Rejecting the stable measuring unit assumption is compliant with IFRS

Today´s Fin24 has an article starting: " South Africa's inflation-targeting framework is likely to be fine-tuned by the new government, said chief economist from Brait, Colen Garrow, on Friday."

"Target may be fine tuned" Fin24 28 June 2009

Mboweni averaged 5.93% annual inflation so far.

Upping the upper band to 7% will result in SA accountants unknowingly destroying a further cumulative 10% in constant items they refuse to maintain over the next 10 years.

They will thus unknowingly destroy 56% instead of 46% of the real value of all Retained Earnings never maintained in SA companies and banks today over the next 10 years.

That may amount to unknowingly destroying R202 billion instead of R200 billion p.a

When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as approved by the IASB 20 years ago in the Framework, Par. 104 (a) which is compliant with IFRS, they will maintain instead of unknowingly destroy - as they are now doing - about R200 billion p.a. in the SA real economy for an unlimited period of time - ceteris paribus.

ABSA´s accountants are unknowingly destroying R3.3 bil. like that now.

Rejecting the stable measuring unit assumption is compliant with IFRS.

It will result in our accountants boosting the SA real economy by at least R200 billion (a conservative estimate) p.a. for an unlimited period of time - ceteris paribus.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

The confusion about inflation accounting

Most accountants and accounting authorities completely ignore the real value maintaining Constant Item Purchasing Power basic accounting model as approved by the IASB in the Framework, Par. 104 (a) as an alternative for the real value destroying traditional HC basic accounting model.

They do not appreciate, firstly, that SA accountants unknowingly destroy real value on a massive scale in the SA real economy when they implement the real value destroying stable measuring unit assumption for an unlimited period of time during indefinite inflation in the case of balance sheet constant items when they do not have sufficient revaluable fixed assets or holding gains to compensate for a real value shortfall in Shareholders´ Equity.

Secondly, they mistakenly assume that any price-level accounting always only relates to inflation accounting during high and hyperinflation despite the fact that the IASB approved a constant item price-level basic accounting model twenty years ago.

Thirdly, they do not appreciate the real value maintaining effect on balance sheet constant items of choosing to measure financial capital maintenance in constant purchasing power units as approved by the IASB in the Framework, Par. 104 (a).

Financial capital maintenance in units of constant purchasing power is generally not implemented in non-hyperinflationary economies.

Measurement in units of constant purchasing power is, however, comprehensively and extensively used for the valuation of income statement constant items, e.g., salaries, wages, rentals, etc in most economies at all levels of inflation, including in South Africa.


© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission

Difference between basic and inflation accounting

The Constant Purchasing Power inflation accounting model required by the IASB in IAS 29 is in contrast to the Constant Item Purchasing Power basic accounting model approved by the IASB in the Framework, Par. 104 (a) as an alternative to the real value destroying traditional basic Historical Cost Accounting model also approved in Par. 104 (a).

Constant Item Purchasing Power Accounting requires that ONLY constant items (instead of constant AND variable non-monetary items in the case of CPP inflation accounting) are inflation-adjusted by means of the CPI during non-hyperinflationary periods for the purpose of implementing a constant purchasing power capital concept of invested purchasing power, a constant purchasing power financial capital maintenance concept and a constant purchasing power profit or loss determination concept.

Variable items are valued in terms of IFRS or SA GAAP for primary valuation purposes during non-hyperinflationary periods. Monetary items are always stated at their original nominal values during the current accounting period.

Current SA inflation - May 2009

Percentage unknowing real value destruction by SA accountants in constant items never maintained since

Jan 1981

93.2%

April 1994

61.9%

May 2008

8.0%

Example: R3.338 billion of the real value of Retained Earnings have unknowingly been destroyed by ABSA´s accountants implementing the stable measuring units assumption as chosen by their board of directors during their 2008 financial year if they maintain that assumption for an unlimited period of time during indefinite inflation.


Cumulative inflation since Jan 1981

1 360.3%

Cumulative inflation since Apr 1994

162.6%

Annual inflation

8.0%

Source of base data: Statistics South Africa

Price-level accounting clearly does not prevail

Price-level accounting clearly does not prevail for balance sheet constant items, as Harvey Kapnick hoped for in 1976, except during rare instances of hyperinflation (e.g., Turkey’s latest period of hyperinflation) when companies are required to implement IAS 29 which is the IASB´s CPP inflation accounting model.
The implementation of IAS 29 inflation accounting by Zimbabwean listed companies as required by the Zimbabwean Stock Exchange made no difference to the Zimbabwean economy during the final stages of the hyperinflationary destruction of the Zimbabwe Dollar. Updating all non-monetary items as required by IAS 29 inflation accounting in terms of the Consumer Price Index when it is not calculated and supplied by the government and when the value of the Zimbabwe Dollar halved every 15 hours, was obviously of no use.

The IASB specifically requires financial capital maintenance in terms of units of constant purchasing power during hyperinflation, but, leaves it as an option to the disastrously destructive traditional HCA model during non-hyperinflationary periods. An option that is ignored by almost all accountants during non-hyperinflationary periods because of, firstly, the lack of appreciating the very destructive effect of the stable measuring unit assumption on the real values of balance sheet constant items during non-hyperinflationary periods; secondly, the lack of appreciating the real value maintaining effect on balance sheet constant items of choosing to measure financial capital maintenance in units of constant purchasing power during non-hyperinflationary periods; as well as, thirdly, the general assumption by most accountants that price-level accounting always refers ONLY to CPP inflation accounting when all non-monetary items (variable and constant items) are inflation adjusted by means of the CPI during high and hyperinflationary periods in terms of IAS 29 inflation accounting.

Price-level accounting does prevail in certain income statement items, e.g. salaries, wages, rentals, etc. which are inflation-adjusted by means of the CPI in most economies, including South Africa.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Changing the way a company does its accounts does change the value of the company for the better

"ABSA joins chorus of doom" on today´s Fin24.com states that ABSA´s operating performance had been knocked by a REDUCTION IN THE VALUE of investment portfolios"

R3.326 Billion of the real value of ABSA´s Retained Earnings was not just reduced during their 2008 financial year but actually unknowingly DESTROYED by ABSA´s accountants implementing the stable measuring unit assumption as an accounting policy chosen by their Board of Directors. They are doing the same this year. Measurement in units of constant purchasing power is compliant with IFRS.

R3.326 Billion is also, more or less, the amount that ABSA´s accountants will unknowingly destroy in the real value of the bank´s Retained Earnings during their current financial year as a result of their implementation of the stable measuring unit assumption because the ABSA Board of Directors selected financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a) which states that "Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

Both bases are compliant with IFRS since the Framework applies (see IAS 8.11). There is not one specific IFRS relating to the valuing of Retained Earnings.

R3.326 Billion is the estimated amount that ABSA´s accountants will maintain in the real value of the banks Retained Earnings during this finacial year and every year there after - ceteris paribus - if ABSA´s Board of Directors decide today to reject the stable measuring unit assumption and to maintain the banks financial capital in real value maintaining units of constant purchasing power - which is compliant with IFRS - instead of in real value destroying nominal monetary units - which is also compliant with IFRS, but, results in their accountants unknowingly destroying the real value of their Retained Earnings as described above.

I think Maria Ramos should perhaps have a look at this.

R3.326 Billion is 4.5% of ABSA´s current market value.

Changing the way a company does its accounts does change the value of the company for the better.

Audited Historical Cost annual financial statements do not fairly present the financial position of a company

1st Update: 24 June 2009

Audited annual financial statements provided by SA companies which prepare them using the traditional Historical Cost basis, i.e., when the directors choose to measure financial capital maintenance in nominal monetary units instead of in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a), are compliant with IFRS, but, do not fairly present the financial position of the companies as required by Art. 29.1(b) of the Companies Act.



Article 29.1 (b) of the SA Companies Act, No 71 of 2008 states:



“If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must-



(b) present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company;”



SA company directors´ choice to measure financial capital maintenance in nominal monetary units, i.e., the traditional HC basis which includes implementing the very destructive stable measuring unit assumption, is compliant with IFRS. However, audited financial statements prepared under this basis do not fairly present the financial position of SA companies, as required by the Companies Act, when the directors do not:



(1) state in those annual financial statements that their choice of the traditional Historical Cost basis which includes the very destructive stable measuring unit assumption, destroys the real value of ONLY constant real value non-monetary items never maintained, at a rate equal to the annual rate of inflation and at a lower rate when they are not fully maintained.



(2) state that this includes the destruction of the real value of Shareholders´ Equity when the company does not have sufficient variable real value non-monetary items that are or can be revalued via the Revaluation Reserve or do not present sufficient hidden and unrecognised holding gains to compensate for the shortfall in real value in Shareholders’ Equity under the HC basis;



(3) state the percentage and amount of Shareholders´ Equity that is not being maintained; i.e., the percentage and amount of Shareholders´ Equity that is subject to real value destruction at a rate equal to the annual inflation rate because of the directors´ choice, in terms of the Framework, Par. 104 (a), to maintain financial capital maintenance in nominal monetary units instead of in units of constant purchasing power – both methods being compliant with IFRS;



(4) state the amount of real value destroyed during the last financial year in Shareholders´ Equity and all other constant items because of the directors´ choice to implement the HC basis;



(5) state the updated total amount of real value destroyed from the company’s start to date in this manner in at least Shareholders´ Equity never or not fully maintained;



(6) state the change in the updated real value of Shareholders´ Equity if the directors decide to measure financial capital maintenance in units of constant purchasing power instead of in nominal monetary units as provided in the Framework, Par. 104 (a) which is complaint with IFRS;



(7) state the directors´ estimate of the amount of real value to be destroyed by their implementation of the stable measuring unit assumption during the following accounting year under the HC basis;



(8) state that the real value calculated in (7) represents the amount of real value the company would gain during the following accounting year and every year there after for an unlimited period of time – ceteris paribus - if the directors´ choose to measure financial capital maintenance in units of constant purchasing power – which is compliant with IFRS – as provided in the Framework, Par. 104 (a);



(9) state the directors´ reason(s) for choosing financial capital maintenance in real value destroying nominal monetary units instead of in real value maintaining units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a).


It is obviously a million times better for company directors to choose to measure financial capital maintenance in constant purchasing power units as provided for in the IASB´s Framework, Par. 104 (a) which states: "Finacial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Both bases are compliant with IFRS. Measuring financial capital maintenance in constant purchasing power units instead of in nominal monetary units stops the unknowing destruction by accountants of massive amounts in real value in constant real value non-monetary items never or not fully updated, for example, Retained Earnings, in the real economy.

There is magic in lower inflation

Thought Leader

Alan Greenspan correctly stated that low inflation is what sustained economic growth is built upon.

It is very irresponsible to suggest an inflation target of 10% to 15%.

Under the current Historical Cost paradigm there are always TWO simultaneous systemic economy-wide real value destruction processes operating in the economy during inflation: (a) inflation in the monetary economy and (b) SA accountants implementing the Historical Cost Accounting model in the non-monetary or real economy:

(1) 161.6% cumulative inflation since April 1994 have destroyed 61.8% of the real value of the Rand in our monetary economy.

(2) During the same period SA accountants have unknowingly destroyed 61.8% of the real value in the non-monetary or real economy of all Retained Earnings balances that remained in SA companies during that period and in the Shareholders´ Equity of all companies with no fixed assets or a lower percentage in companies with insufficient fixed assets to revalue because our accountants implement the very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.

When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as per the International Accounting Standards Board´s Framework, Par. 104 (a) which is compliant with International Financial Reporting Standards, they will maintain instead of unknowingly destroy about R200 billion per annum in real value in constant items not updated in the SA real economy for an unlimited period of time and reduce economy-wide value destruction to simply a single destruction process by inflation in the real value of the Rand.

SA accounting facts as at end of April 2009

Real value unknowingly destroyed by SA accountants in Retained Earnings remaining in SA companies from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in Shareholders´ Equity of SA companies with no variable real value non-monetary items to revalue with equivalent entries in Revaluation Reserve from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in Retained Earnings remaining in SA companies from Apr 1994 to Apr 2009

61.8%

Real value unknowingly destroyed by SA accountants in Shareholders´ Equity of SA companies with no variable real value non-monetary items to revalue with equivalent entries in Revaluation Reserve from Apr 1994 to Apr 2009

61.8%


Cumulative inflation since Jan 1981: 1 354.8%

Cumulative inflation since Apr 1994: 161.6%

Annual inflation: 8.4%

Source of base data: Statistics South Africa

SA inflation facts as at the end of April, 2009

Annual inflation: 8.4% as at April 2009

Cumulative inflation since Jan 1981: 1 354.8%

Cumulative inflation since Apr 1994: 161.6%

Cumulative real value destruction since Jan 1981: 93.1%

Cumulative real value destructionm since April 1994: 61.8%

Real value unknowingly destroyed by SA accountants in all Retained Earnings remaining in SA companies from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in Issued Share Capital of all SA companies with no variable real value non-monetary items to revalue from Jan 1981 to Apr 2009

93.1%

Real value unknowingly destroyed by SA accountants in all Retained Earnings remaining in companies from Apr 1994 to Apr 2009

61.8%

Real value unknowingly destroyed by SA accountants in Issued Share Capital of all SA companies with no variable real value non-monetary items to revalue from Apr 1994 to Apr 2009

61.8%

SA Inflation Facts as at March 2009

1347.9% The cumulative inflation rate in SA since January 1981.

160.3% The cumulative inflation rate in SA since April 1994.

50% of real value in all constant items never updated since April 1994 unknowingly destroyed by SA accountants by December 2005: i.e. in 11 years time by their implementation of the very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.

50% of the real value of all Retained Earings in SA companies as at the end of April, 1994 unknowingly destroyed by SA accountants in 11 years.

61.6% of the real value of all retained earings in SA companies as at the end of April, 1994 unknowingly destroyed by SA accountants by March 2009.

61.6% of the real value of all issued share capital of all SA companies with no variable real value non-monetary items to revalue as at the end of April, 1994 unknowingly destroyed by SA accountants by March 2009.

This is the case when SA accountants choose - as they all do - to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation when they choose to measure financial capital maintenance in nominal monetary units in terms of the IASB´s Framework, Par. 104 (a). SA accountants have unknowingly destroyed 61.6% of all Retained Earingins in all SA companies in this way since April 1994 - as long as they choose to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation - all else being equal.


93.1% of the real value of all retained earings in SA companies as at the end of January, 1981 unknowingly destroyed by SA accountants by March 2009.

93.1% of the real value of all issued share capital of all SA companies with no variable real value non-monetary items to revalue as at the end of January, 1981 unknowingly destroyed by SA accountants by March 2009.

This is the case when SA accountants choose- as they all do - to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation when they choose to measure financial capital maintenance in nominal monetary units in terms of the IASB´s Framework, Par. 104 (a). SA accountants have unknowingly destroyed 93.1% of all Retained Earingins in all SA companies in this way since January, 1981 - as long as they choose to maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation - all else being equal.

The difference between deflation and disinflation

Deflation is a sustained decrease in the general price level resulting in a sustained increase in the real value of the functional currency and other monetary items.

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The functional currency is the currency of the primary economic environment in which an entity operates. It is normally the national or regional measurement currency or monetary unit of account in an economy or monetary union like the Euro in the European Monetary Union.

Deflation only happens below zero percent annual inflation. The functional currency and other monetary items are worth more all the time during deflation as opposed to being worth less all the time during inflation. Deflation is the opposite of inflation. Inflation destroys the real value of the functional currency and other monetary items. Deflation creates more real value in the functional currency and other monetary items.

Disinflation is lower inflation. Prices in an economy are still rising during disinflation, but at a slower rate. The general price level still rises, but, at a slower rate resulting in a continued, but, lower rate of real value destruction in the functional currency and other monetary items.

A lowering of inflation is, by definition, always disinflation. That is the same as a lowering of the rate of increase in the general price level. A lowering of the absolute value of the general price level is deflation.

Deflation means the general price level is not increasing at all, but, actually decreasing continuously and the functional currency and other monetary items are worth more all the time. Deflation causes an increase in the real value of the functional currency and other monetary items.

Inflation destroys the real value of the functional currency. Disinflation destroys the real value of the functional currency at a slower rate. Deflation creates more real value in the functional currency.

Inflation is a sustained increase in the general price level. Disinflation is a slower sustained increase in the general price level. Deflation is a sustained decrease in the general price level.

Disinflation happens, for example, after a period of higher inflation in what are normally considered low inflationary economies and is initially popularly confused with deflation. During disinflation many prominent prices, for example, oil, fuel, property and food prices are falling, but, the general price level is still actually rising, albeit at a much slower rate than during normal low inflation. When the slowing annual inflation rate (slowing increase in general price level) moves lower and lower it eventually gets to a zero percent annual rate for maybe a month or two. There is no increase in the general price level. When the absolute value of the general price level then starts to decrease the economy switches over from inflation to deflation: not just a slower increase in the generally increasing price level as during disinflation but actually a sustained decrease in the absolute value of the general price level below zero percent which causes an increase in the real value of the functional currency and other monetary items: the opposite of inflation.

Countries have little experience of deflation. Deflation is generally regarded as a very serious economic problem that everyone is trying to avoid at all costs especially after what happened during the Great Depression.

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Targeting 6% inflation is not international best practice.

"Inflation targeting is still seen by the markets as international best practice, which is why SA should stick with it." Greta Steyn, Fin24.com

Targeting 6% inflation is not international best practice.

The EMU, US and UK will never target 6% inflation.

Continuous 6% inflation destroys 6% of the real value of the Rand in one year and 71% in 20 yrs.

SA accountants unknowingly destroy 6% of the real value of Retained Earnings of all SA companies in one year and 71% in 20 yrs when they apply the stable measuring unit assumption for an indefinite period of time.

Mboweni, Greta Steyn and company do not even understand that.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Constant Item Purchasing Power Accounting

1.0 Three basic economic items

The economy consists of economic items and economic entities. Economic items have economic value. Accountants value economic items when they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value. Economic items consist of monetary and non-monetary items. The economy is divided in the monetary and non-monetary or real economy. Non-monetary items are sub-divided in variable real value non-monetary items and constant real value non-monetary items. The three fundamentally different basic economic items in the economy are monetary items, variable items and constant items.


Variable real value non-monetary items


Variable items are non-monetary items with variable real values normally traded in markets.

Examples of variable items in today’s economy are property, plant, equipment, inventory, quoted and unquoted shares, raw materials, finished goods, patents, trademarks, foreign exchange, etc.

There are markets for all the above items. All the above items can be bought or sold in a myriad of different markets world wide.

The first economic items were variable real value items. Their real values were determined by supply and demand. Their values were not yet expressed in terms of money because money was not yet invented at that time.

The first economies were barter economies. People bartered economic items they possessed or produced in excess of their own personal needs for other products they desired from other people who had an excess of the products they in turn possessed or produced or wished to exchange.

There was no inflation because there was no money. There was no monetary medium of exchange. There was no monetary unit of account. There was no monetary store of wealth. There was no money illusion.

There was no double entry accounting model at that time.

There were no Historical Cost Accounting model, no stable measuring unit assumption, no historical cost items and no nominal monetary units.

There was no value based accounting.

There was also no Consumer Price Index at that time. Consequently there were no units of constant purchasing power and no price-level accounting. There was no inflation accounting. There was no Constant Purchasing Power Accounting model under which all non-monetary items (variable and constant items) are inflation-adjusted by means of the CPI during hyperinflation.

There was also no Constant Item Purchasing Power Accounting under which only constant items are inflation-adjusted by means of the CPI during non-hyperinflationary periods in order to implement a financial capital concept of invested purchasing power by measuring financial capital maintenance in units of constant purchasing power and determining profit/loss in constant purchasing power units while variable items are valued in terms of specific rules at, for example, market value, fair value, present value, recoverable value or net realizable value.

There were no financial reports: e.g. no income statements, no balance sheets, no cash flow statements and no statements of changes in shareholders´ equity.

There were no monetary items. There were variable real value items not yet expressed in monetary terms.



Monetary items


Money was then invented over a long period of time as a response to the limitations imposed by the barter economy. Eventually money came to fulfil the following three functions:

a. Medium of exchange
b. Store of value
c. Unit of account

Non-monetary items were only defined in monetary terms after the invention of money. The economy came to be divided in the monetary economy and the non-monetary or real economy. There were monetary items and non-monetary items.


Monetary items are money held and items with an underlying monetary nature.

Examples of monetary items in today’s economy are bank notes and coins, bank loans, bank account balances, treasury bills, commercial bonds, government bonds, mortgage bonds, student loans, car loans, consumer loans, credit card loans, notes payable, notes receivable, etc.

Money and other monetary items´ real values are continuously being destroyed by inflation.


Non-monetary items are all items that are not monetary items.

Non-monetary items in today’s economy are divided into two sub-groups:

a) Variable real value non-monetary items
b) Constant real value non-monetary items

Inflation has no effect on the real value of non-monetary items.

There were still no units of constant purchasing power because there was still no CPI at that time. There were still no HCA model and still no stable measuring unit assumption. There were still no price-level accounting, no CPP inflation accounting model and no Constant Item Purchasing Power Accounting model. There were still no financial reports.

Inflation


Inflation is always and everywhere a monetary phenomenon: Milton Friedman.

Inflation is a rise in the general price level of goods and services in an economy over a period of time. Inflation destroys the real value of money and other monetary items over time. Disinflation is a decrease in inflation’s rate of increase. Inflation still destroys the real value of money and other monetary items during disinflation, just at a slower rate than before. Deflation creates real value in money and other monetary items over time. Deflation is a sustained decrease in the general price level after it has passed below zero per cent inflation.

Inflation reared its ugly head soon after the invention of money. It only destroyed the real value of money and other monetary items at that time as it does today. Inflation did not and can not destroy or erode (which is the same as destroy) the real value of non-monetary items – either variable or constant real value non-monetary items. Inflation has no effect on the real value of non-monetary items.

"Purchasing power of non monetary items does not change in spite of variation in national currency value."

Prof. Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.

Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005

There was only one systemic economy-wide process of real value destruction at that time. The economic process of inflation destroyed the real value of money and other monetary items equally throughout the monetary economy at that time as it does today in economies subject to inflation.

There was no second systemic economy-wide HCA practice destroying the real value of constant real value non-monetary items never or not fully updated as we experience today because the real value destroying traditional HCA model, which includes the very destructive stable measuring unit assumption, was not yet invented at that time. Today South African accountants unknowingly destroy the real values of constant real value non-monetary items never or not fully updated because they generally measure financial capital maintenance in SA banks and companies in nominal monetary units. They generally implement the very destructive stable measuring unit assumption as part of the real value destroying traditional HCA model.

Accountants at Johannesburg Stock Exchange listed companies as well as accountants at unlisted SA companies who prepare financial statements in terms of International Financial Reporting Standards generally choose to measure financial capital maintenance in nominal monetary units in terms of the International Accounting Standard Board’s Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a) which they apply in the absence of Standards relating to the valuation of capital, the maintenance of capital and the determination of profit or loss. The Framework, Par. 104 (a) states that financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units. Accountants at JSE listed companies have to prepare financial reports in terms of IFRS while accountants at unlisted SA companies can prepare financial statements either in terms of IFRS or South African Generally Accepted Accounting Practice.

Accountants preparing financial reports of SA unlisted companies in terms of SA GAAP generally also choose to measure financial capital maintenance in nominal monetary units and implement the HCA model since it is the generally accepted traditional accounting model.


Constant items


Constant items are non-monetary items with constant real values over time normally not traded in a market.


There are markets, namely stock markets, for company shares represented in the form of share certificates which are not constant items but variable real value non-monetary items, but, there is no market for the constant real value non-monetary item Issued Share Capital on a company’s balance sheet. Likewise there is no market for the specific individual constant items retained income, share premium, share discount, capital reserves or revaluation reserves, etc. There is no market for the individual constant items deferred tax assets or deferred tax liabilities. There is no market for taxes payable, taxes receivable, royalties payable, royalties receivable, etc. There is no market for trade creditors.

There is, however, a market for trade debtors when they are treated as monetary items. Trade debtors can be sold to a debt collecting company. Trade debtors are generally treated as monetary items in this case as can be seen from the IASB´s partially incorrect definition of monetary items as money held – which is correct and “items to be received or paid in money” which is incorrect. All items to be paid or received in money are not monetary items. Settlement values for most non-monetary items are to be paid or received in money.

The double entry accounting model was first comprehensively codified by the Italian Franciscan monk, Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.

The Consumer Price Index allows accountants to maintain the real values of certain income statement constant items, e.g., salaries, wages, rents, etc during inflationary periods with the constant purchasing power measurement basis while they implement the overall HCA model during non-hyperinflationary periods and with the inflation accounting CPPA model during hyperinflation. Constant Purchasing Power Accounting as defined in International Accounting Standard IAS 29 Financial Reporting In Hyperinflationary Economies is an inflation accounting model where under both variable and constant real value non-monetary items are inflation-adjusted by means of the CPI during hyperinflation.

Only the Constant Item Purchasing Power Accounting model as approved by the IASB in the Framework, Par. 104 (a), enables accountants to maintain the real values of both income statement and balance sheet constant items during non-hyperinflationary periods. The Framework, Par. 104 (a) states that financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units. Maintaining the real value of all constant items in the SA economy where accountants use the double entry accounting model to account economic activity is only possible with the real value maintaining Constant Item Purchasing Power Accounting+ model as authorized by the IASB in the Framework, Par. 104 (a) which is read in conjunction with International Financial Reporting Standards during inflation and deflation. It is not possible, at present, while SA accountants implement the real value destroying traditional HCA model because of their application of the very destructive stable measuring unit assumption during inflation. SA accountants unknowingly destroy real value on a massive scale in the real economy during inflation.

The specific choice of measuring financial capital maintenance in units of constant purchasing power (the Constant Item Purchasing Power Accounting model) at all levels of inflation and deflation as contained in the Framework for the Preparation and Presentation of Financial Statements, was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8." IAS Plus, Deloitte.


IAS8, 11: “In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

There is no applicable International Financial Reporting Standard or Interpretation regarding the valuation of the constant real value non-monetary items issued share capital, retained earnings, capital reserves, share issue premium, share issue discount, all other items in Shareholders Equity, the maintenance of financial capital and the determination of profit or loss. The Framework is thus applicable. There are Standards for trade debtors, trade creditors, other non-monetary payables, other non-monetary receivables, deferred tax assets, deferred tax liabilities, taxes payable and taxes receivable. In terms of IAS8.11 the Standards take precedence over the Framework in the case of these items.

The scope of the Framework includes dealing with defining, recognizing and measuring the items in financial statements and dealing with the concepts of capital and capital maintenance.

The Framework, Par. 110 states that the choice of the measurement bases and the concept of capital maintenance will decide the accounting model applied in the preparation of the financial reports. The Framework applies to different accounting models and is a guide to the preparation and presentation of the financial reports under the chosen accounting model.

The Framework is the IASB approved basis for accountants to choose, in terms of Par. 102, to implement a financial capital concept (instead of a physical capital concept) of invested purchasing power (instead of invested money) where under they choose, in terms of Par. 104 (a), to measure financial capital maintenance in units of constant purchasing power – the Constant Item Purchasing Power Accounting model - instead of in traditional HC nominal monetary units during non-hyperinflationary periods.

In terms of the Framework Par. 110, accountants choose the Constant Item Purchasing Power Accounting model when they choose, in terms of Par. 104 (a), to measure financial capital maintenance in units of constant purchasing power during non-hyperinflationary periods. They choose to implement the constant purchasing power financial capital concept of invested purchasing power, the constant purchasing power financial capital maintenance concept and they choose to determine profit or loss in terms of units of constant purchasing power during non-hyperinflationary periods instead of the traditional HC financial capital concept of invested money and the HC financial capital maintenance concept and the HC profit or loss determination concept in nominal monetary units non-hyperinflationary periods.

The Framework, Par. 102 states that most companies choose a financial concept of capital instead of a physical capital concept. Capital is the same as the company’s shareholders´ equity or its net assets when a financial concept of capital is adopted; either in invested purchasing power or in invested money.

The maintenance of capital being shareholders´ equity or net assets is as important as its recognition and definition. Capital maintenance is an accounting practice implementing a chosen concept of capital: either physical capital maintenance or financial capital maintenance. Financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units. Both methods are compliant with IFRS.


The Framework states that the needs of the users of financial reports should be the basis for choosing the correct concept of capital by a company. When the users of financial reports are mainly concerned with the preservation of the purchasing power of the invested capital or its nominal value, then a financial concept of capital should be used.

According to the Framework, the choice of the measurement bases and the concept of capital maintenance will decide the accounting model applied in the preparation of the financial reports. A profit is made under the financial capital maintenance concept only when the period-end financial (or money) net asset value is greater than at the start of the period, after subtracting distributions and contributions to and from shareholders during the accounting period. Financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units during non-hyperinflationary periods.

The real value maintaining Constant Item Purchasing Power Accounting model is an IASB approved price-level accounting alternative to the real value destroying traditional HCA model also approved by the IASB in Par. 104 (a).

The Framework states that the capital maintenance concept deals with how companies define the capital they want to preserve. It is the link between the concept of capital and the concept of profit or loss since it gives the point of reference for calculating profit or loss.

Examples of constant real value non-monetary items in today’s economy are income statement constant items like salaries, wages, rentals, taxes, duties, fixed interest payments, all other items in the income statement as well as balance sheet constant items like retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, provisions, capital reserves, all other shareholder’s equity items, trade debtors, trade creditors, other non-monetary debtors and creditors, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, etc.

No substance in the statement that choices SA accountants make won't affect the economy.

The debate of how to account for value has been around for decades.
Robert Kemp, CPA Professor, University of Virginia

The three fundamentally different basic economic items in the economy

1. variable items
2. monetary items and
3. constant items

are economic values. Each economic item is an economic value expressed in terms of money, i.e. the functional currency. SA accountants account economic transactions involving these three economic items in an organized manner when they implement a double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the Profit and Loss Account, assets and liabilities in the Balance Sheet plus other financial, management and costing reports.

SA accountants value economic items when they account economic activity in the accounting records and prepare financial reports of SA economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

SA accountants do not simply record economic activity. Accounting is not just a scorekeeping or recordkeeping of economic events. That concept of financial reporting has no substance. SA accountants value economic items when they account them. Subsequent accounting entries are part of generally accepted accounting practice of continuous valuation of the economic items originally valued and accounted over time as required by SA Generally Accepted Accounting Practice and IFRS implemented in conjunction with the IASB´s Framework.

The measurement basis and concept of financial capital maintenance SA accountants choose - either real value destroying traditional Historical Cost nominal monetary units (their current choice) or real value maintaining units of constant purchasing power (the CPPA model) - to value constant real value non-monetary items determine whether they unknowingly destroy or maintain their real values during low, high and hyperinflation. SA accountants are required by the IASB to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. IAS 29 is based on the Constant Purchasing Power Accounting model. Inflation, being a uniquely monetary phenomenon, can not, by definition, destroy the real value of constant real value non-monetary items or variable real value non-monetary items. It is SA accountants’ choice of capital maintenance concept (accounting model) that determines whether they carry on currently unintentionally destroying real value in constant items never or not fully updated or maintain those values for an unlimited period of time – all else being equal.

When SA accountants apply the very destructive stable measuring unit assumption as part of the real value destroying traditional HCA model and value constant items at their HC nominal monetary values and these items are never or not fully updated or inflation-adjusted by means of the CPI over time in SA´s non-hyperinflationary environment, they unknowingly destroy their constant real non-monetary values at a rate equal to the rate of inflation. This is the case with all constant items never or not fully inflation-adjusted including the unintentional destruction by SA accountants of the real value of issued share capital in SA banks and companies which do not have variable real value non-monetary fixed property, plant and equipment that can be revalued at least equal to the updated original real value of all capital contributions under the HC paradigm.

When SA accountants choose to measure financial capital maintenance in real value maintaining units of constant purchasing power (the CPPA model) – as they can freely do in terms of the IASB´s Framework, Par. 104 (a) - they will maintain all constant item real values over time including issued share capital, whether entities have fixed property, plant and equipment to revalue or not.

When SA accountants value constant items in HC nominal monetary units – as they all currently do – they unknowingly destroy their real values at a rate equal to the inflation rate when they are never updated under the HC paradigm.

Variable Items

SA accountants value variable real value non-monetary items in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”
IAS 16 deals with Property Plant & Equipment. It allows two methods of valuation or measurement; either historical cost or revaluation based on fair value. The charge for depreciation relates to the carrying value, whether historical cost or fair value. It is not acceptable under HCA to index up the original cost of an asset by reference to subsequent inflation or to base the depreciation charge on that indexed amount.

There are similar requirements in respect of intangible assets (IAS 38) and inventories (IAS 2).

IAS 39 requires fair values to be applied in valuing investments and derivative financial instruments. A historical cost basis of accounting is not acceptable for these items.

The real values of variable real value non-monetary items, e.g. property, are not destroyed when accountants value them at Historical Cost in terms of IFRS or GAAP. These items will be valued at their market prices when they are eventually sold.


Monetary items


Low inflation is what long term sustainable economic growth is built on. Alan Greenspan.

SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items can not be updated or indexed during the current financial period for the purpose of

1. accounting their values during the reporting period,
2. determining the profit or loss for the reporting period, and
3. measuring financial capital maintenance in either nominal monetary units or constant purchasing power units

during inflation or deflation.

Inflation – not SA accountants - destroys the real value of SA monetary items over time. The internal real value of the Rand is automatically adjusted downwards as it is being destroyed by the economic process of inflation in SA´s inflationary economy as indicated by the rate of change in the CPI. Inflation destroys the real value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors. The accounting model has no affect on the real value of monetary items during the reporting period.

Double entry accounting cannot maintain the real value of monetary items during the reporting period. It is not an attribute of double entry accounting to maintain the real value of monetary items during the reporting period. Inflation destroys the real value of monetary items no matter which accounting model is used. That is why low inflation is so critical for long term sustainable economic growth.

Constant items

SA accountants can choose to measure financial capital maintenance in either nominal monetary units (the HCA model) or in real value maintaining units of constant purchasing power (the CPPA model) as authorized by the IASB in the Framework, Par. 104 (a).

It is very obvious that how SA accountants choose to measure financial capital maintenance does make a big difference to the real value of constant items. There is absolutely no substance in the statement that the choices accountants make won't affect the economy.
The accounting model SA accountants choose in terms of the Framework, Par. 104 (a) is of critical importance. When they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power they will maintain the real values of, for example, all SA banks´ and companies´ retained income values constant over time, all else being equal, instead of unknowingly destroying them, as the currently do. The ONLY way SA accountants can maintain the real value of constant real value non-monetary items during inflation and deflation is by choosing a Constant Purchasing Power Accounting model as per the IASB´s Framework, Par. 104 (a).

Not a single SA accountant in SA chooses to measure financial capital maintenance in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a). SA accountants, unfortunately, choose to measure financial capital maintenance in nominal monetary units and thereby, unknowingly, destroy the real values of constant items at a rate equal to the rate of inflation when they are never or not fully updated over time when they implement the very destructive stable measuring unit assumption as part of the real value destroying HCA model. SA accountants are unknowingly killing the real economy at the rate of about R200 billion per annum – each and every year - as long as they carry on choosing to measure financial capital maintenance in nominal monetary units.


© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission

Constant Item Purchasing Power Accounting

Constant Purchasing Power Accounting as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the IASB´s inflation accounting model required to be implemented during hyperinflation.

Constant Item Purchasing Power Accounting is an International Accounting Standards Board approved basic accounting model alternative to traditional Historical cost accounting during low inflation. IAS 29 requires the updating of all non-monetary items (both variable and constant real value non-monetary items) by means of the Consumer Price Index during hyperinflation. Constant Item Purchasing Power Accounting as approved by the IASB in the Framework, Par. 104 (a) only requires the updating of constant real value non-monetary items during non-hyperinflationary periods. In terms of the Framework, Par. 104 (a), accountants can choose CIPPA to implement a financial capital concept of invested purchasing power instead of the traditional Historical Cost concept of invested money. They will thus implement a constant purchasing power financial capital maintenance concept by measuring financial capital maintenance in units of constant purchasing power instead of the traditional Historical Cost nominal monetary units and they will implement a constant purchasing power profit/loss determination concept. It simply means inflation-adjusting only constant real value non-monetary items, e.g. issued share capital, retained income, shareholders´ equity, trade debtors, trade creditors, deferred tax assets and liabilities, salaries, wages, rentals, etc, by means of the Consumer Price Index while valuing variable real value non-monetary items, e.g. property, plant, equipment, shares, inventory, etc in terms of International Financial Reporting Standards or Generally accepted accounting practice during non-hyperinflationary periods. Monetary items are valued at their original nominal values during the accounting period under all accounting models.

Monetary items, variable items and constant items are the three fundamentally different basic economic items in the economy.

Constant Item Purchasing Power Accounting will automatically maintain instead of continually erode - as the Historical Cost Accounting model is currently doing - the real value of all constant items never or not fully updated, including banks´ and companies´ capital base, for an unlimited period of time - all else being equal. Constant Item Purhcasing Power Accounting was authorized by the IASB in 1989 as an alternative to the traditional historical cost accounting model at all levels of inflation and deflation in the Framework for the Preparation and Presentation of Financial Statements and forms part of International Financial Reporting Standards. [http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32003R1725:EN:NOT]

The Framework, Par. 104 (a)

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Discredited 1970-style CPPA was a form of inflation accounting which tried unsuccessfully - by updating all non-monetary items (variable as well as constant real value non-monetary items) equally by means of the Consumer Price Index during high inflation - to allow for the effect of inflation in an attempt to make corporate accounts more informative when comparing current transactions with previous transactions.

Nevertheless, almost all accountants and accounting authorities - excluding the IASB - still regard Constant item purchasing power accounting as a discredited and failed 1970-style CPPA inflation accounting model. They ignore the Constant Item Purchasing Power Accounting model´s substantial benefits, for example, automatically maintaining banks´ and companies´ capital base, when accountants choose to inflation-adjust only constant items by means of the CPI thus maintaining their real values while they value variable items in terms of IFRS. Monetary items cannot be inflation-adjusted or updated and accountants value them at their original nominal values during the accounting period.

Certain income statement constant real value non-monetary items, most notably salaries, wages and rentals, are inflation-adjusted by means of the CPI, that is, valued or measured in units of constant purchasing power, in most economies.

The IASB specifically requires the CPPA inflation accounting model to be used during hyperinflation as per International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. [http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32003R1725:EN:NOT][http://www.pwc.com/gx/eng/about/svcs/corporatereporting/IAS29Publication06.pdf]PricewaterhouseCoopers, Financial Reporting in Hyperinflationary Economies, Understanding IAS 29


1970-style CPPA was a failed inflation accounting model

International Accounting Standard 29, Par. 6:

"In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued. Some entities, however, present financial statements that are based on a current cost approach that reflects the effects of changes in the specific prices of assets held.

The following quote from Geoffrey Whittington's book Inflation Accounting - An Introduction to the Debate, published in 1983, reflects the above position:

Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index.

Inflation Accounting: An Introduction to the Debate, Geoffrey Whittington, Cambridge University Press, 1983, ISBN 0521270553, ISBN 9780521270557, P. 73.[http://books.google.com/books?hl=en&id=-5Dz0JtXM9sC&dq=inflation+accounting+by+geoffrey+whittington&printsec=frontcover&source=web&ots=vrKex7Mpzp&sig=b6JGICF8YHoHzzAXESioFwOieBc&sa=X&oi=book_result&resnum=1&ct=result#PPA73,M1]

Constant Item Purchasing Power Accounting as a financial capital maintenance concept

The specific choice of measuring financial capital maintenance in units of constant purchasing power (the CIPPA model) at all levels of inflation and deflation as contained in the Framework, was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."

IAS Plus, Deloitte [http://www.iasplus.com/standard/framewk.htm]

IAS8. 11:

“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

[http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32003R1725:EN:NOT]

There is no applicable International Financial Reporting Standard or Interpretation regarding the valuation of constant real value non-monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all other non-monetary receivables and payables, Profit and Loss account items such as salaries, wages, rents, etc. The Framework is thus applicable.

Despite being part of IFRS Constant Item Purchasing Power Accounting is almost completely ignored by accountants in non-hyperinflationary economies even though it would maintain instead of diminish the real values of not only all income statement constant items but also all balance sheet constant real value non-monetary items for an unlimited period of time. This is because the CIPPA model is generally viewed by almost all accountants and accounting authorities, excluding the IASB, as a 1970-style failed CPPA inflation accounting model that requires all non-monetary items - variable real value non-monetary items and constant real value non-monetary items - to be inflation-adjusted by means of the Consumer Price Index. They - including the IASB - fail to introduce the substantial real value maintaining benefits, which last for an unlimited period of time (all else being equal), of measuring financial capital maintenance in units of constant purchasing power in companies and the economy in general.

The IASB did not approve Constant Item Purchasing Power Accounting in 1989 as an inflation accounting model. CIPPA by measuring financial capital maintenance in units of constant purchasing power incorporates an alternative capital concept, financial capital maintenance concept and profit determination concept to the Historical Cost capital concept, financial capital maintenance concept and profit determination concept. CIPPA only requires all constant real value non-monetary items, e.g. issued share capital, retained income, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all items in the profit and loss account, etc to be valued in units of constant purchasing power. Variable real value non-monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS and are not required in terms of the Framework, Par. 104 (a) to be valued in units of constant purchasing power.

CIPPA is authorized by the IASB during low inflation

The statement "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power," in the IASB´s Framework, Paragraph 104 (a), means that Constant Item Purchasing Power Accounting has been authorized by the International Accounting Standards Board since 1989 as an alternative to the traditional Historical Cost Accounting model, including during periods of low inflation. This means that the international accounting profession has been in agreement regarding the use of Constant Purchase Power Accounting for financial capital maintenance in units of constant purchasing power during low inflation since 1989. It also means that Constant Item Purchasing Power Accounting and the inflation-adjustment of constant real value non-monetary items to maintain their real values in a low inflationary environment are authorized by International Financial Reporting Standards since the Framework is part of IFRS.

Constant real value non-monetary items like salaries, wages, rents, pensions, utilities, transport fees, etc are normally valued by accountants in terms of Constant Purchasing Power units during low inflation in most economies. Payments in money for these items are normally inflation-adjusted by means of the Consumer Price Index to compensate for the erosion of the real value of the monetary medium of exchange by inflation. Inflation is always and everywhere a monetary phenomenon and can only erode the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not erode the real value of non-monetary items. Constant real value non-monetary items´ real values can be maintained by accountants choosing the Constant Item Purchasing Power Accounting model as per the Framework during low inflation as authorized in IFRS since 1989 instead of currently being eroded by the implementation by accountants of the traditional Historical Cost Model when they apply the stable measuring unit assumption. It is thus accountants´ choice of accounting model and not inflation that maintains or erodes the real value of constant real value non-monetary items like retained earnings, issued share capital (banks´ and companies´ capital base), capital reserves, other shareholder equity items, trade debtors, trade creditors, deferred tax assets and liabilities, other taxes payable and receivable, etc.

Implementing the CIPPA model means accountants choose to reject the stable measuring unit assumption which they implement when they choose to measure financial capital maintenance in nominal monetary units. Accountants world wide currently choose the traditional Historical Cost Accounting model except during hyperinflation when they are required by IFRS to implement IAS 29 which is based on the CPPA model.

Net monetary gain or loss

Accountants have to calculate the net monetary loss or gain from holding monetary items when they choose the CIPPA model and measure financial capital maintenance in units of constant purchasing power.

CIPPA as per the IASB's Framework


Framework for the Preparation and Presentation of Financial Statements

Concepts of Capital and Capital Maintenance

Concepts of Capital

Par. 102

A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. 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.

Par. 103

The selection of the appropriate concept of capital by an entity should be based on the needs of the users of its financial statements. Thus, a financial concept of capital should be adopted if the users of financial statements are primarily concerned with the maintenance of nominal invested capital '''or the purchasing power of invested capital'''. If, however, the main concern of users is with the operating capability of the entity, a physical concept of capital should be used. The concept chosen indicates the goal to be attained in determining profit, even though there may be some measurement difficulties in making the concept operational.

Concepts of Capital Maintenance and the Determination of Profit

The concepts of capital give rise to the following concepts of capital maintenance:

Par. 104

(a) Financial capital maintenance. Under this concept a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.

(b) 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.

Par. 105

The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between an entity’s return on capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed income the residual amount is a loss.

Par. 106

The physical capital maintenance concept requires the adoption of the current cost basis of measurement. The financial capital maintenance concept, however, does not require the use of a particular basis of measurement. Selection of the basis under this concept is dependent on the type of financial capital that the entity is seeking to maintain.

Par. 107

The principal difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities of the entity. In general terms, an entity has maintained its capital if it has as much capital at the end of the period as it had at the beginning of the period. Any amount over and above that required to maintain the capital at the beginning of the period is profit.

Par. 108

Under the concept of financial capital maintenance where capital is defined in terms of nominal monetary units, profit represents the increase in nominal money capital over the period. Thus, increases in the prices of assets held over the period, conventionally referred to as holding gains, are, conceptually, profits. They may not be recognised as such, however, until the assets are disposed of in an exchange transaction. When the concept of financial capital maintenance is defined in terms of constant purchasing power units, profit represents the increase in invested purchasing power over the period. Thus, only that part of the increase in the prices of assets that exceeds the increase in the general level of prices is regarded as profit. The rest of the increase is treated as a capital maintenance adjustment and, hence, as part of equity.

Par. 109

Under the concept of physical capital maintenance when capital is defined in terms of the physical productive capacity, profit represents the increase in that capital over the period. All price changes affecting the assets and liabilities of the entity are viewed as changes in the measurement of the physical productive capacity of the entity; hence, they are treated as capital maintenance adjustments that are part of equity and not as profit.

Par. 110

The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements. Different accounting models exhibit different degrees of relevance and reliability and, as in other areas, management must seek a balance between relevance and reliability. The Framework is applicable to a range of accounting models and provides guidance on preparing and presenting the financial statements constructed under the chosen model. At the present time, it is not the intention of the Board of IASC to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy. This intention will, however, be reviewed in the light of world developments.

The IASB Framework was approved by the IASC Board in April 1989 for publication in July 1989, and adopted by the IASB in April 2001.

CPPA inflation accounting is required by the IASB during hyperinflation

The IASB authorized the CIPPA model during low inflation in the Framework, Par. 104 (a) as an alternative to the Historical Cost Accounting model. The IASB, however, specifically requires the implementation of the CPPA inflation accounting model during hyperinflation as per IAS 29 Financial Reporting in Hyperinflationary Economies which is based on the CPPA model. [http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32003R1725:EN:NOT]

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Accountants value economic activity

The debate of how to account for value has been around for decades.

Robert Kemp, CPA Professor, University of Virginia – CC http://www.glgroup.com/News/Fair-Value-Accounting---The-Good-And-Bad-Of-It-In-The-Real-World-27848.html


The three distinct economic items in the economy

1. variable items
2. monetary items and
3. constant items

are economic values. Each economic item is an economic value expressed in terms of money. SA accountants account economic transactions involving these three economic items in an organized manner when they implement a double entry accounting model: journal entries, general ledger accounts, trial balances, cash flow statements, items in the Profit and Loss Account, assets and liabilities in the Balance Sheet plus other financial, management and costing reports.

SA accountants value economic items when they account economic activity in the accounting records and prepare financial reports of SA economic entities based on the double entry accounting model. Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

SA accountants do not simply record economic activity. Accounting is not just a scorekeeping or recordkeeping of economic events. Accountants value economic items when they account them. Subsequent accounting entries are part of continuous generally accepted accounting practice of valuation of the economic items originally valued and accounted over time as required by SA Generally Accepted Accounting Practice and IFRS implemented in conjunction with the IASB´s Framework.

The measurement basis SA accountants choose to value constant real value non-monetary items determines whether they maintain or destroy their real values. Inflation being a monetary phenomenon cannot destroy the real value of constant real value non-monetary items. When accountants value constant items at their HC nominal monetary values they unknowingly destroy their constant real non-monetary values at a rate equal to the rate of inflation because the depreciating monetary unit of account is the same as the depreciating monetary medium of exchange and inflation destroys the real value of the depreciating monetary medium of exchange. Only when they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power – as they can freely do in terms of the IASB´s Framework, Par. 104 (a) - do they maintain their real values over time.

Variable Items

SA accountants value variable real value non-monetary items in terms of IFRS or SA GAAP. “Listed companies use IFRS and the unlisted companies could use either IFRS or Statements of GAAP.”

Monetary items

SA accountants value monetary items at their original nominal monetary values; that is, at their original HC values since monetary items can not be updated or indexed during the current financial period for the purpose of

1. accounting their values during the reporting period,
2. determining the profit or loss for the reporting period, and
3. measuring financial capital maintenance in either nominal monetary units or constant purchasing power units

during inflation or deflation.

Inflation – not SA accountants - destroys the real value of SA monetary items over time. The internal real value of the Rand is automatically adjusted downwards as it is being destroyed by the economic process of inflation in SA´s inflationary economy as indicated by the rate of change in the CPI. Inflation destroys the real value of monetary items under any accounting model and also when no accounting model is implemented; that is, when a business does not account its economic activities; for example, street vendors. The accounting model has no affect on the real value of monetary items during the reporting period.

Double entry accounting cannot maintain the real value of monetary items during the reporting period. It is not an attribute of double entry accounting to maintain the real value of monetary items during the reporting period. Inflation destroys the real value of monetary items no matter which accounting model is used. That is why low inflation is so critical for long term sustainable economic growth.

Low inflation is what long term sustainable economic growth is built on. Alan Greenspan.

Constant items

SA accountants can choose to measure financial capital maintenance in either nominal monetary units or in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a).

It is very obvious that how SA accountants choose to measure financial capital maintenance does make a big difference to the real value of constant items. There is no substance in the statement that economic resources´ values – per se - are independent of the way in which we value them – no matter how well respected and how important that person is in the SA accounting and academic circles. The accounting model SA accountants choose in terms of the Framework, Par. 104 (a) is of critical importance. When they choose to measure financial capital maintenance in real value maintaining units of constant purchasing power they will maintain the real values of, for example, all SA banks´ and companies´ retained income values constant over time, all else being equal, instead of unknowingly destroying them as the currently do. The only way they can maintain the real value of constant real value non-monetary items during inflation and deflation is by choosing a Constant Purchasing Power Accounting model as per the IASB´s Framework, Par. 104 (a).

Not a single SA accountant in SA chooses to measure financial capital maintenance in real value maintaining units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a). SA accountants, unfortunately, choose to measure financial capital maintenance in nominal monetary units and thereby, unknowingly, destroy the real values of constant items at a rate equal to the rate of inflation when they are never or not fully updated over time when they implement the very destructive stable measuring unit assumption as part of the HCA model. SA accountants are unknowingly killing the real economy at the rate of about R200 billion per annum – each and every year - as long as they carry on implementing the very destructive stable measuring unit assumption.

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Three fundamentally different basic economic items

The economy is divided in the monetary and non-monetary or real economy. Economic items consist of monetary and non-monetary items. Non-monetary items are sub-divided in variable real value non-monetary items and constant real value non-monetary items. There are thus three fundamentally different basic economic items in the economy: monetary items, variable items and constant items.


Variable real value non-monetary items


The first economic items were variable real value items. Their real values were determined by supply and demand. Their values were not yet expressed in terms of money because money was not yet invented at that time.

The first economies were barter economies. People bartered economic items they possessed or produced in excess of their own personal needs for other products they desired from other people who had an excess of the products they in turn possessed or produced.

There was no inflation because there was no money. There was no monetary medium of exchange. There was no monetary unit of account. There was no monetary store of wealth. There was no money illusion.

There was no double entry accounting model at that time.

There were thus no Historical Cost Accounting model, no stable measuring unit assumption, no historical cost items and no nominal monetary units.

There was also no Consumer Price Index at that time and consequently there were no units of constant purchasing power and no real value maintaining Constant Purchasing Power Accounting model.

There were no financial reports: e.g. no profit and loss accounts and no balance sheets.

There were no monetary items and no constant items. There were only variable real value items not yet expressed in monetary terms.

Examples of variable real value non-monetary items in today’s economy are property, plant, equipment, inventory, shares, raw materials, merchandise, patents, trademarks, etc.


Monetary items


Money was then invented over a long period of time as a response to the limitations imposed by the barter economy. Eventually money came to fulfil the following three functions:

a. Medium of exchange
b. Store of value
c. Unit of account

Non-monetary items were only defined in monetary terms after the invention of money when it came to be used as the basic monetary unit of account in the economy. The economy came to be divided in the monetary economy and the non-monetary or real economy. There were monetary items and non-monetary items.

Monetary items

Monetary items are money held and items with an underlying monetary nature.

Examples of monetary items in today’s economy are bank notes and coins, bank loans, bank account balances, treasury bills, commercial bonds, government bonds, mortgage bonds, student loans, car loans, consumer loans, credit card loans, notes payable, notes receivable, etc.

Non-monetary items

Non-monetary items are all items that are not monetary items.

Non-monetary items in today’s economy are divided into two sub-groups:

a) Variable real value non-monetary items
b) Constant real value non-monetary items


There were still no units of constant purchasing power because there was still no CPI at that time. There was still no Historical Cost Accounting model and still no stable measuring unit assumption. There was still no Constant Purchasing Power Accounting model. There were still no double entry financial reports: still no profit and loss accounts and still no balance sheets.

Inflation

Inflation is always and everywhere a monetary phenomenon: Milton Friedman.

Inflation destroys the real value of money. Deflation creates real value in money.

Inflation reared its ugly head soon after the invention of money. It only destroyed the real value of money and other monetary items at that time as it does today. Inflation did not and can not destroy the real value of variable and constant items. Inflation has no effect on the real value of non-monetary items.

There was only one systemic economy-wide process of real value destruction at that time. The economic process of inflation destroyed the real value of money and other monetary items equally throughout the monetary economy at that time as it does today in economies subject to inflation.

There was no second systemic economy-wide accounting practice destroying the real value of constant real value non-monetary items never or not fully updated as we experience today because the real value destroying Historical Cost Accounting model, which includes the very destructive stable measuring unit assumption, was not yet invented at that time. Today South African accountants unknowingly destroy the real values of constant real value non-monetary items never or not fully updated because they choose to measure financial capital maintenance in SA banks and companies in nominal monetary units when they implement the very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model.


Constant items


Finally the double entry accounting model was invented. It was first comprehensively codified by the Italian Franciscan monk, Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.
The invention of the double entry accounting model enables accountants to maintain the real values of both income statement as well as balance sheet constant real value non-monetary items – the third distinct category of economic items. Maintaining the real value of constant items in the SA economy where accountants use the double entry accounting model to account all economic activity is, however, only possible with the real value maintaining Constant Purchasing Power Accounting model during inflation. It is not possible, at present, while SA accountants implement the real value destroying traditional Historical Cost Accounting model because of their application of the very destructive stable measuring unit assumption during inflation. SA accountants unknowingly destroy real value on a massive scale in the real economy when they implement the traditional Historical Cost model.
The specific choice of measuring financial capital maintenance in units of constant purchasing power (the CPPA model) at all levels of inflation and deflation as contained in the Framework for the Preparation and Presentation of Financial Statements, was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8." IAS Plus, Deloitte.


IAS8, 11: “In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There is no applicable International Financial Reporting Standard or Interpretation regarding the valuation of constant real value non-monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all other non-monetary receivables and payables, Profit and Loss account items such as salaries, wages, rents, etc. The Framework is thus applicable.
The scope of the Framework includes dealing with defining, recognizing and measuring the items in financial statements and dealing with the concepts of capital and capital maintenance.
Framework, Par. 104 (a)

Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.

The Framework, Par. 110 states that the choice of the measurement bases and the concept of capital maintenance will decide the accounting model applied in the preparation of the financial reports. The Framework applies to different accounting models and is a guide to the preparation and presentation of the financial reports under the chosen accounting model.

The Framework is the IASB approved basis for accountants to choose, in terms of Par. 104 (a), to measure financial capital maintenance in units of constant purchasing power – the CPPA model - instead of in nominal monetary units – the traditional HCA model. They can, in terms of Par. 110, choose the Constant Purchasing Power Accounting model implementing the constant purchasing power financial capital concept, capital maintenance concept and the determination of profit/loss in terms of units of constant purchasing power instead of the Historical Cost capital concept, capital maintenance concept and the determination of profit/loss in terms of nominal monetary units.

The Framework, Par. 102 states that most companies choose a financial concept of capital. Capital is the same as the shareholders´ equity of a company or its net assets when a financial concept of capital is adopted, for example, invested purchasing power or invested money.

The maintenance of capital is as important as its recognition and definition. Capital maintenance is an accounting practice implementing a concept of capital.

The Framework states that the needs of the users of financial reports should be the basis for choosing the correct concept of capital by a company. When the users of financial reports are mainly concerned with the preservation of the purchasing power of the invested capital or its nominal value, then a financial concept of capital should be used.

According to the Framework, the choice of the measurement bases and the concept of capital maintenance will decide the accounting model applied in the preparation of the financial reports. A profit is made under the financial capital maintenance concept only when the period-end financial (or money) net asset value is greater than at the start of the period, after subtracting distributions and contributions to and from shareholders during the accounting period. Financial capital maintenance can be calculated in either units of constant purchasing power or in nominal monetary units.

The real value maintaining Constant Purchasing Power Accounting model is thus an IASB approved alternative to the real value destroying traditional Historical Cost Accounting model.

The Framework states that the capital maintenance concept deals with how companies define the capital they want to preserve. It is the connection between the concepts of capital and the concepts of profit/loss since it gives the point of reference for calculating profit/loss.

Examples of constant real value non-monetary items in today’s economy are Profit and Loss Account items like salaries, wages, rentals, pensions, taxes, duties, fixed interest payments, etc as well as balance sheet items like retained earnings, issued share capital, capital reserves, share issue premiums, share issue discounts, provisions, capital reserves, all other shareholder’s equity items, trade debtors, trade creditors, other non-monetary debtors and creditors, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, etc.

CIPPA is an IASB approved alternative to Historical Cost Accounting

The International Accounting Standards Board´s Framework introduced the real value maintaining Constant ITEM Purchasing Power Accounting model as an alternative to the real value destroying traditional Historical Cost Accounting model in 1989 in Par. 104 (a) where it states that financial capital maintenace - not variable real value non-monetary items, e.g. property, plant, equipment, inventory, intangible assets, etc, - can be meansured in either nominal monetary units - the very destructive traditional HCA model - or in units of constant purchasing power: the CIPPA model. [10] The Framework is part of International Financial Reporting Standards.

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The CIPPA model is chosen by hardly any accountant in non-hyperinflationary economies even though it would maintain the real values of constant real value non-monetary items - e.g. issued share capital, retained income, other shareholder equity items, trade debtors, trade creditors, etc for an unlimited period of time. This is because the CIPPA model is generally viewed by accoutants as a 1970´s failed inflation-accounting model that requires all non-monetary items - variable real value non-monetary items and constant real value non-monetary items - to be inflation-adjusted by means of the Consumer Price Index.

The IASB did not approve CIPPA in 1989 as an inflation accounting model. CIPPA by measuring financial capital maintenance in units of constant purchasing power incorporates an alternative capital concept, financial capital maintenance concept and profit determination concept to the Historical Cost capital concept, financial capital maintenance concept and profit determination concept. CIPPA only requires all constant real value non-monetary items, e.g. issued share capital, retained income, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all items in the profit and loss account, etc to be valued in units of constant purchasing power. Variable real value non-monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc are valued in terms of IFRS and are not required in terms of the Framework, Par. 104 (a) to be valued in units of constant purchasing power.

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The IASB requires entities to implement IAS 29 which is a CPP inflation accounting model during hyperinflation.