Comment Letter to the Discussion Paper: A Review of the Conceptual Framework for Financial Reporting

Comment Letter to the Discussion Paper: A Review of the Conceptual Framework for Financial Reporting

The IFRS Foundation                                                                    14 January 2014

Dear Sirs/Mesdames,

Thank you for the opportunity to comment on the IASB's Discussion Paper: A Review of the Conceptual Framework for Financial Reporting.

Please find my detailed answers in the Appendix.

Yours sincerely,

Nicolaas Smith

Capital Maintenance in Units of Constant Purchasing Power

I promote Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI or other daily index at all levels of inflation and deflation including hyperinflation as originally authorized in IFRS in the Framework (1989), Par 104 (a) which states: 'Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.'

CMUCPP 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 during inflation and deflation, including hyperinflation - all else being equal.

The comment letter is published by the IFRS Foundation HERE under the name Capital Maintenance in Units of Constant Purchasing Power. The letter is ID number 167 and appears on page 1 of the table if it is sorted alphabetically by organisation (the default), or page 2 if it is sorted by ID number.

APPENDIX

Answers to the IASB's Discussion Paper: A Review of the Conceptual Framework.

Section 6 Measurement

Question 11

How the objective of financial reporting and the qualitative characteristics of useful financial information affect measurement is discussed in paragraphs 6.6–6.35.

The IASB’s preliminary views are that:

a. the objective of measurement is to contribute to the faithful representation of relevant information about:

I. the resources of the entity, claims against the entity and changes in resources and

claims; and

II. how efficiently and effectively the entity’s management and governing board have

discharged their responsibilities to use the entity’s resources.

b. a single measurement basis for all assets and liabilities may not provide the most relevant information for users of financial statements;

c. when selecting the measurement to use for a particular item, the IASB should consider what information that measurement will produce in both the statement of financial position and the statement(s) of profit or loss and OCI;

d. the relevance of a particular measurement will depend on how investors, creditors and other lenders are likely to assess how an asset or a liability of that type will contribute to future cash flows. Consequently, the selection of a measurement:

i. for a particular asset should depend on how that asset contributes to future cash

flows; and

ii. for a particular liability should depend on how the entity will settle or fulfil that

liability.

e. the number of different measurements used should be the smallest number necessary to provide relevant information. Unnecessary measurement changes should be avoided and necessary measurement changes should be explained; and

f. the benefits of a particular measurement to users of financial statements need to be sufficient to justify the cost.

Do you agree with these preliminary views? Why or why not? If you disagree, what alternative approach to deciding how to measure an asset or a liability would you support?

RESPONSE

No, I do not agree with these preliminary views because they are not complete. They only deal with measurement in terms of financial capital maintenance defined in terms of nominal monetary units. IFRSs are also written from the perspective of an entity using the concept of financial capital maintenance that is defined in terms of units of constant purchasing power.

“Par. 14 . The selection of the capital maintenance concept is a choice that is available within the Conceptual Framework that provides a fundamental basis of preparation of financial statements. Paragraph 4.58 of the Conceptual Framework states that “the selection of the appropriate concept of capital by an entity should be based on the needs of the users of its financial statements”. Accordingly, those who support this view argue that the entity is permitted to use the financial capital maintenance concept defined in constant purchasing power units if this concept, among the alternative concepts described in the Conceptual Framework, provides the most useful information to users.

Par. 15. Having made a choice of using the financial capital maintenance concept in constant purchasing power units, the entity would develop accounting policies by referring to an IFRS that addresses a transaction, other event or condition analysed in accordance with paragraph 10 of IAS 8. The entity would need to adapt each IFRS for the use under that capital maintenance concept.”

Agenda ref 12 STAFF PAPER 10–11 September 2013 IFRS Interpretations Committee Meeting Project IAS 29 Financial Reporting in Hyperinflationary Economies

Paper topic Applicability of the concept of financial capital maintenance defined in constant purchasing power units

IFRS, excluding (1) IAS 29 Financial Reporting in Hyperinflationary Economies and (2) IFRIC 7  Applying the Restatement Approach under IAS 29, are written from the perspective of an entity using the concept of financial capital maintenance that is defined in terms of nominal monetary units (Historical Cost Accounting). This is however a fallacy.

IAS 29 and IFRIC 7 are written from the perspective of an entity using the concept of financial capital maintenance that is defined in terms of units of constant purchasing power in terms of the measuring unit current at the end of the reporting period, i.e., in terms of the monthly published Consumer Price Index. IAS 29 does not result in capital maintenance in units of constant purchasing power during hyperinflation because of the use of the monthly published CPI. IAS 29 had no positive effect in Zimbabwe: the Zimbabwean economy imploded on 20 November 2008 despite the fact that IAS 29 had been implemented during the final 8 years of hyperinflation in that country. Equity can only be maintained constant in real value with capital maintenance in units of constant purchasing power in terms of an index that follows all (at least DAILY) changes in the general price level. This did not and does not happen under IAS 29.

The majority of entities are based on the concept of equity (capital) being equal to net assets under the double-entry accounting model.  I am not referring specifically to the HCA model, but simply to the double-entry accounting model implementing the entity concept. All constant purchasing power of capital (a constant real value non-monetary item) being eroded / destroyed by the stable measuring unit assumption (not inflation) over time during low inflation, high inflation or hyperinflation (for example, in Zimbabwe on 20 November 2008) would mean the end of the entity. Maintaining the constant purchasing power of capital (equity) constant in real value is thus a fundamental objective for an entity.

‘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

It is generally impossible to maintain the real value (constant purchasing power) of capital (equity) constant in nominal monetary units during low inflation, high inflation, hyperinflation and deflation. Financial capital maintenance in nominal monetary units is thus a fallacy during the above periods. It is, however,  the capital maintenance concept most commonly used by entities as a result of historical developments in many areas over the last 3000 years.

The constant purchasing power of capital (equity) is generally automatically maintained constant with capital maintenance in units of constant purchasing power in entities that at least break even in real value - ceteris paribus - in terms of an index that follows all (at least DAILY) changes in the general price level.

Consequently, the IASB may determine that the objectives of general purpose financial reporting / accounting are:

1.  "To provide financial information about  the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.”  Conceptual Framework

and

2. To legalise measurement bases that result in automatic capital maintenance in units of constant purchasing power in terms of an index that follows all (at least DAILY) changes in the general price level for an indefinite period of time in entities that at least break even in real value - ceteris paribus - during low inflation, high inflation, hyperinflation and deflation.

The Board may determine that the objectives of measurement thus also include:

(III) To contribute to capital maintenance in units of constant purchasing power as defined in the objectives of general purpose financial reporting / accounting above.

For example, the Board may determine that the three basic economic items are

1. Monetary items

2. Variable real value non-monetary items and

3. Constant real value non-monetary items.

The Board may determine that most IFRSs apply to the measurement of variable items under financial capital maintenance in nominal monetary units and thus require adaptation for use under capital maintenance in units of constant purchasing power in terms of an index that follows all (at least daily) changes in the general price level - where necessary.

The Board may determine that monetary items are all items in the money supply.

The Board may determine that the following are some of the items that are considered monetary items under financial capital maintenance in nominal monetary units, but are constant real value non-monetary items under financial capital maintenance in units of constant purchasing power in terms of an index that follows all (at least daily) changes in the general price level:

Trade debtors, trade creditors, all non-monetary payables, all non-monetary receivables, interest, salaries, wages, rent, fees, pensions, taxes, duties, all employee benefits and all similar items to the items already stated.

The Board may determine that constant real value non-monetary items include, but are not limited to: all items in shareholders equity, provisions, all profits and losses, all items in the profit and loss account and in the Other Comprehensive Income Statement.

The Board may determine that variable items, when they are not measured in terms of IFRS on a daily basis, are to be updated on a daily basis in terms of an index that follows all (at least daily) changes in the general price level till they are again measured in terms of IFRS.

The Board may determine that foreign exchange is a variable real value non-monetary item and that forex gains and losses are constant real value non-monetary items like all other gains and losses to be measured in units of constant purchasing power in terms of an index that follows all (at least daily) changes in the general price level.

The Board may determine that financial reports are to be updated to the current (today´s ) Daily Index (e.g., the Daily CPI) after the end of the financial period. The Board may determine that it would thus be best to keep financial reports in digital form and not to print hard copies that would be out-of-date the day after the end of the financial period.

Question 26

Capital maintenance

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change.

Do you agree? Why or why not? Please explain your reasons.

In my response to Question 11 above I stated my view that the Conceptual Framework should determine that the objectives of measurement also include:

(III) To contribute to capital maintenance in units of constant purchasing power as defined in the objectives of general purpose financial reporting / accounting above.

Accordingly, I do not support the proposal that leaves the existing descriptions and discussion of this issue largely unchanged until such time as any project on accounting for high inflation indicates a need for change. Capital maintenance is not only critical as from the onset of high inflation - although that is the generally accepted view in most - not all - accounting jurisdictions. For example, it is not viewed like that in Australia.

The IASB´s approach suggests a lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework. There is clearly a pressing need to resolve the issues regarding capital maintenance now.

The comment letter is published by the IFRS Foundation HERE under the name Capital Maintenance in Units of Constant Purchasing Power. The letter is ID number 167 and appears on page 1 of the table if it is sorted alphabetically by organisation (the default), or page 2 if it is sorted by ID number.

Nicolaas Smith

Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Financial reporting unknown known

Financial reporting unknown known

Capital erosion / destruction under financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) is beyond an "unknown known" during low and high inflation: an intractable fact regarding a fallacy we prefer to forget.

It is a fact that HCA destroys billions of USD per annum in the world´s capital investment base because it is generally a fallacy that the real value (constant purchasing power) of capital (equity) can be maintained constant with financial capital maintenance in nominal monetary units in that portion of equity never maintained constant with the real value of net assets during inflation and deflation.

Although IFRS state in the Conceptual Framework, Par. 4.59 (a) that "Financial capital maintenance can be measured in ...... nominal monetary units ......" it is generally impossible to maintain the real value (constant purchasing power) of capital constant during inflation and deflation in nominal monetary units.

‘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

The term "financial capital maintenance" which implies that the real value of capital is being maintained (constant) during inflation and deflation is thus a fallacy.

The implementation of the stable measuring unit assumption (not inflation) under HCA during inflation results in the unnecessary destruction of hundreds of billions of USD per annum in the real value of the world economy´s investment capital base: in that portion of capital (equity) that is never backed by the real value of net assets.

Only Capital Maintenance in Units of Constant Purchasing Power in terms of an index that follows all (at least DAILY, e.g., the Daily CPI) changes in the general price level can generally maintain the constant purchasing power of capital constant only in entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation.


Nicolaas Smith 

Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Institute of Chartered Accountants Australia and CPA Australia recognise three concepts of capital maintenance authorised in IFRS

The Institute of Chartered Accountants Australia and CPA Australia recognise three concepts of capital maintenance authorised in IFRS

ICA Australia and CPA Australia in their combined comment letter to the IASB´s Capital Maintenance Discussion Paper recognised the two major concepts of capital and the three specific concepts of capital maintenance authorised in IFRS.

In their answer to Question 11 they state:

"The IASB should express clearly its view on the issues of the business enterprise and the concept of capital. In the case of the former, does it support a proprietary or entity view? In the case of the latter does it support a (i) financial or (ii) physical concept of capital? We would then like the measurement section to develop the link between the ideal concept of capital, the ideal concept of capital maintenance and the resulting selection of a measurement basis that is the consequence of applying those concepts. 

For example, the Board may determine that in the course of determining the appropriate measure for profit, the ideal concept of capital maintenance is 

(1) the maintenance of financial capital in money terms. It would therefore follow that the appropriate measurement base is historical cost. 

Alternatively, the Board may determine that the ideal concept of capital maintenance is: 

(2) the maintenance of financial capital in real terms with the resulting selection of entry price as a measurement base or 

(3) maintaining the productive (operating) capacity of the entity with the resulting selection of an exit price as the appropriate measurement base." 

ICA Australia and CPA Australia thus recognise that the three specific concepts of capital maintenance authorised in IFRS are:

(I) Financial capital maintenance in nominal monetary units (Historical Cost Accounting) during inflation and deflation.

(II) Financial capital maintenance in units of constant purchasing power under which the real value (constant purchasing power) of capital can generally only be maintained constant in terms of an index that recognises all - at least daily - changes in the general price level (normally a Daily CPI) during inflation and deflation.

(III) Physical capital maintenance under which the physical capital is maintained in terms of physical units of output per day.

The complete comment letter is available HERE dated 2014-01-06 on Page 1.

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IASB has "a lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework"

CPA Australia and the Institute of Chartered Accountants Australia´s comment letter to the IASB´s Conceptual Framework Discussion Paper

Question 26 

Capital maintenance 

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change. 

Do you agree? Why or why not? Please explain your reasons. 

In our response to Question 11 above we stated our view that the Conceptual Framework should articulate an ideal concept of capital maintenance and its relationship to the ideal measurement base. 

Accordingly, we do not support the proposal that leaves the existing descriptions and discussion of this issue largely unchanged until such time as any project on accounting for high inflation indicates a need for change. 

We think this approach suggests a lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework. We also consider that our current difficulties with profit measurement and OCI, which have issues of capital maintenance at their root clearly indicate a pressing need to resolve these issues. 


The complete comment letter is available HERE dated 2014-01-06 on Page 1.

See also: IASB believes that capital maintenance is only required during high inflation and hyperinflation

"No capital maintenance required during low and high inflation and deflation"

"No capital maintenance required during low and high inflation and deflation"

IASB´s Capital Maintenance Discussion Paper:

Question 26

Capital maintenance 

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change. 

Do you agree? Why or why not? Please explain your reasons. 

"Capital maintenance was an important conceptual issue long time ago. In the modern world, this is particularly of importance only to hyper-inflationary economy and IASB is better off tackling this in a separate and dedicated Standard on hyperinflation economy." 

Professor Ho Yew Kee 
Head 
Department of Accounting 
NUS Business School 
National University of Singapore\ 
4 November 2013

Prof. Ho Yew Kee´s complete comment letter is available HERE dated 2014-01-06 on Page 1.

Professor Ho Yew Kee does not know about the existence of IAS 29 Financial Reporting in Hyperinflationary Economies authorised by the IASB twenty-four years ago in 1989. He has a completely mistaken view of capital maintenance during low and high inflation and deflation - on par with the IASB´s lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework as pointed out by CPA Australia and the Institute of Chartered Accountants Australia as well as by myself. 

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IAS 29´s complete failure is of very little importance to the accounting profession

IAS 29´s complete failure is of very little importance to the accounting profession

IAS 29 Financial Reporting in Hyperinflationary Economies requires capital maintenance in units of constant purchasing power in terms of the measuring unit current at the end of the reporting period. This does not result in actual capital maintenance in units of constant purchasing power which can only be achieved in terms of an index that follows all - at least daily - changes in the general price level during hyperinflation, low inflation, high inflation and deflation. IAS 29 requires capital maintenance in units of constant purchasing power in terms of the measuring unit current at the end of the reporting period, i.e., in terms of the monthly published CPI and not the Daily CPI or the daily parallel rate, normally the Daily US Dollar parallel rate.

IAS 29 had absolutely no positive effect during the 8 years it was implemented in Zimbabwe´s hyperinflationary economy. 

The fact that IAS 29 had no positive effect in Zimbabwe is not widely known or widely acknowledged ("widely-used") because Zimbabwe´s economy is so small (GDP of USD 5 billion in 2008) that whatever happened there is of absolutely no importance to the accounting profession outside Zimbabwe and especially not to the IASB. 

Michael Stewart, the IASB´s Director of Implementation Activities, stated in January, 2013 that the IASB had no view on whether IAS 29 had or did not have a positive effect in Zimbabwe because the IASB had not yet ordered a special review of IAS 29´s implementation in Zimbabwe. He further stated that "financial reporting has no effect on the economy" when he referred to the implementation of IAS 29 in Zimbabwe, which is obviously a completely wrong statement. 

The fact that Zimbabwe´s economy imploded after 8 years of the full implementation of IAS 29 is not sufficient for the IASB to realise that IAS 29 had no positive effect in Zimbabwe. The IASB is only capable of making such an evaluation after a special review - according to Michael Stewart. 

It thus appears that the IASB as an international accounting standard-setter does not have the common sense and judgement necessary to realise that IAS 29 had no positive effect in Zimbabwe. In my opinion it is much more likely that the IASB does not have the humility to admit that IAS 29 is seriously flawed since it had absolutely no positive effect in Zimbabwe or Venezuela or Belarus. 

The IASB will never have to admit that IAS 29 is fundamentally flawed because it is normally implemented in small, unimportant and insignificant economies. After the 2008 financial crisis the IASB quickly had a special task force to deal with fair value because it affected the major world economies. There will never be a special task force at the IASB to fix IAS 29 because it is a matter of almost no importance in the world economy. IAS 29 will most probably never be changed to require capital maintenance in units of constant purchasing power in terms of an index that follows all - at least daily - changes in the general price level because economies like Venezuela and Belarus are of absolutely no importance to the IASB and to the accounting profession in general.

The IASB very much works like a book editor: The Board collects information about what is "widely-accepted" in the accounting profession and then reverse-engineers items to arrive at IFRS that "fit into" what is currently "widely-accepted" with little attempt to arrive at the fundamental concepts behind general purpose accounting and financial reporting. 

The fact that IAS 29 had no positive effect in Zimbabwe is thus of almost no consequence at the IASB since it is in general not "widely-accepted" as being of any importance as a result of the insignificance of very small economies like Zimbabwe.

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Conceptual Framework Discussion Paper: Notable Comment Letter from the New Zealand Accounting Standards Board

Conceptual Framework Discussion Paper: Notable Comment Letter from the New Zealand Accounting Standards Board

The NZASB notes:

"We regard the conceptual framework project to be a priority project and commend the IASB for taking the project on. We are pleased that the IASB is developing the Conceptual Framework as a whole; in a single phase, rather than in multiple phases as was originally planned. 

Completing the project in a single phase enables the links between different aspects of the framework to be considered and issues to be dealt with coherently and comprehensively. The Discussion Paper therefore is helpful in providing a collation of issues that the IASB seeks to consider in the project. 

Support for the project and taking an appropriate amount of time in order to be an improvement on the existing Conceptual Framework 

As noted above, we are pleased that the IASB is completing the conceptual framework project in a single phase. Although the Discussion Paper is under-developed in places, we support the IASB intention of inviting comments on an early draft so that early feedback can be obtained on the direction of the project. This will enable the IASB to further refine the scope, content and approach to the conceptual framework project.

However, given the extent of work required for that refinement, the range and complexity of the issues to be addressed and the divergence of views on those issues, if any new framework is going to be a sufficient improvement on the existing Conceptual Framework, more time will be required to debate and deal with the many issues that need to be addressed. Therefore, we strongly encourage the IASB to reconsider the timetable for the next phase of the project. 

While we understand the desire to avoid the project taking too long, the revised Conceptual Framework needs to be enduring and a significant improvement on the existing Conceptual Framework, as it is unlikely to be reviewed again in the near future. Therefore, we strongly encourage the IASB to take an appropriate amount of time to complete the project in order to achieve a higher quality Conceptual Framework. This is certainly preferable to completing the project in a short timeframe resulting in a framework that is not a significant improvement on the existing Conceptual Framework, or that is not comprehensive and/or contains concepts that are not sufficiently robust. In particular, we consider more time should be taken to further develop the following fundamental areas without which any revised Conceptual Framework 
would not be a sufficient improvement on the current Conceptual Framework: 

(a) the meaning of ‘financial performance’; 
(b) the distinction between profit or loss and OCI; 
(c) the meaning of ‘present obligation’; 
(d) recognition criteria (and how to deal with uncertainty); 
(e) measurement; and
(f) presentation and disclosure. 

The above points are discussed in more detail in the appendix to this letter, in our responses to the specific questions for respondents. In addition, in a number of areas, the discussion is too detailed and focused on particular items or issues in isolation. We consider that more time needs to be taken to consider the consistency of concepts across all aspects of the financial statements and to consider the coherence of the Conceptual Framework as a whole. We also consider that providing an executive summary of Conceptual Framework would be helpful to constituents given that the revised Conceptual Framework is likely to be a much longer document and preparing a summary would assist in considering the consistency and coherence of the Conceptual Framework as a whole

Role of the Conceptual Framework

It is important to be clear about the role of the Conceptual Framework, as it has a significant impact on the project, in particular, how issues are approached. We consider that the Conceptual Framework should continue to be a framework of accounting concepts - rather than accounting conventions, methods, or practical expedients. This does not mean that the Conceptual Framework is a highly idealistic document that has little application in the real world. On the contrary, accounting concepts should be based on real 
world economic phenomena. The Conceptual Framework provides the foundation for the preparation of General Purpose Financial Reports (GPFR). If those GPFR are to provide useful information to users, then the concepts need to be grounded in real world economic phenomena. Rather, the point is that the Conceptual Framework should contain concepts without compromises. Standards-level considerations (such as practical and/or political 
considerations) might result in the need for compromise but those compromises are dealt with at standards-level; they should not be embedded into the Conceptual Framework. 

If compromises are embedded into the Conceptual Framework it will fail to serve its purpose of providing a conceptual foundation for GPFR. For this reason, the Conceptual Framework project should not be used as an opportunity to codify or justify existing accounting treatments without 
adequate conceptual justification. We are concerned that there are parts of the Discussion Paper where this seems to be happening; there are places where the Discussion Paper catalogues existing accounting treatments in particular accounting standards, seemingly without any question of the underlying conceptual rationale for those treatments. 

In addition, the Conceptual Framework is not a standard and, therefore, should not be treated as such. For example, in most cases, the Conceptual Framework should describe accounting concepts, rather than precisely define them. Because the Conceptual Framework is not a standard, it does not contain any accounting requirements, which means that it is often not  necessary to include precise definitions or definitive specifications about the application of concepts. Also, because the Conceptual Framework is not a standard, it is not necessary or appropriate to build in ‘anti-abuse’ rules into the Conceptual Framework, such as the comments in paragraph 1.29 about restricting the use of guidance in the Conceptual Framework on when income or expense items would be presented in profit or loss or other comprehensive income (OCI). Any restrictions on the use of concepts should be dealt with at the standards-level, which is where requirements are established. 

Furthermore, the IASB aims to set principles-based standards, therefore, the Conceptual Framework too has to be principles-based.

Purpose of the Conceptual Framework


We consider that the Conceptual Framework is not there only to guide the IASB in standards-level projects. The concepts in the Conceptual Framework are pervasive – these concepts underlie the preparation and presentation of GPFR and therefore the concepts impact on all aspects of financial reporting. This includes – but is not limited to – the IASB’s role in setting accounting standards. The Conceptual Framework is used by the IASB but is also used by: 

(i) preparers and auditors to interpret and apply standards; 

(ii) users of GPFR to understanding the concepts and basis used to prepare GPFR; and 

(ii) all as the basis for communication of accounting concepts and issues using commonly understood accounting language. 

The list of uses and users of the Conceptual Framework is a reflection of this pervasiveness. Therefore, just because the IASB is a primary user of the Conceptual Framework does not mean that the Conceptual Framework should be focused on the IASB’s needs in setting standards. The IASB has an important role in setting standards, but that role is only one part of the financial reporting process. The Conceptual Framework has a much broader purpose, as is stated in the existing Conceptual Framework and it is important to keep this broader purpose in mind, because it provides the context for the Conceptual Framework, that is, the Conceptual Framework is a conceptual framework for general purpose financial reporting, not a toolkit for the IASB in setting standards.

Departures from the Conceptual Framework

We strongly support the proposal to explain any departures from the Conceptual Framework in any accounting standards. However, we consider that it is not helpful to refer to such departures as being ‘rare’. In any standards-level project, there are a variety of considerations that include, but are not 
limited to, the concepts in the Conceptual Framework. Other considerations, such as pragmatic and/or political considerations, might result in the need for a compromise in a particular standard. That does not mean that the Conceptual Framework is flawed or not sufficiently robust, it is simply a reflection of the reality of setting accounting standards. It is not realistic – 
or appropriate – to indicate the frequency with which departures might occur. 

Doing so has the following implications: 

(a) It treats the Conceptual Framework as some form of constitution but a constitution (such as a constitution of a company or a country) is essentially a governance document, which acts to place some constraints on a governing body (of the entity/country) in order to protect other parties (such as shareholders and citizens). We consider that the Conceptual Framework is not a governance document. 

(b) For departures to be rare, it would be necessary for either: 

(i) The IASB to look ahead and anticipate all the key standards-level considerations and all possible future types of transactions, so that they can be taken into account when developing the Conceptual Framework – this is not possible; and/or 

(ii) The Conceptual Framework would need to contain concepts that are at a very high level, vague or ambiguous, so that any standards-level requirements can be said to Instead of referring to ‘rare cases’, in our view, the key point is that the Conceptual Framework provides the conceptual foundation for setting standards and hence should always be the starting point in any standards project. In addition, any departures from (or conflicts with) the Conceptual Framework because of other standards-level factors need to be carefully considered and explained. 

Working with the IPSASB 

We encourage the IASB and the IPSASB to work closely together in developing their conceptual frameworks as the two Boards are likely to be considering similar issues. We consider that the development of the conceptual frameworks is too important for the two Boards to be working independently of each other. Ideally, the IASB and IPSASB frameworks should only contain 
different concepts in instances where there are differences between private and public sectors. 

Responses to specific questions for respondents

We consider that a number of issues discussed in the Discussion Paper are unresolved and further development and/or significant revision is required in a number of areas. Hence, there are some areas in which we consider that the specific questions for respondents are not necessarily focused on the right issues. Nevertheless, our responses to the specific questions for respondents are provided in the appendix to this letter.

The complete comment letter is available HERE dated 2013-12-20 on Page 1.

Conceptual Framework Discussion Paper: Notable Comment Letter from the INSTITUT DER WIRTSCHAFTSPRÜFER

Conceptual Framework Discussion Paper: Notable Comment Letter from the INSTITUT DER WIRTSCHAFTSPRÜFER

The IDW notes:

"The IDW appreciates the opportunity to comment on the IASB Discussion 
Paper 2013/1 ‘A Review of the Conceptual Framework for Financial Reporting.

In general, we welcome the Board’s decision to reinitiate the Conceptual 
Framework project. However, we believe that the timing of the publication of the Discussion Paper is inopportune as the Board is still working on its four main standard projects (revenue recognition, leases, insurance contracts and 
financial instruments). It is essential to ensure that these long-term projects are consistent with one another and completed with priority. Upon completion of these projects, the Board should use the insights gained for revising the 
Conceptual Framework.

We agree with the Board’s decision to develop a complete set of proposals for a revised Conceptual Framework, i.e. not to continue with the phased approach.

Given the complexity as well as the interdependency of the various issues
addressed in the Conceptual Framework project, a phased approach would
necessarily result in unintended consequences and could lead to new 
inconsistencies. However, we had expected the Board to undertake a 
fundamental and comprehensive review of the Conceptual Framework rather 
than merely ‘updating, improving and filling in gaps’. Currently it seems to us 
that the IASB is only proposing a quick fix solution.

We doubt whether the proposals in the Discussion Paper reflect the significance of the Conceptual Framework appropriately. Many of the proposed approaches (e.g. to profit and loss and recycling or for the distinction between equity and liabilities) seem only ‘half-baked’. Moreover, in some cases the dividing line between the principles in the Conceptual Framework and the provisions in IAS 1 is not readily identifiable (e.g. in the case of going concern). Obviously, much more time is needed, and we urge the IASB to take the time necessary to revise the Framework in such a way that it can provide both, a consistent and sound conceptual basis for financial reporting under IFRS and be of real assistance to the IASB in developing or amending future Standards. 

Although the specific provisions at the Standards level should always take 
precedence over the principles of the Conceptual Framework, the Conceptual 
Framework must be generally binding when the IASB develops or amends 
Standards. Therefore, we recommend that – going forward – the IASB’s 
adherence to the final provisions of the Conceptual Framework should be 
monitored. This would also contribute to improving the accountability of the 
entire IASB’s standard-setting process. A departure from the Conceptual 
Framework should only be possible in rare cases." 

The complete comment letter is available HERE dated 2013-12-20 on Page 1.

IASB believes that capital maintenance is only required during high inflation and hyperinflation

The constant purchasing power (real value) of capital needs to be maintained constant during low inflation and deflation and not only during high inflation and hyperinflation as it is generally accepted.


‘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

The above statement refers to low inflation and deflation too.

The following is Question 26 regarding Capital Maintenance in the IASB´s Discussion Paper on the Conceptual Framework:

Question 26 - Other Issues:

Capital maintenance

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change.

Do you agree? Why or why not? Please explain your reasons

The IASB clearly implies above that capital maintenance in units of constant purchasing power (which would maintain the real value of equity) is only required as from the onset of high inflation. The IASB luckily also discovered recently (in June 2013 after I had pointed it out to them) that capital maintenance in units of constant purchasing power was actually required in IAS 29 Financial Reporting in Hyperinflationary Economies even though the Board had authorised it twenty four years ago in 1989. The IASB staff recently (April 2013) still mistakenly stated that there is no guidance in IFRS regarding capital maintenance in units of constant purchasing power. The IASB is by now at least well aware that IAS 29 requires capital maintenance in units of constant purchasing power in terms of the monthly published CPI. 

Entities - including the IASB - operating during low inflation and deflation generally believe that Capital Maintenance in Units of Constant Purchasing Power as authorised in the Conceptual Framework, Par. 4.59 (a) at all levels of inflation and deflation does not need to be applied to ensure the maintenance of the real value (constant purchasing power) of equity during low inflation and deflation. This is the case despite the fact that financial capital maintenance in nominal monetary units (HCA) during continuous 2% annual inflation results in the erosion / destruction of 51% of the real value of that portion of equity not covered by the real value of net assets over 35 years. 

No company in the world knows whether it maintained in the past and currently maintains the constant purchasing power of its capital constant during low and high inflation and deflation. No company in the world does that calculation during low and high inflation and deflation. No-one knows.

Financial capital maintenance in nominal monetary units during 2 percent annual inflation - mistakenly regarded as price stability in the US and European Monetary Union (and everywhere else) - results in the erosion (destruction) of the constant purchasing power (real value) of equity in that portion of equity that is not covered by the REAL value of net assets. 100% of equity being equal to 100% of net assets IN NOMINAL MONETARY TERMS (i.e., balancing the books under financial capital maintenance in nominal monetary units under the Historical Cost Accounting model) does not guarantee that the real value (constant purchasing power) of equity is being maintained constant during low and high inflation and deflation. 

The following are the answers of some respondents to Question 26. It can be seen that they mistakenly believe that capital maintenance only applies as from the onset of high inflation and that it is not required during low inflation.


1. AUSTRALASIAN COUNCIL OF AUDITORS‐GENERAL

ACAG has no view on this issue. The Australian public sector has not been in a high inflation environment for many years and the capital maintenance paragraphs in the existing Conceptual Framework are rarely used.

It is very clear from the above that concepts of capital maintenance are rarely used during low inflation in Australasia.

This view that the capital maintenance paragraphs in the existing Conceptual Framework are rarely used is a very good overall summary regarding capital maintenance during low inflation and deflation, not only in Australasia, but also in the world economy.

2. INSTITUT DER WIRTSCHAFTSPRUFER

We agree with the Board´s view to deliberate the appropriate capital maintenance concept when discussing accounting for high inflation. 

Capital maintenance - maintaining the real value of equity - during low inflation is obviously not considered important in Germany.

3. EUROPEAN SECURITIES AND MARKET AUTHORITY

ESMA is not aware of any issues with IAS 29 Financial Reporting in Hyperinflationary Economies but would welcome a clearer reference in the ED as ESMA agrees that something could be done in the revised CF. 

4. THE HONG KONG ASSOCIATION OF BANKS

We agree with the IASB to defer revision or refinement until it is needed, because we have 

not encountered high inflation issues. 

The Hong Kong Association of Banks clearly also believes no capital maintenance is required during low inflation.

5. THE CERTIFIED GENERAL ACCOUNTANTS ASSOCIATION OF CANADA

We agree that the IASB should defer its work on capital maintenance until it develops new provisions or revises the extant Standard (IAS 29) on accounting for hyperinflation. 

See also: IASB has "a lack of understanding about the fundamental role a capital maintenance concept has within the accounting framework"

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

Conceptual Framework Discussion Paper: Notable Comment Letter from The Linde Group

Conceptual Framework Discussion Paper: Notable Comment Letter from The Linde Group

Question 26 - Other Issues:

Capital maintenance

Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include the existing descriptions and the discussion of capital maintenance concepts in the revised Conceptual Framework largely unchanged until such time as a new or revised Standard on accounting for high inflation indicates a need for change.

Do you agree? Why or why not? Please explain your reasons

"The concept of capital maintenance drives virtually all recognition and measurement rules that exist in a set of accounting rules (except for most disclosure requirements). Therefore the prescription of capital maintenance philosophy behind is the nucleus of all that follows and should be named and illustrated at the beginning of the framework. The theoretically most relevant sort of capital maintenance is the maintenance of earnings power. 

This means that a net gain is only given if the dcf value of the company has changed positively. Given that such a concept of capital maintenance is impracticable, IFRS should at least aim at an approximation to this und the restriction of inter-subjective provability. This means that cost accounting for a machine for instance represents an approximation of the earnings power of this machine if you assume that – at the time of acquisition the maximum purchase price for the machine from the company’s perspective was determined on the basis of a rationale decision process and state of the art valuation techniques in place so that the acquisition cost do not exceed the earning potential within the company. Under these conditions the price paid by the company for the acquisition of the machine represents an observable and therefore verifiable minimum earnings contribution of the asset to the overall earning power of the company. Depreciation then represents a – also very rough but well verifiable – roll forward of this approximated earning contribution value. Once there is evidence that this value is overstated it has to be corrected to the correct amount in the way of impairment. 

In the light of such a capital maintenance concept that only sacrifices earning power contribution for sake of verifiability, the definition of unit of account can be refined more precisely and the basic assumptions for definition and recognition can be derived. Therefore we would plead for giving this point more prominence." 

The complete comment letter is available HERE dated 2013-12-09 on Page 1.

Conceptual Framework Discussion Paper: Notable Comment Letter from the Australian Heads of Treasuries Accounting and Reporting Advisory Commitee

Conceptual Framework Discussion Paper: Notable Comment Letter from the Australian Heads of Treasuries Accounting and Reporting Advisory Committee

The HoTARAC notes:

"HoTARAC has significant concerns on the discussion in a number of areas.

HoTARAC does not believe the discussion of topics proceeds in a logical progression from a coherent set of core principles. In HoTARAC´s view, this, at least in part, derives from:

• insufficient consideration of the objectives of financial reporting and their application to the topics at hand, and reliance on the existing chapters of the conceptual framework;
• delegation of core concepts, often fundamental to the topic discussed, to other projects; and
• the framework being developed to justify current practice, rather than from a sound conceptual basis.

The framework also appears to be developed in isolation from advances in related disciplines, such as communication, finance, economics and valuation with a consequent risk of loss of relevance.

Additionally, HoTARAC is concerned that the framework is being developed without consideration of the future direction of financial reporting, including the development of standards for the not-for-porfit and public sectors."

The complete comment letter is available HERE dated 2013-12-02 on Page 1.

Venezuela is NOT in hyperinflation according to lunatic fringe economist Prof. Steve Hanke

Venezuela is NOT in hyperinflation according to lunatic fringe economist Prof. Steve Hanke: see 

Venezuela’s Playbook: The Communist Manifesto

Millions of accountants and economists world wide follow the International Accounting Standard Board´s definition of 100% cumulative inflation over three years. That is 26% annual inflation for three years in a row. 

Venezuela has thus been officially in hyperinflation since November 2009 and has officially been implementing IAS 29 Financial Reporting in Hyperinflationary Economies for that year end and all following financial periods till today. Steve Hanke simply ignores that.

Venezuela is currently at about 5% monthly inflation or 54% official annual inflation. Hanke puts Venezuela´s implied annual inflation currently at 297% - still far away from his 13 000% annual inflation threshold before hyperinflation takes hold in Venezuela - according to the lunatic fringe crowd.

Lunatic fringe Steve Hanke is waiting for Venezuela to reach 50% monthly inflation, i.e., 13 000 percent annual inflation before he will agree that Venezuela is in hyperinflation. 

Only he, his students (obviously) and a handful other lunatic fringe economists think like that.

The lunatic fringe Professor derides Maduro´s economic policies while Hanke himself refuses to acknowledge the generally accepted, globally implemented definition of hyperinflation.

I would not recommend Hanke for any advice regarding hyperinflation. He also continues to peddle his obsolete and extremely costly Dollarization and Currency Board solutions (which also removes a country´s independent monetary policy capability) to fight hyperinflation. 

Daily Indexing (Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI) is free as well as authorized in International Financial Reporting Standards and US GAAP. 

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

Computation of the Daily CPI in Turkey

Computation of the Daily CPI in Turkey

The Daily CPI is a lagged, daily interpolation of the monthly published CPI. 

All countries issuing government capital inflation-indexed bonds calculate Daily CPIs. Daily CPIs can be one to four month lagged, daily interpolations. 

Turkey uses a three-month lagged daily interpolation of its monthly published CPI.

Computation of the Daily CPI in Turkey

The Turkish Daily CPI is available HERE. (Click on Reference Indices under 

CPI Indexed Government Bonds)

Turkey can use the above Daily CPI to implement Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI during low inflation as authorised 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." 

CMUCPP in terms of a Daily CPI would automatically maintain the constant purchasing power of capital (equity) constant for an indefinite period of time - ceteris paribus - in all entities that at least break even in real value at all levels of inflation and deflation.


Nicolaas Smith

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

Not indexing bank interest to inflation may be unconstitutional

Not indexing bank interest to inflation may be unconstitutional.



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

Venezuela: best real-time economics lesson about HCA during hyperinflation in an oil-rich country

Venezuela: Historical  Cost Accounting 101 during hyperinflation in an oil-rich country


1. The real value of the Bolivar (a monetary item) is being destroyed by Historical Cost Accounting. Proof: If all monetary items (items expressed in Bolivars) in Venezuela were inflation-indexed DAILY there would be no loss of real value in these items. Like Brazil did with many monetary items (not all) from 1964 to 1994. There would, however, still be hyperinflation while the Central Bank of Venezuela keeps on creating too many Bolivars. But, there would be no destruction of real value over time in Bolivar monetary items in Venezuela. Prof Steve Hanke said this is an interesting idea. 

Who is to blame: The International Accounting Standards Board. 

Why? The IASB requires Venezuela to implement IAS 29 Financial Reporting in Hyperinflationary Economies in terms of the MONTHLY published CPI. It has been implemented in Venezuela since 2009. 

Solution: The IASB should change IAS 29 to require DAILY INDEXING instead of the use of the monthly published CPI. This was done very successfully in Brazil and other Latin American countries in the past. The IASB simply ignores that.

2. The real value of variable real value non-monetary items (e.g. electrical appliances) is being destroyed by Nicolas Maduro´s price fixing.

Who is to blame: Nicolas Maduro and his advisers.

Solution: These variable real value non-monetary items should be valued at the parallel rate and normal forces of competitive demand and supply should be allowed to rule in the market. There would - ceteris paribus - be no loss of real value in these items.

3. The real value of constant real value non-monetary items, e.g., salaries, wages, rents, trade debtors, trade creditors, etc. is being destroyed by Historical Cost Accounting. Proof: If they were measured in units of constant purchasing power in terms of a DAILY INDEX there would be no loss of real value in these items, i.e., no loss of real value in salaries, wages, rents, trade debtors, trade creditors, etc. Like Brazil did from 1964 to 1994.

Who is to blame: The International Accounting Standards Board. 

Why? The IASB requires Venezuela to implement IAS 29 Financial Reporting in Hyperinflationary Economies in terms of the MONTHLY published CPI. It has been implemented in Venezuela since 2009. 

Solution: The IASB should change IAS 29 to require DAILY INDEXING instead of the use of the monthly published CPI. This was done very successfully in Brazil and other Latin American countries in the past. The IASB simply ignores what happened in Brazil in the past.

Why does the IASB not change IAS 29 to require DAILY indexing? 

(i) The IASB does not understand financial capital maintenance in units of constant purchasing power in terms of a DAILY index. The IASB is too arrogant to spend the time to properly find out the benefits of Daily Indexing. Financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation was authorised by the IASB twenty four years ago 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." 

(ii) According to Michael Stewart, the Director of Implementation Activities - the IASB´s view is that financial reporting has no effect on the economy. (That was an absolutely silly statement by Michael Stewart. It shows the low level of understanding of basic accounting and economic concepts at the IASB.)

(iii) The IASB is not responsible enough to take financial capital maintenance in units of constant purchasing power in terms of a DAILY INDEX seriously.

(iv) Venezuela and Belarus are relatively small economies and thus not important to the IASB. When the world economy was crippled during the 2008 financial crisis, the IASB had a special task force to deal with fair value accounting. The IASB has not even included research regarding Daily Indexing in Research projects on which preliminary work is not expected to commence until after the 2015 agenda consultation. After an agenda consultation, the IASB normally takes one year to come to conclusions regarding the consultation. They are very laid back at the IASB. The research project Financial Reporting in High Inflationary Economies is now included by the IASB in Research projects for which the timing of preliminary work has not yet been confirmed, i.e., perhaps in 2017 or later.

(v) According to Michael Stewart, the IASB is incapable of expressing a view regarding whether IAS 29 had a positive or negative effect on Zimbabwe´s hyperinflationary economy in the past since the Board has not yet had a special review of the problem while all other accountants in the world would generally agree that it is very, very obvious that IAS 29 had no positive effect  on Zimbabwe´s economy like it is currently not having a positive effect on the Venezuelan economy. The IASB cannot grasp that.

Nicolaas Smith 

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

Daily indexing (CMUCPP) is a paradigm change

Daily indexation, i.e., Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily Index as authorized in IFRS and US GAAP was the macroeconomic measure that stabilized the Brazilian non-monetary and daily indexed monetary economy during hyperinflation.

Asked to define Twitter someone said:

Twitter is the essential utility we need – which we only realized we needed, once we actually had it.

Daily indexing (CMUCPP) is the FREE essential paradigm change needed in Venezuela.

Official dollarization is very costly AND the country loses independent monetary policy.

Spontaneous dollarization is also “free” but the country will continue to lose independent monetary policy.

Daily indexation (CMUCPP) would stablize an economy AT NO COST at any rate of inflation or deflation.

Daily indexation (CMUCPP) is a paradigm change. It is a macroeconomic measure. 

Daily indexation (CMUCPP) stops the Historical Cost paradigm. It stops the stable measuring unit assumption being implemented.

Nicolaas Smith 

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