Example of Daily versus monthly CPI under IAS 29

Example of Daily versus monthly CPI under IAS 29

The following are data showing a derived monthly CPI and Daily CPI for Zimbabwe from 1 November 2007 till 31 December 2007 based on actual monthly inflation percentages. Only the monthly inflation information is actual data from the Central Bank of Zimbabwe. The rest are all theoretically derived data.

Application of IAS 29 and CMUCPP using data from Zimbabwe
Monthly inflation rates reported by the CB of Zimbabwe from Mar 2007 till July 2008 (Steve Hanke article)
Date	Derived relatively stable foreign curreny rate	Mnthly	Derived Monthly CPI on month-end
	ZimDollars per 1 US Dollar	Inflation %	URV based Daily Index on other days
	Zim$/USD rate based on derived CPI		Month-end Daily Index assumed = CPI
01/nov/07	43,8769		4 387,69
02/nov/07	45,7184		4 571,84
03/nov/07	47,5598		4 755,98
04/nov/07	49,4012		4 940,12
05/nov/07	51,2427		5 124,27
06/nov/07	53,0841		5 308,41
07/nov/07	54,9256		5 492,56
08/nov/07	56,7670		5 676,70
09/nov/07	58,6084		5 860,84
10/nov/07	60,4499		6 044,99
11/nov/07	62,2913		6 229,13
12/nov/07	64,1327		6 413,27
13/nov/07	65,9742		6 597,42
14/nov/07	67,8156		6 781,56
15/nov/07	69,6570		6 965,70
16/nov/07	71,4985		7 149,85
17/nov/07	73,3399		7 333,99
18/nov/07	75,1813		7 518,13
19/nov/07	77,0228		7 702,28
20/nov/07	78,8642		7 886,42
21/nov/07	80,7056		8 070,56
22/nov/07	82,5471		8 254,71
23/nov/07	84,3885		8 438,85
24/nov/07	86,2300		8 623,00
25/nov/07	88,0714		8 807,14
26/nov/07	89,9128		8 991,28
27/nov/07	91,7543		9 175,43
28/nov/07	93,5957		9 359,57
29/nov/07	95,4371		9 543,71
30/nov/07	97,2786	131,42	9 727,86
01/dez/07	104,8117		10 481,17
02/dez/07	112,3448		11 234,48
03/dez/07	119,8779		11 987,79
04/dez/07	127,4111		12 741,11
05/dez/07	134,9442		13 494,42
06/dez/07	142,4773		14 247,73
07/dez/07	150,0105		15 001,05
08/dez/07	157,5436		15 754,36
09/dez/07	165,0767		16 507,67
10/dez/07	172,6098		17 260,98
11/dez/07	180,1430		18 014,30
12/dez/07	187,6761		18 767,61
13/dez/07	195,2092		19 520,92
14/dez/07	202,7423		20 274,23
15/dez/07	210,2755		21 027,55
16/dez/07	217,8086		21 780,86
17/dez/07	225,3417		22 534,17
18/dez/07	232,8749		23 287,49
19/dez/07	240,4080		24 040,80
20/dez/07	247,9411		24 794,11
21/dez/07	255,4742		25 547,42
22/dez/07	263,0074		26 300,74
23/dez/07	270,5405		27 054,05
24/dez/07	278,0736		27 807,36
25/dez/07	285,6067		28 560,67
26/dez/07	293,1399		29 313,99
27/dez/07	300,6730		30 067,30
28/dez/07	308,2061		30 820,61
29/dez/07	315,7392		31 573,92
30/dez/07	323,2724		32 327,24
31/dez/07	330,8055	240,06	33 080,55

                                                                                                                                     

 

Example

Zimbabwean company formed on 1 November 2007 with USD 1000 in capital invested on day one in stock and sold on day one with a 300 percent markup. IAS 29 applied in terms of the monthly CPI and the Daily CPI.

						Hist Cost
Date		Dr			Cr	Dr	Cr
		USD			USD	Zim$	Zim$
1/11/07	Capital				1000		43 877
1/11/07	Stock	1000				43 877
1/11/07	Bank		4000			175 508
1/11/07	Sales				4000		175 508
30/11/07
31/12/07	P+L – CoS		1000			43 877
31/12/07	Stock				1000		43 877
31/12/07	Sale		4000			175 508
31/12/07	P+L – Sales				4000		175 508
31/12/07	Net Monetary Loss		-		-	-	-
31/12/07	P+L - Net Mon Loss		-		-	-	-
31/12/07	Net Monetary Loss		-		-	-	-
31/12/07	Ret Profit/Loss				3000		131 631
31/12/07	P+L - Ret Profit/Loss		3000
					Profit		Profit

 

 

				IAS 29 with monthly CPI
Date	Daily CPI	Z$/USD		Conv	Dr	Cr
	Derived	Derived		Factor	Zim$	Zim$
1/11/07	4 387,69	43,8769	Capital	3,40		149 208
1/11/07	4 387,69	43,8769	Stock	3,40	149 208
1/11/07	4 387,69	43,8769	Bank	1,00	175 508
1/11/07	4 387,69	43,8769	Sales	3,40		596 831
30/11/07	9 727,86	97,2786		3,40
31/12/07	33 080,55	330,8055	P+L – CoS	3,40	149 208
31/12/07	33 080,55	330,8055	Stock	3,40		149 208
31/12/07	33 080,55	330,8055	Sales	3,40	596 831
31/12/07	33 080,55	330,8055	P+L - Sales	3,40		596 831
31/12/07	33 080,55	330,8055	Net Monetary Loss		421 322
31/12/07	33 080,55	330,8055	P+L - Net Mon Loss		421 322
31/12/07	33 080,55	330,8055	Net Monetary Loss			421 322
31/12/07	33 080,55	330,8055	Ret Profit/Loss			26 301
31/12/07	33 080,55	330,8055	P+L - Ret Profit/Loss		26 301
					1 939 700	1 939 700
						Profit

 

 

				IAS 29 with Daily CPI
Date	Daily CPI	Z$/USD		Conv	Dr	Cr
	Derived	Derived		Factor	Zim$	Zim$
1/11/07	4 387,69	43,8769	Capital	7,54		330 806
1/11/07	4 387,69	43,8769	Stock	7,54	330 806
1/11/07	4 387,69	43,8769	Bank	1,00	175 508
1/11/07	4 387,69	43,8769	Sales	7,54		1 323 222
30/11/07	9 727,86	97,2786
31/12/07	33 080,55	330,8055	P+L - CoS	7,54	330 806
31/12/07	33 080,55	330,8055	Stock	7,54		330 806
31/12/07	33 080,55	330,8055	Sales	7,54	1 323 222
31/12/07	33 080,55	330,8055	P+L - Sales	7,54		1 323 222
31/12/07	33 080,55	330,8055	Net Monetary Loss	7,54	1 147 714
31/12/07	33 080,55	330,8055	P+L - Net Mon Loss	7,54	1 147 714
31/12/07	33 080,55	330,8055	Net Monetary Loss	7,54		1 147 714
31/12/07	33 080,55	330,8055	Ret Profit/Loss		155 298
31/12/07	33 080,55	330,8055	P+L - Ret Profit/Loss			155 298
					4 611 067	4 611 067
					Loss

 

From the above examples we can see that the results under IAS 29 with a Daily CPI is different from IAS 29 with the monthly CPI. The Daily CPI data show what really happened.

When all sales are for cash, net equity will be the same under both the monthly and Daily CPI. This is only the case when all sales are only for cash.

Under IAS 29 applying HC principles, sales for cash and on credit would have the same result. Debtors are monetary items under HCA and as IAS 29 is implemented. Not under CMUCPP in terms of a Daily CPI. Debtors are constant real value non-monetary items under CMUCPP since they are always linked to non-monetary items and the result would be the same as in USD: no loss at all in the real value of Debtors, i.e., no Net Constant Purchasing Power Loss that is calculated in the same way as the Net Monetary Loss. Profit would be better than in USD. Ideal CMUCPP results in zero erosion of real value, i.e., the same as under zero inflation. There is still erosion of real value in USD since USD accounts assumes the low inflation in the USD does not exist, i.e., the HC stable measuring unit assumption is applied.

Ideal CMUCPP in terms of a Daily Index would result in actual zero erosion of real value in all entities that at least break even in real value – ceteris paribus – at all levels of inflation and deflation.

 

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Only Daily CPI maintains equity as well as current year results

Only Daily CPI maintains equity as well as current year results

IAS 29 requires entities in hyperinflationary economies to restate HC or CC financial statements in terms of the measuring unit current at the end of the reporting period. IAS 29 does not prescribe the use of the monthly published CPI for this purpose. It simply requires restatement in terms of a general price index. The Daily CPI is based on the monthly published CPI, i.e., the general price index. IAS 29 has, however, been implemented since its authorization in 1989 in terms of the monthly published CPI. In this way IAS 29 has been implementing an imperfect form of Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) since current year results are not fully maintained when the monthly published CPI is used. IAS 29 in terms of the monthly CPI can also have absolutely no effect in a hyperinflationary country. That is what happened in Zimbabwe where IAS 29 was implemented for the last 8 years of hyperinflation with no positive effect at all.

Brazil implemented CMUCPP in the form of indexation (monetary correction) in terms of a government supplied daily index from 1964 till 1994. Price-level restatement in terms of a daily index was widely used in Latin America during that period. Brazil did not use IAS 29. Zimbabwe used IAS 29. The result during hyperinflation in the two countries are very well known. Only the IASB refuses to admit that IAS 29 had no positive effect in Zimbabwe. Everyone else has the common sense to realize it. The IASB claims that they first have to have a formal review about what happened before they can form an opinion about the effect of IAS 29 in Zimbabwe.

The IASB does not understand the effect of CMUCPP in terms of a daily index. Basically, the IASB does not understand CMUCPP as implied in IAS 29. In January 2013 an IASB staff paper stated:

"10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units."

IAS 29 prescribes how to restate HC or CC financial statements in terms of the measuring unit current at the end of the reporting period.

Only the IASB does not understand that as stated above. PricewaterhouseCoopers, the World Bank and other Big Four audit companies published papers on how IAS 29 gives guidance on how to restate financial statements in terms of the measuring unit current at the end of the reporting period.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Standard setting institutions (the IASB) are highly politicised

THE PROBLEM WITH ACCOUNTING RESEARCH 

Accounting academics remain disconnected from standards setting, which weakens accounting frameworks.

Problem solving in accounting has, as a result, mainly been left to standard-setting institutions, not universities - in environments that are typically highly politicised and in which academic freedom is conspicuous only for its absence.

Prof Mark Bunting
Rhodes University

The problem with accounting research,  Accountancy SA, May 2013, p 15

IAS 29 Financial Reporting in Hyperinflationary Economies - Reporting according to IFRSs after a period of chronic hyperinflation.

IAS 29 Financial Reporting in Hyperinflationary Economies - Reporting according to IFRSs after a period of chronic hyperinflation.

IFRS Foundation

The Applicability of IAS 29 to financial statements prepared under the concept of financial capital maintenance in constant purchasing power units.

The Applicability of IAS 29 to financial statements prepared under the concept of financial capital maintenance in constant purchasing power units.

The above IFRS Staff Paper contains 16 mistakes which I pointed out to the IASB over here.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

What is the Significance of Generally Accepted Principles of Accounting?

What is the Significance of Generally Accepted Principles of Accounting?

Infoxin

Application of IAS 29

Application of IAS 29

World Bank

Daily CPI one step better than inflation targeting

Daily CPI one step better than inflation targeting

There are no surprises with the Daily CPI. The Daily CPI is always known in advance. The Daily CPI is thus one step better than inflation targeting: it is daily inflation known in advance.

Here are the links to the future daily inflation in the

US,

UK - Daily Reference RPI: Click on Index Ratio data for indexed linked gilts,

Chile (Unidad de Fomento or UF),

Colombia and

Iceland.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

CMUCPP used (not implemented) in low inflationary countries too

CMUCPP used (not implemented) in low inflationary countries too

CMUCPP was implemented in a number of countries, including Turkey, Russia and Zimbabwe during hyperinflation in terms of IAS 29 since 1990, the year of first implementation of the standard (IAS 29). CMUCPP is currently (2013) being implemented during hyperinflation in Venezuela and Belarus in terms of IAS 29. CMUCPP has been used since 1990  in terms of IAS 29 and is currently being used in terms of IAS 29 by multi-nationals with subsidiaries in hyperinflationary countries, in low inflationary countries too when they consolidated/consolidate the financial statements of these subsidiaries in their consolidated financial statements.
Nicolaas Smith Copyright

(c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Capital Maintenance in Units of Constant Purchasing Power is the only accounting model specifically prescribed in IFRS

Capital Maintenance in Units of Constant Purchasing Power is implied during hyperinflation in terms of IAS 29. Capital Maintenance in Units of Constant Purchasing Power, i.e., restatement required in IAS 29, is the only accounting model specifically prescribed in IFRS.

 ‘At the present time, it is not the intention of the Board to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy.’

Conceptual Framework (2010), Par. 4.65

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Different forms of Capital Maintenance in Units of Constant Purchasing Power

The following are all forms of Capital Maintenance in Units of Purchasing Power:

·         Indexation of non-monetary items (including equity) in countries with high or hyperinflation.

·         Monetary correction  of non-monetary items (including equity) in countries with high or hyperinflation.

·         Price-level accounting

·         Price-level restatement of non-monetary items (including equity) in countries with high or hyperinflation.

·         Restatement of Historical Cost or Current Cost financial statements in terms of the measuring unit current at the balance sheet date during hyperinflation (IAS 29).

None of the above would result in ideal Capital Maintenance in Units of Constant Purchasing Power with 100 percent of the constant purchasing power of equity and current year profits/losses maintained without the implementation of a daily index (e.g., the Daily CPI) which generally recognizes all changes in the general price level.

Updated on 13-05-2013
 

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Definition of Capital Maintenance in Units of Constant Purchasing Power

Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) is the maintenance of the constant purchasing power of capital - capital being equal to the real value of net assets - for an indefinite period of time at all levels of inflation and deflation in entities that at least break even in real value – ceteris paribus – in units of constant purchasing power in terms of an index that recognizes all  - normally daily - changes in the general price level.

Updated on 13-05-2013


Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Physical capital maintenance is very different from financial capital maintenance

Physical capital maintenance is very different from financial capital maintenance

Updated on 16-05-2016

In IFRS the Conceptual Framework (2010), Par. 4.59 (b) states the following:

 ‘Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.’

The (1) physical capital maintenance concept is a fundamentally (totally) different capital maintenance concept compared to the two financial capital maintenance concepts, namely (2) financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) and (3) financial capital maintenance in units of constant purchasing power in terms of a Daily CPI. The latter is authorised at all levels of inflation (including hyperinflation) and deflation in IFRS in 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" as an alternative to financial capital maintenance in nominal monetary units (i.e., as an alternative to HCA). 

Financial capital maintenance in units of constant purchasing power is required during hyperinflation in IAS 29 Financial Reporting in Hyperinflationary Economies. It has been implemented under IAS 29 in terms of the monthly published CPI which, unfortunately, does not result in any capital maintenance at all. 

In fact, IAS 29 in terms of the IASB promoted monthly published CPI was implemented for the final 8 years in Zimbabwe´s hyperinflationary economy (hyperinflation in Zimbabwe ended on 20 November 2008) with no positive effect at all, an irrefutable fact the IASB stubbornly refuses to admit. The IASB refuses point blank to research the very successful implementation of financial capital maintenance in units of constant purchasing power in terms of a Daily Index as it was very successfully done in Latin America from 1960 to 1994. The IASB very irresponsibly ignores the fact that daily indexing of all item in terms of all (at least daily) changes in the general price level eliminates the effect of inflation during inflation, the effect of hyperinflation during hyperinflation and the effect of deflation during deflation. 

The IASB also very irresponsibly refuses to update IAS 29 to require DAILY INDEXING in terms of the DAILY CPI although I have pointed out to them a number of times in various comment letters published on their website that the effect of hyperinflation in the entire economy during hyperinflation in the monetary unit is only eliminated (as it was very successfully done in Brazil in the 1990's) when a DAILY CPI is used and that the use of the monthly published CPI is a waste of time as was very clear with the ineffective use of IAS 29 during hyperinflation in Zimbabwe. 

Capital maintenance in units of constant purchasing power (not IAS 29) was widely implemented with great success in the form of DAILY monetary correction or DAILY indexation in Latin America from the early 1960´s to the mid 1990´s and carried on in Chile till 2008).

(1), (2) and (3) above are the three capital maintenance concepts authorised in IFRS.

The Conceptual Framework (2010), Par. 4.57 states:

‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.’

So, it is all about ‘units of output per day’. An entity must be using ‘units of output per day’ as the measurement basis to maintain its physical capital.

Physical capital maintenance is not just another way or an additional way of looking at or presenting the two financial capital maintenance concepts.

Actual physical capital maintenance is not widely used in any economy. Prof. Rachel Baskerville from Victoria University in New Zealand states in her paper ‘100 Questions and Answers about IFRS’, Question 39:

‘It is equally possible for a company to adopt a concept of physical capital; i.e. the cycle of operation moves from assets/goods to dollar to goods/assets. Some public sector entities consider that their stewardship responsibilities are best served by reporting physical capital maintenance; e.g., is the capacity of the waterworks, waste water system, etc. in the local town the same as, or better, than it was last year?

Some Key Performance Indicators (KPIs) will be chosen to report this.

The Framework states: ― ‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.”’

So: physical capital maintenance is not generally about ‘measurements currently reported in balance sheets’. Physical capital maintenance is not often used.

Financial capital maintenance in nominal monetary units (HCA) is the generally accepted accounting model worldwide. It is an option in IFRS: see the Conceptual Framework, Par. 4.59(a).

Financial capital maintenance in units of constant purchasing is REQUIRED during hyperinflation in terms of IAS 29. Unfortunately IAS 29 has been implemented since 1989 in terms of the monthly published CPI which makes it useless during hyperinflation. 

IAS 29 does not actually REQUIRE the use of the monthly published CPI. Companies simply used the monthly published CPI because the Daily CPI has never been used for accounting purposes on a national scale outside of Latin America. In Latin America the use of daily indexing also was not seen as being the implementation of an accounting model in terms of the Daily CPI. It was always seen as monetary correction, something required by the central bank, not an accounting requirement. 

IAS 29, Par. 8 requires the following: "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."

The Daily CPI is also a "measuring unit current at the end of the reporting period." The use of the Daily CPI when IAS 29 is implemented during hyperinflation is thus authorised in IFRS. Unfortunately no-one has implemented IAS 29 in terms of the Daily CPI yet because the IASB very irresponsibly refuses to point out to countries in hyperinflation that Daily indexing of all items would remove the effect of hyperinflation during hyperinflation and that it is authorised in IAS 29. Brazil used a type of Daily CPI during a number of years leading up to June 1994. They used their Unidade Real de Valor daily index which was based on the daily US Dollar exchange rate during hyperinflation. During those years they eliminated a great deal of the effect of hyperinflation during hyperinflation in their monetary unit by indexing most of the economy in terms of their daily index, namely the Unidade Real de Valor. 


Thus financial capital maintenance in units of constant purchasing is widely used in hyperinflationary economies. It (not IAS 29) was very widely used  - very successfully - from 1964 to 1994 in Latin America during high inflation as well as hyperinflation, but always in terms of a DAILY INDEX. That is why it was so successful in South America while IAS 29 in terms of the monthly published CPI had no positive effect at all during the 8 years it was implemented in Zimbabwe´s hyperinflationary economy. IAS 29 was a total disaster in Zimbabwe.

Physical capital maintenance is rarely used.

Update (16-05-2016)

Some respondents in their comment letters regarding the IASB´s Exposure Draft Conceptual Framework for Financial Reporting feel that a new Conceptual Framework should state that a physical capital maintenance concept will never be used. 

"Specific suggestions included that the Conceptual Framework should state that a financial concept of capital maintenance should be adopted, or that a physical capital maintenance concept will never be used."

Project Conceptual Framework 

Paper topic Feedback summary—Measurement and Capital Maintenance 

Par 65 (a), P 15

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation only affects monetary items in financial statements

Inflation only affects monetary items in financial statements

The statement The effects of inflation in financial statements is a very common statement in accounting literature, international accounting standard setting, central banking research and in accounting in general.

Inflation only affects the real value on monetary items and nothing else. Inflation has no effect on the real value of non-monetary items. The stable measuring unit assumption affects the real value of non-monetary items.

What is intended with the statement The effects of inflation in financial statements is to state: The effects of (1) inflation on monetary items and (2) the stable measuring unit assumption on non-monetary items in financial statements.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation-linked accounting unit draws big Money to Chile

Inflation-linked accounting unit draws big Money to Chile

Bloombergs

Not enough inflation

Not enough inflation

Paul Krugman

New York Times

Capital Maintenance in Units of Constant Purchasing Power is quite and old capital maintenance concept

Capital Maintenance in Units of Constant Purchasing Power is quite and old capital maintenance concept
 

A form of Capital Maintenance in Units of Constant Purchasing Power is implemented whenever capital (equity) is measured in units of constant purchasing power; i.e., whenever indexation or monetary correction or restatement is used. Indexation, under the name “monetary correction” was used mainly in Latin America from the early 1960´s till 2010 when Chile stopped monetary correction. It has been used in Venezuela in the form of IAS 29 from 2009 till the present (2013).

Indexation was not understood as an accounting model, which it, in fact, is. Brazil used measurement in units of constant purchasing power in the form of monetary correction in the form of a government supplied daily index from 1964 till 1994.

Chile used monetary correction (indexation or capital maintenance in units of constant purchasing power) from 1967 till 2010 in terms of their Unidad de Fomento. Chile stopped monetary correction in 2010 in order to conform with IFRS which is almost 100 per cent Historical Cost based during low inflation, high inflation and deflation. IFRS are Capital Maintenance in Units of Constant Purchasing Power based during hyperinflation. Chile did not and still does not understand and realize that they stopped Capital Maintenance in Units of Constant Purchasing Power in favour of Historical Cost Accounting in 2010.

 

Capital Maintenance in Units of Constant Purchasing Power was originally authorized in IFRS in the original Framework (1989), Par 104 (a) which states: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant of constant purchasing power? It is currently being implemented in Venezuela and Belarus. Capital Maintenance in Units of Constant Purchasing Power is implemented under IAS 29 in the form of restatement of HC or Current Cost financial statements at the measuring unit current at the end of the reporting period in terms of the monthly published CPI. Unfortunately this does not result in 100 per cent Capital Maintenance in Units of Constant Purchasing Power.

This would be remedied with the use of the generally available Daily CPI. No-one is currently using the Daily CPI for this purpose during hyperinflation or any other level of inflation or deflation. The use of a daily index to measure all non-monetary items and some monetary items in units of constant purchasing power was widely used in Latin American countries from 1964 till 2010.

The IASB regards the use of a daily index which resulted in Capital Maintenance in Units of Constant Purchasing Power in Latin America as irrelevant. The IASB is clueless about Capital Maintenance in Units of Constant Purchasing Power. Although it is required and gives particular guidance on how to prepare financial statements stated in constant purchasing power units in IAS 29, the IASB Staff Paper 20 for the IFRIC meeting on 22-23 January 2013 states:

"10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units."

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Definition of Capital Maintenance in Units of Constant Purchasing Power

Definition of Capital Maintenance in Units of Constant Purchasing Power

Updated on 3 May 2013

Capital Maintenance in Units of Constant Purchasing Power is the maintenance of the constant purchasing power of capital (equity) – with capital being equal to the real value of net assets – for an indefinite period of time at all levels of inflation (low inflation, high inflation and hyperinflation) and deflation in all entities that at least break even in real value – ceteris paribus – in units of constant purchasing power in terms of an index that recognizes all the changes (every change) in the general price level.

Capital Maintenance in Units of Constant Purchasing Power was originally authorised as an option to financial capital maintenance maintenance in nominal monetary units (the 3000 year old, generally accepted, globally implemented, traditional Historical Cost Accounting model) at all levels of inflation (low inflation, high inflation and hyperinflation) and deflation in IFRS in the original Framework (1989), Par 104 (a) which states ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

Capital Maintenance in Units of Constant Purchasing Power is required during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies (IFRS are principles-based standards: the requirement is implied/inferred in IAS 29). Unfortunately IAS 29 has been implemented in terms of the monthly published CPI since its authorization in 1989. This results in the destruction of part of the real value of current year profits by the implementation of the stable measuring unit assumption during the periods that the daily change in the general price level is being ignored under IAS 29 during hyperinflation (from the 1st of the month till the second last day of the month: the monthly CPI is the CPI valid on the last day of the month). [The implications of the difference in the value of the monthly publised CPI and the Daily CPI on the last day of the month need to be analysed]. There are at least 365 different price levels in the general price level during low inflation, high inflation, hyperinflation and deflation. IAS 29 is implemented recognizing only the 12 month-end CPIs during the year during hyperinflation.

Although Capital Maintenance in Units of Constant Purchasing Power is required during hyperinflation in terms of IAS 29,  it, unfortunately, does not result in 100 per cent Capital Maintenance in Units of Constant Purchasing Power during hyperinflation. This is remedied with the implementation of an index that recognizes all changes in the general price level during hyperinflation.

This can be done with (1) the use of the daily US Dollar or other relatively stable foreign currency parallel rate (where a daily parallel rate exists) or (2) a Brazilian-style URV-based daily index that was almost entirely made up of the US Dollar daily exchange rate (not a parallel rate) during hyperinflation or (3) the use of the Daily CPI at initial levels of hyperinflation.

The Daily CPI – available in all countries that issue government capital inflation-indexed bonds, i.e., in 90 per cent of the world economy – which is a lagged daily interpolation of the monthly published CPI, recognizes all changes in the general price level (when the monthly published CPI is recognized as the general price level) during low inflation, high inflation, initial hyperinflation and deflation.

Low inflation is inflation up to 10 per cent per annum. High inflation is inflation from 10 per cent to 26 per cent per annum. Hyperinflation is cumulative inflation of 100 per cent over three years, i.e., 26 per cent per annum inflation for three years in a row.

Judgment and pragmatism have to be used to determine whether (1) the Daily CPI, (2) a daily foreign currency exchange rate (normally the daily US Dollar parallel rate) or (3) a Brazilian-style URV-based daily index (which was almost entirely made up of the USD daily exchange rate) should be used as the general price level during hyperinflation. Judgment has to be used to judge whether the Daily CPI is not, in fact, too far behind real value as determined by the USD parallel rate and the use of the Daily CPI, in fact, would not result in adequate (judgment to be used again) Capital Maintenance in Units of Constant Purchasing Power during hyperinflation.

Pragmatism has to be used when the use of the US Dollar parallel rate is forbidden (illegal) in a country and its use would result in the arrest of company owners and/or directors.

The constant item constant purchasing power concept of capital is implemented under Capital Maintenance in Units of Constant Purchasing Power. Constant items are constant real value non-monetary items as inferred in IFRS which are principles-based standards. 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.’ Capital is a non-monetary item.

Non-monetary items to be measured in units of constant purchasing power are thus constant real value non-monetary items or simply constant items. They include issued share capital, retained earnings, capital reserves, all other items in equity, trade debtors, trade creditors, all other non-monetary receivables, all other non-monetary payables, all items in the income statement, provisions, etc. They are always and everywhere measured in units of constant purchasing power in terms of an index that recognizes all changes in the general price level, e.g., the Daily CPI during low inflation, high inflation and deflation and the US Dollar parallel rate during hyperinflation.

Non-monetary items that are not constant items are variable real value non-monetary items or simply variable items. They include property, plant, equipment,  quoted and unquoted shares, foreign exchange, etc. They are measured in terms of IFRS excluding the stable measuring unit assumption.

The stable measuring unit assumption is never implemented under Capital Maintenance in Units of Constant Purchasing Power.

Net monetary item gains and losses and net constant item gains and losses are accounted under Capital Maintenance in Units of Constant Purchasing Power.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Objective of IAS 29

Objective of IAS 29

IFRS are principles-based standards.

IAS 29 does not specifically state its objective.

Paragraph 2 states:

‘In a hyperinflationary economy, reporting of operating results and financial

position in the local currency without restatement is not useful.’

The closest IAS 29 comes to stating its objective is in Paragraph 7:

‘In a hyperinflationary economy, financial statements, whether they are based on

a historical cost approach or a current cost approach, are useful only if they are

expressed in terms of the measuring unit current at the end of the reporting

period.’

Paragraph 8 states:

‘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.’

 

The reason IAS 29 does not specifically state its objective is because Capital Maintenance in Units of Constant Purchasing Power as originally authorized in the original Framework (1989), Par 104 (a) was not understood at the IASC in 1989 and is still (2013) not understood at the IASB, Big Four accounting companies, national accounting standard setters and by historical cost accountants in general. An important reason for this is the fact that non-monetary items were only split in constant real value non-monetary items and variable real value non-monetary items in the book Real Value Accounting published in 2005.

Which items have to be measured in units of constant purchasing power to maintain the constant purchasing power of capital constant as authorized in Par 104 (a) in 1989? The split is not important to know during hyperinflation because all non-monetary items, variable and constant items, are measured in units of constant purchasing power during hyperinflation. The split is thus not necessary during hyperinflation to achieve capital maintenance in units of constant purchasing power. IAS 29 was also authorized in 1989.

Another reason is the fact that the ineffective “restatement” model was very much in vogue as from the 1970´s and is still the stated model in IAS 29. It is the model most accountants believe will result in making financial statements ‘more meaningful’ during hyperinflation. The term Capital Maintenance in Units of Constant Purchasing Power is not used by the IASB or accountants in general with reference to IAS 29.

The IASB Staff Paper 20 for the IFRIC meeting dated 22-23 January 2013 very surprisingly states:

‘10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units.’ The complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power at the IASB is very evident in the above statement.

PricewaterhouseCoopers states in Understanding IAS 29 (2006)

Objectives of IAS 29

‘The IAS 29 approach is to restate all balances recorded in the financial statements (including comparative numbers) to the year-end general purchasing power of the functional currency.’

Objective of IAS 29

The objective of IAS 29 is to implement Capital Maintenance in Units of Constant Purchasing Power during hyperinflation as authorized in IFRS in the Conceptual Framework (2010), Par 4.59 (a) as follows: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

Unfortunately IAS 29 does not result in Capital Maintenance in Units of Constant Purchasing Power because of the use of the monthly published CPI. There are at least 365 different price levels in a year during hyperinflation.  IAS 29 only recognizes 12. This obviously results in the destruction of part of the real value of current year profits. This is remedied with the use of the generally available Daily CPI. No-one currently (2013) uses the Daily CPI with IAS 29. Because it is not currently widely used, the IASB regards the use of the Daily CPI with IAS 29 as irrelevant. The fact that it was used by every company and every accountant in Brazil for 30 years as well as over more than 45 years in Chile as well as in other Latin American countries for decades is completely ignored by the IASB because of their complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power and their complete resistance to learn what it is about.

Brazil used daily indices supplied by different governments during the 30 years of very high and hyperinflation from 1964 to 1994 with great success. The best and most successful daily index used in Brazil was the Unidade Real de Valor which was almost entirely based on the daily USD exchange rate with the Brazilian currency (which explains its success during hyperinflation). Because of the complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power at the IASB and by the global accounting profession, the great success of using daily indices in South American countries was completely ignored by the accounting profession and the IASB and still is.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IAS 29 gives particular guidance on how to implement Capital Maintenance in Units of Constant Purchasing power.

IAS 29 gives particular guidance on how to implement an incomplete form of Capital Maintenance in Units of Constant Purchasing Power.

Updated on 23 Abril 2013

For example: (i) IAS 29 defines monetary items (incorrectly).

(ii) IAS 29 defines non-monetary items correctly.

(iii) IAS 29 requires that period end finanancial statements be restated in terms of the measuring unit current at the balance sheet date.

IAS 29 does not result in complete Capital Maintenance in Units of Constant Purchasing Power because the current generally accepted practice to use the monthly published CPI results in the erosion/destruction of part of the current year profits. This is fixed with using the generally available Daily CPI.

The IASB Staff Paper 20 for the IFRIC meeting dated 22-23 January 2013 very surprisingly states:

"10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units."

The IASB does not understand the objective of IAS 29 and does not understand Capital Maintenance in Units of Constant Purchasing Power as specifically guide-lined in IAS 29 and authorized in IFRS in 1989.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation

IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation

Updated on 18-04-2013

Capital is required to create wealth. Sustainable wealth creation is the sustainable profitable application of real (not nominal during inflation and deflation) capital: the constant purchasing power of capital. Capital is generally saved up wealth or borrowed financial resources at a financial cost.

Capital needs to be separate from the human owners of capital. It is not reasonable to expect people to risk losing their homes by starting a company.

A legal company structure is thus required plus a double-entry accounting model.

A perfectly stable unit of account is required for double-entry accounting. All generally accepted units of measure, e.g. inch, centimetre, pound, gram, etc., are perfectly constant values. There is no perfectly stable nominal monetary unit of account. A Daily Consumer Price Index is thus required to implement Capital Maintenance in Units of Constant Purchasing Power as authorized in IFRS by measuring constant real value non-monetary items in units of constant purchasing power in terms of a daily index during inflation and deflation.

Capital is a constant real value non-monetary item. The constant purchasing power (real value) of capital has to be maintained constant over time during inflation/high inflation/hyperinflation and deflation. A Capital Maintenance in Units of Constant Purchasing Power accounting model (CIPPA) is thus required.

The above is the ideal (correct/logical) method of creating wealth during low inflation, high inflation, hyperinflation and deflation.

A reasonable person would apply the above method of creating wealth even if it is not authorized or required under IFRS.

Capital Maintenance in Units of Constant Purchasing Power was authorized at all levels of inflation and deflation, including during hyperinflation, in IFRS in the original Framework (1989), Par. 104 (a) [not 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.’

Capital Maintenance in Units of Constant Purchasing Power is not required in terms of IFRS during low inflation, high inflation or deflation. It is optional to the 3000 year old, globally implemented, general accepted, traditional Historical Cost Accounting model (financial capital maintenance in nominal monetary units) during low inflation, high inflation and deflation. Capital Maintenance in Units of Constant Purchasing Power is, however, specifically required during hyperinflation. IAS 29 Financial Reporting in Hyperinflationary Economies requires the "restatement" of Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published CPI. IAS 29 gives specific guidance regarding Capital Maintenance in Units of Constant Purchasing Power: (i) it defines monetary items; (ii) it defines non-monetary items; (iii) it states how to measure capital maintenance in units of constant purchasing power, namely, by "restating" HC or CC period-end financial statements in terms of the measuring unit current at the balance sheet date.

But, IAS 29, although it requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation, unfortunately does not result in complete (or 100%) capital maintenance in units of constant purchasing power because it is generally accepted (2013) to use the monthly published CPI instead of the generally available Daily CPI (most countries in the world issue government capital inflation-indexed bonds which are priced on a daily basis using country specific Daily CPI´s based on the monthly published CPI). Current year profits are thus eroded/destroyed because of the use of the monthly CPI instead of the generally available Daily CPI when IAS 29 is implemented using the monthly CPI. A month can have 28 to 31 different daily price levels, or even more from about 3000 per cent per annum inflation and above. It is mistakenly generally accepted under current implementation practises of IAS 29, to use the CPI at the month end instead of 28 to 31 different generally available Daily CPI values to maintain current year profit. Current year profit is thus not fully maintained in this manner. A portion is eroded/destroyed using IAS 29  in terms of a monthly published CPI during hyperinflation. It is also a well-proven and undeniable fact that the implemetation of IAS 29 can also have absolutely no positive effect during hyperinflation. This was undeniably proven during hyperinflation in Zimbabwe. Zimbabwe´s economy imploded on 20 November 2008 after 8 years of full implementation of IAS 29. Thus, beware of IAS 29 in terms of the monthly CPI during hyperinflation.

PricewaterhouseCoopers states the following regarding the use of the HCA model during hyperinflation:

‘Inflation–adjusted financial statements are an extension to, not a departure from, historical cost accounting.’

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

Inflation has no effect on non-monetary items. Only monetary items in financial statements can be inflation-adjusted. PricewaterhouseCoopers, other Big Four audit firms, the IASB and most historical cost accountants do not understand the concept of Capital Maintenance in Units of Constant Purchasing Power as defined in the Conceptual Framework, Par 4.59 (a) and guide-lined in IAS 29.

What PricewaterhouseCoopers wanted to state was that "Period-end Historical Cost or Current Cost 'financial statements' with non-monetary items restated in units of constant purchasing power, 'are an extension to, not a departure from, historical cost accounting.’ Reporting year financial statements are never inflation-adjusted because it is impossible to inflation-adjust non-monetary items and monetary items in reporting year financial statements are not inflation-adjusted: what happens is the net monetary loss or gain is accounted while monetary items are measured in nominal monetary units. PricewaterhouseCoopers does not understand CMUCPP as authorized in IFRS and guide-lined in IAS 29.

A standard takes precedence over the Framework according to IAS 8, Par. 11. CMUCPP as guide-lined in IAS 29 thus applies during hyperinflation: thus, Capital Maintenance in Units of Constant Purchasing Power is required in IFRS during hyperinflation.

Financial capital maintenance in nominal monetary units (HCA) is a fallacy: it is impossible to maintain the real value of capital in nominal monetary units during inflation per se. It is only possible in the single case where an entity always invests 100 per cent of all contributions to shareholders´ equity in revaluable fixed assets (revalued or not) with an equivalent updated fair value which is most probably only the case with hotel, hospital and other property-intensive entities.

Every company in the world implementing IFRS can now change over to Capital Maintenance in Units of Constant Purchasing Power (CIPPA). Entities in economies subject to hyperinflation implementing IAS 29 already implement an incomplete version of CMUCPP. See IFRS 'X' Capital Maintenance in Units of Constant Purchasing Power. Zimbabwean listed companies implemented IAS 29 Financial Reporting in Hyperinflationary Economies during the last eight years of hyperinflation in that country. The implementation of IAS 29 in Zimbabwe made absolutely no difference.

Capital maintenance in units of constant purchasing power automatically maintains the constant purchasing power of 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 (including during hyperinflation) - ceteris paribus - whether they own any revaluable fixed assets or not.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.