Benefits of automatic constant purchasing power capital maintenance not generally realized

Benefits of automatic constant purchasing power capital maintenance not generally realized


Continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA), despite being authorized in IFRS in the original Framework (1989), Par 104 (a), is not yet generally realized in low inflationary economies. This is the case despite the fact that CIPPA automatically maintains (as opposed to mostly being eroded under the HCA model) the existing constant real non-monetary values of all constant items in all entities that at least break even whether these entities own revaluable fixed assets or not and without the requirement of extra capital from capital providers in the form of extra money or additional retained profits simply to maintain the existing constant real value of existing Shareholders´ Equity constant for an unlimited period of time during low inflation and deflation. Comprehensive economy–wide continuous financial capital maintenance in units of constant purchasing power automatically stops the unknowing, unnecessary and unintentional eroding of hundreds of billions of US Dollars in the real value of constant real value non–monetary items never maintained constant in the world´s constant item economy each and every year. The implementation of CIPPA would result in accountants knowingly boosting the world´s real economy by hundreds of billions of US Dollars per annum for an unlimited period of time during indefinite low inflation – all else being equal.

The reason automatic financial capital maintenance in units of constant purchasing power is not generally implemented is because any price–level accounting model is generally viewed by almost everyone as a 1970–style failed and discredited inflation accounting model that required all non–monetary items (variable real value non–monetary items and constant real value non–monetary items) to be updated by means of the CPI during high inflation. They seem not to realize the substantial benefits of automatic constant purchasing power capital maintenance in all entities that at least break even.

If the enormous automatic real value maintaining benefits of financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized in the original Framework (1989), Par 104 (a) were generally realized, the Historical Cost paradigm would have already been abandoned.

The maintenance of the existing constant real non–monetary values of all existing constant real value non–monetary items (eg. companies´ and banks´ equity) for an unlimited period of time in all entities that at least break even would be automatic under the CIPPA model since it would be the result of the normal double-entry accounting model when the stable measuring unit assumption is abandoned and with it the traditional Historical Cost Accounting model under the current 3000 year old historical cost paradigm.

Deloitte, one of the Big Four accounting and auditing multi–nationals, also ignore the paragraphs in the original Framework (1989) that deal with the concepts of capital, capital maintenance and the determination of profit or loss in their presentation of the Framework on their site IAS Plus, Deloitte. Date: 11th March, 2011 http://www.iasplus.com/standard/framewk.htm

Deloitte do not even mention one word in their presentation of the Framework about the fact that entities have been authorized in IFRS since 1989 to measure financial capital maintenance in units of constant purchasing power during low inflation and deflation. This appears to be another example that it is generally not realized that an essential objective of accounting is automatic maintenance of the existing constant purchasing power of capital by continuously maintaining the real value of all constant real value non–monetary items constant in all entities that at least break even for an indefinite period of time at all levels of inflation and deflation. This can only be achieved automatically during low inflation and deflation with IASB–approved financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) as authorized in 1989 in the original Framework (1989), Par 104 (a) under which only constant real value non–monetary items (not variable real value non–monetary items) are continuously measured in units of constant purchasing power in terms of the monthly change in the annual CPI and IAS 29 with valuation of all non–monetary items at the daily parallel rate or a daily Brazilian-style non-monetary index only during hyperinflation.

Similarly the paragraphs in the original Framework (1989) dealing with the concepts of capital, the concepts of financial capital maintenance and units of constant purchasing power were also omitted from the presentation of the Framework in the Wikipedia article on IFRS till they were added very recently. Previously, the whole of the Framework was summarized in the Wikipedia article, except those paragraphs.

The IASB and FASB are jointly updating and converging their Frameworks. “The project's overall objective is to create a sound foundation for future accounting standards that are principles–based, internally consistent and internationally converged”, per the IASB. The joint Conceptual Framework project has eight phases, one of which is the Measurement phase.

The Boards held roundtable discussions on measurement during January and February 2007. No public Discussion Paper has yet been presented for comment.

All items in the IASB´s current Conceptual Framework (2010) are covered in this project, except the concepts of capital and capital maintenance. Reading the reports about the items discussed thus far in the Measurement Phase I noticed that the discussions are almost entirely about variable real value non–monetary items (property, plant, equipment, stock, shares, financial instruments, etc.) and almost nothing about monetary items and constant real value non–monetary items (all items in the income statement, all items in shareholders’ equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.).

I emailed Kevin McBeth, the FASB Project Manager responsible for the Measurement Phase in the joint project and asked him in which phase the Concepts of Capital and Capital Maintenance are going to be discussed.

He responded by email:

“I cannot speak for the Boards with respect to your query. I can only say that early on in the measurement phase the staff suggested that capital and capital maintenance be discussed in the measurement phase, as it was in the original FASB Conceptual Framework. However, to date the Boards have not taken a decision on where, or even whether, those topics will be included in the converged framework.” (my bold lettering).

I then put the same question to the US Financial Accounting Standards Board.

Ron Lott, the FASB director who is responsible for the joint FASB–IASB Conceptual Framework project responded by email:

“We are of course familiar with paragraphs 4.57 – 110 of the IASB Framework as well as paragraphs 45–48 of FASB Concepts Statement 5. Although not labelled as such, capital maintenance ideas have been raised at various points in the discussions of measurement concepts and will continue to be discussed until the board makes decisions about measurement concepts.


We do not know yet whether there will be a section in the yet–to–be–completed measurement concepts chapter labelled capital maintenance, but the concepts will almost certainly be discussed.”

Kevin McBeth stated the following by email:

“I believe that you may have misunderstood the discussions the FASB and IASB have had about measurement. Those discussions have used examples of various items, some of which you refer to as variable real value non–monetary items. That may have led you to believe that some of your concerns are being ignored. However, the scope of the measurement phase of the Conceptual Framework project does not exclude the items you refer to as constant real value non–monetary items. The Boards are concerned about the effects of selecting measurements on all elements of the financial statements.


Much remains to be done on this project. Although future discussions probably will not use the terminology and classification scheme that you are espousing, there is reason to expect that they will address the items of concern to you.”

The concepts of capital and capital maintenance will thus be discussed in the Measurement Phase.

Possible measurement methods have already been discussed by the FASB and the IASB for six years, but, although the Measurement Phase published material includes the following: “What should the measurement chapter accomplish—The measurement chapter should list and describe possible measurements”, it is quite strange that the term “measurement in units of constant purchasing power” has not yet appeared on the Measurement Phase site as one of “the set of possible measurement methods that are to be considered”.

The concept of automatic financial capital maintenance in units of constant purchasing power during low inflation and deflation seems to have been correctly treated by the IASC Board in 1989 (after proper due process) and then simply just ignored by everyone.

The IASB may be to blame for this by simply stating in the original Framework (1989), Par 104 (a) that financial capital maintenance can be measured in nominal monetary units without qualifying that statement. It is impossible to maintain the constant real value of capital constant with financial capital maintenance in nominal monetary units per se during inflation and deflation. Financial capital maintenance in nominal monetary units is only possible, per se, during sustained zero annual inflation. We have never had sustainable zero inflation on an annual basis in the past and we are not likely to have sustainable zero annual inflation any time soon in the future.

The missing qualification in IFRS is the following: Maintaining the constant real non-monetary value of financial capital constant with financial capital maintenance in nominal monetary units is only possible under the HCA model during low inflation in all entities that at least break even when an entity continuously invests 100% of the updated original real value of all contributions to Shareholders´ Equity in revaluable fixed assets (revalued or not) with an equivalent updated real value. All economic items are valued in accounting and the values are stated in terms of the monetary unit (money) as the unit of account. All functional currencies are unstable in real value: either their real values are being eroded by inflation or, in the case of Japan lately, the Yen’s real value is being increased internally by deflation. It is thus impossible to maintain the constant real non-monetary value of financial capital constant in nominal monetary units – per se – during low inflation and deflation – unless qualified as above.

IFRS did not authorize continuous financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par 104 (a) as an inflation accounting model. They did that with the CPP inflation accounting model in IAS 29 – also in 1989. Constant Item Purchasing Power Accounting as approved in IFRS by continuously measuring financial capital maintenance in units of constant purchasing power constitutes an IASB–authorized alternative to the Historical Cost financial capital concept, HC financial capital maintenance concept and HC profit or loss determination concept, namely a constant purchasing power financial capital concept, constant purchasing power financial capital maintenance concept and constant purchasing power profit or loss determination concept during low inflation and deflation. CIPPA as approved in the Framework only requires all constant real value non–monetary items to be valued in units of constant purchasing power. Variable real value non–monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS or GAAP.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Automatic maintenance of the constant purchasing power of capital

Automatic maintenance of the constant purchasing power of capital

Automatic maintenance of the constant purchasing power of capital can only be achieved by continuously valuing all constant real value non–monetary items in units of constant purchasing power, i.e., by continuously updating all constant items by means of the monthly change in the annual CPI during low inflation and deflation. Valuing / measuring all non-monetary items - both variable real value non–monetary items and all constant items - at the daily parallel rate (usually the daily US Dollar parallel rate) in terms of IAS 29 (or Brazilian–style daily indexation) during hyperinflation results in the real or non-monetary economy being maintained relatively stable during hyperinflation (see Brazil from 1964 to 1994) with real value hyper–erosion in only monetary items.


Historical Cost Accounting has unknowingly, unintentionally and unnecessarily abdicated the essential automatic financial capital maintenance in units of constant purchasing power function of financial reporting to the 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 world´s real economy when the very erosive stable measuring unit assumption is implemented as part of the IFRS–approved traditional HCA model for an unlimited period of time during indefinite inflation.

It is not realized that this unknowing, unintentional and unnecessary erosion can be permanently stopped by simply rejecting the stable measuring unit assumption when the IFRS–compliant Constant Item Purchasing Power Accounting model is implemented during low inflation and deflation.

IFRS do – since 1989 – allow the rejection of the stable measuring unit assumption as an alternative to HCA at all levels of inflation and deflation. The IASB´s original Framework (1989), Par 104 (a) [now the Conceptual Framework (2010), Par 4.59 (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 during hyperinflation. Simple restatement of HC or CC financial statements in terms of the period-end CPI is not the same as daily measuring or valuing all non-monetary items in terms of a Brazilian-style non-monetary index or a daily hard currency parallel rate. Simple restatement of period-end HC financial statements in terms of IAS 29 had no effect during hyperinflation in Zimbabwe.

It is not generally realized that the very erosive stable measuring unit assumption is unknowingly, unintentionally and unnecessarily responsible for the erosion of the real value of constant real value non–monetary items never maintained constant when the traditional HCA model is implemented for an unlimited period of time during indefinite inflation. It is still generally believed that inflation instead of the stable measuring unit assumption is doing the eroding.

It is also not generally realized that this erosion can be permanently stopped by selecting financial capital maintenance in units of constant purchasing power as authorized in IFRS in the original Framework (1989), 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 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 an extreme increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, which resulted in an equivalent extreme rate of erosion of the real value of the Zimbabwe Dollar since the nominal increase in the ZimDollar money supply was not an appropriate response to an 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 erosion.”

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. 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 and rental payments. The implementation of the stable measuring unit assumption (not inflation) erodes the constant real value of fixed salaries, wages, rentals, etc.

The constant real non–monetary values of salaries, wages, rentals, etc are generally maintained constant on an annual basis, i.e. not eroded, when it is chosen to measure the existing constant values of these constant items in units of constant purchasing power in terms of the annual CPI in most economies with monthly payment in depreciating money during inflation. They are updated on an annual basis during low inflation but then paid on a monthly basis applying the stable measuring unit assumption.

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 of companies and banks never maintained constant over time as a result of insufficient revaluable fixed assets, when it is chosen to measure financial capital maintenance in nominal monetary units in terms of the traditional HCA model during low inflation when the stable measuring unit assumption is implemented 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 to correct or eliminate the erosion of the constant real value of only constant real value non–monetary items never maintained constant by the use of the stable measuring unit assumption. The split of non-monetary items in variable and constant items has not yet been identified at that time. The split was only identified in 2005.

It was not realized 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 it is chosen to implement the very erosive stable measuring unit assumption for an unlimited period of time during indefinite inflation. In most cases it is not even known that a choice is made as presented in the original Framework (1989), Par 104 (a). Neither is it realized that the erosion will be stopped automatically by freely choosing to measure financial capital maintenance in units of constant purchasing power by updating only constant items in all entities that at least break even, as approved in IFRS in the Framework (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."

Updated income statement constant real value non–monetary items, for example, salaries, wages, rentals, etc. are – right this very moment – a blessing to users all around the world because they maintain the constant real value or purchasing power of salaries, wages, rentals, etc. constant during low inflation as long as the adjustment is at least equal to inflation over the period in question. Millions of workers, their trade unions, governments, economists and people in general would agree that the practice of updating accounts in a low inflation environment is a blessing to users. In fact, it is one of the basic pillars of a stable economy as has been amply proven by Brazilian accountants, economists and the Brazilian Central Bank during the 30 years of very high and hyperinflation from 1964 to 1994 when they maintained their internal demand in the country relatively stable by updating salaries, wages, rentals and other non–monetary items in their real economy.

Updated balance sheet constant real value non–monetary items, e.g. Issued Share capital, Retained Earnings, Share premiums, Capital Reserves, General Reserves, all other items in Shareholders´ Equity, trade debtors, trade creditors, taxes payable, taxes receivable, salaries payable, salaries receivable, all other non–monetary payables, all other non–monetary receivables, etc in a low inflation economy is a blessing to everyone in that economy when it is simply decided to change from the current implementation of the very erosive stable measuring unit assumption – which is based on a fallacy – and financial capital maintenance in nominal monetary units (the traditional Historical Cost Accounting model) which is impossible during inflation and another fallacy, and it is freely chosen to implement the real value maintaining financial capital maintenance in units of constant purchasing power model during low inflation and deflation ( as applied in the Constant Item Purchasing Power Accounting model) as approved by the IASB in the original Framework (1989), Par 104 (a). Implementing financial capital maintenance in units of constant purchasing power during low inflation knowingly maintains – instead of the generally accepted HCA model currently unknowingly, unnecessarily and unintentionally eroding real value in constant real value non–monetary items never maintained as it also did last year and all the years before and will do next year if the very erosive stable measuring unit assumption is not stopped – all else being equal.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

HCA abdicates a fundamental objective of financial reporting

HCA abdicates a fundamental objective of financial reporting


A fundamental objective of general purpose financial reporting 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.

Historical Cost Accounting abdicates a fundamental objective of general purpose financial reporting to the fiction that money is stable in real value during inflation and deflation. Double-entry accounting (not HCA) makes it possible to automatically maintain the existing constant real non-monetary value of capital constant forever in all entities that at least break even – ceteris paribus – during inflation and deflation whether they own any fixed assets or not. Automatic constant real value financial capital maintenance is, however, only possible with financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting) per se during low inflation and deflation. That is to say: it is only possible with the split of non-monetary items in variable and constant items with only constant items being continuously updated (month-after-month) in terms of the CPI. Automatic constant real value capital maintenance is also possible during hyperinflation, but, only with daily valuation of all non-monetary items (variable and constant items) in terms of a daily Brazilian-style non-monetary index or hard currency daily parallel rate.

The stable measuring unit assumption (not inflation) makes it impossible to automatically maintain the constant real value of capital constant during inflation and deflation per se even when entities break even on a nominal basis. To the contrary: the stable measuring unit assumption automatically erodes the existing constant real value of all constant items never maintained constant during inflation. This amounts to hundreds of billions of US Dollars unknowingly, unintentionally and unnecessarily eroded in the world´s constant item economy year after year. CIPPA automatically stops this erosion forever in all entities that break even during inflation and deflation.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The two different meanings of the word inflation

It is correct, essential and compliant with IFRS to update constant items by means of the monthly change in the CPI during low inflation and deflation. The reason for this is that constant items are expressed in terms of money, i.e. in terms of an unstable monetary unit of account which is the same as the unstable monetary medium of exchange 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 items thus have to be updated 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 IFRS or GAAP at, for example, fair value, market value, present value, recoverable value, net realizable value, etc which always automatically take inflation – amongst many other items – into account. Variable real value non–monetary items are only valued in units of constant purchasing power during hyperinflation as required in IFRS in IAS 29 since the IASB 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 to updated 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 items during the accounting period on a primary valuation basis during non–hyperinflationary periods. These variable items are generally subject to market–based real value changes determined by supply and demand. They incorporate product specific price changes also stated as 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; 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, and

(2) inflation meaning any single or non-general 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 in the 1970´s. 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 original Framework (1989), Par 104 (a).


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Current inflation accounting

Current inflation accounting

Presently, inflation accounting describes a complete price–level accounting model, namely the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined, in principle, in IAS 29 Financial Reporting in Hyperinflationary Economies required to be implemented only during hyperinflation. Hyperinflation is an exceptional circumstance according to the IASB. Hyperinflation is defined in IFRS as cumulative inflation over three years approaching or equal to 100%, i.e. 26% annual inflation for three years in a row. IAS 29 serves to make Historical Cost and Current Cost financial statements more useful at the period-end by requiring all non–monetary items – variable real value non–monetary items and constant real value non–monetary items – to be restated at the period-end by measuring them in units of constant purchasing power by applying the period–end Consumer Price Index only 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.

Inflation has no effect on the real value of non–monetary items over time. 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 and hyperinflation. There is no substance in the statement that inflation erodes 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, US economist and Nobel Laureate, famously stated that “inflation is always and everywhere a monetary phenomenon.” Friedman was not the only economist who understood 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



The stable measuring unit assumption unknowingly, unintentionally and unnecessarily erodes and its rejection knowingly maintains (please note: not creates) the real value of constant real value non–monetary items (please note: not variable real value non–monetary items) depending on whether the IFRS–approved traditional Historical Cost Accounting model is chosen under which the very erosive stable measuring unit assumption is implemented for an unlimited period of time during indefinite inflation or the IFRS–authorized constant real value non–monetary item real value maintaining financial capital maintenance in units of constant purchasing power model (Constant Item Purchasing Power Accounting) under which it is selected 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 financial capital maintenance in nominal monetary units as authorized in IFRS in the original Framework (1989), Par 104 (a) is chosen during low inflationary periods.

It is correct, essential and compliant with IFRS to 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 single or non-general 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 Conceptual Framework (2010), Par 4.59 (a).


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IAS 29 is fundamentally flawed

IAS 29 is fundamentally flawed

Inflation accounting describes financial capital maintenance in units of constant purchasing power as applied only during hyperinflation where under all non-monetary items (variable and constant real value non-monetary items) are updated daily in terms of a daily non-monetary index or in terms of a daily official or unofficial parallel rate, normally the US Dollar parallel rate. The Constant Item Purchasing Power Accounting model under which only constant items (not variable items) are measured in units of constant purchasing power by applying the monthly Consumer Price index ONLY during LOW inflation and deflation. CIPPA is not an inflation accounting model.


Hyperinflation, as defined in IFRS, is cumulative inflation approaching or equal to 100% over three years; i.e., 26% annual inflation for three years in a row. Inflation accounting is implemented in order to stop the erosion of real value in all non-monetary items (both variable and constant real value non-monetary items) caused by the implementation of the very erosive stable measuring unit assumption during hyperinflation.

Under the stable measuring unit assumption it is considered that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power – normally during low inflation and deflation.

Most entities in low inflationary and deflationary economies implement the Historical Cost Accounting model that is based on the stable measuring unit assumption. This means that all balance sheet constant real value non-monetary items (e.g. shareholders´ equity, trade debtors, trade creditors, provisions, other non-monetary payables, other non-monetary receivables, etc.) and most (not all) income statement items are measured at their historical cost, i.e. financial capital maintenance is measured in nominal monetary units as authorized in IFRS. Some income statement items, e.g. salaries, wages, rentals, etc. are updated annually in terms of the CPI, but, are then paid on a monthly basis implementing the stable measuring unit assumption under HCA. It is impossible to maintain the real value of financial capital constant with financial capital maintenance in nominal monetary units per se during inflation, deflation and hyperinflation. Financial capital maintenance in nominal monetary units during inflation and deflation, although authorized in IFRS, is still a popular accounting fallacy not yet extinct.

Complete inflation accounting, i.e. the use of an accounting model to automatically stop the erosion of real value in all non-monetary items (variable and constant items) in all entities that at least break even, is only possible with financial capital maintenance in units of constant purchasing power by applying a daily non-monetary index or relatively stable daily parallel rate (please note NOT the monthly CPI) to the valuation of (please note NOT the “restatement of” Historical Cost or Current Cost period-end financial statements) all non-monetary items during hyperinflation.

This can be stated differently as follows: Only inflation accounting based on daily updating of all non-monetary items in terms of a daily index or daily parallel rate automatically maintains the real value of all non-monetary items in all entities that at least break even during hyperinflation; i.e. maintains the real of non-monetary economy stable during hyperinflation in the monetary unit / economy.

The best example of successful inflation accounting was the use in Brazil of a daily government-supplied non-monetary index to update all non-monetary items daily during the 30 years of very high and hyperinflation in that country from 1964 to 1994.

The IFRS response to the erosion of real value in non-monetary items caused by the implementation of the HCA model, i.e. the implementation of the stable measuring unit assumption, during hyperinflation is stated in IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29 requires entities operating in hyperinflationary economies, NOT to value or measure all non-monetary items in terms of a daily non-monetary index or a daily parallel rate, but, to simply restate HISTORICAL COST or Current Cost period-end financial statements in terms of the period-end CPI.



The financial statements of an entity whose functional currency is the currency


of a hyperinflationary economy, whether they are based on a historical cost


approach or a current cost approach, shall be stated in terms of the measuring


unit current at the end of the reporting period. IAS 29 Par 8



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, historic cost accounting."

Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.



The best example of the failure of the implementation of IAS 29 to have any effect at all on a hyperinflationary economy was its application, as duely required by the Zimbabwean Stock Exchange, by listed companies on the ZSE. The Zimbabwean real or non-monetary economy imploded in tandem with Zimbabwe´s monetary unit and monetary economy despite the implementation of IAS 29. The IASB actually officially admitted / agreed that it was impossible to implement IAS 29 during severe hyperinflation in Zimbabwe.

On the other hand, a daily parallel rate was available till the last day of hyperinflation in Zimbabwe, which officially ended on 20th November, 2008, when Gideon Gono, the governor of the Reserve Bank of Zimbabwe issued regulations that closed down the ZSE which stopped the daily Old Mutual Implied Rate (OMIR) being available in Zimbabwe. The (normally unofficial) parallel rate – usually the US Dollar parallel rate, is an excellent, not a perfect, substitute for a daily non-monetary index in a hyperinflationary economy (currently Venezuela). The US Dollar parallel rate was available 24/7, 365 days a year during Zimbabwe´s hyperinflation. Right at the end, during severe hyperinflation when the CPI was not being published any more, the OMIR was still available on a daily basis.

IAS 29 is fundamentally flawed by simply requiring the restatement of HC or CC period-end financial statements in terms of the period-end CPI instead of daily valuation / measurement of all non-monetary items in terms of a daily Brazilian-style index or parallel rate.

Many people are requesting a fundamental review of IAS 29.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Constant Item Purchasing Power Accounting is not inflation accounting

Constant Item Purchasing Power Accounting is not inflation accounting

The world only goes round by misunderstanding. Charles Baudelaire


Inflation accounting describes an accounting model used during hyperinflation. The Constant Item Purchasing Power Accounting model is only used during low inflation and deflation. CIPPA is not an inflation accounting model.

Hyperinflation is defined in IFRS as cumulative inflation approaching or equal to 100% over three years; i.e., 26% annual inflation for three years in a row. Inflation accounting is implemented in order to stop the erosion of real value in all non-monetary items (both variable and constant real value non-monetary items) caused by the implementation of the very erosive stable measuring unit assumption during hyperinflation.

Implementing the stable measuring unit assumption implies that changes in the purchasing power of money are not considered as sufficiently important to require financial capital maintenance in units of constant purchasing power.

Most entities in low inflationary and deflationary economies implement the Historical Cost Accounting model that is based on the stable measuring unit assumption. This means that all balance sheet constant real value non-monetary items (e.g. shareholders´ equity, trade debtors, trade creditors, provisions, other non-monetary payables, other non-monetary receivables, etc.) and most (not all) income statement items are measured at their historical cost, i.e. financial capital maintenance is measured in nominal monetary units. Some income statement items, e.g. salaries, wages, rentals, etc. are updated annually in terms of the CPI, but, are then paid on a monthly basis implementing the stable measuring unit assumption under HCA.

IAS 29 Financial Reporting in Hyperinflationary Economies defines the inflation accounting model authorized in IFRS.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The high inflation 1970´s

The high inflation 1970´s


During the period of high inflation in the 1970´s various inflation accounting models were tried in an attempt to reflect in company financial reports the effect of high inflation on monetary and – mistakenly – non–monetary items too. Inflation has no effect on the real value of non–monetary items. It was not realized that it was simply the free choice of implementing 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 (revalued or not) during low inflation. The US FASB did mention the stable measuring unit assumption in FAS 89. The IASB never mentioned it in either IAS 6 or IAS 15. Everybody 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 in FAS 89 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. These changes were developed and implemented by the IASB in the form of IAS and IFRS relating 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 (1989), Par 104 (a). 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), - i.e., inflation - 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 as so famously stated by Milton Friedman. It is not inflation, but, the selection of the HCA model which includes the implementation of the 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 based on the very popular IFRS–approved accounting fallacy that financial capital maintenance can be measured in nominal monetary units which is impossible per se during inflation and deflation) 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 real value non–monetary 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) under which all non-monetary items (variable and constant items) were measured in units of constant purchasing power by applying the period end CPI during high inflation.

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 daily non–monetary indexes during high and hyperinflation 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.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

What price stability?

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.” SA Reserve Bank.

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 Alan 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. 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”.

Accounting, 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 are accounted as Historical Cost items: they are measured in nominal monetary units. In conformity with world practice the stable measuring unit assumption is not applied of the valuing of certain (not all) Income Statement constant real value non–monetary items, namely salaries, wages, rentals, etc. which are measured in units of constant purchasing power on an annual basis in terms of the CPI. These items annually updated items are then paid on a monthly basis again applying the stable measuring unit assumption; they are not updated monthly in terms of the monthly change in the annual rate of inflation. Other income statement items are valued in nominal monetary units, i.e. at HC.

Changes in the general purchasing power or real value of the monetary unit are not regarded to be sufficiently important to continuously measure financial capital maintenance in units of constant purchasing power authorized in IFRS in the original Framework (1989), Par 104 (a). Financial capital maintenance in nominal monetary units (HCA) is generally chosen under which the very erosive stable measuring unit assumption is implemented, also authorized in IFRS in the Framework (1989), Par 104 (a). It is impossible to maintain the existing constant real non-monetary value of existing 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.

However, this led to the general implementation of the traditional Historical Cost Accounting model during non–hyperinflationary periods. 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, are measured in nominal monetary units during non–hyperinflationary periods. Both HC variable and HC constant real value non–monetary items are thus considered to be simply HC non–monetary items.

There is a fixation in financial reporting that measurement in units of constant purchasing power simply means adjusting HC or CC period-end financial statements in terms of the period-end CPI mainly to make current year financial statements more useful only during hyperinflation. This is called restatement. Measurement in units of constant purchasing power is almost always automatically thought of as inflation accounting applied only during hyperinflation as defined in IAS 29 Financial Reporting in Hyperinflationary Economies. Measurement in units of constant purchasing power is not automatically thought of as affecting the fundamental constant real non-monetary values of existing constant real value non-monetary items (e.g. salaries, wages, rentals, shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc.) in a double entry accounting model 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, in principle, they are not.

Under Constant Item Purchasing Power Accounting financial capital maintenance is measured in units of constant purchasing power as authorized in IFRS. Only constant real value non-monetary items (not variable real value non-monetary items) are measured in units of constant purchasing power in terms of the monthly CPI. CIPPA automatically maintains the existing constant real value of all constant items constant for an indefinite period of time in all entities that at least break even during low inflation and deflation, whether they own any revaluable fixed assets or not


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Money illusion

Money illusion


This is the result of money illusion. People make the mistake of thinking that money is stable in real value over time 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 unit of measure during inflation and deflation. Money, i.e., the 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. Money 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.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

No split of non-monetary items under the HCA model

No split of non-monetary items under the HCA model


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 entities to choose to implement the 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 IFRS in the Framework (1989), 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.

All non–monetary items stated at HC, whether they are variable real value non–monetary HC items (e.g. land and buildings stated at HC) or constant real value non–monetary HC items (e.g. shareholders´ equity stated at HC) are regarded to be fundamentally the same, namely, simply non–monetary items when the very erosive stable measuring unit assumption is implemented as part of the traditional HCA model during low inflationary periods.


Nicolaas Smith

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 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 during low inflation. 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 they are updated annually in units of constant purchasing power in terms of the annual change in the Consumer Price Index, but, they are then paid monthly applying the stable measuring unit assumption; i.e. they are not updated monthly in terms of the CPI.

In terms of the Historical Cost Accounting model the stable measuring unit assumption is implemented under which balance sheet constant real value non–monetary items are valued at historical cost, i.e. in nominal monetary units thus eroding the existing constant real value of 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) under the HC paradigm during low inflation.

Price–level accounting generally did prevail in the Brazilian economy during the 30 years from 1964 to 1994 when Brazil indexed all non-monetary items (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. Brazil 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. Brazil stopped daily indexation during hyperinflation which is, in principle, continuous financial capital maintenance in units of constant purchasing power during hyperinflation. They should have changed from daily indexation of all non-monetary items (variable and constant real value non-monetary items) during hyperinflation to financial capital maintenance in units of constant purchasing power (CIPPA) during low inflation where under only constant items (not variable items) are measured in units of constant purchasing power by applying the monthly CPI.

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 under the HCA model. The IASB statement in the Framework (1989), 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, exists independently of how we measure them – and that the choice of the measuring unit does not affect their fundamental value, only how we choose to represent that value – and that we can use any monetary unit, Dollars 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 made in accounting will not change that value and will not affect the economy. Measuring constant real value non-monetary items in units of constant purchasing power does affect the economy. That is generally known and a fact.

If it were generally realized that the implementation of the stable measuring unit assumption during low inflation results in the unknowing, unnecessary and unintentional erosion by the implementation of the Historical Cost Accounting model (the stable measuring unit assumption) 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 real value non–monetary item economy year in year out, the HCA model would have been rejected by now.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Accounting cannot and does not create real value out of nothing

Accounting cannot and does not create real value out of nothing

It must be clearly understood, however, that accounting per se cannot and does not create real value out of thin air – out of nothing. Accounting cannot and does not create real value or wealth by simply passing some update or financial capital maintenance in units of constant purchasing power accounting entries when no real value actually exists. Constant real value non–monetary items, e.g. salaries, wages, rentals, 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 the accounting model (CIPPA) to be able to automatically maintain the real values of those existing constant real value non–monetary items constant for an indefinite period of time in all entities that at least break even by continuously measuring financial capital maintenance in units of constant purchasing power as authorized in IFRS and by continuously valuing income statement constant real value non–monetary 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 remedy (CIPPA) during inflation and deflation in one and the same statement in 1989.

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 (1989) 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 other exception, namely, that salaries, wages, rentals, etc. are generally measured in units of constant purchasing power when they are updated on an annual basis.

The IASB does not mention the erosion of the real value of balance sheet constant real value non–monetary items never maintained constant when the stable measuring unit assumption is implemented during low inflationary periods in companies that lack sufficient revaluable fixed assets (revalued or not) because this process of erosion of the real value of constant real value non–monetary items never maintained is not generally realized. The IASB, like the FASB and most others, mistakenly believe that the erosion of companies´ capital and profits is caused by inflation as specifically stated by the FASB and IASB. They 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. The real value maintaining effect on balance sheet constant real value non–monetary items is not realized 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 in IFRS in the Framework (1989), 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. The FASB mentioned the stable measuring unit assumption in FAS 33 and FAS 89.

“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

The IASB never mentioned the stable measuring unit assumption in either IAS 6 Accounting Response to Changing Prices or IAS 15. IAS 15 completely superseded IAS 6. IAS 15 was eventually withdrawn.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Capital deficiency during sub–prime crisis

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 were authorized in the Framework (1989), Par 104 (a). The implementation of the Constant Item Purchasing Power Accounting model would today automatically maintain the existing constant real values of all companies´ and banks´ shareholders´ equity and all other constant items constant since then in companies and banks that at least break even, instead of the erosive stable measuring unit assumption unknowingly, unintentionally and unnecessarily eroding their real values never maintained as it forms part of traditional Historical Cost Accounting at a rate equal to the annual rate of inflation year in year out during low inflationary periods. The stable measuring unit assumption is based on the fallacy that the erosion of the real value of the monetary unit (money) is not sufficiently important to implement continuous financial capital maintenance in units of constant purchasing power during low inflation. The HCA model is implemented because financial capital maintenance in nominal monetary units – a complete fallacy - was also approved in IFRS in the exact same Framework (1989), Par 104 (a).

If only real value maintaining financial capital maintenance in units of constant purchasing power (CIPPA) were 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 the implementation of the very erosive stable measuring unit assumption of the existing constant real value of banks´ and companies´ shareholders´ equity never maintained constant under the HCA model as evidenced during the recent sub–prime financial crisis.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The school of thought that 2% inflation is completely unharmful

The school of thought that 2% inflation is completely unharmful


Also approving the traditional Historical Cost Accounting model in the Framework (1989), Par 4.59 (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 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 incorrect in two of the three valuation processes in our current HC economy and is also mistaken 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 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 in economies with continuous 2% inflation. See the Real Value Table for other levels of real 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, etc., 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, valuation at historical cost.

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. The only constant items generally maintained constant with annual measurement in units of constant purchasing power under the HC paradigm are certain (not all) income statement items, namely, salaries, wages, rentals, etc. They are, however, paid monthly at the same value after being updated annually. 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 paradigm for an unlimited period of time in companies that at least break even – all else being equal.

We can thus safely disagree in the case 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 paradigm is concerned.



Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Financial capital maintenance in units of constant purchasing power

Financial capital maintenance in units of constant purchasing power


Constant Item Purchasing Power Accounting is a price–level accounting model where under only constant items (not variable items) are continuously measured in units of constant purchasing power, i.e., updated every time the real value of the unstable monetary unit of account (money) changes; namely, when the CPI changes - month after month during low inflation and deflation.

Value accounting has been defined in since 1976 via IFRS relating to variable items. Value accounting thus clearly prevails in the valuation and accounting of variable items in terms of IFRS during low inflation and deflation.

Continuous financial capital maintenance in units of constant purchasing power 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 (1989), Par 104 (a) which states that “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” However, the enormous real value eroding effect of the very erosive stable measuring unit assumption when entities choose in terms of the exact same Framework (1989), Par 104 (a), the IASB–approved very popular accounting fallacy of financial capital maintenance in nominal monetary units (the traditional Historical Cost Accounting model) and apply it in the valuing of constant items never maintained, e.g. retained earnings in most entities, in low inflationary economies when they implement stable measuring unit assumption during inflation, is not generally realized. This is clearly verified by the fact that both financial capital maintenance in nominal monetary units (a popular accounting fallacy) as well as real value maintaining continuous financial capital maintenance in units of constant purchasing power during inflation and deflation were approved in IFRS in the Framework (1989), Par 104 (a). Entities can choose the one or the other and state that they have prepared primary financial statements in terms of IFRS. However, when the the traditional HCA model is chosen, the stable measuring unit assumption unknowingly, unintentionally and unnecessarily erodes hundreds of billions of US Dollars in real value in the world´s constant item economy during low inflation. When they choose IFRS–approved continuous financial capital maintenance in units of constant purchasing power they maintain the real values of all constant items constant during inflation and deflation in companies which at least break even, empowering and enriching those companies, their shareholders and the economy in general with the accompanying benefits to workers and employment for an unlimited period of time – all else being equal.

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

Deutsche Bundesbank, 1996 Annual Report, P 83.

Financial capital maintenance in units of constant purchasing power during inflation and deflation results in absolute price stability only in constant items for an unlimited period of time in companies that at least break even – all else being equal – 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. This happens whether these entities own any fixed assets or not.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Price-level accounting

Price–level accounting

Entities generally choose to measure financial capital maintenance in nominal monetary units and thus apply the very erosive stable measuring unit assumption as part of the traditional HCA model. They generally value balance sheet constant items (e.g. equity) as well as most income statement items – which are all constant items – at Historical Cost. They value them in nominal monetary units as a result of the fact that they assume that changes in the purchasing power of the monetary unit are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. Entities do not regard changes in the real value of money during low inflation and deflation 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 original Framework (1989) Par. 104 (a). Entities, in principle, 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 items is concerned. They only value certain income statement constant real value non-monetary items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and update them annually by means of the annual CPI during low inflation. They then pay these annually updated values monthly again implementing the stable measuring unit assumption.

Complete price–level accounting also called Constant Purchasing Power Accounting (CPPA) is an inflation accounting model whereby all non–monetary items – variable and constant items – are measured / valued in units of constant purchasing power by means of the daily US Dollar or other relatively stable foreign currency parallel rate or a daily index rate in order to maintain the real or non-monetary economy relatively stable during hyperinflation. IAS 29 does not require the valuation of all non-monetary items in units of constant purchasing power at the time of the transaction or event. IAS 29 and PricewaterhouseCoopers (amongst most others) accept the implementation of Historical Cost Accounting or Current Cost Accounting during the accounting period. IAS 29 requires the restatement of the HC or CC financial statements in terms of the period–end CPI in order to make them more useful during 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 simply the restatement of HC or CC financial statement in terms 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 Conceptual Framework (2010), Par 4.57 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11.

Deloitte states:

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

IAS8 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 items is thus covered in IFRS in the original Framework (1989), Pa. 104 (a).

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.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Value accounting

Value accounting


There is, on the other hand, also strong awareness in the accounting profession that accounting is actually 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.

It is generally accepted that accounting should be value based. By value based it is meant that variable real value non-monetary items cannot always be valued at HC, but, are to be valued in terms of specific measurement bases defined in IFRS or GAAP; for example, market value, net realizable value, fair value, present value, recoverable value, etc.

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

Value accounting also prevails as far as the valuing and accounting 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 under whatever economic environment: low inflation, deflation and hyperinflation. The real value of monetary items is kept always current, i.e. generally lower by inflation, generally higher by deflation and generally very much lower by hyperinflation since the nominal value of monetary items is not and cannot be updated or measured in units of constant purchasing power during the current accounting period in an inflationary, a deflationary or a hyperinflationary economy.

The CPI which quantifies the erosion of the real value of only monetary items by low inflation and the creation of real value by deflation in only monetary items is published on a monthly basis. The hyper-erosion of the real value of only monetary items is normally known via the daily US Dollar parallel rate or daily index rate or even every 8 hours during hyperinflation. The nominal value of monetary items in actual accounts stays the same forever under any accounting model and under any economic environment, but, the real value is automatically adjusted by inflation, deflation and hyperinflation. The real value of monetary items can be halved every 24.7 hours as it 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 in monetary items caused by inflation, deflation and hyperinflation resulting from holding net monetary item assets or net monetary item liabilities is calculated and accounted in terms of IAS 29 in hyperinflationary economies and in terms of CIPPA in low inflationary and deflationary economies. The calculation and accounting of net monetary losses and gains during low inflation and deflation have thus been authorized in IFRS since 1989. They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick.

"Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical–cost basis."

Harvey Kapnick, Chairman of Arthur Anderson & Company, Value based accounting: Evolution or revolution, Saxe Lecture, 1976, Page 6.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.