IFRS apply to two paradigms

IFRS apply to two paradigms

 

IFRS apply to the following two paradigms:

 

1. Historical Cost (HC) paradigm
2. Constant Item Purchasing Power (CIPP) paradigm

 

The reason for this is the fact that both financial capital maintenance in nominal monetary units (the Historical Cost Accounting model) and financial capital maintenance in units of constant purchasing power (the Constant Item Purchasing Power Accounting model) were authorized in IFRS in the original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] which states: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

 

The fact that IFRS authorized three instead of the generally accepted two concepts of capital maintenance already in 1989 was only identified on this blog in 2008: still quite a revelation to the accounting profession in general. The Framework actually state that there are ‘two’ concepts of capital maintenance, but, in fact, authorize three: physical capital maintenance plus the two authorized in the Framework (1989), Par. 104 (a) (see above). The three capital maintenance concepts authorized in IFRS are now becoming generally accepted as a result of the power of the internet: especially via Wikipedia, Amazon.com, various blogospheres and reflections via millions of other sites.

 

The underlying principle of the HC paradigm is the HC principle which is not based on fact. It is based on an assumption, namely, the stable measuring unit assumption under which changes in the purchasing power of money (and consequently the monetary unit of account) are not considered sufficiently important to require financial capital maintenance in units of constant purchasing power during inflation and deflation. Under the HC paradigm it is assumed, in practice, that money was, is and will always be perfectly stable in real value. It is assumed, in practice, that there never was, is or ever will be inflation and deflation in the economy. They are obviously all wrong assumptions.

 

The underlying principle of the CIPP paradigm is the measurement in units of constant purchasing power principle which is based on fact, namely, the fact that money (the monetary unit of account) is never stable in real value on a sustainable basis. The stable measuring unit assumption is never applied under the CIPP paradigm.

 

In science, a fact will eventually prevail over a wrong assumption regarding that fact.

 

The capital concept applied under the HC paradigm is the Nominal Financial Capital concept.

 

The capital concept applied under the CIPP paradigm is the Constant Item Purchasing Power Financial Capital concept.

 

Financial Capital Maintenance is measured in Nominal Monetary Units under the HC paradigm. It is impossible to maintain the real value of capital constant in nominal monetary units per se during inflation and deflation despite the fact that the Framework states that it can be done. Financial capital maintenance in nominal monetary units is a popular accounting fallacy authorized in IFRS.

 

‘It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.’

FAS 33 1979: 24

 

Financial Capital Maintenance is measured in Units of Constant Purchasing Power in terms of a Daily CPI or other daily index under the CIPP paradigm. Under financial capital maintenance in units of constant purchasing power the constant purchasing power of capital is automatically maintained constant for an indefinite period of time in all entities that at least break even in real value – ceteris paribus – at all levels of inflation and deflation.

 

Under the HC paradigm there are only two basic economic items in the economy, namely, monetary and non-monetary items and the economy is divided in the monetary and non-monetary or real economy.

 

Under the CIPP paradigm there are three basic economic items in the economy, namely, monetary items, variable real value non-monetary items and constant real value non-monetary items and the economy is divided in the monetary, variable and constant item economy.

 

Under the HC paradigm the accounting equation is applied in nominal monetary units, namely, the nominal value of capital is always equal to the nominal value of net assets.

 

Under the CIPP paradigm, the accounting equation is applied in units of constant purchasing power, namely, the constant purchasing power of capital is always equal to the real value of net assets.

 

The CIPP paradigm equals the natural laws of accounting. The HC paradigm equals the assumed laws of accounting.

 

Under the HC paradigm, the original nominal Historical Cost values of HC items (e.g. inventory items measured at cost) are measured in fixed nominal monetary units, i.e. they are not updated in real value. The stable measuring unit assumption (not inflation) thus results in the overstatement of profits and dividends under the HC paradigm and the erosion of that portion of capital not maintained constant with the real value of net assets.

 

Under the CIPP paradigm, the original nominal Historical Cost reference values of HC items (e.g. inventory items measured at cost) are updated in real value to the current (today’s) value in terms of the Daily CPI or other daily index value.

 

Under the HC paradigm, the real value of that portion of capital not maintained by the real value of net assets is eroded by the stable measuring unit assumption (not inflation) at a rate equal to the annual rate of inflation because the real value of the monetary unit of account is eroded by inflation. This erosion amounts to hundreds of billions of US Dollars per annum in the world economy.

 

Under the CIPP paradigm, the constant purchasing power of capital is automatically maintained constant for an indefinite period of time in all entities that at least break even in real value – ceteris paribus – at all levels of inflation and deflation including hyperinflation.

 

The implementation of the CIPP paradigm would stop the erosion mentioned above and would instead maintain hundreds of billions of US Dollars per annum in the world’s constant item economy (capital investment base) at the current world inflation rate.

 

Under the HC paradigm, it is incorrectly believed that the erosion of companies´ capital and invested profits is caused by inflation. Inflation has no effect on the real value of non-monetary items. Capital and invested profits are non-monetary items. Inflation only affects the real value of money and other monetary items.

 

Under the CIPP paradigm, there is no erosion of companies´ capital and invested profits because the stable measuring unit assumption is never applied under this paradigm.

 

The CIPP paradigm is obviously a better paradigm than the HC paradigm.

 

The possible changeover from the current 3000-year old, globally implemented, generally accepted, traditional HC paradigm to the IFRS-authorized CIPP paradigm would take at least another hundred to two hundred years to come about in the world economy (2012) – or it may also never happen.

 

‘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: Par. 4

 

Authors stated about a hundred years ago that HCA is not an appropriate accounting model, but it is still the only accounting model implemented today (2012). It appears that the authorization of financial capital maintenance in units of constant purchasing power in IFRS in 1989 was not meant to be the authorization of a second paradigm, but simply a technical back up for attempted measurement in units of constant purchasing power in IAS 29 (totally ineffective: see its implementation in Zimbabwe) – also authorized in 1989.

 

The IASB has now (2012) unanimously voted to submit the replacement of IAS 29 to research. If the IFRS to replace IAS 29 were to continue with any form of HCA, then the replacement of the HC paradigm with the CIPP paradigm would suffer a severe setback.

 

Any individual company can immediately implement financial capital maintenance in units of constant purchasing power because it was authorized in IFRS in the original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)].

 

No person understanding the above would start a new company implementing the HC paradigm.

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Definition of hyperinflation

Definition of hyperinflation

Hyperinflation only affects the real value of money and other monetary items – and nothing else. Hyperinflation has no effect on the real value of non-monetary items.

The stable measuring unit assumption (not hyperinflation, as generally accepted) as it is implemented as part of the 3000-year-old, generally accepted, globally implemented, traditional Historical Cost Accounting model even during hyperinflation (as supported by the IASB and Big Four accounting firms like PricewaterhouseCoopers), erodes that portion of companies´ equity in only the non-monetary or real economy not backed by the equivalent real value of their net assets during hyperinflation (exactly the same as during low inflation).

So, who needs the definition of hyperinflation:

1. Millions of accountants worldwide - representing almost the entire world economy - who have to value and account economic items in the world economy on a daily basis. These accountants generally implement International Financial Reporting Standards as authorized by the International Accounting Standards Board. American accountants, valuing and accounting economic activity in the world´s biggest economy follow US GAAP. IFRS and US GAAP are in a definite process of convergence (2012).
2. Some academics who write research papers and books about hyperinflation.

The millions of accountants in the world economy implementing IFRS follow the IASB´s definition of hyperinflation, namely:

‘Hyperinflation is indicated by characteristics of the economic environment of a country which include, but are not limited to, the following:

(e) the cumulative inflation rate over three years is approaching, or exceeds, 100%.’

IAS 29 Par. 3 (e)

The above is the widely-accepted definition of hyperinflation since 1 April 1989, the date IAS 29 Financial Reporting in Hyperinflationary Economies was authorized by the IASB.

Some academics follow Philip Cagan´s definition of hyperinflation which has never been implemented in practice in any company or country since 1 April 1989:

´A price-level increase of at least 50% per month.´ (Cagan 1956)

The IASB´s definition is the generally accepted definition:

(1) as a result of its current (2012) worldwide acceptance

(2) and practical application as from 1989 and

(3) due to the fact that Cagan´s definition has never been implemented in practice in any company or country since that date

(4) and would almost certainly not be implemented in practice in a company or country in the future because of

(a) the wide acceptance of the IASB definition and

(b) the devastating effect of hyperinflation in only the monetary economy and the equally devastating effect of the stable measuring unit assumption in only the constant item economy during hyperinflation: no country in the world would currently (2012) wait for hyperinflation of 50 per cent per month before declaring that the country is in hyperinflation and taking preventative actions: the IASB´s definition would be followed.

The US government, the Federal Reserve Bank, the US Financial Accounting Standards Board  and the Securities Exhange Commission would almost certainly not apply Cagan´s definition if hyperinflation should ever come about in the US economy (extremely unlikely). They would apply the IASB´s definition. US GAAP and IFRS are in convergence (2012).

The Argentinean Accounting Federation (2010) and I (2012) suggested preventative actions to the IASB at 10 per cent annual inflation or 26 per cent cumulative inflation over three years. The 10 and 26 per cent limits, however, do not relate to hyperinflation: they relate to high inflation. The IASB has unanimously voted to submit these suggestions regarding the replacement of IAS 29 to research (2012).

Thus the IASB´s widely-accepted definition of hyperinflation is the following in 2012:

Hyperinflation is indicated when the cumulative inflation rate over three years is approaching, or exceeds, 100 per cent.

Steve Hanke and Nicholas Krus use Cagan´s definition in their latest research paper World Hyperinflations.

The IASB’s definition - despite the use of the term ‘approaching’- has resulted, in practice, in a generally accepted precisely defined limit as from when an economy enters into hyperinflation: cumulative inflation equal to 100 per cent over three years.

The term ‘approaching’ makes it appear vague. However, what happened in practice since 1989 resulted in the IASB´s definition now (2012) being widely accepted by millions of accountants in the world economy, namely that an economy enters into hyperinflation at 100 per cent cumulative inflation over three years as happened in the case of Venezuela in 2009.

It appears vague because of the term ‘approaching’. However, in practice, it is strictly applied as hyperinflation coming into effect at 100 per cent cumulative inflation over three years. Its actual application is thus not vague: hyperinflation is, in practice, confirmed in companies and countries, only at 100 per cent cumulative inflation over three years. See hyperinflation in Venezuela in 2009.

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

TIPS would eventually increase in real value during deflation

TIPS would eventually increase in real value during deflation

The statement

“When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater,”

has the following results:

During inflation in the US

TIPS principal’s nominal value increases with inflation: its real value is thus maintained constant.

During initial deflation in the US with the adjusted (decreased) principal still greater than the original principal

TIPS principal’s nominal value decreases with deflation: its real value would thus be maintained constant during the initial period of deflation.

During subsequent deflation in the US with the adjusted principal less than the original principal

TIPS principal’s original nominal value would be maintained constant during subsequent deflation: its real value would thus increase during subsequent deflation. This would be a costly process for the US government.

UK, Canada and Japan

‘The UK, Canada and Japan, do not guarantee a minimum redemption price for their indexed issues.’

Comité de Normalisation Obligataire 2011: 15

The capital amounts of UK, Canadian and Japanese sovereign inflation-linked bonds would thus maintain their real values constant at all levels of inflation and deflation.

 

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Nicolaas Smith


Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

No net monetary losses and gains (in 100 years time)

No net monetary losses and gains (in 100 years time)

 

Constant Item Purchasing Power Accounting (CIPPA) is financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation as authorized by the IASB in IFRS in the original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] in terms of a Daily Consumer Price Index.

The stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power.

Perfect financial capital maintenance in units of constant purchasing power would thus mean the following:

The complete money supply in an economy would be inflation-indexed on a daily basis in terms of the Daily Consumer Price Index with financial capital maintenance in units of constant purchasing power also in terms of a Daily CPI, both with complete co-ordination (everyone doing it).

This would result in no net monetary losses and gains in the entire economy: no cost of inflation. There would still be inflation in the monetary unit but there will be no cost of inflation: all monetary items would be inflation-indexed daily in terms of the Daily CPI in the entire economy.

Why?

Because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power as authorized in IFRS.

There would also be no constant items losses and gains under perfect financial capital maintenance in units of constant purchasing power with complete co-ordination.

Perfect financial capital maintenance in units of constant purchasing power during low inflation would take at least 100 years to come about even in one economy let alone in the world economy.

I implemented a form of financial capital maintenance in units of constant purchasing power in 1996 in Auto-Sueco (Angola) when I implemented accounting-dollarization in terms of the daily US Dollar parallel rate in that company during hyperinflation in Angola.

Brazil also implemented a form of financial capital maintenance in units of constant purchasing power during 30 years of very high and hyperinflation from 1964 to 1994 in terms of their government-supplied Unidade Real de Valor daily index. Brazil then went back to financial capital maintenance in nominal monetary units implementing the stable measuring unit assumption as it forms part of traditional Historical Cost Accounting in 1994 when they introduzed their current Real currency.

A form of financial capital maintenance in units of constant purchasing power was also implemented in Chile from 1967 until 2008 in terms of their Unidad de Fomento, which is a monetized daily indexed unit of account published daily since 1977.  That form of financial capital maintenance in units of constant purchasing power was stopped in Chile when “correción monetaria” was stopped in 2008 ‘to comply with IFRS’. Chile now implements financial capital maintenance in nominal monetary units (HCA) ‘to comply with IFRS’. Chile did not realize in 2008 that financial capital maintenance in units of constant purchasing power had already been authorized in IFRS in 1989.

Chile currently (2012) inflation-indexes 20 to 25 per cent of the country´s entire broad M3 money supply on a daily basis in terms of their Unidad de Fomento according to the Banco Central de Chile.They started this process at a much lower scale in 1967.

More than USD 3.5 trillion in government inflation-indexed bonds are currently (2012) being inflation indexed daily in most countries in the world economy in terms of country specific Daily CPIs.

Financial capital maintenance in units of constant purchasing power during low inflation and deflation was authorized in April 1989 in the original Framework (1989), Par. 104 (a).

We will be very lucky if even just financial capital maintenance in units of constant purchasing power in terms of a Daily CPI during low inflation without complete inflation-indexing of the entire money supply is implemented on a national basis in one complete economy by April 2089.

This will happen during low inflation some time in the future. No-one knows when.

Welcome on the long journey to perfect financial capital maintenance in units of constant purchasing power in terms of a Daily CPI during low inflation and deflation in 100 years time.

Nicolaas Smith

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Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Lonmin miners´ vote of no confidence in the SA Reserve Bank

Lonmin miners´ vote of no confidence in the SA Reserve Bank

During hyperinflation members of the public generally spontaneously start using the US Dollar as a relatively stable unit of account because their own local hyperinflationary currency loses real value at a very rapid rate. They start pricing everything in terms of the US Dollar.

SA has never been in hyperinflation in the past. It is not in hyperinflation at the moment (2012).
However, during the mine unrest at the Lonmin mine at Marikana near Rustenburg in South Africa, the miners stated on CNN that they wanted an increase to USD 1500 per month.

The SA Reserve Bank´s definition of price stability is stated in an inflation target of three to six per cent per annum. The SA Reserve Bank thus defines prices in South Africa increasing at six per cent per annum as being “stable”. The SARB would state that “price stability is being maintained” at inflation at six per cent per annum.

The miners are not economists, but they have a better sense of what is price stability in practice than the SARB.

Contrary to the SARB the miners obviously do not regard SA prices increasing at six per cent per annum as representing “price stability”. They use the US Dollar as a relatively stable unit of account, not the SA Rand. It is a clear vote of no confidence in the SA Reserve Bank´s monetary policies.

The SARB´s Monetary Policy Committee would now state as it stated in past: “The MPC remains fully committed to its mandate of achieving and maintaining price stability”. Six per cent annual inflation is actually “achieving and maintaining price stability” as far as the SARB is concerned. The miners clearly disagree with the SARB.

The Lonmin miners are good practical economists and I am sure they are good miners too.

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Nicolaas Smith Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Purchasing power of capital has to be maintained

Purchasing power of capital has to be maintained

“It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.”

FAS 33

Not a single company in the world economy knows whether it has maintained the purchasing power of its capital over the lifetime of the company.

Financial capital maintenance in units of constant purchasing power in terms of a Daily Consumer Price Index (i.e., Constant Item Purchasing Power Accounting) would automatically  maintain the constant purchasing power of capital constant for an indefinite period of time in all companies that at least break even in real value – ceteris paribus.

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Nicolaas Smith Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Practical result of abolishing the stable measuring unit assumption

Practical result of abolishing the stable measuring unit assumption

In practice abolishing the stable measuring unit assumption, i.e. correctly accepting and implementing the proven fact that money (the monetary medium of exchange) is never perfectly stable under inflation and deflation within and economy will mean that financial statements as prepared at a specific date (e.g. the year end) will only be valid when consulted on that specific date, i.e. the year end date. When the financial statements are consulted after that date, all values at the stated historical date will be updated in terms the current, i.e. today´s, Daily CPI: the date on which the financial statements are consulted. The amounts of the items stated at the date the financial statements were prepared shall then be historical reference amounts (not values – value can only be perceived in terms of current value, i.e. today´s Daily CPI) as at the date of the financial statements and the Daily CPI at that date always to be updated in terms of the Daily CPI to the current, i.e. today´s, date thereafter.

In digital financial statements the amounts at the date of the financial statements will only be visible as part of the financial statements on that date. Thereafter they will never be part of the financial statements again to be seen as original fixed nominal historical amounts. They will be in memory (and on all original dated hard copy documents) at that date with a historical amount (not value – value can only be perceived in terms of current value, i.e. today´s Daily CPI) and the Daily CPI at that date. When consulted at any time after that date the original historical fixed nominal amounts of their real values measured in terms of the Daily CPI at the historical date will always be updated in terms of the current, i.e. today´s, Daily CPI.

During inflation their real values will remain the same for an indefinite period of time, but their nominal values will generally increase daily in terms of the Daily CPI.

During deflation their real values will remain the same for an indefinite period of time, but their nominal values will generally decrease daily in terms of the Daily CPI.

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Nicolaas Smith Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Measurement of inventories under financial capital maintenance in units of constant purchasing power

Measurement of inventories under financial capital maintenance in units of constant purchasing power

The difference between financial capital maitenance in nominal monetary units (traditional Historical Cost Accounting) and financial capital maintenance in unit of constant purchasing power, i.e. Constant Item Purchasing Power Accounting (CIPPA), is that the stable measuring units assumption is always implemented under HCA but is never implemented under CIPPA.

The fact that the real value of money (and thus the monetary medium of exchange) was and is never perfectly stable on a sustainable basis within an economy during inflation and deflation is reflected in an entity in the way the three basic economic items, i.e., monetary, variable and constant items, are measured /valued  (for example variable items in terms of daily fair value and constant items in terms of daily constant purchasing power) over time under financial capital maintenance in units of constant purchasing power.

The reason for and the advantage of financial capital maintenance in units of constant purchasing power in terms of a Daily CPI is the fact that the constant purchasing power of equity (capital) is automatically maintained 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.

Everything is done (and accounted daily) and all historical financial information is stated at the current, i.e. today´s, real value which generally changes every day. The concept of a nominal Historical Cost or a nominal historical value is abolished because the stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power. Tomorrow today´s real values will be historical reference amounts and must be valued (measured) at tomorrow´s real value, e.g. tomorrow´s market price, Daily Consumer Price Index, etc.

Financial capital maintenance in units of constant purchasing power is authorized in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) and includes Historical Cost as a measurement basis, but excludes the stable measuring unit assumption.

Since both financial capital maintenance in units of constant purchasing power (CIPPA) as well as financial capital maintenance in nominal monetary units (HCA) are authorized in the Conceptual Framework (2010), Par. 4.59 (a) it means that IFRS are implemented under two paradigms, namely the HC paradigm and the Constant Item Purchasing Power paradigm.

IAS 2 Inventories, Par. 9 Measurement of Inventories states:

‘Inventories shall be measured at the lower of cost and net realisable value.’

An inventory item measured at Historical Cost in terms of IAS 2 shall be measured in terms of the current, i.e. today´s, Daily Consumer Price Index and continuously updated day after day thereafter because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power.

Par. 10 Cost of Inventories states:

‘The cost of inventories shall comprise all costs of purchases, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.’

All historical costs of purchases, historical costs of conversion and other historical costs incurred in bringing the inventories to their present location and condition shall be measured in terms of the current, i.e. today´s, Daily Consumer Price Index and continuously updated day after day thereafter because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power.

Par. 23 Cost Formulas states:

‘The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.’

The above individual historical costs shall be measured in terms of the current, i.e. today´s, Daily Consumer Price Index and continuously updated day after day thereafter because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power.

Par. 25 states:

‘The cost of inventories, other than those dealt with in paragraph 23, shall be assigned by using the first-in, firts-out (FIFO) or weighted average cost formula.’

The cost of inventories, other than those dealt with in IAS 2, paragraph 23, assigned using the first-in, firts-out (FIFO) or weighted average cost formula shall be measured in terms of the current, i.e. today´s, Daily Consumer Price Index and continuously updated day after day thereafter because the stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power.

Par. 34 Recognition as an expense states:

‘When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised.’

When inventories are sold, the carrying amount of those inventories shall be measured in terms of the current, i.e. today´s, Daily Consumer Price Index and continuously updated day after day thereafter and shall be recognised as an expense in the period in which the related revenue is recognised because the stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power.

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What to do with the world´s accumulated Historical Cost Accounting loss

What to do with the world´s accumulated Historical Cost Accounting loss

Entities preparing their financial statements based on the historical cost basis generally do not know whether they have maintained the constant purchasing power of their equity constant over time.

The test would be to measure every item in current equity in units of constant purchasing power as from the date each item was contributed or came about over the entity´s lifetime and then to compare that total value with the company´s current net asset value measured in real value, i.e. no item in current net assets to be stated at historical cost, but at fair value.

This would be required to be done by an entity adopting financial capital maintenance in unit of constant purchasing power as authorized in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) instead of financial capital maintenance in units of nominal monetary units, the traditional HCA model.

In most entities this would result in an enormous accumulated Historical Cost Accounting loss to be accounted as part of equity.

The net effect would be an enomous increase in the nominal value of equity (measured in units of constant purchasing power over the entity´s lifetime to date) together with and enormous accumulated Historical Cost Accounting loss, but resulting in the same current net equity real value being equal to the current real value of net assets before and after the above calcultions are made.

It is thus advisable to rather simply value current net assets in real value and state that as the constant real value of current equity to be maintained constant as from here on foreward by means of financial capital maintenance in units of constant purchasing power.

It is very doubtful that tax authorities would accept the sudden calculation of enormous accumulated Historical Cost Accounting losses which would represent the erosion of equity by the stable measuring unit assumption (HCA) over the lifetime of the entity to date under the Historical Cost paradigm.

In countries which allow the write-off of profits against accumulated losses over five years, for example, it would mean that no taxes would be paid by entities over the next five years in the case of an entire country adopting financial capital maintenance in units of constant purchasing power as from the same date. No country would accept not receiving any taxes from the corporate sector for five years.

This could be overcome in two ways:

1. The accumulated HCA loss not being allowed for tax purposes. It would thus remain on entities´ balance sheets over many years till it is written off against future profits. The net constant real value of equity would be correct and be maintained constant correctly by means of financial capital maintenance in units of constant purchasing power. This option would be costly in terms of accounting time spent on the calculations. It would reveal the real cost today of having implemented HCA over the lifetime of an entity.
2. Do not value past additions to equity in units of constant purchasing power and do not calculate the current HCA accumualted loss. Value current equity at the real value of current net assets and implement financial capital maintenance in units of constant purchasing as from the current date foreward. This option would have no extra costs, but would hide the accumulated cost of having implemented the HCA model over the lifetime of the entiy.

The second option is obviously the better choice.

So, the answer to the question: what to do about the world´s accumulated HCA loss is: just ignore it J in time-honoured accounting fashion.

However, it is actually required to stop the hundreds of billions of US Dollars (2012) in real value eroded each and every year by the implementation of the stable measuring unit assumption (HCA) in the world´s constant item economy during inflation and hyperinflation.

I do realize that may only happen a hunderd or more years from now (2012). Individual companies (even countries) are free to start anytime they like. It was authorized in IFRS in 1989.

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Unacceptable items in IFRS

Unacceptable items in IFRS

1. IAS 29 Financial Reporting in Hyperinflationary Economies.

It was duely implemented in Zimbabwe for at least the last six years during hyperinflation in that country: it had zero effect in the Zimbabwean hyperinflationary economy during those six years.

2. The IASB definitions of monetary items in IAS 21 and IAS 29.

All items paid or received in money are not monetary items. All economic items – monetary and non-monetary items – are generally paid or received in money as the monetary medium of exchange. A non-monetary item always paid or received in money does not transform that non-monetary item into a monetary item. It remains a non-monetary item always paid or received in money, e.g., salaries and wages.

3. The exclusion of measurement in units of constant purchasing from the FASB´s  and IASB´s joint list of possible basic measurement bases.

Measurement in units of constant purchasing power is a basic measurement basis continously applied in the world economy. Salaries, wages, rentals and many other items are generally measured in units of constant purchasing power on an annual basis in most of the world economy.

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BASIC MEASUREMENT BASES

Monetary items

1. Measurement in terms of the general price level index.

This requires the calculation and accounting of net monetary losses and gains only as long as the stable measuring unit assumption (HCA) is mistakenly still being applied. It is an absolute fact that the monetary unit of measure is not perfectly stable.

Variable real value non-monetary items

2. Fair value and related bases excluding the stable measuring unit assumpiton as stated in the FASB and IASB list (below) of nine measurement bases.

Constant real value non-monetary items

      3. Units of constant purchasing power.

The following is the FASB and IASB list of basic measurement bases which mainly apply to variable items:

“Measurement Bases

“The Boards agreed to the following set of nine measurement basis candidates:

1. Past entry price

2. Past exit price

3. Modified past amount

4. Current entry price

5. Current exit price

6. Current equilibrium price

7. Value in use

8. Future entry price

9. Future exit price.”

It can be seen from the above FASB and IASB list that neither

(i)                  measurement (of monetary items) in terms of a general price level index nor

(ii)                 measurement (of constant items) in units of constant purchasing power

are considered by either the FASB or the IASB as possible basic measurement bases.

The IASB does, however, require the calculation of net monetary losses and gains only during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies.

The inexplicable omission of these two basic measurement bases is obviously a mistake on the part of the FASB and IASB.

Most salaries and wages and tens of thousands of other items have been and are currently measured in units of constant purchasing power on an annual basis in the world economy during at least the last 100 years.

It is impossible to explain how units of constant purchasing power can be omitted by both the FASB and IASB as a basic measurement basis.

The only possible explanation is to state that to err is human.

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Measurement in units of constant purchasing power excluded from IASB and FASB measurement bases list

Measurement in units of constant purchasing power excluded from IASB and FASB measurement bases list

The FASB and IASB spent several years discussing measurement around the world during the Measurement Chapter of their Joint Conceptual Framework Project.

After several years of discussions around the world they published the following joint list of possible basic measurement bases:

MeasurementBases

"The Boards agreed to the following set of nine measurement basis candidates:

1. Past entry price

2. Past exit price

3. Modified past amount

4. Current entry price

5. Current exit price

6. Current equilibrium price

7. Value in use

8. Future entry price

9. Future exit price.”

It can be seen from the above FASB and IASB list that neither

(i)                  measurement (of monetary items) in terms of the Daily Consumer Price Index nor

(ii)                 measurement in units of constant purchasing power

are considered by both the FASB and the IASB as possible basic measurement bases to be included on their list.

Measurement in units of constant purchasing power is thus currently (2012) excluded as a possible basic measurement basis by both the FASB and IASB.

It is to be noted that financial capital maintenance in units of constant purchasing power as an alternative to HCA (see above) automatically maintains the existing constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value – ceteris paribus – at all levels of inflation and deflation.

The omission of measurement in units of constant purchasing power from the FASB´s and IASB´s joint list of possible basic measurement bases is thus noted with concern. It is difficult to come up with a plausible explanation why both the FASB and the IASB exclude measurement in units of constant purchasing power as a possible basic measurement basis.

The fact that financial capital maintenance in units of constant purchasing power is authorized in IFRS in the Framework since 1989 would normally result in it automatically being included in a list of possible basic measurement bases. However, after several years of international discussion both the FASB and IASB do not regard measurement in units of constant purchasing power as a possible basic measurement basis.

A healthy and robust discussion and publication of different viewpoints and research are good for the ongoing development of the understanding of the basic concepts of accounting / financial reporting at the FASB, IASB and elsewhere.

However, excluding measurement in units of constant purhasing power from the current (2012) list of possible basic measurement bases is not compatible with the development of high quality international accounting standards.

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Nicolaas Smith

Copyright (c) 2012 Nicolaas Johannes Smith. All rights reserved. No reproduction without permission.

FORGET INFLATION!?

FORGET INFLATION!?

MONETARY ITEMS

Definition

Monetary items are units of local currency held and items with an underlying monetary nature being substitutes of the former.

MEASUREMENT BASIS

The measurement basis used to measure monetary items over time under financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) is the following:

Measurement in terms of the Daily Consumer Price Index.

This requires the calculation and accounting of net monetary losses and gains only while third party entities you deal with still implement Historical Cost Accounting and apply the stable measuring unit assumption.

ADVANTAGE OF DAILY INFLATION-ADJUSTMENT OF ALL MONETARY ITEMS

Inflation-adjustment on a daily basis of the entire money supply under full co-ordination will eliminate the entire cost of inflation (not actual inflation) from the entire economy. In practice (maybe in 100 years´ time) this will result in no-one being concerned about the actual rate of inflation since monetary item balances will maintain their real values over time.

Chile currently (2012) inflation-adjusts 20 to 25 per cent of its entire broad M3 money supply on a daily basis in terms of their Unidad de Fomento which is a monetized daily indexed unit of account used in the country since 1967 according to the Central Bank of Chile.

At least USD 3 trillion is currently (2012) being inflation-adjusted on a daily basis in terms of country-specific Daily Consumer Price Indices in the world economy. USD 798 billion is today (29-07-2012)  being inflation-adjusted on a daily basis in terms of the US Daily CPI in the US economy.

Yes, under complete inflation-adjustment of the entire money supply with complete co-ordination (everyone doing it) we can forget about inflation. Unfortunately that may only happen in 100 years´ time.

We are still a long way away from that. However, I have no doubt that it will happen one day.

We had a form of it in Angola in 1996 in Auto-Sueco (Angola), the company where I worked. We had it during hyperinflation of 3200 per cent per annum because I implemented accounting-dollarization as from 1 January 1996 in the company. We updated all our trade debtors, new car, new truck, spare parts prices and workshop service rates daily in term of the daily US Dollar black market or parallel rate.

We stopped our fear of hyperinflation with daily updating of all non-monetary items.

Low inflation countries can do the same with daily inflation-adjusting the entire money supply and the implementation of financial capital maintenance in units of constant purchasing power in terms of a Daily CPI as authorized in IFRS.

This will take a very long time to come about, but I am sure we will all eventually do it.

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IASB unanimously support a research programme on financial reporting in high-inflation and hyperinflationary economies

IASB unanimously support a research programme on financial reporting in high-inflation and hyperinflationary economies

At its May 2012 meeting the International Accounting Standards Board unanimously supported initiating a research programme focusing initially on, amongst other items, financial reporting in high-inflation and hyperinflationary economies.

This is an important decision as far as financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting which is implemented   at all levels of inflation and deflation) is concerned.

In the 2011 Agenda Consultation comment letter request document the IASB stated the following:

‘Inflation accounting (revisions to IAS 29 Financial Reporting in Hyperinflationary Economies)

IAS 29 provides guidance on the preparation of financial statements in a functional currency that is suffering from hyperinflation.  Concerns have been raised from some countries whose economies suffer from high inflation, but which are not hyperinflationary. Those concerns are that the effects of high inflation on an entity’s financial results are not adequately reflected in IFRS financial statements. A research paper was prepared on this issue and submitted to the IASB by the Federación Argentina de Consejos Profesionales de Ciencias Económicas. A future project could use this research paper to consider revisions to IAS 29 to include guidance for entities whose functional currency is that of an economy subject to high inflation, but not to hyperinflation.’

The Federación Argentina de Consejos Profesionales de Ciencias Económicas submitted a research report to the IASB in 2010 entitled IFRS ‘X’ INFLATION.  The IASB made the FACPCE´s reseach report available to me on my request.

In an unsolicited comment letter in Jan 2012 I pointed out to the IASB that inflation has no effect on the real value of non-monetary items and I comprehensively amended the FACPCE´s proposal to IFRS ‘X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER.

Both IFRS X’ INFLATION and the amended version IFRS ‘X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER are available in full in the ebook CONSTANT ITEM PURCHASING POWER ACCOUNTING per IFRS here.

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.