Physical capital maintenance is very different from financial capital maintenance

Physical capital maintenance is very different from financial capital maintenance

Updated on 16-05-2016

In IFRS the Conceptual Framework (2010), Par. 4.59 (b) states the following:

 ‘Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.’

The (1) physical capital maintenance concept is a fundamentally (totally) different capital maintenance concept compared to the two financial capital maintenance concepts, namely (2) financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) and (3) financial capital maintenance in units of constant purchasing power in terms of a Daily CPI. The latter is authorised at all levels of inflation (including hyperinflation) and deflation in IFRS in 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" as an alternative to financial capital maintenance in nominal monetary units (i.e., as an alternative to HCA). 

Financial capital maintenance in units of constant purchasing power is required during hyperinflation in IAS 29 Financial Reporting in Hyperinflationary Economies. It has been implemented under IAS 29 in terms of the monthly published CPI which, unfortunately, does not result in any capital maintenance at all. 

In fact, IAS 29 in terms of the IASB promoted monthly published CPI was implemented for the final 8 years in Zimbabwe´s hyperinflationary economy (hyperinflation in Zimbabwe ended on 20 November 2008) with no positive effect at all, an irrefutable fact the IASB stubbornly refuses to admit. The IASB refuses point blank to research the very successful implementation of financial capital maintenance in units of constant purchasing power in terms of a Daily Index as it was very successfully done in Latin America from 1960 to 1994. The IASB very irresponsibly ignores the fact that daily indexing of all item in terms of all (at least daily) changes in the general price level eliminates the effect of inflation during inflation, the effect of hyperinflation during hyperinflation and the effect of deflation during deflation. 

The IASB also very irresponsibly refuses to update IAS 29 to require DAILY INDEXING in terms of the DAILY CPI although I have pointed out to them a number of times in various comment letters published on their website that the effect of hyperinflation in the entire economy during hyperinflation in the monetary unit is only eliminated (as it was very successfully done in Brazil in the 1990's) when a DAILY CPI is used and that the use of the monthly published CPI is a waste of time as was very clear with the ineffective use of IAS 29 during hyperinflation in Zimbabwe. 

Capital maintenance in units of constant purchasing power (not IAS 29) was widely implemented with great success in the form of DAILY monetary correction or DAILY indexation in Latin America from the early 1960´s to the mid 1990´s and carried on in Chile till 2008).

(1), (2) and (3) above are the three capital maintenance concepts authorised in IFRS.

The Conceptual Framework (2010), Par. 4.57 states:

‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.’

So, it is all about ‘units of output per day’. An entity must be using ‘units of output per day’ as the measurement basis to maintain its physical capital.

Physical capital maintenance is not just another way or an additional way of looking at or presenting the two financial capital maintenance concepts.

Actual physical capital maintenance is not widely used in any economy. Prof. Rachel Baskerville from Victoria University in New Zealand states in her paper ‘100 Questions and Answers about IFRS’, Question 39:

‘It is equally possible for a company to adopt a concept of physical capital; i.e. the cycle of operation moves from assets/goods to dollar to goods/assets. Some public sector entities consider that their stewardship responsibilities are best served by reporting physical capital maintenance; e.g., is the capacity of the waterworks, waste water system, etc. in the local town the same as, or better, than it was last year?

Some Key Performance Indicators (KPIs) will be chosen to report this.

The Framework states: ― ‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.”’

So: physical capital maintenance is not generally about ‘measurements currently reported in balance sheets’. Physical capital maintenance is not often used.

Financial capital maintenance in nominal monetary units (HCA) is the generally accepted accounting model worldwide. It is an option in IFRS: see the Conceptual Framework, Par. 4.59(a).

Financial capital maintenance in units of constant purchasing is REQUIRED during hyperinflation in terms of IAS 29. Unfortunately IAS 29 has been implemented since 1989 in terms of the monthly published CPI which makes it useless during hyperinflation. 

IAS 29 does not actually REQUIRE the use of the monthly published CPI. Companies simply used the monthly published CPI because the Daily CPI has never been used for accounting purposes on a national scale outside of Latin America. In Latin America the use of daily indexing also was not seen as being the implementation of an accounting model in terms of the Daily CPI. It was always seen as monetary correction, something required by the central bank, not an accounting requirement. 

IAS 29, Par. 8 requires the following: "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."

The Daily CPI is also a "measuring unit current at the end of the reporting period." The use of the Daily CPI when IAS 29 is implemented during hyperinflation is thus authorised in IFRS. Unfortunately no-one has implemented IAS 29 in terms of the Daily CPI yet because the IASB very irresponsibly refuses to point out to countries in hyperinflation that Daily indexing of all items would remove the effect of hyperinflation during hyperinflation and that it is authorised in IAS 29. Brazil used a type of Daily CPI during a number of years leading up to June 1994. They used their Unidade Real de Valor daily index which was based on the daily US Dollar exchange rate during hyperinflation. During those years they eliminated a great deal of the effect of hyperinflation during hyperinflation in their monetary unit by indexing most of the economy in terms of their daily index, namely the Unidade Real de Valor. 


Thus financial capital maintenance in units of constant purchasing is widely used in hyperinflationary economies. It (not IAS 29) was very widely used  - very successfully - from 1964 to 1994 in Latin America during high inflation as well as hyperinflation, but always in terms of a DAILY INDEX. That is why it was so successful in South America while IAS 29 in terms of the monthly published CPI had no positive effect at all during the 8 years it was implemented in Zimbabwe´s hyperinflationary economy. IAS 29 was a total disaster in Zimbabwe.

Physical capital maintenance is rarely used.

Update (16-05-2016)

Some respondents in their comment letters regarding the IASB´s Exposure Draft Conceptual Framework for Financial Reporting feel that a new Conceptual Framework should state that a physical capital maintenance concept will never be used. 

"Specific suggestions included that the Conceptual Framework should state that a financial concept of capital maintenance should be adopted, or that a physical capital maintenance concept will never be used."

Project Conceptual Framework 

Paper topic Feedback summary—Measurement and Capital Maintenance 

Par 65 (a), P 15

Nicolaas Smith

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

Inflation only affects monetary items in financial statements

Inflation only affects monetary items in financial statements

The statement The effects of inflation in financial statements is a very common statement in accounting literature, international accounting standard setting, central banking research and in accounting in general.

Inflation only affects the real value on monetary items and nothing else. Inflation has no effect on the real value of non-monetary items. The stable measuring unit assumption affects the real value of non-monetary items.

What is intended with the statement The effects of inflation in financial statements is to state: The effects of (1) inflation on monetary items and (2) the stable measuring unit assumption on non-monetary items in financial statements.

Nicolaas Smith

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

Inflation-linked accounting unit draws big Money to Chile

Inflation-linked accounting unit draws big Money to Chile

Bloombergs

Not enough inflation

Not enough inflation

Paul Krugman

New York Times

Capital Maintenance in Units of Constant Purchasing Power is quite and old capital maintenance concept

Capital Maintenance in Units of Constant Purchasing Power is quite and old capital maintenance concept
 

A form of Capital Maintenance in Units of Constant Purchasing Power is implemented whenever capital (equity) is measured in units of constant purchasing power; i.e., whenever indexation or monetary correction or restatement is used. Indexation, under the name “monetary correction” was used mainly in Latin America from the early 1960´s till 2010 when Chile stopped monetary correction. It has been used in Venezuela in the form of IAS 29 from 2009 till the present (2013).

Indexation was not understood as an accounting model, which it, in fact, is. Brazil used measurement in units of constant purchasing power in the form of monetary correction in the form of a government supplied daily index from 1964 till 1994.

Chile used monetary correction (indexation or capital maintenance in units of constant purchasing power) from 1967 till 2010 in terms of their Unidad de Fomento. Chile stopped monetary correction in 2010 in order to conform with IFRS which is almost 100 per cent Historical Cost based during low inflation, high inflation and deflation. IFRS are Capital Maintenance in Units of Constant Purchasing Power based during hyperinflation. Chile did not and still does not understand and realize that they stopped Capital Maintenance in Units of Constant Purchasing Power in favour of Historical Cost Accounting in 2010.

 

Capital Maintenance in Units of Constant Purchasing Power was originally authorized in IFRS in the original Framework (1989), Par 104 (a) which states: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant of constant purchasing power? It is currently being implemented in Venezuela and Belarus. Capital Maintenance in Units of Constant Purchasing Power is implemented under IAS 29 in the form of restatement of HC or Current Cost financial statements at the measuring unit current at the end of the reporting period in terms of the monthly published CPI. Unfortunately this does not result in 100 per cent Capital Maintenance in Units of Constant Purchasing Power.

This would be remedied with the use of the generally available Daily CPI. No-one is currently using the Daily CPI for this purpose during hyperinflation or any other level of inflation or deflation. The use of a daily index to measure all non-monetary items and some monetary items in units of constant purchasing power was widely used in Latin American countries from 1964 till 2010.

The IASB regards the use of a daily index which resulted in Capital Maintenance in Units of Constant Purchasing Power in Latin America as irrelevant. The IASB is clueless about Capital Maintenance in Units of Constant Purchasing Power. Although it is required and gives particular guidance on how to prepare financial statements stated in constant purchasing power units in IAS 29, the IASB Staff Paper 20 for the IFRIC meeting on 22-23 January 2013 states:

"10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units."

Nicolaas Smith

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

Definition of Capital Maintenance in Units of Constant Purchasing Power

Definition of Capital Maintenance in Units of Constant Purchasing Power

Updated on 3 May 2013

Capital Maintenance in Units of Constant Purchasing Power is the maintenance of the constant purchasing power of capital (equity) – with capital being equal to the real value of net assets – for an indefinite period of time at all levels of inflation (low inflation, high inflation and hyperinflation) and deflation in all entities that at least break even in real value – ceteris paribus – in units of constant purchasing power in terms of an index that recognizes all the changes (every change) in the general price level.

Capital Maintenance in Units of Constant Purchasing Power was originally authorised as an option to financial capital maintenance maintenance in nominal monetary units (the 3000 year old, generally accepted, globally implemented, traditional Historical Cost Accounting model) at all levels of inflation (low inflation, high inflation and hyperinflation) and deflation in IFRS in the original Framework (1989), Par 104 (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 required during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies (IFRS are principles-based standards: the requirement is implied/inferred in IAS 29). Unfortunately IAS 29 has been implemented in terms of the monthly published CPI since its authorization in 1989. This results in the destruction of part of the real value of current year profits by the implementation of the stable measuring unit assumption during the periods that the daily change in the general price level is being ignored under IAS 29 during hyperinflation (from the 1st of the month till the second last day of the month: the monthly CPI is the CPI valid on the last day of the month). [The implications of the difference in the value of the monthly publised CPI and the Daily CPI on the last day of the month need to be analysed]. There are at least 365 different price levels in the general price level during low inflation, high inflation, hyperinflation and deflation. IAS 29 is implemented recognizing only the 12 month-end CPIs during the year during hyperinflation.

Although Capital Maintenance in Units of Constant Purchasing Power is required during hyperinflation in terms of IAS 29,  it, unfortunately, does not result in 100 per cent Capital Maintenance in Units of Constant Purchasing Power during hyperinflation. This is remedied with the implementation of an index that recognizes all changes in the general price level during hyperinflation.

This can be done with (1) the use of the daily US Dollar or other relatively stable foreign currency parallel rate (where a daily parallel rate exists) or (2) a Brazilian-style URV-based daily index that was almost entirely made up of the US Dollar daily exchange rate (not a parallel rate) during hyperinflation or (3) the use of the Daily CPI at initial levels of hyperinflation.

The Daily CPI – available in all countries that issue government capital inflation-indexed bonds, i.e., in 90 per cent of the world economy – which is a lagged daily interpolation of the monthly published CPI, recognizes all changes in the general price level (when the monthly published CPI is recognized as the general price level) during low inflation, high inflation, initial hyperinflation and deflation.

Low inflation is inflation up to 10 per cent per annum. High inflation is inflation from 10 per cent to 26 per cent per annum. Hyperinflation is cumulative inflation of 100 per cent over three years, i.e., 26 per cent per annum inflation for three years in a row.

Judgment and pragmatism have to be used to determine whether (1) the Daily CPI, (2) a daily foreign currency exchange rate (normally the daily US Dollar parallel rate) or (3) a Brazilian-style URV-based daily index (which was almost entirely made up of the USD daily exchange rate) should be used as the general price level during hyperinflation. Judgment has to be used to judge whether the Daily CPI is not, in fact, too far behind real value as determined by the USD parallel rate and the use of the Daily CPI, in fact, would not result in adequate (judgment to be used again) Capital Maintenance in Units of Constant Purchasing Power during hyperinflation.

Pragmatism has to be used when the use of the US Dollar parallel rate is forbidden (illegal) in a country and its use would result in the arrest of company owners and/or directors.

The constant item constant purchasing power concept of capital is implemented under Capital Maintenance in Units of Constant Purchasing Power. Constant items are constant real value non-monetary items as inferred in IFRS which are principles-based standards. The Conceptual Framework (2010), Par 4.59 (a) states ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’ Capital is a non-monetary item.

Non-monetary items to be measured in units of constant purchasing power are thus constant real value non-monetary items or simply constant items. They include issued share capital, retained earnings, capital reserves, all other items in equity, trade debtors, trade creditors, all other non-monetary receivables, all other non-monetary payables, all items in the income statement, provisions, etc. They are always and everywhere measured in units of constant purchasing power in terms of an index that recognizes all changes in the general price level, e.g., the Daily CPI during low inflation, high inflation and deflation and the US Dollar parallel rate during hyperinflation.

Non-monetary items that are not constant items are variable real value non-monetary items or simply variable items. They include property, plant, equipment,  quoted and unquoted shares, foreign exchange, etc. They are measured in terms of IFRS excluding the stable measuring unit assumption.

The stable measuring unit assumption is never implemented under Capital Maintenance in Units of Constant Purchasing Power.

Net monetary item gains and losses and net constant item gains and losses are accounted under Capital Maintenance in Units of Constant Purchasing Power.

Nicolaas Smith

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

Objective of IAS 29

Objective of IAS 29

IFRS are principles-based standards.

IAS 29 does not specifically state its objective.

Paragraph 2 states:

‘In a hyperinflationary economy, reporting of operating results and financial

position in the local currency without restatement is not useful.’

The closest IAS 29 comes to stating its objective is in Paragraph 7:

‘In a hyperinflationary economy, financial statements, whether they are based on

a historical cost approach or a current cost approach, are useful only if they are

expressed in terms of the measuring unit current at the end of the reporting

period.’

Paragraph 8 states:

‘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.’

 

The reason IAS 29 does not specifically state its objective is because Capital Maintenance in Units of Constant Purchasing Power as originally authorized in the original Framework (1989), Par 104 (a) was not understood at the IASC in 1989 and is still (2013) not understood at the IASB, Big Four accounting companies, national accounting standard setters and by historical cost accountants in general. An important reason for this is the fact that non-monetary items were only split in constant real value non-monetary items and variable real value non-monetary items in the book Real Value Accounting published in 2005.

Which items have to be measured in units of constant purchasing power to maintain the constant purchasing power of capital constant as authorized in Par 104 (a) in 1989? The split is not important to know during hyperinflation because all non-monetary items, variable and constant items, are measured in units of constant purchasing power during hyperinflation. The split is thus not necessary during hyperinflation to achieve capital maintenance in units of constant purchasing power. IAS 29 was also authorized in 1989.

Another reason is the fact that the ineffective “restatement” model was very much in vogue as from the 1970´s and is still the stated model in IAS 29. It is the model most accountants believe will result in making financial statements ‘more meaningful’ during hyperinflation. The term Capital Maintenance in Units of Constant Purchasing Power is not used by the IASB or accountants in general with reference to IAS 29.

The IASB Staff Paper 20 for the IFRIC meeting dated 22-23 January 2013 very surprisingly states:

‘10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units.’ The complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power at the IASB is very evident in the above statement.

PricewaterhouseCoopers states in Understanding IAS 29 (2006)

Objectives of IAS 29

‘The IAS 29 approach is to restate all balances recorded in the financial statements (including comparative numbers) to the year-end general purchasing power of the functional currency.’

Objective of IAS 29

The objective of IAS 29 is to implement Capital Maintenance in Units of Constant Purchasing Power during hyperinflation as authorized in IFRS in 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.’

Unfortunately IAS 29 does not result in Capital Maintenance in Units of Constant Purchasing Power because of the use of the monthly published CPI. There are at least 365 different price levels in a year during hyperinflation.  IAS 29 only recognizes 12. This obviously results in the destruction of part of the real value of current year profits. This is remedied with the use of the generally available Daily CPI. No-one currently (2013) uses the Daily CPI with IAS 29. Because it is not currently widely used, the IASB regards the use of the Daily CPI with IAS 29 as irrelevant. The fact that it was used by every company and every accountant in Brazil for 30 years as well as over more than 45 years in Chile as well as in other Latin American countries for decades is completely ignored by the IASB because of their complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power and their complete resistance to learn what it is about.

Brazil used daily indices supplied by different governments during the 30 years of very high and hyperinflation from 1964 to 1994 with great success. The best and most successful daily index used in Brazil was the Unidade Real de Valor which was almost entirely based on the daily USD exchange rate with the Brazilian currency (which explains its success during hyperinflation). Because of the complete lack of understanding of Capital Maintenance in Units of Constant Purchasing Power at the IASB and by the global accounting profession, the great success of using daily indices in South American countries was completely ignored by the accounting profession and the IASB and still is.

Nicolaas Smith

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

IAS 29 gives particular guidance on how to implement Capital Maintenance in Units of Constant Purchasing power.

IAS 29 gives particular guidance on how to implement an incomplete form of Capital Maintenance in Units of Constant Purchasing Power.

Updated on 23 Abril 2013

For example: (i) IAS 29 defines monetary items (incorrectly).

(ii) IAS 29 defines non-monetary items correctly.

(iii) IAS 29 requires that period end finanancial statements be restated in terms of the measuring unit current at the balance sheet date.

IAS 29 does not result in complete Capital Maintenance in Units of Constant Purchasing Power because the current generally accepted practice to use the monthly published CPI results in the erosion/destruction of part of the current year profits. This is fixed with using the generally available Daily CPI.

The IASB Staff Paper 20 for the IFRIC meeting dated 22-23 January 2013 very surprisingly states:

"10. Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units."

The IASB does not understand the objective of IAS 29 and does not understand Capital Maintenance in Units of Constant Purchasing Power as specifically guide-lined in IAS 29 and authorized in IFRS in 1989.

Nicolaas Smith

Copyright (c) 2005-2013 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

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 and deflation) capital: the constant 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, centimetre, 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 purchasing power (real value) of capital has to be maintained constant over time during inflation/high inflation/hyperinflation 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 practises 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 no 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.

ECB should make unlimited credit available to PIGS as requested by Spain

ECB should make unlimited credit (see current US and Japan policies) available to PIGS as finally requested by Spain (see Bloomberg article below). In Portugal, no-one in the government or at the Bank of Portugal or in the financial press or at economics departments at Portuguese universities even knows what quantitative easing is. No-one in Portugal even mentions the subject.

PIGS´ politicians mistakenly signed away national Central Banks'  sovereign power to stimulate the economy with free money (like the US and Japan are doing right now) to the ECB for 20 years (or more) of recession and stagnation imposed by austerity. An initial lost decade after entrance into the EMU is now becoming a lost generation(s?) because the political class failed their nations.

Central Banks at Ease Limit Risk Political Backlash

Bloomberg
 

By Craig Torres & Simon Kennedy - Apr 16, 2013 9:26 AM GMT+0100

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Central banks are setting new expectations for monetary policy that may be hard to reverse as they slide deeper into the realms of fiscal policy.
To save their economies from debt crises or slow growth, the Bank of Japan is uniting with a new government by aiming to lift inflation to 2 percent by 2015, and the European Central Bank stands ready to purchase bonds of stressed nations. The Bank of England now has more room to ignore price pressures and is discussing with politicians how to ease credit further, while the Federal Reserve has extended more than $1 trillion worth of unprecedented credit to a single industry: housing.

Enlarge image

BOJ Governor Haruhiko Kuroda

Tomohiro Ohsumi/Bloomberg

Haruhiko Kuroda, governor of the Bank of Japan (BOJ), attends the annual meeting of the Trust Companies Association of Japan in Tokyo on April 15, 2013.

Haruhiko Kuroda, governor of the Bank of Japan (BOJ), attends the annual meeting of the Trust Companies Association of Japan in Tokyo on April 15, 2013. Photographer: Tomohiro Ohsumi/Bloomberg

13:21

March 27 (Bloomberg) -- Axel Weber, chairman of UBS AG, talks about the outlook for the company's wealth management business, capital controls in Cyprus and equity markets. He speaks with Francine Lacqua on Bloomberg Television's "On the Move." (Source: Bloomberg)

1:28:43

March 25 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke speaks about central bank monetary policies and global exchange rates. Bank of England Governor Mervyn King, UBS AG Chairman Axel Weber, former U.S. Treasury Secretary Lawrence Summers and International Monetary Fund chief economist Olivier Blanchard also speak at the London School of Economics. (Source: Bloomberg)

3:25

April 4 (Bloomberg) -- European Central Bank President Mario Draghi talks about the decision to leave the benchmark interest rate at 0.75 percent, the euro-zone economy and the financial crisis in Cyprus. Draghi, speaking in Frankfurt at his monthly news conference, also discusses inflation expectations. (Excerpts. Source: Bloomberg/European Central Bank)

The defense for activism is that monetary authorities need to protect their inflation goals from the possibility of Japan-style disinflation if governments don’t boost demand. The risk is they’re left doing the work of those governments -- or even financing them, creating precedents they may be pressured to extend or repeat in the future.
“Central banks have to be very careful in what they’re doing,” Axel Weber, chairman of UBS AG, told Bloomberg Television on March 27. “There is a challenge that their independence may be undermined simply because they’re getting closer to fiscal policy and politics.”
Weber resigned as president of the Bundesbank in 2011 partly because of his opposition to the ECB’s purchase of sovereign assets.

‘Unprecedented Intervention’

The role of central banks will be front and center in Washington this week when officials gather for the spring meetings of the International Monetary Fund. Maintaining independence is key to controlling inflation expectations, the IMF said April 9, and in an April 11 report, it urged authorities to remain vigilant to negative side effects from what it called their “unprecedented intervention.”
“Central banks are now doing something that if you asked 10 or 15 years ago whether they should, people would have said emphatically not,” said Alistair Darling, the U.K.’s chancellor of the exchequer from 2007 to 2010. “They are not targeting inflation any more, they are targeting growth.”
The shift has been accelerating since the outbreak of the global financial crisis in 2008 and marks a rejection of the rigid monetary orthodoxy that made low inflation a primary objective for central banks.

Greater Responsibility

In the U.K., Japan, euro-area countries including France and Spain, and at least among Democrats in the U.S., politicians are looking to central banks to take greater responsibility for the health of their economies because fiscal policy is constrained and dragging on expansions.
The Fed’s $85 billion in monthly bond buying is leaning against fiscal tightening. The U.S. Congressional Budget Office estimates that federal outlays will fall to 21.5 percent of gross domestic product by 2017 from 22.8 percent last year and 25.2 percent in 2009.
According to research by Tom Lam, chief economist at DMG & Partners Securities in Singapore, for every one percentage-point rise in the projected ratio between the U.S. budget deficit and gross domestic product, yields on U.S. 10-year notes rise 24 basis points. The yield was 1.68 percent at 5 p.m. on April 15 in New York, according to Bloomberg Bond Trader prices.
“It is politicians who abdicated their responsibility for dealing with a whole host of regulatory and fiscal issues that put central banks in this situation,” said Michael Hanson, senior U.S. economist at Bank of America Merrill Lynch in New York, and a former Fed staffer. They “have gone far beyond what most people thought their role was.”

Reduced Yield

The 1997 decision to hand the Bank of England independence may have reduced the extra yield investors demand for inflation risk by as much as 150 basis points as measured by long-dated breakeven rates, estimates Philip Rush, an economist at Nomura International Plc. in London. The U.K. 10-year breakeven rate, an index of inflation expectations, traded last week at thehighest level in more than 4 1/2 years.
Not all central banks have drifted from their mandates. The Bank of Canada maintained its focus on inflation throughout the crisis period and began raising interest rates in June 2010, saying it its actions were “consistent with achieving the 2 percent inflation target.”
The Reserve Bank of Australia cut its benchmark rate to a half-century low during the crisis, then raised it to a developed-world high of 4.75 percent in 2010 to contain inflation as the biggest resource-investment expansion in more than a century spurred hiring.

Cooperation Groundwork

Fed Chairman Ben S. Bernanke laid the groundwork for active fiscal-monetary cooperation in May 2003. In a speech on Japanese monetary policy, he said the government could cut taxes for households and businesses and the Bank of Japan could buy government debt, in effect financing the deficit. Or the Bank of Japan could buy government debt to finance “industrial restructuring.”
“It is important to recognize that the role of an independent central bank is different in inflationary and deflationary environments,” Bernanke said. In times of deflation, “a more cooperative stance on the part of the central bank may be called for.”
He didn’t describe in the speech how the central bank would re-establish its independence relative to the politically controlled fiscal authority once the crisis ended.

Possible Backlash

Now, central banks’ more explicit targeting of economic growth or segments of financial markets could produce a backlash. Legislatures could take a greater interest in monetary-policy decision making or ask central banks for even more direct support of industries or federal programs. Republicans in the U.S. have continuously championed an audit of U.S. monetary policy, making it a plank in their 2012 presidential platform.
Also, larger balance sheets take on interest-rate and credit risks that might reduce payments to taxpayers as central banks sell these assets when interest rates rise. They typically return profits they make on their portfolios to their national treasuries, supplementing government revenue.
Some members of the U.S. Federal Open Market Committee have been “concerned that a substantial decline in remittances might lead to an adverse public reaction or potentially undermine Federal Reserve credibility,” according to the minutes of the March 19-20 meeting released April 10.

Potential Hazard

The Bank of England in November said it would transfer about 35 billion pounds ($54 billion) in income to the Treasury from gilts it had bought. The potential hazard is a loss when interest rates gain, requiring money to flow in the opposite direction. A study by the U.K. central bank last month estimated the purchases could end up costing taxpayers 8 billion pounds.
Central banks also may obscure the cost of fiscal imbalances by keeping long-term interest rates low, reducing pressure on politicians to regain budgetary control. Even some Fed supporters in Congress lament the extremes monetary policy has taken because of the lack of better fiscal policy.
Political systems too often “just default to the central bank” because it becomes tough to make hard fiscal choices, Senator Mark Warner, a Virginia Democrat, said in an interview March 21. “At the end of the day, we should be making the hard choices, not the central bankers.”

Economic Ailments

Central bankers aren’t blind to the risks and regularly warn that monetary policy alone cannot fix economic ailments.
“I am not surprised by the questions that have arisen about our independence and, around the globe, about the governance arrangements around central banks,” Richmond Federal Reserve Bank President Jeffrey Lacker said in response to a question from Bloomberg News April 9. “The scale and scope of our intervention in 2008 went well beyond what people expected.”
Lacker opposes the Fed’s purchases of mortgage-backed securities because the program targets monetary policy toward a single industry.
Some central banks may find themselves with little option but to keep pulling the monetary levers or risk deeper economic pain. Not acting also could risk the credibility of banks including the Fed and Bank of Japan.
The Fed has an explicit mandate from Congress to achieve“maximum employment” as well as price stability. The jobless rate was 7.6 percent in March, above the 5.2 percent to 6 percent rate Fed officials estimate represents full use of labor resources.

‘Three Arrows’

The Japanese central bank is working closely with the government after Prime Minister Shinzo Abe won power in December, counting monetary stimulus with fiscal spending and deregulation as the “three arrows” aimed at reversing 15 years of falling prices.
Abe nominated Haruhiko Kuroda to replace Masaaki Shirakawa as governor, and the bank said on April 4 that it will double monthly bond purchases to 7.5 trillion yen ($78 billion) with the aim of doubling the country’s monetary base and achieving 2 percent inflation within two years. This will mean buying the equivalent of 70 percent of the government’s new bond issuances each month. Abe says changing the law governing the central bank is an option, signaling he could remove its freedom to set the policy target if it fails to revive the economy.
“The cooperation to conquer deflation between the government and the BOJ has never been stronger,” said Masamichi Adachi, senior economist at JPMorgan Chase & Co. in Tokyo and a former BOJ official. “The Japanese public are frustrated with the state of Japan’s economy. In that sense, the BOJ doesn’t have independence any more.”

Bundesbank Offshoot

The ECB, initially viewed by the euro’s founders as an offshoot of Germany’s proudly independent Bundesbank, also is fueling tension over how far it’s willing to help governments battle a debt crisis that has just taken Cyprus as its latest victim.
Having already bought government bonds to soothe markets, made unlimited long-term loans to banks and diluted the quality of acceptable collateral, President Mario Draghi last year crafted the Outright Monetary Transactions program, which allows the ECB to buy the bonds of nations that agree to austerity and to revamp their economies. He says doing so would help unblock bottlenecks that prevent the central bank’s easy-money stance from filtering equally through the 17-nation region.

Printing Money

As yet untapped, it has been opposed by Bundesbank President Jens Weidmann on the grounds that it’s tantamount to printing money to finance governments, which the ECB’s founding treaty prohibits. Underscoring German disdain, former ECB board member Juergen Stark, who quit in 2011 in protest at the first round of bond buying, dubs the strategy “Out of Mandate Transactions.”
“The ECB has made an amazing power grab on fiscal policy,” said Tim Duy, an economist at the University of Oregon in Eugene who writes a blog on monetary policy. “To what extent does this political intrusion prevent them from doing their job in the future?”
The independence dilemma may be greater for the ECB than its counterparts because “there is more incentive for an individual country to push risk on to the central bank, since that way it spreads the risk away from the country itself to the euro area as a whole,” said Huw Pill, chief European economist at Goldman Sachs Group Inc. and a former ECB official.

At Odds

Some politicians already want more. Spanish Prime MinisterMariano Rajoy last week called on the ECB to match the quantitative easing of the U.S. and Japan. French PresidentFrancois Hollande has leaned on the ECB to do more to weaken the euro.
The government and central bank of Cyprus also are at odds over whether to sell the nation’s gold. Bundesbank board member Andreas Dombret warned in today’s Handelsblatt newspaper against politicizing central banks by handing them sole responsibility in areas requiring democratic legitimacy such as financial market supervision.
The fiscal and monetary authorities of the U.K. also may be blurring lines amid the risk of a third recession since 2008. The central bank already has tolerated inflation above its 2 percent target every month since November 2009 and has 375 billion-pound quantitative-easing program.
The ties may nevertheless be getting stronger as the economy stays weak. Calling “monetary activism” a necessary part of the government’s economic strategy, Chancellor of the Exchequer George Osborne last month made the bank’s mission statement more flexible and told it to explore Fed-style policy guidance to enhance stimulus after Mark Carney becomes governor in July.
The Fed in December tied changes in its benchmark lending rate directly to economic indicators for employment and inflation for the first time.

‘Actively Considering’

Osborne also said government and central-bank officials are“actively considering” extending the Funding for Lending Scheme they united to start last year. The goal is to boost the provision of credit by lowering funding costs for financial companies.
“There does seem to be an element of politicization” in the programs, said Robert Wood, chief U.K. economist at Berenberg Bank in London and a former Bank of England official.“But for the moment it’s not pushing policy where it shouldn’t be because the economy does need stimulus.”
The upshot is that the world economy is in a period when central banks are willing to restrain the cost of servicing government and household debt for fear of derailing economies if they don’t, said Joachim Fels, co-global head of economics at Morgan Stanley in London.
“Central bank independence is history,” he said.

Bloomberg

Understanding IAS 29 per PricewaterhouseCoopers: Corrections 16: Financial statements prepared under IAS 29 can be very (even completely) unreliable and irrelevant depending on the level of hyperinflation

Understanding IAS 29 per PricewaterhouseCoopers: Corrections 16: Financial statements prepared under IAS 29 can be very (even completely) unreliable and irrelevant depending on the level of hyperinflation

‘Benefits of purchasing power adjusted financial statements

Financial statements that are expressed under IAS 29 in a measuring unit that is current at the balance sheet date provide several benefits:

• They enable management to make more reliable decisions on capital expenditure plans, as the financial statements are more relevant;’

PricewaterhouseCoopers Understanding IAS 29 2006 p4

Correction 16

Financial statements that are expressed under IAS 29 in a measuring unit that is current at the balance sheet date based on using the monthly published CPI result in the erosion/destruction of a part of the real value of current year profits. They thus impede management in making reliable decisions on capital expenditure plans, as the financial statements do not demonstrate this fact and are thus not fully relevant. They were completely irrelevant and completely unreliable during the 8 years that IAS 29 was implemented during hyperinflation in Zimbabwe. The Zimbabwe economy imploded on 20 November 2008 with full implementation of IAS 29. Thus beware of IAS 29 in terms of the monthly published CPI during hyperinflation.

Only implementing IAS 29 in terms of the Daily CPI will correctly result in capital maintenance in units of constant purchasing power (a departure from HCA) during hyperinflation. Brazil did that, without IAS 29, for 30 years from 1964 to 1994 with governments supplied daily indices based almost entirely on the US Dollar daily exchange rate with their currency.

Both PricewaterhouseCoopers and the IASB simply ignore what was so successfully done during 30 years of very high and hyperinflation of up to 2000 per cent per annum in Brazil because PwC and the IASB do not understand the concept of capital maintenance in units of constant purchasing power as authorized in IFRS in 1989. They blindly believe in the incorrect and misleading “restatement” model as they advise their clients incorrectly and misleadingly.

Nicolaas Smith

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

Daily indexation has three applications

Daily indexation has three applications

1.      The Daily CPI is used in the form of a 4, 3, 2 or 1 month lagged daily interpolated daily index based on the monthly CPI based on similar formulae used to price government capital inflation-indexed bonds on a daily basis in this USD 3.5 trillion global market. This is done in most countries in the world. Most countries in the world thus already publish a Daily CPI. The US uses the Daily Reference CPI-U.

2.      The  Daily CPI is being suggested to the IASB in IFRS ´X´ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER to be used to correctly implement Capital Maintenance in Units of Constant Purchasing Power as already authorized in IFRS in terms of a Daily CPI in the future replacement of IAS 29 Financial Reporting in Hyperinflationary Economies. This application is the use of the Daily CPI with capital maintenance in units of constant purchasing power to replace the stable measuring unit assumption, i.e., to replace (depart from) Historical Cost Accounting.

3.      Daily indices were used in the form of government supplied daily indices as “correcção monetaria” or monetary correction in mainly Latin American countries during generally very high and hyperinflationary periods from the 1960´s to 2010. Correcção monetary or monetary correction was stopped in Chile in 2010 in order to conform with IFRS which are almost 100 per cent Historical Cost Accounting based. The Brazilian Unidade Real de Valor (URV) was one of these very successful Daily Indices used in Latin America. Others are the currently used Unidad de Fomento in Chile and the currently used Real Value Unit in Colombia. The latter is used to index all mortgages in Colombia on a daily basis. Latin American countries did not see daily indexing as simply an accounting model (which it, in fact, is), but as monetary correction as they inflation-indexed some, not all, monetary items as well as all non-monetary items. This was done very successfully during 30 years in Brazil under different governments and with different daily indices without the implementation of IAS 29. This was not done during 14 years of hyperinflation in Zimbabwe with the last 8 years with full implementation of IAS 29 and the Zimbabwe economy imploded on 20 November 2008 - with full implementation of IAS 29. 

Nicolaas Smith

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

Understanding IAS 29 per PricewaterhouseCoopers: Corrections 14 and 15: Daily indexing is required

Understanding IAS 29 per PricewaterhouseCoopers: Corrections 14 and 15: Daily indexing is required

‘Benefits of purchasing power adjusted financial statements

Financial statements that are expressed under IAS 29 in a measuring unit that is current at the balance sheet date provide several benefits:

• They provide management, shareholders and other users with comparable information from period to period, relating to the underlying results of operations, capital maintenance and trends in performance;’

PricewaterhouseCoopers Understanding IAS 29 2006 p4

Correction 14

Under IAS 29 in terms of the monthly published CPI (the way PricewaterhouseCoopers advises its clients to implement IAS 29), a part of the real value of the underlying profit made during the current year is eroded/destroyed. IAS 29 in terms of the monthly CPI does not provide this information. IAS 29 in terms of the monthly CPI causes this to happen as PricewaterhouseCoopers advises its clients.

IAS 29 in terms of the Daily CPI maintains 100 per cent of the real value of trading profit made during the current year. PricewaterhouseCoopers does not advise clients to use the Daily CPI because PricewaterhouseCoopers does not understand that IAS 29 is not about making financial statements more meaning full via “restatement”, but about capital maintenance in units of constant purchasing power during hyperinflation as authorized in IFRS. PricewaterhouseCoopers does not understand the concept of capital maintenance in units of constant purchasing power as authorized in IFRS. PricewaterhouseCoopers still believes that the “restatement” of financial statements as it advises its clients to do will maintain the real value of capital constant.

Corrections 15

From Correction 14 it is clear that the real value of capital is not maintained under IAS 29 in terms of the monthly CPI. The way PricewaterhouseCoopers advises its clients to implement IAS 29 causes them to erode/destroy a part of the real value of their capital.

It is a very well-known fact that IAS 29 was implemented during the last eight years of hyperinflation in Zimbabwe with absolutely no positive effect: Zimbabwe´s economy imploded on 20 November 2008 with full implementation of IAS 29.

Brazil implemented daily indexation of all non-monetary and some monetary items during 30 years (1964 to 1994) of very high and hyperinflation in terms of a government supplied daily index almost entirely based on the daily US Dollar exchange rate. Daily indexation is not a new idea.

Nicolaas Smith

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