economy that does not use the US Dollar as functional currency. It does not necessarily mean that you do all your actual business transactions in US Dollars. You normally do some business in US Dollars and some in the local hyperinflationary currency. You may even do no business in US Dollars.
You simply note down the daily parallel US Dollar rate and use it in all your daily business transactions and daily accounting. The existence of a US Dollar foreign exchange rate, official or unofficial, is essential for the application of accounting dollarization. When there is only one US Dollar rate the economy will normally not be in hyperinflation and accounting dollarization will not be required. Sometimes the US Dollar parallel rate changes more than the normal once per day. It can change every 8 hours, for example, during severe hyperinflation.
Accounting dollarization is the same as Capital Maintenance in Units of Constant Purchasing Power as defined in IAS 29 which requires financial capital maintenance in units of constant purchasing power during hyperinflation, but, not at the period-end monthly published CPI, as required in IAS 29, but at the DAILY US Dollar parallel rate.
I implemented it for the first time in Auto-Sueco (Angola), the Volvo agents in Angola, starting in January, 1996. Auto-Sueco (Angola) is the subsidiary of Auto-Sueco in Portugal.
Accounting dollarization is also not the same as the US GAAP requirement that US companies with subsidiaries in hyperinflationary economies simply translate their year-end HCA financial statements prepared in the hyperinflationary local currency into US Dollars at the year-end rate before consolidation into the controlling US company´s consolidated accounts. Accounting dollarization is running any local business in a hyperinflationary economy in US Dollars on a daily basis applying the daily parallel rate. This eliminates the hyper-eroding effect of
(1) the stable measuring unit assumption as implemented under HCA on the real value of all non-monetary items (variable and constant real value non-monetary items) in a hyperinflationary economy as well as the hyper-eroding effect of
(2) hyperinflation on monetary items inflation-indexed daily in terms of the daily US Dollar parallel rate.
Accounting dollarization is a daily price-level accounting model or daily indexation or daily monetary correction applying financial capital maintenance in units of constant purchasing power in terms of a Daily Index as authorized in IFRS in the original Framework (1989), Par. 104 (a), now the Conceptual Framework (2010), Par. 4.59 (a).
Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproducation without permission.
Monday, 24 January 2011
Inflation only has a monetary component
I stated the following in a Letter to the Editor published in the Financial Mail in South Africa:
“Financial Mail 09 May 2008
Accounting for inflation
Nicolaas Smith, Lisbon
DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).
SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.
There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.
We have to remember that inflation is the destruction of value in monetary and constant items over time.
Inflation has two components: a monetary component - inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.
The 10,6% (March) inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.
Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.
The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.
We will still have 10,6% inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.
Inflation would then have only a monetary component, namely, inflation.
No-one stops us from revoking the stable measuring unit assumption.
The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.”
The full understanding of the difference between the generally accepted accounting practice whereby accountants unnecessarily, unknowingly and unintentionally erode the real values of only existing constant real value non-monetary items never maintained constant only in the constant item economy with their free choice of implementing their very erosive stable measuring unit assumption during low inflation as authorized by the IASB when it approved the very popular accounting fallacy of financial capital maintenance in nominal monetary units per se during low inflation in the Framework, Par 104 (a) in 1989 and the erosion by the economic process of inflation of the real value of only money and other monetary items only in the monetary economy is an ongoing process. It has become clear to me, since September 2008, that inflation and hyperinflation only erode the real value of money and other monetary items. Inflation and hyperinflation only have one – a monetary – component. It is clear to me now that it is not inflation or hyperinflation that is causing the erosion of the real value of existing constant real value non-monetary items never maintained in the real economy. It is clear to me now that inflation does not have a non-monetary component and that inflation has no effect on the real value of non-monetary items.
Copyright (c) Nicolaas J Smith. All rights reserved. No reproduction without permission.
“Financial Mail 09 May 2008
Accounting for inflation
Nicolaas Smith, Lisbon
DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).
SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.
There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.
We have to remember that inflation is the destruction of value in monetary and constant items over time.
Inflation has two components: a monetary component - inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.
The 10,6% (March) inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.
Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.
The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.
We will still have 10,6% inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.
Inflation would then have only a monetary component, namely, inflation.
No-one stops us from revoking the stable measuring unit assumption.
The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.”
The full understanding of the difference between the generally accepted accounting practice whereby accountants unnecessarily, unknowingly and unintentionally erode the real values of only existing constant real value non-monetary items never maintained constant only in the constant item economy with their free choice of implementing their very erosive stable measuring unit assumption during low inflation as authorized by the IASB when it approved the very popular accounting fallacy of financial capital maintenance in nominal monetary units per se during low inflation in the Framework, Par 104 (a) in 1989 and the erosion by the economic process of inflation of the real value of only money and other monetary items only in the monetary economy is an ongoing process. It has become clear to me, since September 2008, that inflation and hyperinflation only erode the real value of money and other monetary items. Inflation and hyperinflation only have one – a monetary – component. It is clear to me now that it is not inflation or hyperinflation that is causing the erosion of the real value of existing constant real value non-monetary items never maintained in the real economy. It is clear to me now that inflation does not have a non-monetary component and that inflation has no effect on the real value of non-monetary items.
Copyright (c) Nicolaas J Smith. All rights reserved. No reproduction without permission.
Accountants value everything they account
The debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail.
Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.
Economic items have economic value. Accountants deal with economic items all the time. They deal with economic values when they account economic items and prepare financial reports. Accountants value economic items when they account economic transactions and events. Financial reporting does not simply report on what took place in the past. Accountants are not just scorekeepers of what happened in the past. Accountants value everything they account in the economy.
The three fundamentally different basic economic items in the economy, namely variable items, monetary items and constant items, have economic values expressed in terms of money; i.e. the functional currency. Accountants account economic transactions involving these three basic economic items in an organized manner when they implement the double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the income statement, assets and liabilities in the balance sheet plus other financial, management and costing reports.
Accountants value economic items when they account economic activity in the accounting records and prepare financial reports of economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.
Many accountants still think that accounting is simply a recording exercise during which they merely record past economic activity. That is not correct. Accountants value economic items when they account them. Financial reporting (accounting) is, firstly, the continuous maintenance of the constant purchasing power of capital and secondly the provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users. It includes the valuing, recording, classifying, summarizing and reporting of an entity’s economic activity.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.
Economic items have economic value. Accountants deal with economic items all the time. They deal with economic values when they account economic items and prepare financial reports. Accountants value economic items when they account economic transactions and events. Financial reporting does not simply report on what took place in the past. Accountants are not just scorekeepers of what happened in the past. Accountants value everything they account in the economy.
The three fundamentally different basic economic items in the economy, namely variable items, monetary items and constant items, have economic values expressed in terms of money; i.e. the functional currency. Accountants account economic transactions involving these three basic economic items in an organized manner when they implement the double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the income statement, assets and liabilities in the balance sheet plus other financial, management and costing reports.
Accountants value economic items when they account economic activity in the accounting records and prepare financial reports of economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.
Many accountants still think that accounting is simply a recording exercise during which they merely record past economic activity. That is not correct. Accountants value economic items when they account them. Financial reporting (accounting) is, firstly, the continuous maintenance of the constant purchasing power of capital and secondly the provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users. It includes the valuing, recording, classifying, summarizing and reporting of an entity’s economic activity.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Friday, 21 January 2011
The objectives of general purpose financial reporting
The objectives of general purpose financial reporting are:
1) Maintenance of the constant purchasing power of capital.
2) Provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users.
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Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
1) Maintenance of the constant purchasing power of capital.
2) Provision of continuously updated decision-useful financial information about the reporting entity to capital providers and other users.
Buy the ebook for $2.99 or £1.53 or €2.68
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Examples of constant real value non-monetary items
Examples of constant real value non-monetary items are all income statement items as well as the balance sheet constant items, e.g. retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, capital reserves, all other shareholder’s equity items, trade debtors, trade creditors, provisions, other non-monetary debtors and creditors, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, all other non-monetary payables, all other non-monetary receivables, etc.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday, 20 January 2011
Constant Item Purchasing Power Accounting
Constant Item Purchasing Power Accounting (CIPPA) is the International Accounting Standards Board's basic accounting alternative authorized in International Financial Reporting Standards in the Framework for the Preparation and Presentation of Financial Statements (1989), Paragraph 104 (a) which states: "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power." It is the IASB-approved alternative to traditional Historical Cost Accounting whereunder ONLY constant real value non-monetary items (NOT variable real value non-monetary items) are measured in units of constant purchasing power; i.e. continuously inflation-adjusted or updated by applying the monthly change in the Consumer Price Index, during low inflation and deflation.
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.
Examples of constant items are 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 payables, all other non-monetary receivables, salaries, wages, rentals, all other items in the income statement, etc. valued in units of constant purchasing power during low inflation and deflation when financial capital maintenance in units of constant purchasing power (CIPPA) is implemented during low inflation and deflation.
Examples of variable items are property, plant, equipment, listed and unlisted shares, inventory, foreign exchange, etc. Variable items are valued in terms of 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. Examples of monetary items are bank notes and coins, bank account balances, all monetary loans owed or granted, house loans, car loans, consumer loans, student loans, government and commericial bonds, ets.
CIPPA is a price-level accounting model which implements the principle of financial capital maintenance in units of constant purchasing power during non-hyperinflationary periods. It automatically maintains the real value of all constant real value non-monetary items constant in all entities that at least break even, 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 real value capital constant. This is opposed to the traditional Historical Cost Accounting model which unknowingly, unnecessarily and unintentionally erodes the real value of that portion of shareholders´equity never maintained constant as a result of insufficient revaluable fixed assets (revalued or not) during low inflation. The IASB´s Framework, Par 104 (a) is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of specific constant real value non-monetary items.
Constant Purchasing Power Accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the IASB´s inflation accounting model required to be implemented ONLY during hyperinflation under which ALL non-monetary items (variable and constant real value non-monetary items) are measured in units of constant purchasing power by applying the change in the period-end CPI.
Accountants can freely choose the Constant Item Purchasing Power Accounting model to implement a financial capital concept of invested purchasing power. They will thus implement a constant purchasing power financial capital maintenance concept and they will implement a constant purchasing power profit/loss determination concept in units of constant purchasing power instead of in real value eroding nominal monetary units during low inflation.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
F
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.
Examples of constant items are 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 payables, all other non-monetary receivables, salaries, wages, rentals, all other items in the income statement, etc. valued in units of constant purchasing power during low inflation and deflation when financial capital maintenance in units of constant purchasing power (CIPPA) is implemented during low inflation and deflation.
Examples of variable items are property, plant, equipment, listed and unlisted shares, inventory, foreign exchange, etc. Variable items are valued in terms of 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. Examples of monetary items are bank notes and coins, bank account balances, all monetary loans owed or granted, house loans, car loans, consumer loans, student loans, government and commericial bonds, ets.
CIPPA is a price-level accounting model which implements the principle of financial capital maintenance in units of constant purchasing power during non-hyperinflationary periods. It automatically maintains the real value of all constant real value non-monetary items constant in all entities that at least break even, 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 real value capital constant. This is opposed to the traditional Historical Cost Accounting model which unknowingly, unnecessarily and unintentionally erodes the real value of that portion of shareholders´equity never maintained constant as a result of insufficient revaluable fixed assets (revalued or not) during low inflation. The IASB´s Framework, Par 104 (a) is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of specific constant real value non-monetary items.
Constant Purchasing Power Accounting (CPPA) as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the IASB´s inflation accounting model required to be implemented ONLY during hyperinflation under which ALL non-monetary items (variable and constant real value non-monetary items) are measured in units of constant purchasing power by applying the change in the period-end CPI.
Accountants can freely choose the Constant Item Purchasing Power Accounting model to implement a financial capital concept of invested purchasing power. They will thus implement a constant purchasing power financial capital maintenance concept and they will implement a constant purchasing power profit/loss determination concept in units of constant purchasing power instead of in real value eroding nominal monetary units during low inflation.
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
F
Wednesday, 19 January 2011
Conflict in IFRS
There is a conflict with the continuous financial capital maintenance in units of constant purchasing power concept as stated in the Framework, Par 104 (a) when IFRS treat constant real value non-monetary items like monetary items or variable real value non-monetary items, e.g. treating trade debtors and trade creditors like monetary items instead of constant real value non-monetary items. The only way the financial capital concept of continuously measuring financial capital maintenance in units of constant purchasing power in terms of the provision in the Framework, Par 104 (a) can be correctly implemented, is with the correct treatment of all constant items as constant items and not as monetary or variable items. The incorrect treatment of constant items as monetary or variable items in terms of IFRS would lead to the incorrect calculation of the Net Monetary Loss or Gain from holding monetary items as required when measuring financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a) (Constant ITEM Purchasing Power Accounting) during low inflation and deflation and as required in IAS 29 (Constant Purchasing Power Accounting) during hyperinflation.
The crucial factor is the correct definition of monetary items because non-monetary items are correctly defined in IAS 29 as all items that are not monetary items. When the definition of monetary items is wrong – as it is under IAS 29 and IAS 21 – then the calculation of the net monetary loss or gain would be wrong as it is under current IFRS, namely in terms of IAS 29 and IAS 21. Monetary items are money held and other items with an underlying monetary nature. Monetary items are not items to be received or paid in money as stated in IAS 29. All items – monetary and non-monetary items - are normally received or paid in money.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The crucial factor is the correct definition of monetary items because non-monetary items are correctly defined in IAS 29 as all items that are not monetary items. When the definition of monetary items is wrong – as it is under IAS 29 and IAS 21 – then the calculation of the net monetary loss or gain would be wrong as it is under current IFRS, namely in terms of IAS 29 and IAS 21. Monetary items are money held and other items with an underlying monetary nature. Monetary items are not items to be received or paid in money as stated in IAS 29. All items – monetary and non-monetary items - are normally received or paid in money.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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