Net monetary gain or loss conundrum (for dummies :-)

The world´s top accounting authority (the International Accounting Standards Board or just the IASB) orders you to calculate what you lose or gain in real value from actually keeping cash or loans in your business during hyperinflation.

During normal low inflation they pretend that they are very dumb and just ignore the fact that you ALSO gain or lose real value from keeping cash or loans in your business - during low inflation.

But, they give you a choice of doing your accounting properly and not destroying the profits you make simply by the way you do normal traditional historical cost accounting.

If you pick this alternative, they tell you again - correctly - to calculate the gain or loss from keeping cash or loans in your business - now during actual normal low inflation.

They are thus a bit of a joke.

Under hyperinflation you MUST calculate this loss or gain from cash and loans.

But, during low inflation, you don'´t have to (and no-one does) - unless you pick the other, much better and correct way of doing your accounts (which NO-ONE picks).

Huh??

So, what is their story?

Are there losses and gains from keeping cash and loans in your business?

If yes, as it actually is, why are we only allowed to calculate and show this during hyperinflation and not with normal historical cost accounting during low inflation?

But, if we pick their much better and correct alternative, then we suddenly can calulate these monetary losses and gains - during low inflation?

It is one helluva big puzzle.

So you ask, what is the correct thing to do?

Pick the other better and correct way of doing your accounts (they - the BIG ACCOUNTING BOSSES approved it 20 years ago) with which you do not AUTOMATICALLY destroy your capital and profits you keep in your company as your accountant does right now with traditional Historical Cost Accounting during low inflation.

Here is the link for more info.

(New book coming soon - watch this space :-) [This time you´ll have to pay for it.]

If you want to email me (I´m available :-) realvalueaccounting@yahoo.com

Kindest regards,

Nicolaas Smith

Net monetary gain or loss conundrum

Accountants have to calculate the net monetary gain or loss from holding monetary items when they choose the Constant Item Purchasing Power Accounting model and measure financial capital maintenance in units of constant purchasing power in the same way as the IASB currently requires its calculation and accounting only during hyperinflation in IAS 29.

There are net monetary losses and net monetary gains during low inflation too, but they are not required to be calculated when accountants choose the traditional Historical Cost Accounting model.

It is an inexplicable contradiction that net monetary gains and losses are required by the IASB to be calculated and accounted during hyperinflation but not during non-hyperinflationary periods, especially when the IASB approved alternative to Historical Cost Accounting, namely Constant Item Purchasing Power Accounting does require their calculation and accounting during low inflation.

Kindest regards,

Nicolaas Smith

The Market Monkey and the Real Value Accountant - Part 2

Market Monkey said:

heh heh.

You miss understand my disagreement NS.

I agree that the current accounting mis-states the true value of the firm's capital.

I just don't agree it has any relevance to the real world. I must be in the top 1.0% of the population who uses accounts to make real world decisions and value ... and I really don't care that the capital is stated at historic cost.

... and

I think that I would actually complain if units of constant purchasing power were used.

Why?

Well. I like having the raw data. I can then adjust it for inflation myself. If the accountants had to do the calculations for me then I wouldn't know what I'm dealing with? I might disagree with the inflation rate they have used ... the global CPI numbers are all already a load of hog wash with them being adjusted for "heuristics", leaving out key consumtion items etc.

Do you get my point and why I prefer the current system?

Keep a swinging,

MM.

P.s. Also just so there is no confusion; I'm not an accountant (i.e. CA), I just use accounts to make decisions and money.

Real Value Accountant said:

Hi Market Monkey,

We have to be professional here:

I never stated that historical cost accounting “misstates” the true value of the firm´s capital.

I state that historical cost accounting accountants unknowingly DESTROY the real value of constant items never updated. This includes the real value of firms´ issued share capital and retained earnings.

Your agreement that current accounting misstates the true value of the firm´s capital is the same as the hackneyed “historical cost accounting erodes the firm´s capital.”

I understand.

It is a very, very, very big step to agree that historical cost accountants unknowingly destroy real value on a massive scale in the real economy.

It is agreeing that the 500 year old Historical Cost paradigm is over.

It is similar to agreeing that the world is round when you have always believed it is flat.

I understand.

This is not going to happen overnight. I accept that.

I already proved to you in a previous comment on another post that historical cost accountants unknowingly destroy the real value of retained profits.

You simply refuse to accept that it makes any difference in the real world.

That is also fine with me.

You accept the mainstream, generally accepted view of things.

That is fine.

Let me show you where your mainstream approach will take you:

If SA trade unions manage to increase wages at rates of 26% and above and this is taken up generally in SA and SA enters into hyperinflation (26% annual inflation for three years in a row totalling 100% cumulative inflation) you will receive all your annual financial statements that you use in your work done in terms of IAS 29. That is, in terms of the IASB´s Constant Purchasing Power inflation accounting model under which ALL non-monetary items, variable and constant items, are inflation adjusted. These financial statements will have new items that you do not deal with during low inflation: net monetary losses and net monetary gains.

You will accept all that as will all accountants in SA because it is required by the IASB and IFRS. Like Turkey did recently.

Then, when SA gets out of hyperinflation back into low inflation again, then you and all SA accountants will suddenly again receive/produce financial statements devoid of net monetary gains and net monetary losses and no units of constant purchasing power for all constant items. As Turkey did recently.

[I do not promote IAS 29 Constant Purchasing Power inflation accounting during low inflation in SA by which ALL non-monetary items are inflation adjusted. I promote the IASB´s Constant ITEM Purchasing Power basic accounting model under which ONLY constant items are inflation-adjusted and variable items are valued in terms of IFRS.]

Then you and all SA accountants will suddenly state again that there is no such thing as net monetary gains and net monetary losses and that the Rand is perfectly stable, as you, Market Monkey, and all SA accountants state right now, as far as the valuation of Issued Share Capital, Retained Profits, Capital Reserves, Share Issue Premiums, Share Issue Discounts, all other items in Shareholders Equity, trade debtors, trade creditors, taxes payable, taxes receivable, etc are concerned.

Horses for courses for you and SA accountants.

See what I mean?

How can investors and people in general have great faith in accounting when the above takes place. And it does – as you well know. It happened in the case of Turkey.

Below 26% annual inflation for 3 years in a row (the current low inflation situation): no net monetary gains and losses and the Rand is perfectly stable for the valuation of balance sheet constant items – i.e. implementing the stable measuring unit assumption as you and all SA accountants do at the moment.

At and above 26% annual inflation for 3 years in a row (recent Turkey-style hyperinflation of about 100 to 150%): net monetary gains and losses and no stable measuring unit assumption at all – just units of constant purchasing power.

It makes no sense at all.

The critical factor is to get to the point when you accept that historical cost accountants unknowingly destroy real value on a massive scale in the real economy.

Market Monkey, I do not know when you will be ready to accept that.

Most probably you will only accept it when the majority of companies in SA 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 states: "Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

I understand and accept that. You are a mainstream person - not a doubter and searcher like me.

Kindest regards,

Nicolaas Smith

PS: Yes, Market Monkey, I can see why you prefer the current system. The problem is you do not understand that SA accountants unknowingly destroy about R200 billion in the SA real economy last year and this year and next year again if they carry on with their stable measuring unit assumption.

That is a helluva lot of real value to destroy each and every year. It will make a big difference to the SA real economy when that is not destroyed but maintained forever - year after year after year.

That is what you do not understand.

This is what Dr. Cemal KÜÇÜKSÖZEN, Head of the Accounting Standards Department of the
Capital Markets Board of Turkey stated in public in 2005 after he read the manuscript of my first book:

"I totally agree with you."

NS

Julius, why are you not proud of Tito Mboweni?

Julius, Tito Mboweni is black.

He halved to 5.9% (REDUCE BY 50%) the average inflation in SA during 10 years compared to the last 12 years of white apartheid rule.

What better proof is there of black intelligence and excellence of unquestionable quality?

Julius, you have a short memory.

SA is proud of Tito Mboweni.

Why are you not?

Kindest regards,

Nicolaas Smith

The Investor and the Real Value Accountant

Port Elizabeth Coat of Arms


Investor said:

"They will not create new real value out of nothing by just passing some accounting entries. They will boost the SA real economy BY NOT DESTROYING EXISTING REAL VALUE"
I don't get it? how do book keeping entries not destroy wealth. I ddon't get the connection at all. Please explain in lay man's terms so I can follow the mechanics.

Real Value Accountant said:

Hi Investor,

How is my beloved PE? Still windy? I see on Google Earth that Sardinia Bay is still the same. Theesecombe (where I grew up) and Kragga Kamma have changed a bit. So has Lorraine. Where do you stay in PE? Did you go to UPE? Which schools did you attend?

Your questions:

Let me start off by saying that I did not invent financial capital maintenance in units of constant purchasing power. The International Accounting Standards Board formulated it in 1989 in the Framework, Par. 104 (a) and other paragraphs in the Framework.

How do bookkeeping entries not destroy value – in lay man’s terms?

As follows:

Let´s start with your salary. Your salary is an income statement constant item as opposed to a balance sheet constant item.

Bookkeeping is double entry; that is, for every debit there is a credit.

Dr Salaries R20 000
Cr Salaries payable R20 000

Your salary in Year 1.

Inflation 6.9%

Entries for Year 2

Dr Salaries (R20 000 X 1.069) R21 380
Cr Salaries payable R21 380

Your salary was updated at 6.9% from R20 000 to R21 380. In real value it is exactly the same thing. You got no increase. Simply an inflation-adjustment of your basic salary.

Your salary was inflation-adjusted because it´s real value was measured in units of constant purchasing power as all salaries are world wide.

Bookkeeping entries in Year 2 – the inflation-adjusted values – means the real value of your salary was NOT destroyed.

If your salary was NOT updated in Year 2 and you were still paid R20 000 you will agree that the real value of your salary would have been destroyed by 6.9%.

Not because of inflation, but because your accountant measured the real value of your salary in nominal monetary units or at historical cost. Your accountant applied the stable measuring unit assumption and assumed, just for the purpose of valuing your salary, that there was no such thing as inflation. He or she assumed that the Rand was perfectly stable. So it is his or her selection of the historical cost measurement basis that destroyed the real value of your salary.

Your accountant can also, as they all actually do, measure the real value of your salary in units of constant purchasing power and maintain its real value no matter what the rate of inflation is. So it is not inflation that is destroying your salary when it is not updated, but the measuring basis your accountant chooses.

World wide all accountants select the historical cost accounting model, BUT, they value salaries, NOT at historical cost, but in units of constant purchasing power.

However, they do NOT value retained profits, which is also a constant item, in units of constant purchasing power, like they do with your salary. All of them value retained profits during low inflation at historical cost.

So, you know that they destroy retained profits´ real value at a rate equal to the inflation rate exactly as they would have done with your salary if they had not inflation-adjusted it in Year 2.

Bookkeeping for Retained Profits

Year 1

Retained Profits R 40.665 billion (ABSA´s balance at 31.12.08)

Year 2

Retained Profits R40.665 billion (That 31.12.08 value in ABSA´s books carried forward to 31.12.09) under historical cost accounting.

Real value destroyed by ABSA´s board of director´s decision to implement the historical cost accounting model:

R40.665 x 0.069 (if inflation stays at 6.9 % for the whole of 2009) = R 2.806 billion

So, when ABSA´s board decides to select financial capital maintenance in units of constant purchasing power as the IASB authorized them to do in the Framework, Par. 104 (a) twenty year ago, the entries will be as follows:

ABSA 31.12.2008

Retained Profits R40.665 billion

ABSA 31.12.2009

Retained Profits R43.471 billion

You will ask: where does that value come from. It is not new value. It is simple existing real value maintained by inflation-adjusting the real value.

But, you will say: accounting is double entry.

Yes, you are right.

Let us assume ABSA´s balance sheet is as follows:

ABSA at 31.12.2008 under their current Historical Cost Accounting model as selected by their current board of directors.

Assets Liabilities

Trade Debtors R40.665 billion Retained Profits R40.665 billion

Nothing changes during the whole of 2009

ABSA at 31.12.2009 under their current Historical Cost Accounting model as selected by their current board of directors.

Assets Liabilities

Trade Debtors R40.665 billion Retained Profits R40.665 billion

Everything stays exactly the same.

We all know that everything did not stay exactly the same. We all know that that R40.665 billion in Retained profits and R40.665 billion in Trade Debtors are not the same in real value after a year of 6.9% inflation.

But, that is how things are done. So, that´s it then. SA accountants destroy R200 billion per annum in this way.

Their auditors will sign the above accounts off as fairly representing the ABSA business with accounts drawn up on the historical cost basis and compliant with IFRS.

If ABSA´s board of directors suddenly wakes up to the billions of real value they are destroying year after year (or if the SA government forces them to stop the real value destruction), they will select to measure financial capital maintenance in units of constant purchasing power in terms of the Framework, Par. 104 (a) which is fully complaint with IFRS.

Their accounts will then be as follows:


ABSA at 31.12.2008 under Constant Item Purchasing Power Accounting

Assets Liabilities

Trade Debtors R40.665 billion Retained Profits R40.665 billion

Nothing changes during the whole of 2009 except that inflation for the whole year was 6.9%.


ABSA at 31.12.2008 under Constant Item Purchasing Power Accounting

Assets Liabilities

Trade Debtors R43.471 billion Retained Profits R43.471 billion


Their auditors will sign the above accounts off as fairly representing the ABSA business with accounts drawn up on the Constant Item Purchasing Power Accounting basis and compliant with IFRS.

So, you can see that ABSA under current historical cost accounting lost R2.806 billion by not updating their Trade Debtors and their Retained Profits as they should have.

This loss is not stated anywhere. It just happens - like the loss in the real value of the Rand.

Under historical cost accounting during low inflation, the net monetary loss caused by inflation in the real value of the Rand is not stated anywhere.

But, lo and behold: let SA get into hyperinflation which is 26% inflation for 3 years in a row, and suddenly: hey presto: net monetary loss will appear in all financial reports and constant purchasing power accounting everywhere.



But, only during hyperinflation. Out of hyperinflation and all SA accountants will state that there is no such thing as a net monetary loss.

What a joke accounting seems to be. Anything goes, as long as everyone is doing it.

Nobody has much faith in economists after the last financial crisis.

Imagine what this is going to do to the image of accountants. They are killing the real economy left, right and centre. All of them, everywhere. The least damage would be done if accountants admit the Historical Cost Mistake quickly and then ban Historical Cost Accounting.

If the SA government can grasp the amount of real value destroyed by SA accountants in the SA real economy each and every year, they should ban Historical Cost Accounting in SA.

Their auditors will sign the above accounts off as fairly representing the ABSA business with accounts drawn up on the Constant Item Purchasing Power Accounting basis and compliant with IFRS.



Investor, I hope you understand the above.

Give my regards to all in PE,

Nicolaas Smith

Capital maintenance for dummies

Companies´ capital and retained profits are like salaries: constant items.

When your salary is not inflation-adjusted, its real vlaue is destroyed at the rate of inflation. We all know that. No-one disagrees. Not even Market Monkey :-)

Exactly the same is true for companies´ capital and retained profits.

No-one inflation adjusts companies´ capital and retained profits during low inflation.

Result: SA accountants unknowingly destroy the real value of companies´ capital and retained profits by not inflation-adjusting them.

This amounts to about R200 billion for SA per annum.

When SA accountants inflation-adjust companies´ capital and retained profits they will boost the SA real economy by at least R200 billion PER ANNUM forever - year after year after year.

They will not create new real value out of nothing by just passing some accounting entries. They will boost the SA real economy BY NOT DESTROYING EXISTING REAL VALUE as they unknowingly do at the moment in all SA banks and companies with their stable measuring unit assumption. They value capital and retained profits at historical cost. They refuse point blank to inflation-adjust them.

You all work so hard to create that capital and retained profits and make SA grow. SA accountants unknowingly and unintentionally quietly simply destroy their real values at the rate of inflation right under your noses - year after year after year.

Inflation-adjusting capital and retained profits during low inflation was authorized by the International Accounting Standards Board 20 years ago. It is compliant with International Financial Reporting Standards.

That would be wonderful for everybody in SA, wouldn´t it?

Stronger banks and companies meaning a stonger economy with more investment capital available meaning more jobs and more growth.

Kindest regards,

Nicolaas Smith

1.1% Drop in inflation lowers ABSAs 6 monthly real value destruction to R1.910 bn from R2.348 bn

Inflation can only destroy the real value of the Rand and other monetary items in the SA monetary economy.

Inflation can not destroy the real value of ABSA´s Retained Earnings.

ABSA´s board of directors selecting the historical cost accounting model unknowinly destroys the real value of the bank´s existing Retained Earnings at a rate equal to the rate of inflation by implementing the stable measuring unit assumption.

When ABSA´s board of directors choose to measure financial capital maintenance in units of constant purchasing power as the International Accounting Standard Board authorized them to do 20 years ago in the Framework, Par. 104 (a) which states: "Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power", which is compliant with International Financial Reporting Standards (see IAS8.11), they will knowingly maintain the real value of the bank´s Retained Earnings no matter what the rate of inflation in SA instead of destroying the real value of the existing Retained Earnings at a rate equal to the rate of inflation as they are unknowingly doing right now.

ABSA had R40.665 billion in Retained Earnings at 31.12.08. ABSA´s board of directors selected the historical cost model to do the bank´s accounting. The group financial director, Jacques Schindehütte, continue to implement the stable measuring unit assumption and continue to unknowingly destroy group retained earnings at a rate equal to the rate of inflation.

Luckily for him and the board, inflation is down to 6.9% in June and he and they unknowingly only destroyed R1.910 billion in retained earnings in the 6 months to June 2009, instead of R2.438 billion if the inflation rate had stayed at 8.0% to June, 2009.

The 1.1% drop in the inflation rate means they unknowingly maintain R438 million in the existing real value of the bank´s Retained Earnings. That can now be paid out in a higher dividend or can be kept in the bank to grow the bank´s business.

Unfortunately, as long as the board of directors select the historical cost model to do the bank´s accounts, they will unkowingly keep on destroying even the value they now unknowingly maintain because of the drop in inflation.

Kindest regards,

Nicolaas Smith

The Market Monkey and the Real Value Accountant

Market Monkey said:

Sorry NS but I'm kinda in the other camp.

I don't believe historic cost accounting destroys any real world value.

The people using the accounts to either [a] determine the company's market value, [b] determine the dividend or [c] determine next years salaries all adjust the figures to take inflation into account.

For me the accounts are just records and I much prefer them to be historic cost because then I know what I'm dealing with and I can make my own adjustments. I use accounts on a daily basis and I am 100% sure which method I prefer ... and constant purchasing power accounting ain't it.

Best luck with ya crusade though.

MM.

The Real Value Accountant said:

Hi Market Monkey,

First of all: you use constant ITEM purchasing power accounting – not constant purchasing power accounting - every day and you do not even know it. We’ll come to that later.

You are 100% correct in (a) that inflation is taken into account by investors on the JSE in determining the real value of a company’s market value - a variable real value non-monetary item. The function of financial accounting as presented in the financial statements is not to value the business as a whole, but to convey value information about the economic resources of a business. This distinction recognizes the need to segregate the accounting function from the investor function. Thus, a company’s market value can be higher or lower than the company’s net book value.

You are also 100% correct that inflation is taken into account to determine next year´s salaries. Salaries are constant real value non-monetary items. Salaries, wages, rentals and many other Income Statement constant real value non-monetary items are valued in terms of units of constant purchasing power by all companies in all economies world wide – generally speaking. You do not seem to realize that measurement in units of constant purchasing power has been used for this purpose for ages.

You are 100% wrong as far as (b) is concerned in the non-hyperinflationary world: the fact that inflation destroys the real value of the Rand is not taken into account by anyone in SA for determining the dividend. They simply use what is in the Retained Earnings account. They value Retained Earnings as you agree they should value it: at historical cost although the IASB authorized them 20 years ago to value it in real value maintaining units of constant purchasing power. You and SA accountants refuse to do that.

You will agree with me that R100 000 kept at home for a year in brand new notes will have lost 6.9% of their real value one year from now – ceteris paribus. You will agree with me that not accounting but inflation destroys the real value of the Rand.

You will also agree with me that if you close your company’s accounts today and you have R100 000 in net after tax profits and you decide not to declare the R100 000 in dividend to yourself as sole-owner of the company but rather keep it in the company as retained earnings and you then pay that dividend to yourself in a year’s time you will receive R100 000 in nominal value but 6.9% less in real value – all else being equal. You will agree with me that your decision to use historical cost accounting – more exactly the stable measuring unit assumption whereby you do not update retained earnings in your books – resulted in historical cost accounting – and not inflation - destroying 6.9% of the real value of your retained earnings over the next year – as it is doing to all companies´ retained earnings in SA.

Why? Because you could have chosen in terms of the IASB´s Framework, Par. 104 (a) – approved 20 years ago – to measure your financial capital maintenance in units of constant purchasing power. Par. 104 (a) states: “Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power.”

You can inflation-adjust all constant items in your business – no matter what the rate of inflation. So, it is not inflation that is destroying the real value of your retained earnings. It is your selection of the historical cost accounting model. When you choose constant ITEM purchasing power accounting you maintain the real value of your retained earnings forever – ceteris paribus.

This is not 1970-style Constant Purchasing Power INFLATION accounting whereby ALL non-monetary items are inflation adjusted.

This is Constant ITEM Purchasing Power BASIC accounting whereby ONLY constant items are inflation adjusted – as approved by the IASB 20 year ago and which is compliant with IFRS.

So, there you have it Market Monkey: you agree with me that historical cost accounting destroys value. Easy, isn’t it?

Btw: the total real value destroyed in this fashion by SA accountants implementing historical cost accounting for SA as a whole is conservatively estimated at about R200 billion PER ANNUM.

When they switch over to constant ITEM purchasing power accounting they will maintain R200 billion PER ANNUM in the SA real economy FOREVER – ceteris paribus.

I am sure you will agree with me that maintaining existing R200 billion PER ANNUM instead of each and every year destroying that value - as SA accountant are unknowingly doing right now - will make quite a difference to the SA real economy.

So, now I have proved to you - without any doubt - that

"historic cost accounting destroys real world value."

We all live and learn.

I´m sure you will be able to teach me many things about the market that I previously did not understand.

Kindest regards

Nicolaas Smith

Trust me, I´m an accountant: I will destroy your retained profits at a rate equal to the inflation rate.

AccountingWeb has a headline on the web at the moment:

Trust me. I am an accountant.

Well, that is the historical cost accounting fantasy story.

Here is the real value real story:

Trust me. I am an accountant. I will destroy all your constant items never updated at a rate equal to the rate of inflation.

Kindest regards,

Nicolaas Smith

6.1 percent real increase in salaries is good for internal demand. Hope it is not inflationary.

A 13% nominal increase for municipal workers is a 6.1% real increase with annual inflation at 6.9%.

That is good for internal demand in the SA economy. Workers will have 6.9% more real value to spend in the internal economy.

It would be wonderful if the trade unions and workers could find a way to force SA accountants to abandon their silly stable measuring unit assumption.

That would boost the SA real economy by R200 billion each and every year forever.

Just imagine how many extra jobs would be created with a R200 billion boost in the real economy each and every year for an unlimited period of time.

It must be remembered that if shops now push up all prices by 13% then workers will have a zero increase in real value. The real value of their salaries will stay exactly the same. They will have no increase at all.

Let´s see how the battle between shops and Gill Marcus turn out eventually.

It will obviously be a disaster if inflation increases to 13 % again.

Kindest regards,

Nicolaas Smith

A 1% drop in inflation

A 1% drop in inflation means that R19.5 billion will be maintained in the real value of the SA money supply (real value of the Rand) over the next year - if nothing else changes.

It also means that SA accountants will unknowingly destroy 1% or about R850 million less in the real value of the existing retained profits of JSE listed companies with their stable measuring unit assumption.

They will unknowingly only destroy about R84.15 billion in existing JSE retained profits over the next year - ceteris paribus.


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

Salaries and wages under Constant Item Purchasing Power Accounting

Under Constant Item Purchasing Power Accounting (CIPPA) all constant items´ - including salaries and wages - real values are maintained constant by updating or inflation-adjusting them in terms of the Consumer Price Index (CPI) on a monthly basis.

As the CPI changes month by month, so are salaries and wages adjusted - on a monthly basis. They thus remain at the same real value from month to month all year long.

When annual salary and wage increases have to be negotiated, all that have to be discussed are real increases of one or two or three or more per cent for real increases in productivity as a result of technology improvements, efficiency, etc, or social upliftment or other adjustments for whatever reasons.

What is important to understand is that CIPPA is a double entry accounting model like all accounting models: the books have to balance - in real value, or, the books always do actually balance - in real value - when there is no stable measuring unit assumption whereby SA accountants simply assume that ONLY for the purpose of valuing constant items, there is suppose to be no such thing as inflation, or, inflation is permanentely zero percent, or, the Rand is perfectly stable all the time. Note: they ONLY apply this rule to some constant items, namely issued share capital, retained profits, all other items in shareholders equity - basically all balance sheet constant items. SA accountants are forced by the trade unions to inflation-adjust salaries and wages, for example. The trade unions do not get involved with the valuing of the other items in the income statement, so, accountants value them at historical cost.

Maintaining the real values of salaries and wages as well as all other constant real value non-monetary items (issued share capital, retained profits, all other items in shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc) constant does not mean paying more real value.

It simply means rejecting SA accountants´ stable measuring unit assumption. ALL constant items are maintained constant by means of computerized monthly CPI adjustments well as maintaining all variable real value non-monetary items at their up-to-date market values, fair values, net realizable values, recoverable values or present values as they are valued in terms of International Financial Reporting Standards or SA Generally Accepted Accounting Practice.

All that have to be calculated correctly thereafter to make the books balance, is the net monetary loss or net monetary gain depending on the level of inflation and the average monetary value balance in a company month by month.

Kindest regards,

Nicolaas Smith

Anglo Plats destroyed R848 million over the last 6 months

Anglo Plats had Accumulated Profits of R 19.045 billion on 31 Dec 2007. Their Board of Directors selected the Historical Cost basis to do their accounting in 2008. They thus do not update the real value of their Accumulated Profits. By not updating it, they destroy its real value at a rate equal to the rate of inflation - the same as you lose real value in Rands you keep at home.

The CPI was 93.3 on 31 Dec 2007 and 102.2 on 31 Dec 2008. If they had applied the IASB´s Framework, Par. 104 (a) [approved 20 years ago] and measured financial capital maintenance in units of constant purchasing power which is compliant with IFRS, they would have maintained that existing R19.045 billion real value on 31.12.07 to the amount of 19.045 X (102.2/93.3) } R20.862 billion on 31.12.2008. They did not. So, they destroyed R20.862 - R19.045 billion = R1.817 billion in the real value of their Accumulated Profits.

On 31.12.2008 they had R19.691 billion (CPI 102.2) of Accumulated Profits. The CPI at the end of May, 2009 was 106.6. They destroyed a further R848 million in the real value of their Accumulated profits over the last 6 months (June CPI not yet available).

The estimated total destroyed like this ANNUALLY for all JSE listed companies in the real value of their Accumulated Profits is about R85 billion.

The conservatively estimated total for SA is about R200 billion PER ANNUM.

Makes you think? Or does it not?

Kindest regards,

Nicolaas Smith

The unknown enemy

Everybody must be very happy to hear that Gill Marcus will be an enemy of inflation.

Milton Friedman stated correctly that inflation is always and everywhere a monetary phenomenon. Inflation only destroys the real value of the Rand and other monetary items in the SA monetary economy. Inflation has no effect on the real value of non-monetary items.

The economy consists of three parts:

1. The monetary economy - the Rand money supply and other monetary items like bank loans, credit card loans, home loans, student loans, etc.

2. The variable item economy - everything you see around you except actual money and bank/loan accounts: items with variable prices over time (cars, houses, products, etc)

3. The constant item economy - salaries, wages, rents, company issued share capital, retained profits in companies, trade debtors, trade creditors, taxes payable, taxes receivable, etc: items with constant real values over time (you know your salary or wage has a constant real value over time).

We all know that inflation is the enemy in the monetary economy. Inflation can only destroy the real value of the Rand and other monetary items - at 8% per annum at the moment. It has destroyed 93.2% of the real value of the Rand since January 1981. Cumulative inflation since then now runs at 1 354%. Taking it from another date: inflation has destroyed 61.9% of the real value of the Rand since April, 1994 because we have had 162% cumulative inflation since the start of the current government.

There are no enemies in the variable item economy because the market eventually kills all enemies to its proper working: variable items are mostly exchanged at market prices determined by supply and demand.

The enemy in the constant item economy has been killed off by COSATU and other trade unions in the past and in the present in salaries and wages. Trade unions ensured in the past and ensure in the present that the enemy of constant wages and salaries, accountants´ stable measuring unit assumption, is dead and stays dead. COSATU and other trade unions see to it that the real values of salaries and wages are measured in units of constant purchasing power. COSATU and other trade unions reject SA accountants´ stable measuring unit assumption: i.e. they see to it that salaries and wages are inflation-adjusted in a low inflation environment.
SA accountants´ stable measuring unit assumption whereby they simply assume there is no such thing as inflation (accountants simply assume the Rand is PERFECTLY stable for this purpose) is so ingrained in accountants´ minds that it has become a completely unknown enemy to the constant item economy as far as the valuation of SA companies´ issued share capital, retained profits, debtors, creditors, taxes payable, taxes receivable, etc are concerned.

Accountants - after very many years of pressure from trade unions - inflation-adjust salaries and wages in low inflation environments but they refuse point blank to measure financial capital maintenance in units of constant purchasing power although the International Accounting Standards Board authorized them to do exactly that 20 years ago in the Framework, Par. 104 (a) which states: "Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."

SA accountants simply refuse to reject their stable measuring unit assumption during low inflation.
So, what is the result of SA accountants´ stable measuring unit assumption: they refuse point blank to update the existing real values of SA banks´ and companies´ existing retained profits, for example. This means they unknowingly destroy the existing real value of all SA banks´ and companies´ existing retained profits at a rate equal to the annual rate of inflation because they value these items in Rands. This amounts to them unknowingly destroying about R85 billion PER ANNUM just in the existing real value of existing retained profits of companies listed on the Johannesburg Stock Exchange. They are unknowingly doing it right now.

It is conservatively estimated that they unknowingly destroy about R200 billion PER ANNUM in the existing real value of existing constant items never updated in the SA constant item economy. They are unknowingly doing it this year as they unknowingly did last year and as they unknowingly will do next year if they carry on with their stable measuring unit assumption.

What will happen when SA accountants follow the IASB´s advice given 20 years ago and stop their stable measuring unit assumption?

They will knowingly boost the existing SA constant item economy with at least R200 billion PER ANNUM for an unlimited period of time in the future - ceteris paribus - by simply maintaining instead of destroying existing real values in existing constant items. Now they destroy them with their stable measuring unit assumption. When they stop their stable measuring unit assumption they will maintain them.

SA accountants can not and do not create real value out of nothing by simply passing some accounting entries. They will boost the existing SA constant item economy by about R200 billion PER ANNUM for an unlimited period of time by not destroying existing real value in existing constant items as they did in the past and as they are doing right now whenever they stop their stable measuring unit assumption.


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

The stable measuring unit assumption is the enemy in the real economy

Fin24.com today reported that:

"Head of research at the South African Reserve Bank (Sarb), Dr Johan van den Heever, said Governor-elect Gill Marcus will be an enemy of inflation when she takes over on November 9. "

I am very happy to hear that.

I am sure that Gill Marcus and the SARB know that inflation is a uniquely monetary phenomenon and only destroys the real value of the Rand - currently at 8% per annum - and other monetary items in the SA monetary economy.

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.

http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

Inflation has no effect on the SA real or non-monetary economy. The Historical Cost Accounting model SA accountants and boards of directors of SA banks and companies choose has a devastating effect on the real value of constant real value non-monetary items never updated in the SA real economy, for example, the Retained Earnings of all SA banks and companies.

SA accountants unknowingly destroy a massive amount - conservatively estimated at about R200 billion per annum - in the real value of non-monetary items never updated in the SA real economy with their very destructive stable measuring unit assumption each and every year.

The stable measuring unit assumption is the enemy in the real economy.
When SA accountants measure financial capital maintenance in units of constant purchasing power as the International Accounting Standard Boards authorized them to do 20 years ago in the Framework, Par. 104 (a) which state that:


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

which is compliant with International Finanicial Reporting Standards, they will reject the stable measuring unit assumption and maintain instead of destroy about R200 billion in the real value of constant real value non-monetary items in the SA real economy for an unlimited period of time.


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

Constant items

Geoffrey Whittington in his definitive work on inflation accounting in the beginning of the 1980´s, Inflation Accounting - An Introduction to the Debate, published in 1983, clearly indicated that with 1970-style CPP accounting all non-monetary accounts (with no distinction being made between variable and constant real value non-monetary item accounts) were updated by means of the CPI.

He stated that Constant Purchasing Power inflation accounting (CPP) was a method of inflation-adjusting all non-monetary accounts consistently by means of the Consumer Price Index which reflected changes in money’s purchasing power. 1970-style CPP inflation accounting tried to deal with the problem of inflation in the popularly understood sense, as a decrease in the real value of money. According to Whittington, CPP inflation accounting tried to solve this problem by inflation-adjusting all non-monetary items at the reporting date by means of the CPI.

This eventually led to the failure of 1970-style CPP accounting as an inflation accounting model.
SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.

The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.


Salaries, wages, rentals, etc are normally inflation-adjusted in South Africa and generally too in most economies.
Inflation-adjusted income statement constant real value non-monetary items, for example, salaries and wages, are – right this very moment - a blessing to users in SA – and all around the world - because they maintain the real value or purchasing power of salaries and wages during inflation as long as the inflation-adjustment is at least equal to inflation over the period in question. Millions of SA workers, their trade unions, the SA government, SA accountants and South Africans in general would agree that the practice of inflation-adjusting accounts in a low inflation environment is a blessing to users and does not insult them.

Inflation-adjusted balance sheet constant real value non-monetary items, e.g. Issued Share capital, Retained Earnings, etc in SA´s low inflation environment will be a blessing to everyone in SA when our accountants simply choose to change from their current implementation of the real value destroying traditional HCA model and freely choose to implement the real value maintaining Constant Item Purchasing Power Accounting model as approved in the IASB´s Framework, Par. 104 (a) twenty years ago. They would maintain - instead of currently destroy as they also did last year and all the years before - at least R200 billion annually in constant item real value in the SA real economy for an unlimited period – all else being equal.


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

Generally accepted inflation concepts

It is generally accepted and a fact that inflation destroys the real value of money (the internal functional currency) and other monetary items over time.

It is also generally accepted and a fact that hyperinflation can destroy the real value of a country’s entire monetary base as happened in Zimbabwe recently. That was the result of a massive increase in the volume and nominal value of bank notes in the country by Gideon Gono, the governor of the Reserve Bank of Zimbabwe, with an equivalent extreme rate of destruction of the real value of the Zimbabwe Dollar since the massive nominal increase in ZimDollar money supply was not the result of a concomitant increase in real value in the real or non-monetary economy of Zimbabwe.

It is generally accepted and a fact that inflation destroys the real value of the capital amounts of monetary savings and money lent over time.

It is generally accepted, but not a fact, that inflation erodes, which is the same as destroys, the real value of constant real value non-monetary items with fixed nominal payments over time, e.g. fixed salary, wage, rental payments, etc.

The constant real value non-monetary values of salaries, wages, rentals, etc are generally maintained, i.e. not destroyed, when accountants choose to measure the real value of these constant real value non-monetary items in units of constant purchasing power in terms of the CPI in most economies with payment in depreciating money during inflation.

It is not generally accepted, but a fact, that SA accountants unknowingly destroy the real value of Retained Earnings of all SA companies and banks over time when they choose to measure financial capital maintenance in nominal monetary units in terms of the real value destroying traditional HCA model during inflation when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation and these companies and banks have no revaluable variable items or insufficient revaluable variable items to maintain 100% of the updated original real value of all contributions to their Shareholders´ equity.

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

No reproduction without permission.

The rejection of the stable measuring unit assumption

Accountants and accounting authorities do not appreciate that they can stop accountants destroying real value on a massive scale in the real economy by simply rejecting the stable measuring unit assumption when they choose the IFRS compliant Constant Item Purchasing Power Accounting model and measure financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation.

IFRS do, however, already – 20 years ago - allow the rejection of the stable measuring unit assumption as an alternative to HCA at all levels of inflation and deflation. The IASB´s Framework, Par. 104 (a) states that financial capital maintenance can be calculated in either constant purchasing power units or in nominal monetary units. Par. 104 (a) was authorized by the IASB predecessor body, the International Accounting Standards Committee Board in April, 1989 and adopted by the IASB in 2001.

The stable measuring unit assumption is also rejected in IAS 29 Financial Reporting in Hyperinflationary Economies.
The Standards thus already reject the stable measuring unit assumption under two circumstances:

1.) In IAS 29 during hyperinflationary conditions with the IASB´s Constant Purchasing Power inflation accounting model which is a complete price-level inflation accounting model under which all non-monetary items, variable and constant items, are inflation-adjusted by means of the CPI during hyperinflation, and

2.) In the Framework, Par. 104 (a) in the implementation of the Constant Item Purchasing Power basic accounting model with the measurement of financial capital maintenance in units of constant purchasing power as an alternative to the real value destroying traditional HCA model when the stable measuring unit assumption is maintained for an unlimited period of time during indefinite inflation.
 IFRS already allow the rejection of the stable measuring unit assumption under two circumstances: (1) as an alternative to the real value destroying traditional basic HCA model under low inflation and (2) as a specific requirement by the IASB during hyperinflation – both items approved 20 years ago.

The IASB approved Framework, Par. 104 (a) which is applicable in this case since there is no specific IFRS relating to the valuation of Issued Share capital, Retained Earnings and other items in Shareholders´ Equity during non-hyperinflationary periods, allows accountants to reject the stable measuring unit assumption during all levels of inflation and deflation when they choose to measure financial capital maintenance in units of constant purchasing power as an alternative to measurement in nominal monetary units as applied in the traditional HCA model.

It is not generally appreciated by accountants that they are unknowingly responsible for the destruction of the real value of constant real value non-monetary items never or not fully updated or inflation-adjusted or maintained over time when they implement the real value destroying traditional HCA model: more specifically, the very destructive stable measuring unit assumption during periods of inflation when they maintain it for an unlimited period of time during indefinite inflation. This lack of appreciation also applies to economists, business people and the public in general.

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

No reproduction without permission.

It is an essential function of accounting to maintain the real value of constant items during inflation

1970-style Constant Purchasing Power (CPP) inflation accounting was a popular but failed attempt at inflation accounting at that time. It was a form of inflation accounting which tried unsuccessfully to make corporate accounts more informative when comparing current transactions with previous transactions by updating ALL non-monetary items (without distinguishing between variable and constant real value non-monetary items) equally by means of the Consumer Price Index during high inflation.

Measurement in units of constant purchasing power was used for variable and constant balance sheet items during the high inflation 1970´s. 1970-style CPP inflation accounting was abandoned as a failed and discredited inflation accounting model for reasons explained below when general inflation decreased to low levels thereafter.
The function of financial accounting is not just “to convey value information about the economic resources of a business” as Harvey Kapnick stated in the 1976 Sax Lecture.

http://newman.baruch.cuny.edu/DIGITAL/saxe/saxe_1975/kapnick_76.htm

It is an essential function of accounting to maintain the real value of constant items during inflation and deflation. This can only be achieved by inflation-adjusting all constant items by means of the CPI as approved by the IASB in the Framework, Par. 104 (a) twenty years ago. Accountants have abdicated the essential financial capital maintenance function of accounting to their fiction that money is stable in real value during inflation and deflation. In so doing, they have in the past unknowingly destroyed and currently unknowingly destroy real value on a massive scale in the real economy when they implement the very destructive stable measuring unit assumption as part of the IASB approved real value destroying traditional Historical Cost Accounting model during non-hyperinflationary periods when they implement the stable measuring unit assumption for an unlimited period of time during indefinite inflation.


Kindest regards,

Nicolaas Smith

SA accountants´ stable measuring unit assumption costs SA about R200 billion each and every year

Hi,

I point out that SA accountants unknowingly destroy about R200 billion per annum in the SA real economy with their implementation of the very destructive stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model.

Simply put: SA accountants unknowingly destroy about R200 billion per annum doing normal traditional Historical Cost accounting.

They can maintain about R200 billion PER ANNUM for an unlimited period of time in the SA real economy by updating all constant items as they are allowed to do 20 years ago by the IASB.

Maintaining constant items´ real values during low and hyperinflation is an essential function of accounting.

It is hard to believe that the IASB only requires / mandates / demands that during hyperinflation with IAS 29.

The IASB leaves it as an option during low inflation.

That Historical Cost Mistake costs SA about R200 billion per annum.

Kindest regards,

Nicolaas Smith