Salaries and wages maintained constant during low inflation

Salaries and wages maintained constant during low inflation

The annual indexation or measurement in units of constant purchasing power of salaries and wages in a low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages constant during inflation. This often involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating monetary unit payment values for constant real value non–monetary salaries and wages to maintain their purchasing power constant on an annual basis in a low inflationary economy where the real value of the monetary unit of account is continuously being eroded by inflation. The nominal values of constant real value non–monetary salaries and wages are thus updated or indexed in terms of the annual CPI to cover or compensate for at least the expected annual rate of erosion in the real value of the depreciating monetary unit which is the depreciating monetary unit of account for accounting purposes as well as the depreciating monetary medium of exchange for payment purposes in the economy during low inflation. The period is normally for the year ahead. They often agree on an additional percentage increase for increases in productivity and / or for social security reasons.

Both parties to the salary and wage negotiations agree that constant real value non–monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very erosive stable measuring unit assumption whereby it is simply assumed that changes in the purchasing power of depreciating money are not sufficiently important to require measurement in units of constant purchasing power during inflation. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated monetary units whose real values are continuously being eroded by inflation. They would not receive the full constant real non–monetary values of their salaries and wages.

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

Inflation can only erode the real value of the depreciating monetary medium of exchange (depreciating money, i.e. the depreciating monetary unit inside an inflationary economy) and other depreciating monetary items.

Inflation has no effect on the real values of salaries and wages which are constant real value non–monetary items. Inflation can only erode the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. The very erosive stable measuring unit assumption implemented as part of the traditional HCA model when salaries and wages are fixed over time, unknowingly, unintentionally and unnecessarily erodes the real value of salaries and wages when they are not measured in units of constant purchasing power in terms of the monthly CPI during low inflation.

Inflation cannot erode the real value of non–monetary items. Inflation can only erode the real value of the unstable monetary medium of exchange (the unstable monetary unit – unstable money) used to transfer the constant real non–monetary values of salaries and wages from the employer to the employee.

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005, Page 9.

http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

The erosion at a rate equal to the annual rate of inflation of all constant real value non–monetary items never maintained constant under HCA during inflation automatically stops forever the very moment the Boards of Directors of companies implement the IFRS–approved financial capital maintenance in units of constant purchasing power model (CIPPA) in all entities that at least break even during low inflation – all else being equal. The choice is theirs. The power to stop the erosion of real value in the real economy is in their hands – as authorized in IFRS since 1989 in the IASB´s original Framework (1989), Par 104 (a) which is applicable in the absence of specific IFRS. It is the choice of the accounting model (CIPPA or HCA) and not inflation that automatically maintains or generally erodes the existing constant real non–monetary value of constant real value non–monetary items never maintained constant in low inflationary economies.

The constant real non–monetary values of salaries and wages expressed in terms of the depreciating unstable monetary unit as the depreciating unstable monetary unit of account are presently being maintained constant on an annual basis in the first month of payment in low inflationary economies when their nominal monetary values are indexed or updated by means of the CPI in low inflationary environments. This happens not because of a lowering of inflation, but because of employers and trade unions valuing salaries and wages in units of constant purchasing power on an annual basis instead of the Historical Cost measurement basis for this particular purpose. Salaries and wages are then normally kept fixed for the 12 month period of the accounting year; i.e. they are not updated or measured in units of constant purchasing power on a monthly basis. The stable measuring unit assumption is generally applied with monthly payments after the annual update.

If the parties to the salary and wage determination process were to agree to value salaries and wages annually at fixed Historical Cost (in nominal monetary units) – like Iceland recently decided to freeze salaries because of their financial crisis –  then their annual constant real non–monetary values are eroded at a rate equal to the annual rate of inflation because constant real value non–monetary salaries and wages are expressed in term of the depreciating monetary unit of account and are normally paid in depreciating monetary units. Salaries and wages are not depreciating monetary items. They are constant real value non–monetary items on an annual and on a monthly basis. They are, however, - after the annual update - normally paid monthly in depreciating money during low inflation.

“Income Statement

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

All items in the income statement are constant real value non–monetary items to be continuously updated by applying the monthly change in the annual CPI during low inflation and deflation. The real values of salaries and wages would thus not be eroded by inflation if they were valued in nominal monetary units (fixed salaries and wages), but by the choice of the measurement basis, namely, Historical Cost, i.e. in nominal monetary units, which means the implementation of the very erosive stable measuring unit assumption whereby it is considered that the continuous erosion of the purchasing power of the monetary unit is not sufficiently important during low inflation in order to require the indexation or measurement in units of constant purchasing power of the existing constant real values of constant real value non–monetary salaries and wages by means of the monthly CPI in order to maintain their existing constant real non–monetary values constant. What is done, in essence, is it is assumed that the constantly depreciating monetary unit of account – the depreciating monetary unit – is perfectly stable when the stable measuring unit assumption is applied. It is assumed, in principle, that the depreciating monetary unit is perfectly stable whenever the stable measuring is implemented.

Nicolaas Smith.

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

CIPPA is not inflation accounting

CIPPA is not inflation accounting


This project is not about inflation accounting during high and hyperinflationary periods.

This project is not about implementing 1970–style inflation accounting in low inflationary economies by inflation–adjusting all non–monetary items equally by means of the CPI.

The following peer reviewed article Financial Statements, Inflation & The Audit Report I wrote was published in SAICA´s journal– Accountancy SA – in September 2007.

“In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued.” ¹


The International Accounting Standards Board (IASB) only recognizes two economic items:


1.) Monetary items defined as “money held and items to be received or paid in money;” and


2.) Non–monetary items: All items that are not monetary items.


Non–monetary items include variable real value non–monetary items valued, for example, at fair value, market value, present value, net realizable value or recoverable value.


They also include Historical Cost items based on the stable measuring unit assumption.


One of the basic principles in accounting is “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency.

This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.” ²


This makes these Historical Cost items equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies with no well located and well maintained land and/or buildings or other variable real value non–monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.


Retained Income is a constant real value non–monetary item valued at Historical Cost which makes it subject to the destruction of its real value by inflation – exactly the same as in cash.


It is an undeniable fact that South Africa’s monetary unit’s internal real value is constantly being destroyed by inflation in the case of our low inflationary economy, but this is not considered important enough to adjust the real values of constant real value non–monetary items in the financial statements – the universal stable measuring unit assumption.


The combination of the Historical Cost Accounting model and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is easy to calculate in the case of each and every company in South Africa with Retained Income. It is also possible to calculate this value for all companies in the world economy with Retained Income.


It is broadly known that the destruction of the internal real value of the monetary unit of account is a very important matter and that inflation thus destroys the real value of all variable real value non–monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.


But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non–monetary item – the change in the real value of money is not regarded as important to update the value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.


Yes, inflation is very important!


All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter. Financial newspapers and economics journals dedicate thousands of columns to the fight against inflation.


But, when it comes to constant real value non–monetary items, it doesn’t seem as if inflation is important. We happily destroy hundreds of billions of Dollars in Retained Income real value year in year out.


However, when you are operating in an economy with hyperinflation (perhaps only Zimbabwe at the moment with 3 713% inflation), then we all agree that you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. You have to update variable AND constant real value non–monetary items.


But, ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% – the rate required for the implementation of IAS 29.


Once you are not in hyperinflation anymore, for example, 15% annual inflation for as many years as you want, then you are not allowed to update constant real value non–monetary items any more. Then you must destroy their real value again – at 15% per annum. Or 7.0% per annum in the case of South Africa (April 2007).


For example:


Shareholder value permanently  destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil's Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).


The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).


Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during 2005 as a result of the application of the stable measuring unit assumption in the accounting of their Retained Income. (Dec 2005 values).


Should this value be reflected in the financial statements?


Maybe it should.


Nicolaas Smith”


Footnotes

¹ International Accounting Standards Committee, (1995), International Accounting Standard 1995, London, IASC, Page 502


² Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.

http://www.accountancysa.org.za/resources/ShowItemArticle.asp?ArticleId=1235&issue=857

This article was first published in Accountancy SA (September 2007, pg 38). Accountancy SA is published by the South African Institute of Chartered Accountants. www.accountancysa.org.za

The understanding of the global, economy–wide erosion of banks´ and companies´ capital and profits (equity) during low inflation caused by the implementation of the stable measuring unit assumption is an ongoing process. In 2007 I, like almost everyone else, still believed that inflation eroded the real value of non–monetary items. Since then I have realized that I made a mistake by believing what everyone else believes and state with regard to the erosive effect of inflation on the real value of non–monetary items. I realized since then that inflation is in fact always and everywhere only a monetary phenomenon, as the late Milton Friedman so eloquently stated. I realized since then that inflation can only erode the real value of money and other monetary items – nothing else. I realized since then that inflation has, in fact, no effect on the real value of non–monetary items as so correctly stated by Prof Dr. Ümit GUCENME and Dr. Aylin Poroy ARSOY from Uludag University, Bursa, Turkey:

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

The theme of this project is thus not inflation–accounting. Inflation accounting is an accounting model to be applied only during very high and hyperinflation. Inflation accounting is specifically defined in IAS 29 Financial Reporting in Hyperinflationary Economies and required by IFRS only during hyperinflation.

The theme of this project is financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (as implemented via the Constant Item Purchasing Power Accounting model) as authorized in IFRS in the original Framework (1989), Par 104 (a). Stated differently: the theme of this project is the rejection of the stable measuring unit assumption, i.e. the rejection of the generally accepted, globally implemented, traditional Historical Cost Accounting model, during low inflation and deflation . HCA is also authorized in IFRS in the exact same original Framework (1989), Par 104 (a). The rejection of the stable measuring unit assumption is authorized in IFRS since financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is authorized in IFRS as an alternative to financial capital maintenance in nominal monetary units, i.e. the Historical Cost Accounting model under which the stable measuring unit assumption is implemented.

Non–monetary items are subdivided in variable real value non–monetary items and constant real value non–monetary items as published in the above Accountancy SA article. Only constant real value non–monetary items are updated under financial capital maintenance in units of constant purchasing power (CIPPA) to maintain their existing constant real non–monetary values constant during low inflation and deflation in order to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units. That is what this project is about. Variable real value non–monetary items are valued in terms of IFRS or GAAP in a manner that takes into account all elements – including inflation – which determine the variable real value non–monetary item’s real value at the date of valuation during low inflation and deflation. Monetary items are always valued at their original nominal monetary values under all accounting models and under all economic environments. Constant real value non–monetary items are also valued in terms of IFRS in units of constant purchasing power when financial capital maintenance is measured in units of constant purchasing power during low inflation and deflation by implementing the CIPPA model.

This project is about the existing real values of constant real value non–monetary items – e.g., banks´ and companies´ shareholders´ equity – automatically being maintained constant forever in all entities that at least break even – ceteris paribus – during low inflation and deflation by continuously implementing the real value maintaining financial capital maintenance in units of constant purchasing power model (CIPPA) as approved in the IFRS in the original Framework (1989), Par 104 (a).

This project is about knowingly indexing or updating or measuring in units of constant purchasing power only constant real value non–monetary items by implementing the CIPPA model during low inflation and deflation as approved in IFRS in the original Framework (1989), instead of unknowingly, unintentionally and unnecessarily eroding their real values on a massive scale with the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional HCA model when financial capital maintenance is measured in nominal monetary units during inflation.

This project is about knowingly choosing to measure financial capital maintenance in banks and companies in real value maintaining units of constant purchasing power during low inflation and deflation as approved in IFRS instead of in real value eroding nominal monetary units as a result of the choice to implement the very erosive stable measuring unit assumption during low inflation also authorized in IFRS in the same original Framework (1989), Par 104 (a).

This project is about rejecting the stable measuring unit assumption and instead adopting IFRS–approved real value maintaining constant purchasing power units as the measurement basis for only constant real value non–monetary items including banks´ and companies´ shareholders´ equity and not only for income statement constant real value non–monetary items, e.g. salaries, wages, rentals, etc during non–hyperinflationary conditions.

This project is about stopping the implementation of the Historical Cost Accounting model which unknowingly, unintentionally and unnecessarily erodes hundreds of billions of US Dollars per annum of existing constant real value in existing constant real value non–monetary items (bank´s and companies´ capital) in the constant item economy because the traditional HCA model is chosen when the very erosive stable measuring unit assumption is implemented during inflation instead of the IFRS–approved real value maintaining CIPPA model.

The Historical Cost Mistake is the implementation of the very erosive stable measuring unit assumption as part of the traditional HCA model during inflation.

This project is about knowingly, automatically maintaining hundreds of billions of US Dollars per annum of existing constant real non–monetary value in the real economy for an unlimited period of time in all entities that at least break even complying with IFRS instead of unknowingly, unintentionally and unnecessarily eroding that value year in year out as is unknowingly being done at the moment with the implementation of the stable measuring unit assumption during inflation.

This project is about abandoning the very erosive traditional HCA model and adopting the real value maintaining CIPPA model in low inflationary and deflationary economies as 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.

Hurdles to CIPPA

Hurdles to CIPPA


Financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) which automatically maintains the constant purchasing power of financial capital constant in all entities that at least break even for an indefinite period of time – ceteris paribus - is not yet generally accepted and accounting students are not yet taught to select the real value maintaining IFRS–approved alternative to the 3000 year old very erosive generally accepted traditional Historical Cost Accounting model because:
(1) The CIPPA due process is an on-going process although the principle of financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation has been authorized in IFRS since 1989.

(2) It is still generally assumed that any price–level accounting model refers to the CPPA inflation accounting model to be used only during hyperinflation.

(3) It is not yet generally realized that the implementation of the traditional Historical Cost Accounting model – in general - unknowingly, unintentionally and unnecessarily erodes real value on a significant scale (hundreds of billions of US Dollars per annum) in the world´s constant item economy when the stable measuring unit assumption is implemented and financial capital maintenance is measured in nominal monetary units during inflation in entities when the constant purchasing power of constant items is never maintained.

(4) It is not yet generally realized that this massive annual erosion of existing constant real value in existing constant real value non–monetary items never maintained constant can be stopped by simply selecting the alternative approved by the IASB predecessor body, the IASC Board in 1989.

(5) The fallacy that "financial capital maintenance can be measured in nominal monetary units" is also approved in IFRS in the original Framework (1989), Par 104 (a).

(6) The stable measuring unit assumption that is based on the fallacy that changes in the real value of the monetary unit of account is not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation is implemented by most entities world-wide.

(7) The fallacy that "the erosion of business profits and invested capital is caused by inflation" as stated by the FASB in FAS 89 is still generally accepted.

(8) The cost of the stable measuring unit assumption (a generally accepted accounting practice) is mistakenly still generally accepted to be the same as the cost of inflation (the net monetary loss from holding a net balance of monetary item assets) and needs to be limited by central banks´ monetary policies: it is not realized that it is the implementation of the stable measuring unit assumption and not inflation that is eroding the real value of constant items never maintained constant.


Nicolaas Smith

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

CIPPA is authorized during low inflation

CIPPA is authorized during low inflation


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

Measurement in constant monetary units (e.g. constant Dollars), i.e. in units of constant purchasing power by updating constant real value non–monetary items during low inflation and deflation as an alternative paradigm is authorized not only in IFRS, but, also in particular country´s accounting regulations. An alternative measurement in constant monetary units paradigm has been authorized in Portuguese accounting in the Plano Official de Contas (POC) also since 1989.
“Os registos contabilísticos devem basear–se em custos de aquisição ou de produção, quer a escudos nomonais, quer a escudos constantes.”

Carlos Baptista da Costa and Gabriel Correia Alves, Contabilidade Financeira, Rei dos Livros, 1996, P 79

Income statement constant real value non–monetary items like salaries, wages, rentals, utilities, transport fees, etc., are normally updated annually in units of constant purchasing power during low inflation in most economies. Payments in money for these items are normally updated annually by means of the CPI to compensate for the annual erosion of the real value of the unstable monetary medium of exchange by inflation. Inflation is always and everywhere a monetary phenomenon and can only erode the real value of money (the monetary unit inside an economy) and other monetary items. Inflation cannot and does not erode the real value of non–monetary items. See GUCENME and ARSOY above. These items are then, however, paid on a monthly basis in the new accounting year applying the stable measuring unit assumption, i.e. they are only updated annually, not monthly under the HC paradigm.

Constant real value non–monetary items´ real values can automatically be maintained constant in all entities that at least break even by choosing the CIPPA model as per the IASB´s Framework during low inflation as authorized in 1989 instead of currently unknowingly, unintentionally and unnecessarily being eroded by the implementation of the traditional HCA model when the very erosive stable measuring unit assumption is applied during inflation. It is thus the choice of accounting model and not inflation that maintains or erodes the real value of constant real value non–monetary items like Retained Earnings, Issued Share capital, capital reserves, other shareholder equity items never maintained, etc. when the very erosive stable measuring unit assumption is implemented for during inflation.

Implementing the CIPPA model means the stable measuring unit assumption is rejected which is implemented when it is instead chosen to measure financial capital maintenance in nominal monetary units – also in terms of the original Framework (1989), Par 104 (a).


Nicolaas Smith

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

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.