Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily
[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]
Financial capital
maintenance in units of constant purchasing power in terms of a daily rate at
all levels of inflation and deflation (CIPPA), under which the very erosive
stable measuring unit assumption is never applied, requires the following:
Monetary items
inflation–adjusted daily
Variable items updated
daily
Constant items
measured in units of constant purchasing power daily
(a) Monetary items inflation–adjusted daily
All monetary items – historical and current
period monetary items – are required to be inflation–adjusted daily in terms of
a Daily CPI or monetized daily indexed unit of account during low inflation,
high inflation and deflation and daily in terms of a daily hard currency
parallel rate or daily index rate during hyperinflation.
Inflation-adjusting
all monetary items daily would result in the complete elimination of the cost
of inflation (zero cost of inflation), but not the elimination of actual low
inflation, high inflation or hyperinflation in the unstable monetary unit. There
would be no net monetary loss or gain in the entire monetary economy excluding
in actual bank notes and coins, only with complete co-ordination in
inflation-adjusting all monetary items daily. Daily updating of a part of the
money supply is currently being done in Chile in terms of the UF and in
countries with inflation-indexed bond markets, e.g. the US, UK, Turkey, France,
Mexico, Poland, Columbia, South Korea, Brazil, Italy, Japan, Germany, Canada,
Sweden, etc. under the HC paradigm.
Monetary items would
be required to be inflation–adjusted daily because there is no stable measuring
unit assumption under CIPPA, or it is already a generally accepted monetary
practice for part of the money supply, e.g. the daily inflation-indexing of 20
to 25 per cent of the broad M3 money supply in Chile in terms of the UF or as a
result of inflation–indexed bond markets in countries like the US, UK, France,
etc. implementing HCA, i.e. implementing the stable measuring unit assumption
in the valuation of the greater part of the money supply in the economy.
Net monetary losses
and gains are not calculated during low inflation, high inflation and deflation
in terms of IFRS and US GAAP under the current HC paradigm. They are, however,
required to be calculated during hyperinflation under the same HC paradigm in
terms of IAS 29. This is one of the various contradictions under HCA corrected
under CIPPA. Net monetary gains and losses are – very logically – calculated
and accounted at all levels of inflation and deflation because they do in fact
exist whenever monetary items are not inflation-adjusted and deflation-adjusted
under CIPPA. There is no stable measuring unit assumption under CIPPA.
Complete co-ordination
in implementing CIPPA in an economy would most probably not be achieved right
from the start. Banks, companies and private individuals will take time to
learn to inflation–adjust all monetary items in the economy when they do not
yet understand all the benefits of inflation–adjusting all monetary items daily
as well as the benefits of financial capital maintenance in units of constant
purchasing power in terms of a daily rate at all levels of inflation and
deflation as authorized in IFRS as far back as 1989. Chilean banks operate
profitably with inflation–adjusting a portion (currently 20 to 25 per cent of
their broad M3 money supply) of deposits from clients since 1967. They
inflation–index daily, for example mortgages, car loans, student loans,
consumer loans, business loans, personal loans, etc., which include their profit
margins, to clients in terms of the UF.
‘Because most
accountants and users of financial statements have been inculcated with a model
of financial reporting that assumes stability of the monetary unit, accepting a
change of this consequence would take a lengthy period of time under the best
of circumstances.’ (FAS 89, Par. 4)
Nevertheless, entities
may start financial capital maintenance in units of constant purchasing power
in terms of a daily rate (CIPPA) at all levels of inflation and deflation without
inflation–adjusting or deflation-adjusting any more or all monetary items. They
may be motivated by one or more of the following: the invisible hand of
self–interest, shareholder pressure or more financial crises caused by often
undercapitalized banks and companies. They may wish to immediately benefit from
automatically maintaining the constant purchasing power of their own
shareholders´ equity constant for an indefinite period of time as long as they
break even in real value at all levels of inflation and deflation – ceteris
paribus – whether they own any revaluable fixed assets or not.
The full cost of or
gain from low and high inflation and deflation – net monetary loss or gain –
would be recognized by these entities in their operations. It would be
calculated and accounted in financial reports prepared under CIPPA. Under
partial inflation–adjustment of monetary items – e.g. in Chile, the US, UK,
Canada and all countries issuing inflation–indexed sovereign and commercial
bonds – the net monetary loss or gain
would be calculated and accounted for the part not inflation–indexed; i.e.
currently for the greater part of the money supply under CIPPA. This is
presently not being done in Chile, the US, UK, Canada, etc. because these
countries implement the HCA model under which net monetary losses and gains are
not calculated and accounted during low inflation, high inflation and
deflation. They are required under IFRS to be calculated during hyperinflation
under the same HC paradigm.
The constant purchasing
power of capital can automatically be maintained constant for an indefinite
period of time in entities that at least break even in real value at all levels
of inflation and deflation – ceteris paribus – whether they own any revaluable
fixed assets or not, only when they implement financial capital maintenance in
units of constant purchasing power in terms of a daily rate (CIPPA) because the
constant purchasing power of capital is equal to the real value of net assets -
as qualified - in a double entry accounting model. Financial capital maintained
in nominal value by means of measurement in nominal monetary units is always
equal to net assets in nominal value per se, but it is not equal to net assets
in real value per se even though IFRS and US GAAP authorized financial capital
maintenance in nominal monetary units (the HCA model) and even though it is the
3000–year–old, generally accepted, globally implemented, traditional accounting
model used by most entities during low inflation and deflation. Financial
capital maintenance in nominal monetary units during inflation and deflation
per se is a popular accounting fallacy approved in IFRS.
Under HCA the cost of
inflation in the monetary economy is not calculated and accounted because the
books are not being balanced in real terms but in nominal monetary terms.
Historical Cost illusion that it is possible to maintain the real value of
capital in nominal monetary units per se during inflation and deflation makes
HCA a very erosive and, in principle, an inappropriate accounting policy.
Entities, on the one
hand, apply the stable measuring unit assumption under HCA in the valuation of
their own shareholders´ equity in their own financial reports in nominal
monetary units under which they may not take into account unreported hidden
reserves for fixed assets not revalued when they apply the HC approach to the
valuation of fixed assets in terms of IFRS. On the other hand, they always
value third parties´ shareholders´ equity taking into account unreported hidden
reserves for fixed assets not revalued, e.g. in the share price of listed
companies which they value at market value in terms of IFRS, as well as in
their valuations of unlisted companies.
This means that under
HCA only entities with revaluable fixed assets (revalued or not) with an
updated fair value equal to 100 per cent of the updated original constant real
value of all contributions to shareholders´ equity maintain the real
non-monetary value of their capital under the concept of nominal financial
capital is equal to net assets with financial capital maintenance measured in
nominal monetary units during low and high inflation and deflation. This may
only be the case in hotel, hospital and other property–intensive entities.
CIPPA, on the other hand, automatically maintains the constant purchasing power
of financial capital constant for an indefinite period of time in all entities
that at least break even in real value at all levels of inflation and deflation
– ceteris paribus – whether they own any revaluable fixed assets or not. This
requires the calculation and accounting of net monetary losses and gains as
well as net constant item losses and gains (a new accounting concept) because
the books are being balanced in real terms for the first time; i.e. the stable
measuring unit assumption is never applied under CIPPA.
This also means that,
under HCA, the portion of shareholders´ equity never covered by sufficient
revaluable fixed assets (revalued or not) has always been and is still –
currently – unnecessarily,
unintentionally and unknowingly being eroded at a rate equal to the annual rate
of inflation; not by inflation, but by the implementation of the stable
measuring unit assumption during inflation.
The erosion is equal
to the annual rate of inflation because economic items are valued in terms of
unstable money which is the legal unstable monetary unit of account and
inflation erodes the real value of only unstable money and other unstable
monetary items.
Shareholders´ equity
is a constant real value non–monetary item. This unnecessary erosion in
constant item real value by the implementation of the stable measuring unit
assumption under HCA amounts to hundreds of billions of US Dollars per annum in
the world´s capital investment base at the current level of world inflation.
The US definition of a billion, 1 000 000 000, is followed in this book.
Financial capital
maintenance in units of constant purchasing power in terms of a daily rate at
all levels of inflation and deflation (CIPPA) would stop this erosion for an
indefinite period of time and would instead maintain hundreds of billions of US
Dollars per annum in the world´s capital investment base for as long as world
inflation remains at current levels.
Prof. Rachel
Baskerville, Associate Professor, School of Accounting and Commercial Law at
the Victoria University in Wellington, New Zealand, changed her publication 100
Questions (and Answers) about IFRS on the Social Science Research Network to
confirm that there are three concepts of capital maintenance authorized in IFRS
after I pointed it out to her. Prof Baskerville discussed the change with her
colleague Prof Kevin Simpkins before changing her article. He is the Chairman
of the New Zealand Accounting Standards Review Board. She then pointed her
readers to my SA blog and added this conclusion:
‘There is much to be
gained from moving away from reporting on the basis Financial Capital Maintenance in Nominal
Monetary Units.’ (Baskerville, 2010)
The Deutsche Bundesbank very wisely stated:
‘The benefits of price
stability, on the other hand, can scarcely be overestimated, especially as
these are, in principle, unlimited in duration and accrue year after year.’ (Deutsche
Bundesbank, 1996)
[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
