Example of CMUCPP with a Daily CPI versus IAS 29

Example of CMUCPP with a Daily CPI versus IAS 29

All non-monetary receivables and payable are treated as monetary items under Historical Cost Accounting. They are not monetary items. Monetary items are defined as constituting the money supply. Non-monetary receivables and payables are not part of the money supply. They are constant real value non-monetary items since they are linked to underlying non-monetary items.

IAS 29 does not specifically require the implementation of Historical Cost Accounting during hyperinflation. IAS 29 requires the implementation of Capital Maintenance in Units of Constant Purchasing Power in the form of the restatement of HC or CC financial statements in terms of the measuring unit current at the balance sheet date. All non-monetary receivables and payables are thus treated as monetary items under IAS 29 too. The net “monetary” gain or loss is calculated with reference to these items under IAS 29.

They are constant real value non-monetary items under CMUCPP and are accounted as such. There is no net constant purchasing power gain or loss under ideal CMUCPP with complete coordination. This results in the maintenance of 100% of the real value of all non-monetary receivables and payables instead of destroying their real values at the rate of hyperinflation with the implementation of the stable measuring unit assumption during the 353 days of the year that the daily general price level is not recognized under IAS 29. IAS 29 only recognizes the 12 month-end CPIs.

The following example clearly proves the above:

				Hist Cost		Historical	Cost
						Zim$ Results
Date	Daily CPI	Z$/USD		Dr	Cr	Dr	Cr	Dr	Cr
	Derived	Derived		USD	USD	Zim$	Zim$	USD	USD
1/11/07	4 387,69	43,8769	Capital		1000		43 877		133
1/11/07	4 387,69	43,8769	Stock	1000		43 877		133
1/11/07	4 387,69	43,8769	Debtors	4000		175 508		531
1/11/07	4 387,69	43,8769	Sales		4000		175 508		531
30/11/07	9 727,86	97,2786
31/12/07	33 080,55	330,8055	P+L –CoS	1000		43 877		133
31/12/07	33 080,55	330,8055	Stock		1000		43 877		133
31/12/07	33 080,55	330,8055	Sale	4000		175 508		531
31/12/07	33 080,55	330,8055	P+L – Sales		4000		175 508		531
31/12/07	33 080,55	330,8055	Net MonetaryLoss	-	-	-	-
31/12/07	33 080,55	330,8055	P+L - Net Mon Loss	-	-	-	-
31/12/07	33 080,55	330,8055	Net MonetaryLoss	-	-	-	-
31/12/07	33 080,55	330,8055	Dividend	3000		131 631		398
31/12/07	33 080,55	330,8055	Bank		3000		131 631		398

				IAS 29 with the monthly CPI
Date	Daily CPI	Z$/USD		Conv	Dr	Cr	Dr	Cr
	Derived	Derived		Factor	Zim$	Zim$	USD	USD
1/11/07	4 387,69	43,8769	Capital	3,40		149 208		451
1/11/07	4 387,69	43,8769	Stock	3,40	149 208		451
1/11/07	4 387,69	43,8769	Debtors	1,00	175 508		531
1/11/07	4 387,69	43,8769	Sales	3,40		596 831		1 804
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		451
31/12/07	33 080,55	330,8055	Stock	3,40		149 208		451
31/12/07	33 080,55	330,8055	Sale	3,40	596 831		1 804
31/12/07	33 080,55	330,8055	P+L - Sales	3,40		596 831		1 804
31/12/07	33 080,55	330,8055	Net MonetaryLoss		421 322		1 274
31/12/07	33 080,55	330,8055	P+L - Net Mon Loss		421 322		1 274
31/12/07	33 080,55	330,8055	Net MonetaryLoss			421 322		1 274
31/12/07	33 080,55	330,8055	Dividend		26 301		80
31/12/07	33 080,55	330,8055	Bank			26 301		80

				CMUCPP (IAS 29) with Daily CPI
Date	Daily CPI	Z$/USD		Conv	Dr	Cr	Dr	Cr
	Derived	Derived		Factor	Zim$	Zim$	USD	USD
1/11/07	4 387,69	43,8769	Capital	7,54		330 806		1000
1/11/07	4 387,69	43,8769	Stock	7,54	330 806		1000
1/11/07	4 387,69	43,8769	Debtors	7,54	1 323 222		4000
1/11/07	4 387,69	43,8769	Sales	7,54		1 323 222		4000
30/11/07	9 727,86	97,2786
31/12/07	33 080,55	330,8055	P+L - CoS	7,54	330 806		1000
31/12/07	33 080,55	330,8055	Stock	7,54		330 806		1000
31/12/07	33 080,55	330,8055	Sale	7,54	1 323 222		4000
31/12/07	33 080,55	330,8055	P+L - Sales	7,54		1 323 222		4000
31/12/07	33 080,55	330,8055	Net MonetaryLoss	7,54	-
31/12/07	33 080,55	330,8055	P+L - Net Mon Loss	7,54	-
31/12/07	33 080,55	330,8055	Net MonetaryLoss	7,54		-
31/12/07	33 080,55	330,8055	Dividend		992 417		3000
31/12/07	33 080,55	330,8055	Bank			992 417		3000

From the above we can see that:

1.       Under IAS 29 in terms of the monthly CPI – the way IAS 29 has been implemented since 1990 although a monthly CPI is not specifically required in the standard, 54.9% of the real value of whatever capital was still left in Zimbabwe was destroyed, not by hyperinflation, but the stable measuring unit assumption (HCA) during the two months of November and Dezember 2007 in the Zimbabwean economy. That is what happened in the whole economy.

2.       Under ideal Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI with complete coordination (everyone doing it – like in Brazil from 1964 to 1994), 100% of the real value of capital, all receivables and payables and all current year profits would have been maintained. That is, in principle, what happened during the very high and hyperinflation in Brazil from 1964 till 1994 when that country implemented a form of CMCUPP (indexation or monetary correction) in terms of a government supplied Daily Index. 

Nicolaas Smith

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

UNDERSTANDING CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

UNDERSTANDING CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

DEFINITION: Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) is the maintenance of the constant purchasing power of capital 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 (Smith 2012 Ch 1.15).

Capital is equal to the real value of net assets (Smith 2012 Ch 12.2).

The general price level can change more than once a day (even hourly) during hyperinflation (Hanke and Kwok 2009, p 359, Smith 2012 Ch 11.7).

The following are all forms of CMUCPP:

1.      Indexation

2.      Monetary correction

3.      Price-level accounting

4.      Price-level restatement

of non-monetary items (including equity) in countries with high or hyperinflation (Central Bank of Chile 2002 p 8).

5.      Restatement of Historical Cost or Current Cost financial statements in terms of the measuring unit current at the end of the reporting period during hyperinflation as required in IAS 29 Financial Reporting in Hyperinflationary Economies (IAS 29 Par 8).

CMUCPP is a relatively old capital maintenance concept.

‘The consumer price index was first used in 1707. In 1925 it became institutionalized when the Second International Conference of Labour Statisticians, convened by the International Labour Organization, promulgated the first international standards of measurement.’  (Vink, Kirsten and Woermann 2004 p 217)

CMUCPP in the form of indexation (monetary correction) or price-level restatement was widely used in Latin America from the early 1960´s (Lefort and Schmidt-Hebbel 2002 p 2).

‘A common feature of financial statements that are prepared throughout Latin America is that they are adjusted in some way to take into consideration the economic effects of price changes in the local economy (Nobes and Parker 1991).  In the case of Chile, this adjustment primarily reflects changes in the general price level.  The values of assets, liabilities and owners’ equity that are not fixed in terms of the local currency are restated to reflect changes in the purchasing power of the local currency.  The unrealized gains and losses that result from this restatement are recorded as a single line-item in the income statement that is referred to as the “monetary correction” (corrección monetaria).’ (Jennings and Maturana 2005 p 86)

CMUCPP has been used in Venezuela in the form of IAS 29 from 2009 (PricewaterhouseCoopers 2009) to the present (2013). Brazil used CMUCPP very successfully in the form of indexation (monetary correction) in terms of different government-supplied daily indices under different governments from 1964 till 1994 (Central Bank of Brazil 2007).

Advantages of CMUCPP

CMUCPP in terms of an index that recognizes all (normally daily) changes in the general price level would:

1.   Maintain the 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, including during hyperinflation (Smith 2012).

2.   Stabilize the constant real value non-monetary item economy at all levels of inflation or deflation including during hyperinflation (see Brazil from 1964 to 1994).   

‘Indexation also has macroeconomic implications. In particular, indexation has played a critical role in many stabilization programs.’ (Lefort and Schmidt-Hebbel 2002 p 1)

    3.  Maintain the constant purchasing of all constant items besides equity, e.g.,

salaries, wages, rents, etc. by means of measurement in units of constant purchasing power in terms of a daily index.

‘Indexation allows the system of relative prices to survive large inflation shocks. Wage and financial indexation are clear examples of arrangements that accomplish this purpose. Wage indexation substitutes for the need for frequent renegotiation of wages and may reduce labor market transactions costs in economies where inflation is at least moderate.’ (Lefort and Schmidt-Hebbel 2002 p 1)

     4. Maintain the real value of monetary items constant when they are inflation-adjusted in terms of a daily index.

‘And the experience of several emerging economies shows that indexing financial instruments may be key to success in developing liquid long-term fixed-income markets.’ (Lefort and Schmidt-Hebbel 2002 p 1)

CMUCPP authorized in IFRS

CMUCPP was originally authorized in IFRS as an option to financial capital maintenance in nominal monetary units (Historical Cost Accounting) at all levels of inflation and deflation 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.’

CMUCPP implied in IAS 29

CMUCPP during hyperinflation is implied in IAS 29. CMUCPP, 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)

IFRS are principles-based standards. (ICAS 2006 p20) The principle of CMUCPP was originally authorized in the Framework (1989) Par 104 (a). The requirement is implied/inferred in IAS 29 since restatement of non-monetary items (including equity) in terms of the general price index is a form of CMUCPP.

(1)   IAS 29 Par 24 requires nominal capital to be restated by applying a general price index which is measurement in units of constant purchasing power by applying a general price index during hyperinflation.

(2)   Par 12 and 14 define monetary items and classifies non-monetary items. Current period nominal monetary items are generally not inflation-adjusted during the reporting year.  

(3)   Par 27 and 28 require the accounting of net monetary gains and losses.  

(4)   Par 26 requires the restatement (measurement in units of constant purchasing power) of all items in the statement of comprehensive income.

The above four features are all CMUCPP features.

Daily Index

The implementation of an index that recognizes all changes (normally daily changes) in the general price level would maintain the constant purchasing power of capital and profits as was done very successfully in Brazil from 1964 till 1994.

Daily indices were also used elsewhere in Latin America, e.g., in Chile with the very successful Unidad de Fomento (UF) (Shiller 1998) – still used in Chile today – the world´s first inflation-indexed unit of account that was copied in Mexico, Colombia (the Real Value Unit used currently) and Ecuador (Lefort and Schmidt-Hebbel 2002 p 5).

Daily indices that could be used during hyperinflation are:

(1) The US Dollar or another relatively stable foreign currency parallel exchange rate as a generally available substitute for a daily index representing current real value where the parallel rate´s use is accepted (officially allowed) and the greater part of the  economy is valued in terms of the parallel rate or

(2) A Brazilian-style Unidade-Real-de-Valor-based daily index that was almost entirely made up of the US Dollar daily exchange rate during hyperinflation or

(3) A Daily CPI at initial levels of hyperinflation.

‘Another coordination problem is that we must decide, and agree, on a way to smooth the CPI. We should not define prices just in terms of the latest CPI because the CPI is vulnerable to sudden jumps from month to month. This is particularly true when we are talking about indexing financial contracts to the CPI. A unit of account like the UF would smooth out the CPI movements, otherwise there would be important jumps in deposit balances on the dates of new announcements of the CPI. Thus, the smoothing of the CPI in producing the UF has also been a fundamental part of the functioning of the UF as an analogue of money. (Shiller 1998 p 13)

Smoothing is a lagged, daily interpolation of the monthly published CPI. There are no surprises with a Daily CPI: it is always known in advance, e.g., the US Daily CPI Index.

Daily CPI

The Daily CPI – available in all countries that issue government capital inflation-indexed bonds, i.e., in almost the entire world economy, is a one to four month (Olfasson and Jonsson 2007 p 2) lagged, daily interpolation of the monthly published general price level Consumer Price Index (Shiller 1998). The Daily CPI normally recognizes all changes in the general price level (when the CPI is recognized as the general price level) during low inflation, high inflation, initial hyperinflation and deflation.

The following are links to Daily CPIs

US

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

Iceland

Daily CPIs are currently being used in most of the world economy to inflation-adjust more than USD 3.4 trillion sovereign capital inflation-indexed bonds on a daily basis.

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.

Constant real value non-monetary items

The constant item constant purchasing power concept of capital (Smith 2012 Ch 1.21.1.(iii)) is implemented under CMUCPP. Constant real value non-monetary items (Smith 2007, 2012 Ch 4) are inferred in IFRS in the Conceptual Framework (2010) Par 4.59 (a).

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 (Smith 2012 Ch 4).

Variable real value non-monetary items

Non-monetary items that are not constant items are variable real value non-monetary items (Smith 2007, 2012 Ch 3) or simply variable items. They include property, plant, equipment, trademarks, quoted and unquoted shares, foreign exchange, inventories, etc. They are measured in terms of IFRS excluding the stable measuring unit assumption (Smith 2012 Ch3).

The stable measuring unit assumption is never implemented under ideal CMUCPP (Smith 2012 Ch 1.11.1).

(a)   Net monetary gains and losses and

(b)   Net constant purchasing power gains and losses

are calculated and accounted under CMUCPP.

Trade debtors, trade creditors, other non-monetary payables and other non-monetary receivables are generally accepted under the HCA model – including in IAS 29 – to be monetary items (PricewaterhouseCoopers 2006 p 7). They are constant real value non-monetary items under CMUCPP since they are linked to underlying non-monetary items.

The calculation and accounting of (a) net monetary gains and losses and (b) net constant purchasing power losses and gains are the same under CMUCPP. Non-monetary receivables´ and non-monetary payables´ (CMUCPP classification) different classifications under the two models are consequently not a problem as far as the accounting of the above net gains or losses under IAS 29 and ideal CMUCPP is concerned.

Value date

The value date under CMUCPP is the current date; i.e., today because the stable measuring unit assumption is never implemented under this model. All items (monetary and non-monetary items) in financial statements at a date in the past are always accessed/viewed/presented/stated/valued/measured at the current, i.e., today´s Daily CPI during low and high inflation and deflation or today´s daily US Dollar parallel rate during hyperinflation (Smith 2012 Ch 4.13.20) .

CMUCPP was specifically proposed to the International Accounting Standards Board in January 2012 in the proposal ‘IFRS “X” CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER’ (Smith 2012 Ch 12) as the replacement for IAS 29 which was identified by the IASB as a future priority research project entitled Financial Reporting in High Inflationary Economies.

REFERENCES

CENTRAL BANK OF BRAZIL 2007 Written communication as quoted in Smith 2012 Ch 1.9

CENTRAL BANK OF CHILE 2002 VIII Meeting on Central Banks Accounting and Budgetary Aspects. Effects of inflation in financial statements

GUCENME U and ARSOY A P 2005 Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005  Academy of Accounting Historians 2005 Research Conference 6-8 Oct 2005 Ohio State University Columbus Ohio USA

HANKE S H and KWOK A K F 2009 On the Measurement of Zimbabwe’s Hyperinflation, Cato Journal Vol 29 No 2 (Spring/Summer 2009) pp 353–64

INSTITUTE OF CHARTERED ACCOUNTANTS OF SCOTLAND (ICAS), 2006 Principles-based or Rules-based Accounting Standards. A Question of Judgement

JENNINGS R and MATURANA G 2005 The Usefulness of Chilean Inflation Accounting Revista ABANTE Vol 8 Nº 1 pp 85-118 April 2005

LEFORT F and SCHMIDT-HEBBEL K (eds) 2002  Indexation, Inflation, and Monetary Policy Central Bank of Chile

OLAFSSON B O and JONSSON R F 2007 Recommendations Concerning the Method of Calculating Daily CPI and CTI Index Values

PRICEWATERHOUSECOOPERS 2006 Understanding IAS 29

PRICEWATERHOUSECOOPERS 2009 Straight away – Venezuela hyperinflation

SHILLER R J 1998 Indexed Units of Account: Theory and Assessment of Historical Experience Cowles Foundation Discussion Paper Nº 1171

SMITH NJ 2007 Financial Statements, Inflation and the Audit Report Accountancy SA Sept

SMITH NJ 2012 Constant Item Purchasing Power Accounting per IFRS

VINK N, KIRSTEN J and WOERMANN C, 2004, South Africa’s Consumer Price Index for food (CPIF): A comparative historical view Agrekon, June 2004, Vol 43, No 2 pp 217-227



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