Measurement of constant items

Measurement of constant items

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1 Definition 

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

Constant real value non-monetary items are fixed in terms of real value while their nominal values change daily in terms of a Daily CPI or other daily index under financial capital maintenance in units of constant purchasing power (CIPPA).

2 Measurement

Measurement of constant items is the generally accepted accounting practice of determining the monetary amounts at which constant items are to be recognised, valued, carried and accounted on a daily basis in the economy under all levels of inflation and deflation. This involves the selection of the particular basis of measurement. Constant items can only be measured in units of constant purchasing power during inflation and deflation because the stable measuring unit assumption is not applied in their measurement. Constant items are always and everywhere valued in terms of IFRS in units of constant purchasing power by applying the Daily CPI or a monetized daily indexed unit of account at the current (today’s) rate under financial capital maintenance in units of constant purchasing power (CIPPA) during low and high inflation and deflation. Constant items would always and everywhere be valued on a daily basis in terms of a relatively stable foreign currency parallel rate or a Brazilian-style Unidade Real de Valor index rate during hyperinflation.

Financial capital maintenance in nominal monetary units (HCA) and its IFRS–authorized alternative – financial capital maintenance in units of constant purchasing power (CIPPA) – would be one and the same accounting model at permanently sustainable zero inflation. This is proof that financial capital maintenance in units of constant purchasing power (CIPPA) is the logical next step in our fundamental model of accounting.

The IASB defined monetary items in IAS 29 incorrectly as money on hand and items to be paid in money or to be received in money. Most variable real value non–monetary items as well as constant real value non–monetary items are generally received or paid in money as the generally accepted monetary medium of exchange. The fact that the IASB defines non–monetary items as all items in the income statement and all other assets and liabilities in the balance sheet that are not monetary items, after having defined monetary items incorrectly, leads to the wrong classification of some constant real value non–monetary items, notably trade debtors and trade creditors, as monetary items by, for example, PricewaterhouseCoopers in their publication Understanding IAS 29. This results in the net monetary gain or loss generally being calculated incorrectly by companies implementing IAS 29 in hyperinflationary economies.

The definition of non–monetary items as being all items that are not monetary items is a generic definition. It is thus premised by the IASB that there are only two fundamentally distinct items in the economy: monetary and non–monetary items and that the economy is divided into two parts: the monetary and non–monetary economy. IAS 29 and other IFRS are based on this premise of only two fundamentally different items in the economy. This is a false premise.

It is not true that there are only two basic economic items as defined in IFRS. There are three fundamentally different basic economic items in the economy:

1 Monetary items

2 Variable real value non–monetary items

3 Constant real value non–monetary items

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Foreign exchange is not a monetary item

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A foreign currency is not a monetary item since its real value is not affected by local inflation and deflation. A unit of foreign currency is not a monetary item in the local economy because it is not a unit of local currency held or an item with an underlying monetary nature being a substitute for a unit of internal currency held in the local economy.

Money has three functions:

1 Unstable medium of exchange

2 Unstable store of value

3 Unstable unit of account

The local currency is the monetary unit in the local economy. A foreign currency like the US Dollar or the Euro is generally a medium of exchange in any economy outside the US and the European Monetary Union, respectively. Most businesses and individuals would accept the US Dollar or the Euro as a means of payment; that is, as a medium of exchange because they normally can easily exchange the foreign currency amounts they would receive in transactions at their local banks for local currency.

A relatively stable foreign currency is also a store of value in a foreign economy. The US Dollar and the Euro are foreign currencies with daily changing market values in economies outside the US and the EMU respectively. They are generally accepted world–wide as a relatively stable store of value. People know there are normal daily small changes in their foreign exchange values.

The USD and the Euro are, however, not national units of account in non-dollarized economies outside the US and EMU, respectively. You do not normally do your accounting in US Dollars or Euros for tax purposes during low inflation and deflation in non-dollarized economies outside the US and EMU, respectively. You normally do your accounting in local currency values during low inflation and deflation in non-dollarized economies. The USD and the Euro are not functional currencies in non-dollarized economies outside the US and EMU, respectively. A foreign currency like the USD or the Euro is only a medium of exchange and a store of value in non-dollarized economies outside the US and EMU, respectively. Their real values are not affected by local inflation outside the US and EMU, respectively. They are not monetary items in non-dollarized economies outside the US and EMU, respectively.

Foreign currencies are variable real value non–monetary items. They have variable real values which are determined in the foreign exchange markets daily.

The US Dollar, for example, is only a functional currency outside the United States of America in countries like Ecuador, Panama and Zimbabwe which have dollarized their economies. They use the US Dollar as their functional currency. They do not have their own local currencies.

It just appears very strange to say that the US Dollar or the Euro is not a monetary item in SA, for example. Theoretically speaking that is correct because an economic item is only a monetary item in a non–dollarized economy when it is affected by local inflation. The Euro is only a monetary item within the European Monetary Union (EMU) and the USD is only a monetary item within the US economy. The real value of the US Dollar in the US is only affected by US inflation.

The man and woman in the street, however, regard anything that is a medium of exchange as ‘money’ in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.

The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. Foreign exchange would be classified within the SA economy as a variable real value non–monetary item stated at its current market value (today) and not the same as the SA Rand, that is, not as a monetary item under financial capital maintenance in units of constant purchasing power (CIPPA).

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

Valuing variable items at HC does not erode their real values

Valuing variable items at HC does not erode their real values

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The real values of variable items are not eroded by the stable measuring unit assumption when entities value these items at their original nominal HC values before the date that they are actually sold or exchanged during inflation and deflation. They would be valued at their current market values on the date of exchange or sale in an open economy. During hyperinflation all non–monetary items (variable and constant real value non–monetary items) are required to be restated in terms of IAS 29 to make these restated HC or Current Cost period–end financial reports – supposedly – more useful by applying the period–end monthly published CPI. A hard currency parallel rate – normally the US Dollar parallel rate – or a Brazilian–style URV daily index is applied on a daily basis when a country wishes to stabilize its real economy during hyperinflation.

Variable items´, e.g., land and buildings´, real values are not being unknowingly eroded by the HCA model as a result of the implementation of IFRS since they exist independently of how we value them. Entities can value land and buildings in the balance sheet at their historical cost 50 years ago, but, when these assets are sold in the market today they would be transacted at the current market price in an open market. The real values of variable items are also not being eroded uniformly at, e.g., a rate equal to the annual inflation rate because of valuing them at original nominal HC. Inflation has no effect on the real value of non–monetary items.

Where real losses are made in dealing with variable items in the economy, these losses are the result of supply and demand or business or private decisions, e.g., selling at a bad price, obsolescence, stock market crashes, credit crunches, other impairments, etc. They do not result from the implementation of the HC accounting model. These losses and impairments are treated in terms of IFRS.

A house is a variable real value non–monetary item. Let us assume a house in Port Elizabeth, South Africa is fairly valued in the PE market at say R 2 million on 1 January in year one. With no change in the market a year later but with annual inflation at 6 per cent in SA, the seller would increase his or her price to R2.12 million – all else being equal. The house’s real value remained the same. The depreciating monetary value of the house expressed in the depreciating Rand medium of exchange – all else being equal – was updated to compensate for the erosion of the real value of the depreciating Rand in the internal SA market by 6 per cent annual inflation. It is clear that inflation does not affect the house’s variable non–monetary real value – all else being equal.

However much inflation rises, it can only erode the SA Rind’s real value at a higher rate and over a shorter period of time. As inflation rises the price of the house would rise to keep pace with inflation or value erosion in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non–monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.

The house’s real value is not a constant real value non–monetary item. It is only assumed in this example that only inflation changes with all else being equal. This is not normally the case in the actual property market. The house is a variable real value non–monetary item.

When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 29 years (2010) since January, 1981 in the company’s balance sheet. When it is eventually sold in 2010 for R 1.4 million we can see that inflation did not erode the property’s variable real non–monetary value – all else being equal. Inflation only eroded the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 29 year period – all else being equal. This would be taken into account by the buyer and seller at the time of the sale in a free and open market. The selling price quoted in terms of the depreciating Rand would be increased to compensate for the erosion of the real value of the depreciating Rand by inflation. R1.4 million in 2010 was the same as R100 000 in January, 1981 – all else being equal.

As the two academics from Turkey state:

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

Guceneme and Arsoy 2005: 9

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Nicolaas Smith

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

Historical Cost Debate

Historical Cost Debate

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The Historical Cost Debate is the debate over the last 100 years or so about the use of Historical Cost for accounting purposes. The entities realized a long time ago that financial reports based on Historical Cost for all economic items do not fairly represent a company’s results and operations. As a result of this debate the pure Historical Cost accounting model was improved and changed dramatically during this time, so much so, that today we have a huge volume of IFRS where under variable real value non–monetary items are not all valued at HC, but at, e.g., fair value or the lower of cost and net realizable value or market value or recoverable value or present value, etc. This debate has thus been a very valid and successful debate regarding the valuation of variable real value non–monetary items. IFRS mainly refer to variable items.

Unfortunately, the stable measuring unit assumption is still an IFRS–approved option that is used for the valuation of most constant items (excluding annual measurement of salaries, wages, rents, etc. in units of constant purchasing power) during inflation and deflation. Fortunately, the option of measuring financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA) was approved in IFRS in the original Framework (1989), Par. 104 (a).

Entities value variable items in terms of IFRS when they implement both the traditional HCA model and when they measure financial capital maintenance in units of constant purchasing power during inflation and deflation applying CIPPA. The stable measuring unit assumption is implemented under HCA. It is not to be implemented under financial capital maintenance in units of constant purchasing power (CIPPA). The net monetary loss or gain is calculated and accounted whenever monetary items are not inflation-adjusted daily during the current financial period under financial capital maintenance in units of constant purchasing power. The net constant item loss or gain is calculated whenever constant items are not maintained constant during the current accounting period under financial capital maintenance in units of constant purchasing power (CIPPA).

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Measurement bases

Measurement bases  

Measurement bases used in the valuation of variable items in terms of IFRS include – but are not limited to – the following:

Market value

Fair value

Historical Cost

Net realisable value

Present value

Recoverable value

Current cost

Carrying value

Residual value

Value in use

Settlement value

Replacement cost

Examples of variable items         

Property

Freehold land

Buildings

Leasehold improvements

Plant

Equipment

Equipment under finance lease

Investment property

Other intangible assets

Capitalised development items

Patents

Trademarks

Licences

Investments in associates

Joint ventures  

Available–for–sale investments  

Quoted and unquoted shares

Inventories

Raw materials

Work–in–progress

Finished goods

Foreign exchange

Commodities

Precious metals

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Inflation

Inflation

Inflation is always and everywhere a monetary phenomenon.

Milton Friedman

              

Inflation is a sustained increase in the general price level of goods and services within an economy over a period of time. During inflation an entity pays more money for the same real value. Inflation is generally accepted to refer to annual inflation. All prices are normally quoted in terms of unstable money. During inflation each unit of the unstable monetary unit buys fewer goods and services. Inflation has no effect on the real value of non–monetary items.

                

Inflation erodes real value evenly in money and other monetary items. Under the Historical Cost paradigm under which the stable measuring unit assumption is implemented, there are, consequently, real hidden monetary costs to some and real hidden monetary benefits to others from this erosion in purchasing power in unstable monetary items that are assets to some while – a the same time – liabilities to others, e.g., the capital amount of a monetary loan. Under the HC paradigm the debtor generally gains during inflation since he, she or it (a company) has to pay back the nominal value of the loan, the real value of which is being eroded by inflation. The debtor pays back less real value during inflation. The creditor loses out because he, she or it receives the nominal value of the loan back, but, the real value paid back is lower as a result of inflation. Efficient lenders attempt to recover this loss in real value by charging interest at a rate they hope will be higher than the inflation rate during the period of the loan.

              

Capital inflation-indexed government bonds overcome this problem for lenders.

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

Measurement of variable items

Measurement of variable items

Measurement in the case of variable items is the process of determining the monetary amounts at which variable items are to be recognised, valued, carried and accounted on a daily basis in an economy under all levels of inflation and deflation. This involves the selection of particular bases of measurement.

Variable items are valued daily in terms of IFRS, excluding the stable measuring unit assumption, under financial capital maintenance in units of constant purchasing power (CIPPA). Variable item revaluation losses and gains are treated in terms of IFRS. Variable items, when not valued daily in terms of IFRS, would be updated in terms of a Daily CPI or a monetized daily indexed unit of account during low and high inflation and deflation and in terms of a daily hard currency parallel rate or Brazilian – style Unidade Real de Valor daily index rate during hyperinflation because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation (CIPPA).

Variable items in the non–monetary or real economy are valued at, for example, fair value or the lower of cost and net realizable value or recoverable value or market value or present value, etc. in terms of IFRS excluding the stable measuring unit assumption.

The real values of variable items exist independently of being valued at their original nominal Historical Cost values in terms of IFRS. Valuing a variable item at its original Historical Cost in fixed nominal monetary units during its entire lifetime does not erode its real value because it would be valued at its current market value whenever it is finally exchanged or sold in the future. Any variable item valued at HC, when not being revalued, would be continuously updated in terms of a Daily Consumer Price Index or other daily index rate since the stable measuring unit assumption is not applied under financial capital maintenance in units of constant purchasing power (CIPPA).

Originally all items in financial statements – monetary, variable and constant real value non–monetary items – were valued at Historical Cost before there were any GAAP, IAS or IFRS, since money – the monetary unit of account – was generally assumed to be stable in real value over time: the infamous stable measuring unit assumption. Today, the traditional Historical Cost Accounting model maintains this very erosive and very economically destabilizing assumption for the valuation of all income statement items, all balance sheet constant items and certain variable items, e.g., inventories which are measured at the lower of cost and net realisable value. Under financial capital maintenance in units of constant purchasing power (CIPPA) any item originally valued at HC in terms of IFRS (e.g. an inventory item) is then updated daily in terms of the Daily CPI or other daily index rate while it is not valued daily thereafter.

The IASB only makes a distinction between monetary and non–monetary items. The stable measuring unit assumption allows the IASB to side–step the split between variable real value non–monetary items and constant real value non–monetary items in the practical application of IFRS under the HC paradigm. Both constant and variable real value non-monetary items are however inferred in IFRS under the Constant Item Purchasing Power paradigm. Financial capital maintenance in units of constant purchasing power (CIPPA) as authorized in the original Framework, Par. 104 (a) is implemented under the CIPP paradigm.

Variable items may hold their values in terms of purchasing power under HCA as a result of the ways in which they are valued in terms of IFRS in which their nominal values are adjusted at the time of exchange or disposal to allow for the many factors that determine their real values – including inflation, deflation and hyperinflation. For example: fair value, market value, net realizable value, present value and recoverable value all adjust for inflation, deflation and hyperinflation – in the real value of the monetary unit – as part of the specific valuation process.

Nicolaas Smith

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

Valuation of constant items during hyperinflation

Valuation of constant items during hyperinflation

The stable measuring unit assumption is applied in the valuation of constant real value non–monetary items, e.g., salaries, wages, rentals, equity, trade debtors, trade creditors, taxes payable, etc. during hyperinflation when these items are not updated at all or not fully updated during hyperinflation; i.e., when the HCA model is implemented during hyperinflation as mistakenly approved in IAS 29 and mistakenly supported by Big Four accounting firms like PricewaterhouseCoopers (PricewaterhouseCoopers 2006).

The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach shall be stated in terms of the measuring unit current at the end of the reporting period.

IAS 29 Par. 8

It is clear from the above quotes that IFRS approve and PricewaterhouseCoopers support the implementation of the Historical Cost Accounting model and the very erosive stable measuring unit assumption during hyperinflation. That is a fundamental mistake during hyperinflation. HCA should be banned by law during hyperinflation.

Certain (not all) income statement items, e.g., salaries, wages, rentals, etc. are measured as a generally accepted accounting practice in units of constant purchasing power on an annual basis (they are updated annually – not monthly) as part of the traditional Historical Cost Accounting model during low inflation. The Framework states that various measurement bases are used in conjunction in the HCA model during inflation, hyperinflation and deflation.

A constant real value non–monetary item´s legal existence is determined by contract or statute (company law, commercial law, etc.). However, these constant real value non–monetary items are – in practice – treated as monetary items (cash) during the period that they are not measured in units of constant purchasing power in terms of the daily US Dollar or other daily hard currency parallel rate or a daily index rate during hyperinflation.

Salaries, wages, rentals, trade debtors, trade creditors, all other non–monetary payables, all other non–monetary receivables, etc. are not required in IAS 29 to be measured at the date of payment in terms of the period–end monthly published CPI. That is, obviously, not practically possible when the period–end monthly CPI is normally only available one or two months after the month to which it relates during hyperinflation. What is required in IAS 29 is that these constant real value non–monetary items´ nominal Historical Cost or Current Cost values – after payment or after the liability for the payment has been accounted – in HC or CC financial statements at the end of the accounting period be restated in terms of the period–end monthly CPI in order – simply – to make the HC or CC financial statements more useful during hyperinflation. The practical implementation of IAS 29 thus generally does not result in financial capital maintenance in units of constant purchasing power during hyperinflation. That explains the complete failure of IAS 29 when it was implemented during hyperinflation in Zimbabwe. It did not manage to keep the Zimbabwe real economy relatively stable like daily measurement in terms of the daily index supplied by various governments during 30 years of very high and hyperinflation in Brazil did. The complete failure of IAS 29 in Zimbabwe seems to make absolutely no difference to the IASB´s confidence in this failed standard.

When there is no CPI published as happened towards the end of severe hyperinflation in Zimbabwe, values measured in terms the CPI cannot be determined. It was impossible to implement IAS 29 during severe hyperinflation in Zimbabwe.

The Zimbabwe government last published an official Zimbabwe dollar inflation index in July 2008. This, combined with the complexities of not having a stable currency due to the phenomenon described above, meant that there were severe limitations to accurate financial reporting in the period from August 2008. During this period the Institute of Chartered Accountants in Zimbabwe set up a technical subcommittee to address these challenges, as it was impossible to apply IAS 29 “Financial Reporting in Hyperinflationary Economies” without a general price index, or IAS 21 “Exchange Rates” without a single spot rate.

Whiley 2010

However, these constant items´ legal or contractual values (labour contracts, company registrations) do not disappear even when the accounting items – temporarily – cannot be valued. The companies act and labour laws governing labour contracts, etc. are still valid during hyperinflation, severe hyperinflation, monetary meltdown and thereafter. The accounting concept that the constant purchasing power of capital is equal to the real value of net assets always applies. Their legal or contractual constant real non–monetary values still exist even after monetary meltdown of only the local currency. They are valued in terms of IAS 1 in the opening balance sheet after monetary meltdown applying the principle that the constant purchasing power of capital is equal to the real value of net assets.

The IASB authorized an addition to IAS 1 in 2011 to allow for the fair value valuation of non–monetary items in the opening balance sheet of companies applying IFRS after severe hyperinflation and a monetary meltdown. Inflation and hyperinflation have no effect on the real value of non–monetary items. All non–monetary items (constant and variable items) were still there to be fair–valued and included in the opening balance sheets of companies after the monetary meltdown in Zimbabwe in 2008.

No exchangeability with any relatively stable foreign currency means no exchange rate which means no hyperinflation (no prices being set in the local currency) and vice versa: no exchange rate with any relatively stable foreign currency means no exchangeability which means no hyperinflation (no prices being set in the local currency). No prices being set in the local currency means monetary meltdown: the total money supply (only local currency money and only other monetary items stated in the local currency) has no value. This does not include any non-monetary item, variable or constant real value non-monetary item.

Nicolaas Smith

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

Non–monetary real value does not disappear with a monetary meltdown

Non–monetary real value does not disappear with a monetary meltdown

Only ZimDollars and other monetary items (loans, etc.) expressed in the ZimDollar had no value after the monetary meltdown. The real values of all non–monetary items (variable and constant real value non–monetary items) still existed after the monetary meltdown while the real value of ZimDollar money and monetary items terminated. All non–monetary items (constant and variable items) still had economic real values despite the lack of a CPI and despite the monetary meltdown of the ZimDollar.

Variable items, e.g., finished goods for sale, are generally valued in terms of the daily US Dollar parallel rate during hyperinflation. A variable item is sold at a lower price when a seller does not know the current street rate and sells it at the previous level of the parallel rate. This unnecessary real loss is not caused by the implementation of the stable measuring unit assumption. The seller did not assume the local hyperinflationary currency was stable in real value. The seller was simply not properly informed regarding the current level of the daily US Dollar parallel rate at the time of the sale.

Finished goods and all other variable real value non–monetary items still exist after monetary meltdown. They are then priced / valued / measured at fair value in terms of IAS 1 in the opening balance sheet in the new relatively stable currency adopted as the functional currency after monetary meltdown.

Valuation of constant items during hyperinflation

The stable measuring unit assumption is applied in the valuation of constant real value non–monetary items, e.g., salaries, wages, rentals, equity, trade debtors, trade creditors, taxes payable, etc. during hyperinflation when these items are not updated at all or not fully updated during hyperinflation; i.e., when the HCA model is implemented during hyperinflation as mistakenly approved in IAS 29 and mistakenly supported by Big Four accounting firms like PricewaterhouseCoopers (PricewaterhouseCoopers 2006).

The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach shall be stated in terms of the measuring unit current at the end of the reporting period.

IAS 29 Par. 8

It is clear from the above quotes that IFRS approve and PricewaterhouseCoopers support the implementation of the Historical Cost Accounting model and the very erosive stable measuring unit assumption during hyperinflation. That is a fundamental mistake during hyperinflation. HCA should be banned by law during hyperinflation.

Certain (not all) income statement items, e.g., salaries, wages, rentals, etc. are measured as a generally accepted accounting practice in units of constant purchasing power on an annual basis (they are updated annually – not monthly) as part of the traditional Historical Cost Accounting model during low inflation. The Framework states that various measurement bases are used in conjunction in the HCA model during inflation, hyperinflation and deflation.

A constant real value non–monetary item´s legal existence is determined by contract or statute (company law, commercial law, etc.). However, these constant real value non–monetary items are – in practice – treated as monetary items (cash) during the period that they are not measured in units of constant purchasing power in terms of the daily US Dollar or other daily hard currency parallel rate or a daily index rate during hyperinflation.

Salaries, wages, rentals, trade debtors, trade creditors, all other non–monetary payables, all other non–monetary receivables, etc. are not required in IAS 29 to be measured at the date of payment in terms of the period–end monthly published CPI. That is, obviously, not practically possible when the period–end monthly CPI is normally only available one or two months after the month to which it relates during hyperinflation. What is required in IAS 29 is that these constant real value non–monetary items´ nominal Historical Cost or Current Cost values – after payment or after the liability for the payment has been accounted – in HC or CC financial statements at the end of the accounting period be restated in terms of the period–end monthly CPI in order – simply – to make the HC or CC financial statements more useful during hyperinflation. The practical implementation of IAS 29 thus generally does not result in financial capital maintenance in units of constant purchasing power during hyperinflation. That explains the complete failure of IAS 29 when it was implemented during hyperinflation in Zimbabwe. It did not manage to keep the Zimbabwe real economy relatively stable like daily measurement in terms of the daily index supplied by various governments during 30 years of very high and hyperinflation in Brazil did. The complete failure of IAS 29 in Zimbabwe seems to make absolutely no difference to the IASB´s confidence in this failed standard.

When there is no CPI published as happened towards the end of severe hyperinflation in Zimbabwe, values measured in terms the CPI cannot be determined. It was impossible to implement IAS 29 during severe hyperinflation in Zimbabwe.

The Zimbabwe government last published an official Zimbabwe dollar inflation index in July 2008. This, combined with the complexities of not having a stable currency due to the phenomenon described above, meant that there were severe limitations to accurate financial reporting in the period from August 2008. During this period the Institute of Chartered Accountants in Zimbabwe set up a technical subcommittee to address these challenges, as it was impossible to apply IAS 29

“Financial Reporting in Hyperinflationary Economies” without a general price index, or IAS 21 “Exchange Rates” without a single spot rate.

Whiley 2010

However, these constant items´ legal or contractual values (labour contracts, company registrations) do not disappear even when the accounting items – temporarily – cannot be valued. The companies act and labour laws governing labour contracts, etc. are still valid during hyperinflation, severe hyperinflation, monetary meltdown and thereafter. The accounting concept that the constant purchasing power of capital is equal to the real value of net assets always applies. Their legal or contractual constant real non–monetary values still exist even after monetary meltdown of only the local currency. They are valued in terms of IAS 1 in the opening balance sheet after monetary meltdown applying the principle that the constant purchasing power of capital is equal to the real value of net assets.

The IASB authorized an addition to IAS 1 in 2011 to allow for the fair value valuation of non–monetary items in the opening balance sheet of companies applying IFRS after severe hyperinflation and a monetary meltdown. Inflation and hyperinflation have no effect on the real value of non–monetary items. All non–monetary items (constant and variable items) were still there to be fair–valued and included in the opening balance sheets of companies after the monetary meltdown in Zimbabwe in 2008.

No exchangeability with any relatively stable foreign currency means no exchange rate which means no hyperinflation (no prices being set in the local currency) and vice versa: no exchange rate with any relatively stable foreign currency means no exchangeability which means no hyperinflation (no prices being set in the local currency). No prices being set in the local currency means monetary meltdown: the total money supply (only local currency money and only other monetary items stated in the local currency) has no value. This does not include any non-monetary item, variable or constant real value non-monetary item.

Nicolaas Smith

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

Hyperinflation has no effect on the real value of non–monetary items

Hyperinflation has no effect on the real value of non–monetary items

Hyperinflation only erodes the real value of the monetary unit extremely rapidly. Hyperinflation has no effect on the real value of non–monetary items. All non–monetary items (variable and constant real value non–monetary items) maintain their real values during hyperinflation when they are measured in units of constant purchasing power daily in terms of a daily parallel rate (a black market or street rate) normally the daily official or unofficial US Dollar or other unofficial hard currency parallel exchange rate or an official Brazilian–style daily URV non–monetary index normally almost totally based on the daily US Dollar exchange rate as Brazil did during 30 years of very high and hyperinflation.

The stable measuring unit assumption (HCA) – not hyperinflation – unknowingly, unnecessarily and unintentionally erodes the real value of constant real value non–monetary items not maintained constant as fast as hyperinflation erodes the real value of the local currency and other monetary items, e.g., loans stated in the local currency, because all economic items (monetary, variable and constant items) in the hyperinflationary economy are measured in terms of the hyperinflationary monetary unit. A monetary meltdown erodes all real value only in the monetary economy; i.e., in the local currency money supply.

Hyperinflation is not always stopped with first a period of severe hyperinflation in the final stage and then a complete monetary meltdown. Hyperinflation was successfully overcome by various countries, e.g., Turkey, Brazil and Angola, without dollarization or a monetary meltdown.

Brazil actually grew their non–monetary economy in real value during 30 years of very high and hyperinflation of up to 2000 per cent per annum from 1964 to 1994 and never had severe hyperinflation followed by a complete monetary meltdown at the end. Brazil stopped its hyperinflation with the Real Plan in 1994. Brazil managed to have years of positive Gross Domestic Product growth during those 30 years of very high and hyperinflation because the various governments during those three decades supplied the population with a daily non–monetary index based almost entirely on the daily US Dollar exchange rate with their monetary unit. It was used to update most non–monetary items (variable and constant real value non–monetary items), e.g., goods, services, equity, trade debtors, trade creditors, salaries payable, wages payable, taxes payable, etc., in the hyperinflationary economy daily.

Brazil would not have been able to maintain its non–monetary or real economy relatively stable with actual real GDP growth during hyperinflation if it had applied restatement of HC or CC financial statements in terms of the period–end monthly published CPI as required in IAS 29 Financial Reporting in Hyperinflationary Economies during that period. IAS 29 does not require continuous daily measurement of all non–monetary items in terms of a daily index during hyperinflation. IAS 29 does not require continuous daily updating of all non-monetary items in terms of the US Dollar parallel rate or a Brazilian–style URV daily index rate. IAS 29 simply requires restatement of Historical Cost and Current Cost financial statements during hyperinflation applying the monthly Consumer Price Index at the end of the reporting period (monthly, quarterly, six monthly or annual) – generally available a month or two months after the current month – to make these financial statements more useful. It is not the intention of IAS 29 to, and in its current form it cannot, stop the continuous daily rapid erosion of the real value of constant real value non–monetary items never maintained constant as Brazil did for 30 years of high and hyperinflation generating positive economic growth.

This daily very rapid erosion of constant real value non-monetary items never maintained constant is caused, not by hyperinflation, but, by the implementation of the stable measuring unit assumption (HCA) during hyperinflation. Applying the monthly CPI a month or two months after the current month is very ineffective during hyperinflation as far as the constant real non–monetary value of salaries, wages, rentals, equity, trade debtors, trade creditors, etc., positive economic growth, economic stability in the real or non–monetary economy, the maintenance of internal demand and the continuous daily maintenance of the real value of all non–monetary items during hyperinflation are concerned. All non–monetary items (variable and constant items) have to be updated daily in terms of the parallel US Dollar rate or a Brazilian–style URV daily index rate in order to maintain the real economy relatively stable during hyperinflation in the local currency monetary unit. That would be financial capital maintenance in units of constant purchasing power (CIPPA) during hyperinflation.

When the stable measuring unit assumption is implemented under HCA or financial capital maintenance in nominal monetary units also originally authorized in IFRS in the Framework (1989), Par. 104 (a), it is assumed, in practice, that there was, is and never ever will be inflation, deflation or hyperinflation as far as the valuation of constant real value non–monetary items are concerned. It is assumed, in principle, that money was, is and will always in the future be perfectly stable at all levels of inflation, hyperinflation and deflation.

Various accounting authorities are requesting a fundamental review of IAS 29. See IFRS X Capital Maintenance in Units of Constant PurchasingPower.  

David Mosso state:

Neither IFRS 29 nor FAS 89 is complete in the sense of a single authoritative standard.

Mosso 2011

Severe hyperinflation is defined by the IASB as a period at the end of completely uncontrolled hyperinflation when exchangeability between the hyperinflationary monetary unit and most relatively stable foreign currencies does not exist. The wording of the IASB definition thus confirms that at least one exchangeability has to exist for prices to be established in the hyperinflationary monetary unit; i.e., for severe hyperinflation to exist. Severe hyperinflation is only present when there is still exchangeability with at least one relatively stable foreign currency in order for prices to continue to be set in the hyperinflationary monetary unit in terms of this final exchangeability. The one exchange rate that lasted till the end of severe hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR).

The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate.

Hanke and Kwok 2009: 8

Hyperinflation (severe or not) stops the moment exchangeability between the local hyperinflationary currency and all foreign currencies does not exist.

Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non–cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.

Hanke and Kwok 2009: 9–10

There was severe hyperinflation in Zimbabwe while there was exchangeability (prices could still be set in the ZimDollar) with at least one relatively stable foreign currency – the British Pound in this case as it was made possible via the OMIR. When this last exchangeability stopped it was not possible to set prices in the ZimDollar anymore and severe hyperinflation stopped: no exchangeability means no hyperinflation. That was a monetary meltdown. The entire ZimDollar money supply had no value as from that date on.

Nicolaas Smith

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