Split of non-monetary items derived in IFRS

Split of non-monetary items derived in IFRS

It is generally accepted that there are only two basic, fundamentally different economic items in the economy; namely, monetary and non–monetary items and that the economy is divided in the monetary and non–monetary or real economy. However, non–monetary items are not all fundamentally the same. The split of non-monetary items is implied in IFRS.

Owners´ equity (capital) is defined as a non-monetary item in IAS 29, Financial Reporting in Hyperinflationary Economies in various paragraphs including paragraphs 24 and 25. All items in owners´ equity are thus non-monetary items.

The original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] furthermore states: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’

Financial capital maintenance can thus be measured in units of constant purchasing power over time in terms of IFRS under the Constant Item Purchasing Power (CIPP) paradigm. The original Framework (1989), Par. 104 (a) authorized the principle on which the CIPP paradigm is based. The CIPP paradigm is fundamentally different from the Historical Cost (HC) paradigm. The stable measuring unit assumption is applied in the valuation of, for example, owners´ equity and other items measured in nominal monetary units under the HC paradigm. The stable measuring unit assumption is never applied under financial capital maintenance in units of constant purchasing power; i.e., under the Constant Item Purchasing Power paradigm. Financial capital maintenance in units of constant purchasing power is fundamentally different from financial capital maintenance in nominal monetary units (Historical Cost Accounting).

The real value of financial capital can thus be maintained in units of constant purchasing power by measuring capital maintenance in units of constant purchasing power over time. The real non-monetary values of all items in owners´ equity would be maintained constant when financial capital is maintained in units of constant purchasing power over time.

Capital and all other items in owners´ equity are thus constant real value non-monetary items. The concept of a constant real value non–monetary item is thus implied in IFRSs, which is logical since IFRSs are principles-based standards.

Measurement in units of constant purchasing power is not simply the restatement of items in the statement of financial position and the statement of comprehensive income from financial reports produced under whatever capital maintenance model as stated by Gamble. There are actually economic items with constant real values over time; namely, constant real value non-monetary items. Examples include all items in owners´ equity, all income statement items, salaries, wages, pensions, borrowing costs, interest, bank charges, fees, rentals, trade debtors, trade creditors, all other non-monetary payables and receivables, provisions, etc.

However, not all non-monetary items are measured in units of constant purchasing power in terms of Par. 104 (a).

Non–monetary items which are not constant real value non–monetary items are thus variable real value non–monetary items valued in terms of IFRS, e.g. property, plant, equipment, inventory, shares, etc. Their real values vary over time. They are valued at net realizable value, fair value, present value, recoverable value, etc. in terms of IFRS – excluding the stable measuring unit assumption – because the stable measuring unit is never applied under financial capital maintenance in units of constant purchasing power.

Conclusion: The split of non-monetary items in variable and constant real value non-monetary items is derived in IFRS.

There are thus three fundamentally different, basic economic items in the economy:

(a)               Monetary items

(b)               Variable real value non–monetary items

(c)               Constant real value non–monetary items

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Definition of monetary items

DEFINITION

Monetary items are all items in the money supply.

Updated on 17 Jan 2014

Elaboration on the definition of monetary items

Monetary items are thus units of currency held the change in the real value of which is indicated by internal inflation and deflation and other items with an underlying monetary nature, the latter being substitutes for said units of currency held.

Examples of units of currency held which are only affected by internal inflation and deflation are internal bank notes and coins.

Examples of items with an underlying monetary nature which are substitutes for said units of currency held include the capital amount of bank loans, bank savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds, Treasury Bills, all capital and money market investments, notes payable, notes receivable, etc. when these items are not in the form of internal units of currency held.

Inflation and deflation have no effect on the real value of non-monetary items.

Examples of constant real value non-monetary items treated as monetary items under the Historical Cost paradigm in IFRS which implements the stable measuring unit assumption in the valuation of these items:

Pensions, salaries, wages, borrowing costs, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and receivables, interest (paid and received), bank charges, fees,
etc.

The stable measuring unit assumption is never applied under financial Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) as authorized in the original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] as follows:






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

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Two paradigms in IFRS

Two paradigms in IFRS

 IFRS are almost 100 per cent issued for the only accounting paradigm the world has ever known, namely, the Historical Cost paradigm. The stable measuring unit assumption is applied under the HC paradigm. In terms of the stable measuring unit assumption it is assumed that changes in the purchasing power of money are not sufficiently important to require capital maintenance in units of constant purchasing power during inflation. It is basically assumed that there is no such thing as inflation. It is assumed that there has never been inflation in the past, there is no inflation now and there will never be inflation in the future.

This assumption is mainly applied to the valuation of shareholder´s equity items, all items in the income statement, trade debtors, trade creditors and other non-monetary item payables and receivables under the HC paradigm. These items are thus simply treated as the same as monetary items.

IFRS also authorized a second paradigm, namely the Constant Item Purchasing Power paradigm in the original Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)] as follows:

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

There is no stable measuring unit assumption under the CIPP paradigm.  The six words ‘or units of constant purchasing power’ are the only part of IFRS directed at the second paradigm, i.e. the CIPP paradigm.

IFRS are principles-based standards. The CIPP paradigm is truly principle based: only the principle is stated for financial capital maintenance in units of constant purchasing power – nothing else.

Almost 100 per cent of IFRS are thus directed at the HC paradigm.

For example, the two definitions of monetary items:

In IAS 21, Par 8

‘Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency’

 and in IAS 29, Par. 12

‘Monetary items are money held and items to be received or paid in money.’

The above two definitions are obviously directed at the HC paradigm and not at the CIPP paradigm.

Under the CIPP paradigm monetary items are defined as follows:

‘Monetary items are units of internally created currency held and other items with an underlying monetary nature, the latter being substitutes for units of internally created currency held.’

The IFRS treatment of borrowing costs and the cost model for property, plant and equipment are some of the numerous items (basically 100% of IFRS)  that are only directed to the HC model.

There is nothing in IFRS besides the six words ‘or units of constant purchasing power’ directed to the second paradigm authorized in IFRS, namely the Constant Item Purchasing Power paradigm.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Argentina can single-handedly solve its "high inflation" problem

Argentina can single-handedly solve its "high inflation" problem

The Federación Argentina de Consejos Profesionales de Ciencias Económicas (FACPCE) can by itself solve the problem of the erosion of Argentinean companies´ shareholders´ equity by the stable measuring unit assumption (mistakenly generally still seen as caused by inflation).

Capital Maintenance in Units of Constant Purchasing Power was authorized 23 years ago during low inflation, high inflation and deflation in the International Accounting Standards Board´s original Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)] as follows:

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

This means that all Argentinean companies can right now freely choose to implement it immediately instead of traditional Historical Cost Accounting (financial capital maintenance in nominal monetary units) in the whole Argentinean economy since it is compliant with current International Financial Reporting Standards during low and high inflation and deflation. Implementation is compliant with current IFRS. Unfortunately it is not required: it is optional.

Fortunately, it is possible for the FACPCE to authorize an Argentinean national accounting standard requiring Capital Maintenance in Units of Constant Purchasing Power (which is compliant with current IFRS) at annual inflation greater than 10 per cent and cumulative inflation greater than 26 per cent over three years based on the amended version of the FACPCE´s original proposal in this regard to the IASB in 2010.

The FACPCE thus has the authority to single-handedly solve the problem of the erosion of Argentinean companies´ capital and retained profits by the stable measuring unit assumption (still mistakenly seen as caused by inflation) immediately while the FACPCE is, at the same time, encouraging the IASB to solve the problem worldwide by authorizing its proposal as amended.

Such an Argentinean accounting standard would be early implementation normally encouraged by the IASB in the case of a soon to be authorized IFRS if the FACPCE´s proposal is currently accepted as an IASB project.

If the FACPCE´s proposal is not accepted right now by the IASB, then such an Argentinean national accounting standard would be a precursor to an IASB project in the not immediate future.

Capital Maintenance in Units of Constant Purchasing Power is optional during low and high inflation under current IFRS. Not a single Argentinean company has adopted it over the last 23 years since authorization in 1989. Neither would they adopt it of their own free will now. Only requirement by the FACPCE would succeed in solving the problem immediately in Argentina – independent from any standard setting activity by the IASB. No company worldwide has adopted it since 1989 except Auto Sueco (Angola) where I implemented it in the form of accounting-dollarization during hyperinflation in 1996.

Capital Maintenance in Units of Constant Purchasing Power would automatically maintain the constant purchasing power of shareholders´ equity constant for an indefinite period of time in all Argentinean companies that at least break even in real value during low and high inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not.

In my opinion the FACPCE should immediately issue such an Argentinean national accounting standard, the implementation of which is fully compliant with current IFRS.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Valuation of monetary items

Valuation of monetary items

         Accounting values and accounts unstable monetary items on recognition at their nominal values in nominal monetary units under all accounting models – including CIPPA. Monetary items not inflation-adjusted daily over time (this currently – in 2012 – always includes all bank notes and coins) are then valued daily in fixed nominal monetary units (unstable in real value) only during the current financial period. The net monetary loss or gain is, logically and necessarily, calculated and accounted under CIPPA which implements financial capital maintenance in units of constant purchasing power. The net monetary loss or gain is also calculated and accounted as required in IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29 is not a departure from, but an extension to Historical Cost Accounting. All historical monetary items are inflation-adjusted daily in terms of the current (today´s) Daily CPI thereafter, i.e. once they are reported in historical financial reports, whether for comparison purposes or not. The historical net monetary loss or gain (a constant real value non-monetary item once accounted) is thereafter measured in units of constant purchasing power in terms of the current (today´s) Daily CPI or daily rate.

Low inflation, high inflation, deflation and hyperinflation determine the always current unstable real value of the unstable monetary unit (US Dollar, Euro, British Pound, Bolívar, Yen, Yuan, etc.) and other unstable monetary items within the monetary economy. This is because of the monetary nature of money.

The real value of money held and other unstable monetary items changes equally (all unstable monetary units are affected evenly) on a daily basis at all levels of inflation and deflation. The change is quantified with the daily publication of the Daily CPI or monetized daily indexed unit of account value during low inflation, high inflation and deflation and the daily US Dollar or other hard currency parallel rate or Brazilian-style daily Unidade Real de Valor during hyperinflation. The daily black market or parallel US Dollar exchange rate or street rate is generally constantly (24/7, 365 days a year) available in a hyperinflationary economy.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The monetary nature of a monetary item

The monetary nature of a monetary item

A monetary item is an economic item very different from the other two basic economic items (variable and constant real value non-monetary items) because of its monetary nature, namely the unique combination of its attributes during inflation and deflation - some of which are listed below.

Monetary items are money held and items with an underlying monetary nature that are substitutes for money held. Bank notes and coins are examples of money held.

Attributes:

its three functions, namely

medium of exchange,

store of value and

unit of account,

portability,

it is generally available in small change,

it is only a monetary item within (not outside) an economy (foreign exchange is a non–monetary item),

it is legal tender,

it is always affected by inflation and deflation,

which affect all monetary items evenly,

when it has no exchangeability with foreign exchange currencies it is worthless.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

All monetary items are always affected by inflation and deflation.

All monetary items are always affected by inflation and deflation

A monetary item should always be inflation-adjusted daily in terms of the Daily CPI or other daily rate. This has never been and is currently (2012) still not possible with physical bank notes and coins. The net monetary loss or gain thus needs to be calculated and accounted during the current financial period under financial capital maintenance in units of constant purchasing power (CIPPA). This is also true for other monetary items not inflation-adjusted daily. All monetary items are always affected by inflation and deflation.

Under the stable measuring unit assumption it is assumed that changes in the purchasing power of money are not sufficiently important to require capital maintenance in units of constant purchasing power on a daily basis. Another way to state the stable measuring unit assumption is to state that it is assumed that the real value of money is perfectly stable over time. The stable measuring unit assumption is applied to the measurement of certain non-monetary items and all monetary items under HCA. It is not applied under CIPPA.

 It is not assumed that bank notes and coins have nominal values over time: it is a fact, not an assumption. It is a fact (2012) that the nominal value of a bank note or coin is perfectly stable over time.

The real values of monetary items inflation-adjusted daily are still affected by inflation and deflation, but, by inflation-adjusting or deflation-adjusting them their real values are maintained constant by contract. They have constant real values over time, e.g. capital inflation-indexed government bonds. They are, however, not constant real value monetary items. That would only be the case at permanently sustainable zero inflation. Inflation and deflation thus always affect the real values of all monetary items within an economy. The real values of monetary items inflation-adjusted daily are maintained constant by contract. The entire cost of inflation (not actual inflation) in all monetary items (excluding bank notes and coins) would be eliminated when the total money supply (as qualified) is inflation-adjusted daily.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Valuing the three basic economic items

Valuing the three basic economic items

Monetary items

(1)                    The real value of the unstable monetary unit (money) and all other unstable monetary items not inflation-adjusted daily in the unstable monetary economy generally changes every day at all levels of inflation and deflation in terms of a Daily Consumer Price Index or daily monetized unit of account, e.g. the Unidad de Fomento in Chile, during low inflation, high inflation and deflation and in terms of the daily US Dollar or other relatively stable foreign currency parallel rate or a Brazilian-style daily Unidade Real de Valor index during hyperinflation.

Bank notes and coins currently (2012) cannot be inflation-adjusted. Inflation and deflation always affect the real value of bank notes and coins. All other monetary items can be inflation-adjusted on a daily basis. 20 to 25 per cent of the broad M3 money supply in Chile is inflation-adjusted daily in terms of the Unidad de Fomento according to the Banco Central de Chile. $ 2.89 trillion of sovereign inflation-linked bonds are inflation-indexed daily worldwide in terms of country specific Daily Consumer Price Indices. Inflation-adjusting the total money supply (excluding bank notes and coins) would eliminate the entire cost of inflation (not inflation) from the monetary economy. This would require complete co-ordination (everyone doing it).

Months of zero annual inflation are rare and generally not sustained for more than a month of two. During hyperinflation the real value of the very unstable monetary unit and all other very unstable monetary items often changes once per day, but, during severe hyperinflation it can change every 8 hours or so. (Hanke – Cato Journal)

Variable items

(2)                    The real values of variable real value non–monetary items may change all the time, e.g. the price of foreign currencies, precious metals, quoted shares, commodities, properties, finished goods, services, raw materials, etc. Variable items are valued on a daily basis in terms of IFRS excluding the stable measuring unit assumption and the cost model in the valuation of property, plant, equipment and investment property after recognition under capital maintenance in units of constant purchasing power (CIPPA). Their historic prices (e.g., of the day before) are updated on a daily basis to the current (today´s) rate in terms of a Daily CPI or daily rate when they are not valued at the current date (today) in terms of IFRS as qualified.

Inflation and deflation have no effect on the real value of non-monetary items. Historic variable items are thus not inflation-adjusted or deflation-adjusted daily. They are updated daily when they are not valued daily in terms of IFRS as qualified.

Constant items

(3)                    Constant real value non-monetary items are always and everywhere (historic and current period constant items) measured in units of constant purchasing power in terms of the current (today´s) Daily CPI or other daily rate.

Financial reporting has to take all three scenarios – occurring simultaneously – into account over time when an entity´s economic activities are accounted daily and financial reports are prepared and presented periodically and accessed or viewed today at the current Daily CPI or other daily rate.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Accounting values everything that happens in the economy on a daily basis

Accounting values everything that happens in the economy on a daily basis


Financial reporting is the valuing, recording, classifying, summarizing and reporting of economic transactions and events of the three basic economic items in terms of an unstable depreciating functional currency during all levels of inflation and an unstable appreciating functional currency during deflation.

Accounting is the daily valuation and recording of an entity´s economic activities.

Accounting always deals with economic values on a daily basis when an entity´s daily economic activities are accounted.

Financial reporting is a real net asset valuation of an entity on a specific day in terms of a Daily Consumer Price Index or daily monetized indexed unit of account, e.g. the Unidad de Fomento in Chile during low inflation, high inflation and deflation or a daily rate, for example the US Dollar parallel rate or a Brazilian-style Unidade Real de Valor daily index rate during hyperinflation. The real net asset value of an entity is reported in financial terms by means of valuations of the three economic items in terms of IFRS by means of the implementation of the practice of financial reporting.

A statement of financial position (a financial report) is prepared periodically reporting the real net asset value (not the real market value or the real intrinsic value) of an entity on a specific day, e.g. the end of a month, the end of a quarter, the end of six months, the end of a financial year or sometimes a longer financial period.

Financial reporting is a financial report relating to an instant in an entity´s economic activity. A report about the real net asset value of an entity on one single day: on the date of the financial report in terms of the Daily Consumer Price Index or daily rate on that day when the financial report is accessed or viewed on that day under capital maintenance in units of constant purchasing power (CIPPA).

The next day, and every day thereafter, the real net asset value of the entity is generally different because the daily valuations of variable real value non-monetary items have changed, the entity has created more constant real value in the form of constant real value non-monetary net income, has suffered a constant real value non-monetary net loss or extra capital or other resources have been contributed by shareholders or other third parties. The entity is a going concern and its real net asset value generally changes day after day.

However, the real net asset value of the entity as reported in the statement of financial position on the date of the report stays constant in real value (not in nominal value during inflation and deflation) for an indefinite period of time with reference to the date of the financial report. But, the real value of the unstable monetary unit of account (the functional currency), as represented by the Daily CPI or monetized daily indexed unit of account in a non-dollarized economy has changed as evidenced by the daily nominal change of the index value during all levels of inflation and deflation. Thus, all items in a historic statement of financial position and all historic financial reports have to be valued at the current, i.e. today´s, Daily CPI or daily rate under capital maintenance in units of constant purchasing power (CIPPA).

Economic items are valued or measured whenever economic transactions and events are accounted. Financial reporting under capital maintenance in units of constant purchasing power does not simply report on what took place in the past in nominal historical cost terms. Accounting is not just a scorekeeping exercise of what happened in the past. Accounting values everything that happens in the economy on a daily basis.

The three fundamentally different basic economic items in the economy, namely, monetary items, variable items and constant items, have economic values expressed in terms of unstable money; i.e. the unstable monetary unit of account. Economic transactions and events involving these three basic economic items are accounted in an organized manner when a double entry accounting model is implemented: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the income statement, assets and liabilities in the statement of financial position plus other financial, management and costing reports.

Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Measurement myths in IFRS

Measurement myths in IFRS

1.       Financial capital maintenance can be measured in nominal monetary units.

This was originally authorized in the Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)] which states:

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

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

In the vast majority of cases the stable measuring unit assumption (not inflation - as generally accepted) erodes the real value of that portion of shareholders´ equity (e.g. total retained earnings) never maintained constant under Historical Cost Accounting with sufficient revaluable fixed assets (revalued or not) currently amounting to hundreds of billions of USD of constant item real value eroded in the world´s capital investment base each and every year for as long as HCA is implemented as the global, traditional accounting model. (See the ongoing financial crisis).

2.       Companies´ invested capital and retained earnings are eroded by inflation.

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.’

             Gucenme, U. and Arsoy, A. P. (2005). Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005. Special Issue Accounting for the Global and the Local: The Case of Turkey. Critical Perspectives on Accounting, Volume 20, Issue 5, July 2009, p. 568–590.

The erosion of companies´ capital and retained profits is caused by the implementation of the stable measuring unit assumption as part of the traditional HCA model during inflation.

3.       Changes in the purchasing power of money are not sufficiently important to require Capital Maintenance in Units of Constant Purchasing Power.

      This is the stable measuring unit assumption as authorized in IFRS as part of the authorization of the Historical Cost Accounting model in the original Framework (1989), Par. 104 (a).

Changes in the purchasing power of unstable money logically require financial Capital Maintenance in Units of Constant Purchasing Power during low and high inflation, hyperinflation and deflation.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation is generally paying more money for the same real value.

Inflation is generally paying more money for the same real value

Inflation is the erosion of the real value of monetary items over time.

Inflation only erodes the real value of monetary items not inflation-adjusted daily in terms of a Daily Consumer Price Index or monetized daily indexed unit of account, e.g. the Unidad de Fomento in Chile during low and high inflation or a daily foreign currency parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate during hyperinflation.

The cost of inflation is the consequence of not inflation-adjusting a monetary item on a daily basis. There is no cost of inflation when a monetary item is inflation-adjusted on a daily basis. 20 to 25 per cent of the broad M3 money supply in Chile is inflation-adjusted on a daily basis in terms of the Unidad de Fomento according to the Central Bank of Chile. $ 2.89 trillion of government inflation-linked bonds are inflation-adjusted daily in terms of a Daily Consumer Price index worldwide.

Paying more money for more real value is a price increase. That is not inflation. That is simply a real value price increase. Generally paying more money for the same real value is inflation. That is an increase in the general price level.



Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Only a non-revisable Daily Consumer Price Index should be used with Capital Maintenance in Units of Constant Purchasing Power

Only a non-revisable Daily Consumer Price Index should be used with Capital Maintenance in Units of Constant Purchasing Power

Updated on 18 July 2013

The French National Statistics Institute makes corrections in the monthly published CPI during the next month. That is an unacceptable method under Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily Consumer Price Index or daily rate.  

Revising previously published CPI data is not practical under Capital Maintenance in Units of Constant Purchasing Power since the monthly published CPI value is used for the calculation of the Daily CPI which is used on a daily basis to value government capital inflation-indexed bonds as well as to implement the Capital Maintenance in Units of Constant Purchasing Power model in terms of daily index. 

Legally binding transactions are concluded using the Daily CPI. It is not practical (legal?) to revise all daily legal contracts executed in terms of a Daily CPI that can be revised afterwards.  

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

What would happen if Greece leaves the European Monetary Union

What would happen if Greece leaves the European Monetary Union

The Euro would become a foreign currency like the US Dollar in Greece. Very little would actually change.

It would be illegal for the Greek monetary authority to overprint a foreign currency, the Euro or the US Dollar, stating it is worth 50 per cent less. Foreign currencies, for example the US Dollar or the Euro, trade in foreign exchange markets. The US Dollar cannot be overprinted by the Greek goverment stating that it is now 50 per cent less in real value. The same is true for the Euro as a foreign currency.

Greek citizens would own a lot of foreign currency, namely, Euros, which play a very important role in the world economy, exactly like the US Dollar. Greek citizens would never lose one cent in value. Greeks will never lose real value holding US Dollars, Yen, Swiss Franks, OR EUROS.

All companies would carry on quoting prices in the Euro, which would be generally available in Greece, and the New Drachma, IF it were to be introduced.

Payments would be accepted in the Euro, a generally available foreign currency. There would never be an overprinting of Euros in Greece as a Drachma worth 50% less. The Euro would simply be a foreign currency like the US Dollar, the Rouble, the Chinese Yuan, the Japanese Yen, the British Pound or the South African Rand.

The Greek central bank would manage the creation of new Drachmas in Greece via fractional reserve banking in Greece. Credit would be created in New Drachmas via fractional reserve banking just like in all other economies. The Euro would circulate in the Greek economy with the new Drachma, the US Dollar, Swiss Francs, etc.. The Euro would simply be a very generally available foreign currency. All products in Greece would have an almost permanently stable price in Euros and maybe an increasing price in the New Drachma, depending on how badly or how well the new economic regime in Greece outside the EMU is being managed by the Greek private sector, not the Greek government.

This is not new territory. Many countries have passed this way in the past.

Inflation-adjusting the entire Greek money supply would remove the total cost of inflation (not inflation) from the Greek economy under complete co-ordination (everybody doing it).

Capital maintenance in units of constant purchasing power as authorized in IFRS would automatically maintain the constant purchasing power of all Greek companies constant for an indefinite period of time in al Greek companies that at least break even in real value at any level of inflation or deflation - ceteris paribus - whether they own any revaluable fixed assets or not.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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

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

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

Updated on 18-04-2013

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

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

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

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

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

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

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

Capital Maintenance in Units of Constant Purchasing Power was authorized at all levels of inflation and deflation, including during hyperinflation, in IFRS in the original Framework (1989), Par. 104 (a) [not the Conceptual Framework (2010), Par 4.59 (a)] which states:

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

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

But, IAS 29, although it requires Capital Maintenance in Units of Constant Purchasing Power during hyperinflation, unfortunately does not result in complete (or 100%) capital maintenance in units of constant purchasing power because it is generally accepted (2013) to use the monthly published CPI instead of the generally available Daily CPI (most countries in the world issue government capital inflation-indexed bonds which are priced on a daily basis using country specific Daily CPI´s based on the monthly published CPI). Current year profits are thus eroded/destroyed because of the use of the monthly CPI instead of the generally available Daily CPI when IAS 29 is implemented using the monthly CPI. A month can have 28 to 31 different daily price levels, or even more from about 3000 per cent per annum inflation and above. It is mistakenly generally accepted under current implementation practices of IAS 29, to use the CPI at the month end instead of 28 to 31 different generally available Daily CPI values to maintain current year profit. Current year profit is thus not fully maintained in this manner. A portion is eroded/destroyed using IAS 29 in terms of a monthly published CPI during hyperinflation. It is also a well-proven and undeniable fact that the implemetation of IAS 29 can also have absolutely not positive effect during hyperinflation. This was undeniably proven during hyperinflation in Zimbabwe. Zimbabwe´s economy imploded on 20 November 2008 after 8 years of full implementation of IAS 29. Thus, beware of IAS 29 in terms of the monthly CPI during hyperinflation.

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

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

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

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

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

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

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

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

Capital maintenance in units of constant purchasing power automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation (including during hyperinflation) - ceteris paribus - whether they own any revaluable fixed assets or not.

Nicolaas Smith

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

Financial reporting values everything that is accounted

Financial reporting involves the valuing, recording, classifying, summarizing and reporting of transactions and events involving the three basic economic items in terms of a depreciating functional currency during inflation and an appreciating functional currency during deflation.

Accounting deals with the valuation and recording of an entity´s daily economic activities.

Accounting deals with economic values on a daily basis when an entity´s economic activities are accounted daily in terms of the three basic economic items. Accounting is the daily valuation of the activities of an economic entity. Accounting is a real net asset valuation of an entity on a daily basis in terms of a Daily Consumer Price Index or daily rate, for example the US Dollar parallel rate during hyperinflation. The real net asset value of an entity is presented in terms of valuations of the three economic items in terms of IFRS by means of the process of accounting.

A statement of financial position (a financial report) is prepared periodically reporting the real net asset value (not the market value or the intrinsic value) of an entity on a specific day, e.g. the end of the month, the end of the quarter, the end of six months, the end of the financial year or sometimes a longer financial period.

Financial reporting is an instant in an entity´s economic activity: a report about the real net asset value of an entity on one single day: on the date of the financial report in terms of the Daily Consumer Price Index or daily rate on that day when the financial report is accessed or viewed on that day under capital maintenance in units of constant purchasing power.

The next day, and every day thereafter, the real net asset value of the entity is generally different because the daily valuations of variable real value non-monetary items have changed, the entity has created more constant real value in the form of net income, has suffered a net loss or extra capital or other resources have been contributed by shareholders or third parties. The entity is a going concern and its real net asset value generally changes day after day.

However, the real net asset value of the entity as reported in the statement of financial position on the date of the report stays constant for an indefinite period of time with reference to the date of the financial report. But, the human perception of value, as represented by the Daily CPI has changed as evidenced by the daily nominal change of the index value. Thus, all items in a historic statement of financial position have to be valued at the current, i.e. today´s, Daily CPI or daily rate.

A statement of financial position prepared under capital maintenance in units of constant purchasing power relates to the real net asset value of an entity on one single day: the date the statement of financial position was prepared when the financial report is accessed or viewed on that day. Thereafter all the values (excluding current period monetary items not inflation-adjusted on a daily basis) change daily either in terms of the Daily CPI or their specific variable item daily valuations.

Economic items are valued or measured when economic transactions and events are accounted. Financial reporting does not simply report on what took place in the past. Accounting is not just a scorekeeping exercise of what happened in the past. Accounting values everything that happens in the economy.

The three fundamentally different basic economic items in the economy, namely, monetary items, variable items and constant items, have economic values expressed in terms of unstable money; i.e. the unstable monetary unit of account. Economic transactions and events involving these three basic economic items are accounted in an organized manner when a double entry accounting model is implemented: journal entries, general ledger accounts, trial balances, cash flow statements, income and expenses in the income statement, assets and liabilities in the statement of financial position plus other financial, management and costing reports.

Accounting entries are valuations of the economic items (the debit items and the credit items) being accounted.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

General purpose financial reports are designed to show the value of a reporting entity

General purpose financial reports are designed to show the value of a reporting entity

The Conceptual Framework for Financial Reporting (2010), paragraph OB7 states:

‘General purpose financial reports are not designed to show the value of a

reporting entity.’

A reporting entity´s value can be one of three values:

1.       Real market value

2.       Real intrinsic value

3.       Real net asset value

The Conceptual Framework is correct in the case of real market value and real intrinsic value. General purpose financial reports are not designed to show the real market value or real intrinsic value of a reporting entity.

It is stated in the original Framework (1989), Par. 104 (a) [now Conceptual Framework (2010), Par. 4.59 (a)]:

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

General purpose financial reports prepared under the concept of capital maintenance in units of constant purchasing power in terms of a Daily Consumer Price Index or daily rate (e.g. the daily US Dollar parallel rate during hyperinflation) are designed – as a result its combination with the double-entry accounting  model – to automatically maintain the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not.

The real value of capital is always equal to the real value of net assets under capital maintenance in units of constant purchasing power in terms of a Daily CPI or daily rate.

Conclusion:

General purpose financial reports prepared under the concept of capital maintenance in units of constant purchasing power as authorized in IFRS are designed to show the real net asset value of a reporting entity and to maintain it constant for an indefinite period of time as qualified above.

The real net asset value of an entity as reported on the date of the statement of financial position is only valid for that day when the statement is accessed or viewed on that day. Thereafter the historic constant real net asset value of the entity as reported on the date of the statement of financial position remains constant for an indefinite period of time, but, its nominal value changes daily in terms of a Daily Consumer Price Index or other daily rate.

Monetary items in the historic statement of financial position or other financial report have to be inflation-adjusted, variable items have to be updated and constant items have to be measured in units of constant purchasing power in terms of the current (today´s) Daily CPI or other daily rate after the date of the financial report.

The actual real net asset value of an entity also generally changes daily as a result of an entity being a going concern and generally involved in daily operations.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Only capital indexed inflation-linked bonds maintain the real value of capital

Only capital indexed inflation-linked bonds maintain the real value of capital

Only capital indexed inflation-linked bonds maintain the real value of the capital amount during inflation. A capital indexed inflation-linked bond´s capital value is maintained constant during inflation as well as the real value of the periodic coupon payments.

A coupon indexed inflation-linked bond´s capital values is a nominal value. It´s real value is not maintained constant during inflation.

See: The French Bond Association, Inflation-linkedBonds, CNO, 2.1.1 Comparison of Capital Indexed, Coupon Indexed and Nominalcash flows, p. 14.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.