Capital is a constant real value non-monetary item.
However, there is no constant real value non-monetary item capital in South Africa under the Historical Cost Accounting model during low inflation.
Issued Share Capital and Share Premium Account values are, in fact, treated as variable items under HCA when a SA company owns revaluable fixed assets.
Issued Share Capital and Share Premium Account real values depend on the variable real non-monetary values of the fixed assets over time determined at fair value in terms of IFRS during low inflation.
When SA companies have no revaluable fixed assets under HCA, capital is, in principle, treated the same as a monetary item (money or cash) and SA accountants unknowingly destroy its real value at a rate equal to the rate of inflation because of their choice of the HCA model which include their very destructive stable measuring unit assumption in SA´s low inflationary environment.
Capital will only become a constant real value non-monetary item in the SA economy when SA accountants freely choose financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) twenty years ago. This is compliant with IFRS.
SA accountants are told that it is not them but inflation doing the destroying. That statement is dead wrong. Most people think it is inflation doing the destroying. The US FASB sums up this view very well in its statement: “ the erosive impact of inflation on profits and capital ".
Copyright © 2005-2010 Nicolaas J Smith
Sunday, 20 December 2009
Friday, 18 December 2009
Sticky salaries and wages
The constant real value non-monetary items salaries and wages are generally sticky downwards: it is not easy for firms to reduce them in nominal value.
It is, of course, very easy to reduce their real values during inflation: just keep them the same or increase them at a rate lower than the inflation rate.
It may happen that it could be some time before the concept of enhanced economic stability during deflation via financial capital maintenance in units of constant purchasing power is generally accepted.
Salaries and wages would then be automatically decreased in nominal value by means of measurement in units of constant purchasing power while their real values would stay the same during deflation. This would improve economic stability substantially and help central banks in their task of getting the economy into a low inflationary mode again. It would also reduce the level of the monetary effect of lower prices during deflation.
Salaries and wages are already being decreased in nominal value in the labour market during deflation, but, not yet by measuring them in units of constant purchasing power in terms of the negative change in the CPI.
There is a lot to be learned about how financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) as an alternative to the real value destroying traditional Historical Cost Accounting model would enhance general economic stability substantially during both low inflation and deflation. It would remove a great part of the distortion in the economy caused by SA accountants´ choice to implement their very destructive stable measuring unit assumption.
This is besides maintaining about R200 billion per annum in the SA constant item economy unnecessarily, unknowingly and unintentionally currently being destroyed by SA accountants´ choice of the stable measuring unit assumption during low inflation.
SA accountants mistakenly blame their unnecessary, unknowing and unintentional destruction of the real value of companies´ capital and profits on inflation since they do not value and account it the same way they do not value and account the net monetary gain or loss from holding monetary items during low inflation and deflation although this can be done according to Kapnick.
SA accountants can not stop the destruction of real value of monetary items in the SA monetary economy. The SARB with its monetary policy and the government with its economic policies have to reduce inflation which would reduce the amount of real value destruction in the monetary economy. The late Milton Friedman so famously stated "Inflation is always and everywhere a monetary phenomenon." Inflation can only destroy the real value of the Rand and other monetary items in the SA monetary economy - nothing else. Inflation has no effect on the real value of non-monetary items
“Purchasing power of non monetary items does not change in spite of variation in national currency value.”
Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
SA accountants can easily stop their about R200 billion annual destruction of the profits and capital of SA banks and companies and its negative effect on economic growth and employment during low inflation.
When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as the IASB authorized them 20 years ago, they would value and account the cost of inflation during low inflation as they are already required (forced) to do during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. They would also maintain about R200 billion in SA banks´ and companies´ existing profits and capital by not unknowingly destroying that amount each and every year as they are unknowingly doing right now in existing reported constant items, e.g. all reported Retained Profits in all SA banks and companies, never maintained in the SA non-monetary or real economy with their very destructive stable measuring unit assumption during low inflation. This would have a positive impact on economic growth and employment for an unlimited period of time.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
It is, of course, very easy to reduce their real values during inflation: just keep them the same or increase them at a rate lower than the inflation rate.
It may happen that it could be some time before the concept of enhanced economic stability during deflation via financial capital maintenance in units of constant purchasing power is generally accepted.
Salaries and wages would then be automatically decreased in nominal value by means of measurement in units of constant purchasing power while their real values would stay the same during deflation. This would improve economic stability substantially and help central banks in their task of getting the economy into a low inflationary mode again. It would also reduce the level of the monetary effect of lower prices during deflation.
Salaries and wages are already being decreased in nominal value in the labour market during deflation, but, not yet by measuring them in units of constant purchasing power in terms of the negative change in the CPI.
There is a lot to be learned about how financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) as an alternative to the real value destroying traditional Historical Cost Accounting model would enhance general economic stability substantially during both low inflation and deflation. It would remove a great part of the distortion in the economy caused by SA accountants´ choice to implement their very destructive stable measuring unit assumption.
This is besides maintaining about R200 billion per annum in the SA constant item economy unnecessarily, unknowingly and unintentionally currently being destroyed by SA accountants´ choice of the stable measuring unit assumption during low inflation.
SA accountants mistakenly blame their unnecessary, unknowing and unintentional destruction of the real value of companies´ capital and profits on inflation since they do not value and account it the same way they do not value and account the net monetary gain or loss from holding monetary items during low inflation and deflation although this can be done according to Kapnick.
SA accountants can not stop the destruction of real value of monetary items in the SA monetary economy. The SARB with its monetary policy and the government with its economic policies have to reduce inflation which would reduce the amount of real value destruction in the monetary economy. The late Milton Friedman so famously stated "Inflation is always and everywhere a monetary phenomenon." Inflation can only destroy the real value of the Rand and other monetary items in the SA monetary economy - nothing else. Inflation has no effect on the real value of non-monetary items
“Purchasing power of non monetary items does not change in spite of variation in national currency value.”
Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
SA accountants can easily stop their about R200 billion annual destruction of the profits and capital of SA banks and companies and its negative effect on economic growth and employment during low inflation.
When SA accountants freely choose to measure financial capital maintenance in units of constant purchasing power as the IASB authorized them 20 years ago, they would value and account the cost of inflation during low inflation as they are already required (forced) to do during hyperinflation in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. They would also maintain about R200 billion in SA banks´ and companies´ existing profits and capital by not unknowingly destroying that amount each and every year as they are unknowingly doing right now in existing reported constant items, e.g. all reported Retained Profits in all SA banks and companies, never maintained in the SA non-monetary or real economy with their very destructive stable measuring unit assumption during low inflation. This would have a positive impact on economic growth and employment for an unlimited period of time.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Tuesday, 15 December 2009
IASB got it wrong: there are 3 not just 2
"One can say that capital, as a category, did not exist before double-entry bookkeeping". Werner Sombart
Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.”
Monetary items are money held and items with an underlying monetary nature.
Non-monetary items are all items that are not monetary items.
Non-monetary items are subdivided in
a) Variable real value non-monetary items and
b) Constant real value non-monetary items.
Constant items are non-monetary items with constant real non-monetary values measured in units of constant purchasing power in terms of the CPI over time normally expressed in terms of money in a non-hyperinflationary economy.
Hyperinflation is defined as an exceptional circumstance by the IASB and all non-monetary items – variable and constant items - are required to be valued in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies.
IAS 29 defines monetary items incorrectly as “money held and items to be received or paid in money”. Most items, monetary and non-monetary items are generally received or paid in money as the 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 non-monetary items, notably trade debtors and trade creditors, as monetary items by the Board. This results in the net monetary gain or loss being calculated incorrectly by companies implementing IAS 29 in hyperinflationary economies.
The above definition of non-monetary items describes them generically. It is thus defined 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 economy and the non-monetary or real economy. IAS 29 and other IFRS are based on this premise.
It is not true that there are only two basic economic items as defined by the IASB. There are three fundamentally different basic economic items in the economy:
1. Monetary items
2. Variable items
3. Constant items
The above definition of constant items is confirmed by the IASB in the Framework by implication. The fact that certain non-monetary items have constant real non-monetary values is implied by the IASB in the Framework for the Preparation and Presentation of Financial Statements.
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8." Deloitte, IAS Plus
IAS 8.11
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There are no applicable IFRS or Interpretations regarding the capital concept, the capital maintenance concept and the valuation of constant items. The explicit and implied definitions of these items in the Framework are thus applicable.
The Framework, Par. 102 states that most companies choose a financial concept of capital to prepare their financial reports. An entity’s capital is the same as its shareholders´ equity or net assets when it adopts a financial concept of capital, for example, invested purchasing power or invested money.
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) states:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
Constant items are non-monetary items with constant purchasing power non-monetary values measured in units of constant purchasing power in terms of the CPI over time normally expressed in terms of money in a non-hyperinflationary economy.
Kindest regards,
Nicolaas Smith
Professor William Paton noted in 1922, "the value of the dollar — its general purchasing power — is subject to serious change over a period of years... Accountants... deal with an unstable, variable unit; and comparisons of unadjusted accounting statements prepared at intervals are accordingly always more or less unsatisfactory and are often positively misleading.”
Monetary items are money held and items with an underlying monetary nature.
Non-monetary items are all items that are not monetary items.
Non-monetary items are subdivided in
a) Variable real value non-monetary items and
b) Constant real value non-monetary items.
Constant items are non-monetary items with constant real non-monetary values measured in units of constant purchasing power in terms of the CPI over time normally expressed in terms of money in a non-hyperinflationary economy.
Hyperinflation is defined as an exceptional circumstance by the IASB and all non-monetary items – variable and constant items - are required to be valued in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies.
IAS 29 defines monetary items incorrectly as “money held and items to be received or paid in money”. Most items, monetary and non-monetary items are generally received or paid in money as the 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 non-monetary items, notably trade debtors and trade creditors, as monetary items by the Board. This results in the net monetary gain or loss being calculated incorrectly by companies implementing IAS 29 in hyperinflationary economies.
The above definition of non-monetary items describes them generically. It is thus defined 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 economy and the non-monetary or real economy. IAS 29 and other IFRS are based on this premise.
It is not true that there are only two basic economic items as defined by the IASB. There are three fundamentally different basic economic items in the economy:
1. Monetary items
2. Variable items
3. Constant items
The above definition of constant items is confirmed by the IASB in the Framework by implication. The fact that certain non-monetary items have constant real non-monetary values is implied by the IASB in the Framework for the Preparation and Presentation of Financial Statements.
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8." Deloitte, IAS Plus
IAS 8.11
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There are no applicable IFRS or Interpretations regarding the capital concept, the capital maintenance concept and the valuation of constant items. The explicit and implied definitions of these items in the Framework are thus applicable.
The Framework, Par. 102 states that most companies choose a financial concept of capital to prepare their financial reports. An entity’s capital is the same as its shareholders´ equity or net assets when it adopts a financial concept of capital, for example, invested purchasing power or invested money.
Par. 103 states that the needs of financial report users should determine the choice of the correct concept of capital by a company. If the users of financial reports are mainly concerned with the maintenance of nominal invested capital or the maintenance of the purchasing power of invested capital then a financial concept of capital should be chosen.
Par. 104 states that the concepts of capital stated in Par. 102 give origin to the financial capital maintenance concept. Par. 104 (a) states:
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
Constant items are non-monetary items with constant purchasing power non-monetary values measured in units of constant purchasing power in terms of the CPI over time normally expressed in terms of money in a non-hyperinflationary economy.
Kindest regards,
Nicolaas Smith
Saturday, 12 December 2009
SA´s second economic enemy
There are two processes of systemic real value destruction in the SA economy, although it is generally accepted that there is only one economic enemy. This is a mistake. The first process is by the well known enemy inflation. This economic enemy manifests itself in the Rand´s store of value function and only destroys real value in the SA monetary economy. Inflation can only destroy the real value of the Rand and other monetary items in the SA monetary economy - nothing else. Inflation has no effect on the real value of non-monetary items.
The second economic enemy is SA accountants´ choice of traditional HCA which includes their very destructive stable measuring unit assumption. This second process of systemic real value destruction manifests itself in accountants´ stable measuring unit assumption only in the constant item part of the SA non-monetary or real economy when they freely choose to measure financial capital maintenance in nominal monetary units when they implement the traditional HCA model in most SA companies during low inflation.
Accountants (and everyone else) make the mistake of blaming the destruction of companies´ profits and capital by their choice of traditional HCA - which includes the stable measuring unit assumption - on inflation.
Accountants identify the problem, namely, that the real value of companies´ profits and capital are being destroyed over time during inflation when implementing HCA. They blame inflation.
The US Financial Accounting Standards Board blames inflation:
“In Mr. Mosso's view, conventional accounting measurements fail to capture the erosion of business profits and invested capital caused by inflation.”
Statement of Financial Accounting Standard No. 33, P. 24
They blame the wrong enemy. They blame inflation when it is in fact their free choice of traditional HCA; specifically the stable measuring unit assumption. When they freely choose financial capital maintenance in units of constant purchasing power, as the IASB authorized them 20 years ago, they would stop their unknowing and unintentional destruction forever. It is thus completely unnecessary and easily avoidable destruction by SA accountants´ choice of traditional HCA of the investment base and long term capital of SA banks and companies and their corollaries: sustainable economic growth and employment.
Everyone only sees one enemy in the economy being responsible for all of the invisible and untouchable systemic real value destruction in the economy. They think inflation is responsible for all real value destruction in the economy.
SA accountant feel that the SARB with its monetary policies and the SA government with its economic policies should lower inflation which would lower the destruction of companies´ profits and capital.
They are under inflation illusion: the mistaken belief that inflation destroys companies´ profits and capital when it is accountants´ choice of HCA - which includes the stable measuring unit assumption.
This second enemy is a stealth enemy since the way it operates is not understood by SA accountants and accounting lecturers at SA universities. If they understood it, they would have stopped it by now as they have been authorized by the IASB in the Framework, Par. 104 (a) in 1989.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
The second economic enemy is SA accountants´ choice of traditional HCA which includes their very destructive stable measuring unit assumption. This second process of systemic real value destruction manifests itself in accountants´ stable measuring unit assumption only in the constant item part of the SA non-monetary or real economy when they freely choose to measure financial capital maintenance in nominal monetary units when they implement the traditional HCA model in most SA companies during low inflation.
Accountants (and everyone else) make the mistake of blaming the destruction of companies´ profits and capital by their choice of traditional HCA - which includes the stable measuring unit assumption - on inflation.
Accountants identify the problem, namely, that the real value of companies´ profits and capital are being destroyed over time during inflation when implementing HCA. They blame inflation.
The US Financial Accounting Standards Board blames inflation:
“In Mr. Mosso's view, conventional accounting measurements fail to capture the erosion of business profits and invested capital caused by inflation.”
Statement of Financial Accounting Standard No. 33, P. 24
They blame the wrong enemy. They blame inflation when it is in fact their free choice of traditional HCA; specifically the stable measuring unit assumption. When they freely choose financial capital maintenance in units of constant purchasing power, as the IASB authorized them 20 years ago, they would stop their unknowing and unintentional destruction forever. It is thus completely unnecessary and easily avoidable destruction by SA accountants´ choice of traditional HCA of the investment base and long term capital of SA banks and companies and their corollaries: sustainable economic growth and employment.
Everyone only sees one enemy in the economy being responsible for all of the invisible and untouchable systemic real value destruction in the economy. They think inflation is responsible for all real value destruction in the economy.
SA accountant feel that the SARB with its monetary policies and the SA government with its economic policies should lower inflation which would lower the destruction of companies´ profits and capital.
They are under inflation illusion: the mistaken belief that inflation destroys companies´ profits and capital when it is accountants´ choice of HCA - which includes the stable measuring unit assumption.
This second enemy is a stealth enemy since the way it operates is not understood by SA accountants and accounting lecturers at SA universities. If they understood it, they would have stopped it by now as they have been authorized by the IASB in the Framework, Par. 104 (a) in 1989.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Friday, 11 December 2009
SA accountants blame inflation but admit it´s the stable measuring unit assumption
SA accountants unknowingly destroy the real value of reported Retained Profits in companies over time during low inflation implementing their very destructive stable measuring unit assumption as part of the real value destroying traditional HCA model in exactly the same way as the real value of your salary is destroyed over time during low inflation when your salary is measured in nominal monetary units, i.e. when it is not updated during low inflation.
The real value of your salary is also not destroyed by inflation because inflation can not destroy the real value of any non-monetary item and never has in the past. Your salary is a non-monetary item as defined by the IASB in IAS 29 where it is stated that all income statement items are non-monetary items, in fact, they are all constant real value non-monetary items. Inflation can only destroy the real value of money and other monetary items - nothing else.
It is SA accountants´ choice of measuring unit that destroys the real value of your salary when your salary is measured in nominal monetary units (actually SA accountants´ stable measuring unit assumption) because your salary can be measured in units of constant purchasing power, i.e. it can be inflation-adjusted. Then it will not matter what the rate of inflation is, the real value of your salary will always be maintained: 2% or 2000% like in the case of Brazil which during 30 years of hyperinflation of up to 2000% inflation per annum maintained their real or non-monetary economy stable with indexation (which is, in principle, the same as valuation in units of constant purchasing power) while they had up to 2000% annual inflation in their monetary economy.
It is exactly the same with reported Retained Profits.
SA accountants unnecessarily, unknowingly and unintentionally destroy the real value of all existing reported Retained Profits never maintained in all SA companies, currently at 5.9% per annum, with their very destructive stable measuring unit assumption - all else being equal. They can freely stop their continuous destruction of SA companies´ long term capital and investment base with its negative impact on economic growth and employment, by freely choosing to measure financial capital maintenance in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a). SA accountants unknowingly destroy about R200 billion per annum in SA companies´ existing reported constant items never maintained in this manner.
SA accountants blame this on inflation.
SA accountants are very strongly under inflation illusion.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
The real value of your salary is also not destroyed by inflation because inflation can not destroy the real value of any non-monetary item and never has in the past. Your salary is a non-monetary item as defined by the IASB in IAS 29 where it is stated that all income statement items are non-monetary items, in fact, they are all constant real value non-monetary items. Inflation can only destroy the real value of money and other monetary items - nothing else.
It is SA accountants´ choice of measuring unit that destroys the real value of your salary when your salary is measured in nominal monetary units (actually SA accountants´ stable measuring unit assumption) because your salary can be measured in units of constant purchasing power, i.e. it can be inflation-adjusted. Then it will not matter what the rate of inflation is, the real value of your salary will always be maintained: 2% or 2000% like in the case of Brazil which during 30 years of hyperinflation of up to 2000% inflation per annum maintained their real or non-monetary economy stable with indexation (which is, in principle, the same as valuation in units of constant purchasing power) while they had up to 2000% annual inflation in their monetary economy.
It is exactly the same with reported Retained Profits.
SA accountants unnecessarily, unknowingly and unintentionally destroy the real value of all existing reported Retained Profits never maintained in all SA companies, currently at 5.9% per annum, with their very destructive stable measuring unit assumption - all else being equal. They can freely stop their continuous destruction of SA companies´ long term capital and investment base with its negative impact on economic growth and employment, by freely choosing to measure financial capital maintenance in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a). SA accountants unknowingly destroy about R200 billion per annum in SA companies´ existing reported constant items never maintained in this manner.
SA accountants blame this on inflation.
SA accountants are very strongly under inflation illusion.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Wednesday, 9 December 2009
Inflation illusion
Most accountants agree that "inflation influences reported results". Everybody blames "inflation". Yes, inflation destroys the real value of money and other monetary items - but, nothing else. Inflation has no effect on the real value of non-monetary items.
“Purchasing power of non monetary items does not change in spite of variation in national currency value.”
Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
Because the net montary gain or loss from holding monetary items is not accounted under HCA, the monetary item cost of inflation is not accounted in low inflationary economies. Everybody, and I mean everybody: IASB, FASB, all accountants, all economists, etc, they all think it is "inflation" "eroding" companies´ capital, as they say. They never say destroy when erode and destroy are exactly the same thing in this case.
However, it is simply accountants with their free choice of the stable measuring unit assumption who are unknowingly and unintentionally destroying the real value of existing reported constant items never maintained, e.g. reported Retained Profits, during low inflation. No-one forces them into HCA. Because "they simply do not record it" they think the "erosion" of the real value of companies´ profits and captial is also done by "inflation" and this cost or destruction of real value is also "not recorded". So, they are all very blasé about the situation: Gill Marcus and the ANC control inflation according to them.
The central bank with its monetary policy and the government with its economic policies have to bring down inflation and lower the "erosion" of companies´ profits and capital caused by "inflation". Everybody thinks it has absolutely nothing to do with accountants, accounting standard setters and the 700 year old traditional Historical Cost Accounting model.
Meanwhile, the IASB has actually already approved the Framework, Par. 104 (a) twenty years ago stating "Financial capital maintenance can be measured in either nominal monetary units (HCA as the whole world does) or units of constant purchasing power". The units of constant purchasing power option would stop this completely unnecessary and unknowing destruction of real value in existing reported constant items never maintained by SA accountants forever.
Why don´t they do it? It´s been there for 20 years! They are highly educated and very experienced accountants, aren´t they?
Accountants were prisoners of Generally Accepted Accounting Practice till 1989. The IASB set them free from HCA with Par. 104 (a) 20 years ago. Most of them don´t know that. Since they think the rate of inflation equivalent destruction of the real value of companies´ existing reported retained profits and capital, not backed by sufficient revaluable fixed assets, is inflation´s fault, they do not look for a solution in IFRS. They do not know there is an IFRS solution for a national economic problem they do not even know they cause directly. They do not know their choice of HCA is the cause of the problem. They do not even know they make a choice. They think there is no choice - like under GAAP. They can freely change to the IFRS compliant IASB approved option of measuring financial capital maintenance in units of contstant purchasing power during low inflation and deflation any time they want. No-one stops them.
They think it is "inflation" doing the destroying and they state: it is not recorded just like the destruction of the real value of the Rand and other monetary items - the actual and only harm done by inflation - is not recorded under HCA, although it can be done according to Harvey Kapnick, a past president of Arthur Anderson.
I call this inflation illusion: the mistaken belief that inflation destroys companies´ profits and capital when it is accountants´ choice of HCA which includes the stable measuring unit assumption.
It is clear that when you have R40 billion in existing reported Retained Profits, then R2.4 billion of its real value would be destroyed during a year when Retained Profits are valued in nominal monetary units and inflation destroys 6% of the real value of the Rand, the monetary unit of account in SA. Everyone will also agree that when accountants freely choose to measure financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, in Par. 104 (a) in 1989, then the real value of that R40 billion at the beginning of the year (stated in beginning of the year CPI value) would be R42.4 billion at the end of the year CPI value. When it is not done which is the current situation in SA, then those accountants are unnecessarily destroying R2.4 billion of the real value of the R40 billion - as all accountants in SA are doing right now in companies with existing reported Retained Profits in their companies. No-one can deny that.
It is not a matter of extra money to maintain capital: it is a capital maintenance concept in a double entry accounting model: it is a matter of measuring financial capital maintenance in units of constant purchasing power by implementing a double entry accounting model in all the company´s assets, liabilities, income and expenses in a low inflationary environment - as approved by the IASB 20 years ago and compliant with IFRS.
So, it is not inflation doing the destroying. It is SA accountants freely choosing to measure financial capital maintenance in nominal monetary units in terms of the IASB´s Framework, Par. 104 (a) whereby they implement the traditional HCA model which includes their very destructive stable measuring unit assumption. They simply assume that the destruction of the real value of the Rand below 26% per annum for 3 years in a row is not sufficiently important for them to change to measuring financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g. salaries, wages, rentals, etc during inflation below 26% per annum for 3 years in a row.
When inflation increases to 26% per annum for 3 years in a row and above, they immediately change their minds: then they would inflation-adjust not only constant items but also variable items. They would inflation-adjust all non-monetary items as required by IAS29.
But, only as long as annual inflation stays above 26% for three years in a row. When inflation drops below 26% per annum for 3 years in a row, they will again refuse to inflation-adjust capital and retained profits: they will happily go back and unknowingly destroy those real values at, say 20% per annum - as they are doing now at 5.9% and as they were doing not so long ago at 13% annual inflation in SA.
Strange, isn´t it? Well, SA accountants unnecessarily, unknowingly and unintentionally destroy about R200 billion per annum in real value in the long term capital and investment base and its corollaries, economic growth and employment, in SA companies each and every year - all else being equal. They will carry on with their annual unknowing destruction as long as they refuse to abandon their very destructive stable measuring unit assumption while SA experiences low inflation up to 26% per annum for 3 years in a row.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
“Purchasing power of non monetary items does not change in spite of variation in national currency value.”
Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
Because the net montary gain or loss from holding monetary items is not accounted under HCA, the monetary item cost of inflation is not accounted in low inflationary economies. Everybody, and I mean everybody: IASB, FASB, all accountants, all economists, etc, they all think it is "inflation" "eroding" companies´ capital, as they say. They never say destroy when erode and destroy are exactly the same thing in this case.
However, it is simply accountants with their free choice of the stable measuring unit assumption who are unknowingly and unintentionally destroying the real value of existing reported constant items never maintained, e.g. reported Retained Profits, during low inflation. No-one forces them into HCA. Because "they simply do not record it" they think the "erosion" of the real value of companies´ profits and captial is also done by "inflation" and this cost or destruction of real value is also "not recorded". So, they are all very blasé about the situation: Gill Marcus and the ANC control inflation according to them.
The central bank with its monetary policy and the government with its economic policies have to bring down inflation and lower the "erosion" of companies´ profits and capital caused by "inflation". Everybody thinks it has absolutely nothing to do with accountants, accounting standard setters and the 700 year old traditional Historical Cost Accounting model.
Meanwhile, the IASB has actually already approved the Framework, Par. 104 (a) twenty years ago stating "Financial capital maintenance can be measured in either nominal monetary units (HCA as the whole world does) or units of constant purchasing power". The units of constant purchasing power option would stop this completely unnecessary and unknowing destruction of real value in existing reported constant items never maintained by SA accountants forever.
Why don´t they do it? It´s been there for 20 years! They are highly educated and very experienced accountants, aren´t they?
Accountants were prisoners of Generally Accepted Accounting Practice till 1989. The IASB set them free from HCA with Par. 104 (a) 20 years ago. Most of them don´t know that. Since they think the rate of inflation equivalent destruction of the real value of companies´ existing reported retained profits and capital, not backed by sufficient revaluable fixed assets, is inflation´s fault, they do not look for a solution in IFRS. They do not know there is an IFRS solution for a national economic problem they do not even know they cause directly. They do not know their choice of HCA is the cause of the problem. They do not even know they make a choice. They think there is no choice - like under GAAP. They can freely change to the IFRS compliant IASB approved option of measuring financial capital maintenance in units of contstant purchasing power during low inflation and deflation any time they want. No-one stops them.
They think it is "inflation" doing the destroying and they state: it is not recorded just like the destruction of the real value of the Rand and other monetary items - the actual and only harm done by inflation - is not recorded under HCA, although it can be done according to Harvey Kapnick, a past president of Arthur Anderson.
I call this inflation illusion: the mistaken belief that inflation destroys companies´ profits and capital when it is accountants´ choice of HCA which includes the stable measuring unit assumption.
It is clear that when you have R40 billion in existing reported Retained Profits, then R2.4 billion of its real value would be destroyed during a year when Retained Profits are valued in nominal monetary units and inflation destroys 6% of the real value of the Rand, the monetary unit of account in SA. Everyone will also agree that when accountants freely choose to measure financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework, in Par. 104 (a) in 1989, then the real value of that R40 billion at the beginning of the year (stated in beginning of the year CPI value) would be R42.4 billion at the end of the year CPI value. When it is not done which is the current situation in SA, then those accountants are unnecessarily destroying R2.4 billion of the real value of the R40 billion - as all accountants in SA are doing right now in companies with existing reported Retained Profits in their companies. No-one can deny that.
It is not a matter of extra money to maintain capital: it is a capital maintenance concept in a double entry accounting model: it is a matter of measuring financial capital maintenance in units of constant purchasing power by implementing a double entry accounting model in all the company´s assets, liabilities, income and expenses in a low inflationary environment - as approved by the IASB 20 years ago and compliant with IFRS.
So, it is not inflation doing the destroying. It is SA accountants freely choosing to measure financial capital maintenance in nominal monetary units in terms of the IASB´s Framework, Par. 104 (a) whereby they implement the traditional HCA model which includes their very destructive stable measuring unit assumption. They simply assume that the destruction of the real value of the Rand below 26% per annum for 3 years in a row is not sufficiently important for them to change to measuring financial capital maintenance in units of constant purchasing power. They only inflation-adjust some income statement items, e.g. salaries, wages, rentals, etc during inflation below 26% per annum for 3 years in a row.
When inflation increases to 26% per annum for 3 years in a row and above, they immediately change their minds: then they would inflation-adjust not only constant items but also variable items. They would inflation-adjust all non-monetary items as required by IAS29.
But, only as long as annual inflation stays above 26% for three years in a row. When inflation drops below 26% per annum for 3 years in a row, they will again refuse to inflation-adjust capital and retained profits: they will happily go back and unknowingly destroy those real values at, say 20% per annum - as they are doing now at 5.9% and as they were doing not so long ago at 13% annual inflation in SA.
Strange, isn´t it? Well, SA accountants unnecessarily, unknowingly and unintentionally destroy about R200 billion per annum in real value in the long term capital and investment base and its corollaries, economic growth and employment, in SA companies each and every year - all else being equal. They will carry on with their annual unknowing destruction as long as they refuse to abandon their very destructive stable measuring unit assumption while SA experiences low inflation up to 26% per annum for 3 years in a row.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
Tuesday, 8 December 2009
The IASB and FASB still get this wrong - but not street vendors.
Money cannot be declared by statute or by institutional definition to be a non-monetary item. Money is either money or it is not money. To be money it has to fulfil the three functions of money in an economy: medium of exchange, store of value and unit of account.
This applies to non-monetary items too. Trade debtors and trade creditors are defined incorrectly by the International Accounting Standards Board and US Financial Accounting Standards Board to be monetary items. They are generally non-monetary items. Defining them as monetary items means the net monetary gain or loss in companies with trade debtors and trade creditors will always be calculated incorrectly under the IASB and FASB definition.
They are generally non-monetary items. All street vendors in hyperinflationary economies know that trade debtors and trade creditors (or their equivalents) are non-monetary items by experience, even if they have never been to school.
The IASB and FASB still get this wrong.
Who else got it right? Brazil got it right for 30 years from 1964 to 1994 as confirmed by the previous head of the Central Bank of Brazil, Dr Gustavo Franco:
When I asked him: "Were trade debtors and trade creditors treated as monetary items under the URV and not updated or were they treated as non-monetary items an updated in terms of the Unidade Real de Valor? What are trade debtors and trade creditors in your opinion? Are they monetary or non-monetary items?"
He responded: "Dear Mr. Smith
I am not sure I understood your question. If I got it right, two observations are in order. First, for spot transactions the existence of the URV is imaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enteres the picture only when at least one leg of a commercial transaction is defferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs are to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.
It was essentil, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denomiated obligation had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetized.
Att
GF"
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
This applies to non-monetary items too. Trade debtors and trade creditors are defined incorrectly by the International Accounting Standards Board and US Financial Accounting Standards Board to be monetary items. They are generally non-monetary items. Defining them as monetary items means the net monetary gain or loss in companies with trade debtors and trade creditors will always be calculated incorrectly under the IASB and FASB definition.
They are generally non-monetary items. All street vendors in hyperinflationary economies know that trade debtors and trade creditors (or their equivalents) are non-monetary items by experience, even if they have never been to school.
The IASB and FASB still get this wrong.
Who else got it right? Brazil got it right for 30 years from 1964 to 1994 as confirmed by the previous head of the Central Bank of Brazil, Dr Gustavo Franco:
When I asked him: "Were trade debtors and trade creditors treated as monetary items under the URV and not updated or were they treated as non-monetary items an updated in terms of the Unidade Real de Valor? What are trade debtors and trade creditors in your opinion? Are they monetary or non-monetary items?"
He responded: "Dear Mr. Smith
I am not sure I understood your question. If I got it right, two observations are in order. First, for spot transactions the existence of the URV is imaterial, sums of means of payment are surrendered in exchange for goods, all delivered and liquidated on spot. Second, the unit of account enteres the picture only when at least one leg of a commercial transaction is defferred. In this case, the URV serves the purpose of defining the price at the day of the contract. The same quantity of URVs are to be paid at the payment day, though this should represent larger quantities of whatever means of payment is used.
It was essentil, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denomiated obligation had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetized.
Att
GF"
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
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