Differences between CIPPA and CPPA (updated)

Differences between CIPPA and CPPA (updated)

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

(Whittington, 1983)

It is very clear from the above that Prof. Whittington also considered – at that time – that ‘indexing accounts by means of a general index’ would ‘deal with the inflation problem’ and not the stable measuring unit assumption problem. The term ‘stable measuring unit assumption’ does not appear in his book at all.

CPPA is an inflation accounting model and is dealt with in this book as it is implemented in terms of IAS 29.

CIPPA implements financial capital maintenance in units of constant purchasing power in terms of a daily rate which automatically maintains the constant purchasing power of owners´ equity constant for an indefinite period of time in 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 net monetary loss or gain and the net constant item loss or gain are calculated and accounted in the income statement. CIPPA is a basic accounting model alternative to HCA at all levels of inflation and deflation including during hyperinflation. It is not only an inflation accounting model to be implemented during hyperinflation like CPPA. CIPPA is a price–level basic accounting alternative to HCA authorized in IFRS at all levels of inflation and deflation. The stable measuring unit assumption is never implemented under CIPPA.

Differences

CIPPA

CPPA

1                     When implemented

Implemented at all levels of inflation and deflation.

Only implemented during hyperinflation as required by IAS 29.

                                                            

2                     Stable measuring unit assumption

The stable measuring unit assumption is never implemented.

The stable measuring unit assumption is implemented as part of a number of different measurement bases in the preparation of HC or CC financial reports which are then restated in terms of the period-end monthly published CPI only during hyperinflation.

3                     Non–monetary items

Non–monetary items are split in variable  and constant real value non–monetary items.

No split in non–monetary items.

4                     Capital concept

Constant item purchasing power financial    capital concept implemented.

Nominal financial capital concept implemented in HC or CC financial reports then restated in terms of the period–end monthly published CPI only during hyperinflation.

5                     Capital maintenance concept

Financial capital maintenance in units    of constant purchasing power concept        implemented; i.e., owners´ equity      is measured in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation.

Nominal financial capital maintenance concept implemented; owners´ equity is measured in nominal monetary units in HC or CC financial reports during the accounting period which are then restated in terms of the period–end monthly published CPI only during hyperinflation.

6                     Inflation–accounting model

A basic accounting model implemented  at all levels of inflation and deflation including during hyperinflation.

Only an inflation accounting model implemented during hyperinflation.

                                                                                                                       

7                     IFRS authorization

Originally authorized in IFRS in the Framework (1989), Par. 104 (a).

Authorized in IFRS in IAS 29 in 1989.

8                     Measurement

Daily measurement of all items in terms of a daily rate as detailed below.

Non-monetary items in HC or CC financial reports are restated at the end of the accounting period in terms of the period-end monthly published CPI.

                                  

9                     Measurement of monetary items

Historic and current period monetary    items are inflation–adjusted daily in terms of a daily rate. When not inflation  –adjusted daily during the current  period, the net monetary loss or gain   is calculated and accounted.

Current period monetary items are measured in nominal monetary units. They are not restated. Inflation-indexed items are adjusted in accordance with the contract in order to state the amount outstanding at the end of the reporting period. The net monetary loss or gain is calculated and accounted in terms of incorrectly defined monetary items.

                                                                                    

10                 Measurement of variable items

Variable items are measured in terms of IFRS excluding the stable measuring unit assumption and the definitions of monetary items (2011). They are updated daily in terms of a daily index when not measured daily.

Non–monetary items are not split in variable and constant items. Variable items in HC or CC financial reports are restated in terms of the period–end monthly published CPI. The daily hard currency parallel rate is used for the valuation of some, not all, variable items at the time of purchase during hyperinflation. Most variable item selling prices are updated daily in terms of the daily parallel rate.

11                 Measurement of constant items

Historic and current period constant items are always and everywhere measured in units of constant purchasing power on a daily basis in terms of a daily rate at all levels of inflation and deflation.

Non–monetary items are not split in variable and constant items. Constant items, e.g., equity, is measured in nominal monetary units in HC or CC period-end financial statements during hyperinflation. All non–monetary items in these financial reports are restated in terms of the period–end monthly published CPI.

12                 Net constant item loss or gain

Net constant item loss or gain calculated and accounted. This is a new accounting concept.

A net constant item loss or gain concept does not exist under HCA, CPPA, IFRS or US GAAP.

13                 Measurement of trade debtors and trade creditors

Constant real value non–monetary payables and receivables (e.g., trade debtors and trade creditors) are measured in terms of a daily rate. The net constant item loss or gain is accounted where applicable.

Trade debtors and trade creditors and other non-monetary payables and receivables are treated as monetary items and measured in nominal monetary units in HC or CC financial reports. They are not restated. The net real value loss or gain as a result of the implementation of the stable measuring unit assumption during hyperinflation is incorrectly accounted as a net monetary loss or gain in terms of IAS 29. It is a net constant item loss or gain.

14                 Consumer Price Index 

Daily Consumer Price Index or a monetized daily indexed unit of account used during low and high inflation and deflation. Daily US Dollar parallel or Brazilian-style URV daily index rate used during hyperinflation.

Monthly Consumer Price Index used during hyperinflation as per IAS 29.

15                 Parallel rate

Daily hard currency parallel rate used  during hyperinflation in the absence of a Brazilian-style daily index for the daily valuation of variable and constant real value non-monetary items as well as the calculation and accounting of the net monetary gain or loss when monetary items are not inflation-adjusted daily in terms of the daily parallel rate as well as for the accounting of the net constant items loss or gain.

Daily hard currency parallel rate used for the valuation of some, not all, variable items at the time of purchase during hyperinflation. These values are then restated in HC or CC financial reports in terms of the period-end monthly published CPI. Not used for the daily measurement of constant items. Used for the daily updating of the selling prices of most variable items.

16                Indexation

CIPPA is daily indexation at all levels of inflation and deflation.

Monthly indexation can be used only during hyperinflation.

17                 Monetized daily indexed unit of account

A monetized daily indexed unit of account can be used at all levels of inflation and deflation.

A monetized daily indexed unit of account not used during hyperinflation.

18                Constant real value non-monetary item concept

The constant real non-monetary item concept, namely that there are non-monetary items with constant real non-monetary values over time, is a fundamental concept under CIPPA.

There is no concept of a constant real value non-monetary item under Historical Cost Accounting. CPPA is taken to be implemented in terms of IAS 29. IAS 29 requires the restatement of Historical Cost or CC financial statements.

19                Net assets

The real value of net assets is always equal to the real value of capital.

The nominal value of net assets is always equal to the nominal value of capital.

20 Fundamental value date

The fundamental value date is the current date, i.e., today. All items are always accessed, read and valued at the current, today´s, value or Daily CPI or other daily rate.

The fundamental value date is the date of the financial report. During hyperinflation financial reports can become meaningless the next day as a result of hyperinflation.

Nicolaas Smith

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

Daily valuation required

Daily valuation required

Constant items’ real values are maintained constant over time under CIPPA by means of measurement of financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or monetized daily indexed unit of account during low inflation, high inflation and deflation and in terms of a relatively stable foreign currency daily parallel rate (normally the US Dollar daily parallel rate) or a daily Brazilian-style Unidade Real de Valor index during hyperinflation. Daily measurement of constant items is essential in the case of trade debtors, trade creditors and all other non-monetary payables and receivables which can be paid on any day of the month.

When it is intended to maintain the real value of a monetary item, for example, a government inflation-indexed bond during inflation, it is immediately realized that a Daily Consumer Price Index is required since these bonds trade on a daily basis. Many countries use Daily CPIs to value these bonds on a daily basis.

A daily US Dollar (or other relatively stable foreign currency) parallel rate is generally spontaneously used by the population and in the consumer markets to value variable real value non-monetary items on a daily basis during hyperinflation.

Brazil, for example, used government supplied daily indices from 1964 to 1994 to index most non-monetary items on a daily basis in the entire economy during 30 years of very high inflation and hyperinflation of up to 2000 per cent per annum.

‘Não temos como fornecer, conforme solicitado, os detalhes exatos do indexador utilizado durante o período de alta inflação no Brasil. Vale esclarecer que, desde 1964, quando foi implementado o Programa de Ação Econômica do Governo – PAEG, vários mecanismos de indexação foram introduzidos na economia brasileira objetivando reduzir os efeitos da inflação não antecipada sobre o lado real da economia. Podemos destacar os mecanismos destinados à taxa de câmbio, aos salários e e à correção monetária de ativos financeiros. Ao longo da existência das ORTNs e de seus sucedâneos, por exemplo, os governos mudaram em diversas oportunidades as fórmulas de cálculo da correção monetária e trocaram várias vezes os índices de preços que eram utilizados no cálculo da mesma.

Assim sendo, sugerimos uma consulta ao Ministério da Fazenda, que talvez possa fornecer o histórico dos indexadores utilizados no País.’

(Central Bank of Brazil, 2010)

Chile has been using a monetized daily indexed unit of account, the Unidad de Fomento, to inflation index a part of its money supply since 1977. The UF´s value is calculated and published daily by the Banco Central de Chile since 1990.

Prof. Robert Shiller stated:

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

Shiller, R.J. (1998). Indexed Units of Account: Theory and Assessment of Historical Experience. Cowles Foundation Discussion Paper, No 1171, p. 13.

A Daily CPI is thus a fundamental requirement when implementing financial capital maintenance in units of constant purchasing power (CIPPA).


Nicolaas Smith

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

Constant real value non–monetary items

Constant real value non–monetary items

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

Pacioli did not invent the double entry accounting model. He wrote the first book about the practice of double entry accounting in 1494.

Definition

A constant real value non-monetary item is a non-monetary item with a constant real value over time whose real value within an entity is not generally determined in a market on a daily basis.

Examples include borrowing costs, comprehensive income, interest paid, interest received, bank charges, royalties, fees, short term employee benefits, pensions, salaries, wages, rentals, all other income statement items, issued share capital, share premium accounts, share discount accounts, retained earnings, retained losses, capital reserves, revaluation surpluses, all accounted profits and losses, all other items in owners´ equity, trade debtors, trade creditors, dividends payable, dividends receivable, deferred tax assets, deferred tax liabilities, all taxes payable, all taxes receivable, all other non-monetary payables, all other non-monetary receivables, provisions, etc.

Constant items are fixed in terms of real value while their nominal values change daily in terms of a daily rate under financial capital maintenance in units of constant purchasing power (CIPPA).

Nicolaas Smith

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

Inflation-adjusting monetary items

Inflation-adjusting monetary items

 Only unstable money and other unstable monetary items´ real values are continuously being eroded by low inflation, high inflation and hyperinflation over time. Inflation has no effect on the real value of non–monetary items.

‘Inflation is always and everywhere a monetary phenomenon,’ per Milton Friedman.

‘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.

Deflation increases the real value of only unstable money and other unstable monetary items over time. Deflation has no effect on the real value of non–monetary items.

The entire money supply can be inflation–adjusted or deflation-adjusted on a daily basis in terms of a Daily Consumer Price Index or a monetized daily indexed unit of account during low and high inflation and deflation. This would be done in terms of a relatively stable foreign currency (normally the US Dollar) daily parallel rate or a daily Brazilian-style Unidade Real de Valor (URV) index during hyperinflation. Inflation-adjusting the entire money supply on a daily basis would remove the entire cost of inflation - not actual inflation - from the total money supply in the case of complete co-ordination (everybody doing it). According to the Banco Central de Chile 20 to 25 per cent of Chile´s broad M3 money supply is inflation–indexed daily (2011) in terms of the Unidad de Fomento which is a monetized daily indexed unit of account.

‘A more extended measure of money, as M2 or M3, includes inflation indexed assets, but they are expressed in Chilean pesos. In M3, those assets are roughly 20 to 25% of total.’ (Banco Central de Chile, 2011)

 Net monetary losses and gains are not calculated and accounted during low inflation in Chile.

Nicolaas Smith

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

Monetary nature of monetary items that are not units of internal currency held

Monetary nature of monetary items that are not units of internal currency held

 All items in the economy – monetary items, variable real value non-monetary items and constant real value non-monetary items – are normally received or paid in money. That obviously does not mean they are all monetary items. Money is simply used as the generally accepted medium of exchange. Non-monetary items remain non-monetary items even when they are always paid and received in money, e.g., borrowing costs paid and finance charges received. This is also true even when they are mostly paid / collected immediately they become due; e.g. bank interest and bank charges. Banks immediately collecting bank charges and bank interest by charging these items to a bank account immediately they become due create the impression that they are monetary items. However, they are all constant real value non-monetary items always paid or received in money as the generally accepted medium of exchange.

 Monetary items that are not units of internal currency held (e.g. money loans) have the exact same attributes as money held except that they are not present as bank notes and coins. A bank loan is a monetary item that is not always money held. It can be received or paid in actual bank notes and coins or as an electronic transfer into a bank account. A bank loan that is not money held is an example of an item with an underlying monetary nature. An item with an underlying monetary nature is, in principle, a substitute for money held.

 A building is a non-monetary item. It is not a substitute for money held. It is normally paid for in money. The owner normally receives money for selling it, and the buyer normally pays for it in money, but that is simply the medium of exchange. The owner can also receive the payment for the building in diamonds. The building is a variable real value non-monetary item irrespective of how it is exchanged between two entities.

 The capital amounts of commercial bonds, government bonds, inflation-indexed government bonds, money market items, debt items, capital market items, bank loans, credit card loans, car loans, housing loans, student loans, consumer loans, etc. are all, in principle, substitutes for units of internal currency held. They are all items with an underlying monetary nature.

 Interest, borrowing costs, bank charges, pensions, salaries, wages, rentals, etc. are generally paid and received in money, but they are not monetary items. They are not substitutes for units of internal currency held. They are all constant real value non-monetary items.

 They are not, in principle, substitutes for money held. Money is simply the generally accepted medium of exchange in the settlement of these items.

 A salary payable is an obligation to deliver compensation for the work done in terms of the employment contract by the salary earner in the form of payment in a mutually agreed generally accepted medium of exchange. The generally accepted mutually agreed form of payment is money. Payment can be in any mutually agreed form. A salary is not, in principle, a substitute for money held. A salary is not an item with an underlying monetary nature. The work to be done by the worker in terms of the employment contract is not an item with an underlying monetary nature.

 A rental payment is not a substitute for money held. A rental payment is a substitute for the right to occupy a particular space in terms of the rental contract. Money is simply the generally accepted medium of exchange. Payment can be in any mutually agreed form of payment. Payment can be in big Macs or cases of beer too.

Nicolaas Smith

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

Monetary nature of a monetary item
A monetary item is an economic item very different from the other two basic economic items because of its monetary nature; namely, the unique combination of its attributes during inflation and deflation, some of which are listed below.

A monetary item is an item the change in real value of which is indicated by internal inflation and deflation.

A monetary item´s attributes in combination determine its monetary nature during inflation and deflation.

Attributes of a monetary item during inflation and deflation

(i)                 It is an unstable medium of exchange.

(ii)               It is an unstable store of value.

(iii)             It is an unstable unit of account

(iv)             It is easily portable or transferable.

(v)               It is generally available in small change.

(vi)             It is only a monetary item within an economy.

(vii)           It is legal tender.

(viii)         The change in its real value is indicated by internal inflation and deflation.

(ix)             Monetary items are generally affected evenly within an economy by inflation and deflation.

(x)               It loses its monetary nature when it´s physical representation (bank note or coin) only has value as a collector´s item; i.e., when it becomes a variable real value non-monetary item.

(xi)             As a bank note or coin, the internal unit of currency has its denomination permanently printed or moulded on it.

(xii)           In modern economies it is created by government fiat in the banking system.

Nicolaas Smith

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

Concept of a constant real value non–monetary item derived in IFRS

Concept of a constant real value non–monetary item derived 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.

In the original Framework for the Preparation and Presentation of Financial Statements (1989), Par. 104 (a) [now the Conceptual Framework for Financial Reporting (2010), Par. 4.59 (a)] it is stated:

‘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 constant item purchasing power 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 (Constant Item Purchasing Power Accounting) is fundamentally different from financial capital maintenance in nominal monetary units (Historical Cost Accounting).

 The real value of financial capital can thus be maintained constant in units of constant purchasing power by measuring financial capital maintenance in units of constant purchasing power over time. The constant 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.

 Issued share 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 derived in IFRS which are principles-based standards.

Nicolaas Smith

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