Price-level accounting
SA accountants generally choose to measure financial capital maintenance in nominal monetary units (one of the three very popular accounting fallacies not yet extinct) and thus apply their very destructive stable measuring unit assumption (another of the three accounting fallacies) as part of the traditional HCA model based on these fallacies. They generally value balance sheet constant items as well as most income statement items – which are all constant items - at Historical Cost because they value them in nominal monetary units as a result of the fact that they assume the Rand is perfectly stable for this purpose. They only value certain income statement items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and inflation-adjust them by means of the annual CPI during low inflation.
Complete price-level accounting
Complete price-level accounting also called Constant Purchasing Power Accounting (CPPA) was developed as an inflation accounting model whereby all non-monetary items – variable and constant items – are inflation-adjusted by means of the period-end CPI in order to make financial statements more comparable with previous year statements during periods of high and hyperinflation. The non-monetary or real economy of a hyperinflationary economy can only be maintained stable by applying the daily parallel US Dollar exchange rate to the valuation of all non-monetary items instead of the period-end CPI as required by IAS 29.
The Framework is applicable
The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non-hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Framework, Par 102 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11. The valuation of the constant items Issued Share capital, reported retained earnings, other items in Shareholders´ Equity and other constant items is thus covered in the IASB´s Framework, Par 104 (a) which states “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” authorized in 1989.
Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:
“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price-level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”
Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.
Kindest regards,
Nicolaas Smith
© Copyright 2010 Nicolaas J Smith
Friday, 29 January 2010
Wednesday, 27 January 2010
Value accounting prevails for monetary and variable items
The accounting model SA accountants choose determines whether they unknowingly destroy massive amounts annually in the real value of reported constant items never maintained or knowingly would maintain massive amounts of real value every year in reported constant items in the constant item economy depending on whether they choose the IASB-approved traditional HCA model when they apply the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation or IASB-approved financial capital maintenance in units of constant purchasing power during inflationary and deflationary periods – both models amazingly approved in the Framework, Par 104 (a) in 1989. It is not inflation doing the destroying in reported constant real value non-monetary items never maintained, e.g. in companies´ capital and profits, as the IASB, the FASB and most accountants believe. SA accountants are unnecessarily, unknowingly and unintentionally doing the destroying when they implement the stable measuring unit assumption during indefinite inflation. Inflation has no effect on the real value of non-monetary items.
Value accounting
There is, on the other hand, also strong awareness in the accounting profession that accounting is really about value and not simply about Historical Cost.
"...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions”
Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.
Most SA accountants agree that accounting should be value based. By value based they mean that variable real value non-monetary items can not always be valued at Historical Cost and are to be valued in terms of specific standards formulated in IFRS or SA GAAP at, for example, market value, net realizable value, fair value, present value or recoverable value, etc.
Value accounting has been specifically defined in International Standards since 1976 via IAS and IFRS relating to variable items. Value accounting thus prevails in the valuation and accounting of variable items in terms of IAS and IFRS.
Value accounting also prevails as far as the accounting and valuing of monetary items during the current accounting period are concerned. Monetary items are measured in nominal monetary units no matter which accounting model is used. The real values of monetary items are kept always current by inflation and deflation since the nominal values of monetary items are normally not updated or inflation-adjusted during the current accounting period in any inflationary or deflationary economy. The real value of money and other monetary items generally changes monthly during inflation and deflation. It is destroyed during inflation and increased during deflation.
The nominal values of monetary items stay the same during the current financial period under any accounting model, but, their real values are automatically adjusted by inflation and deflation. The real value of money and other monetary items can be halved every 24.7 hours as has happened recently during hyperinflation in Zimbabwe. According to Prof Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.
The net monetary loss or net monetary gain resulting from holding an excess of either monetary item assets or monetary item liabilities is currently only calculated and accounted during the implementation of Constant Purchasing Power inflation accounting as defined in IAS 29 in hyperinflationary economies. Net monetary gains and losses would also be calculated and accounted during low inflation and deflation when companies start measuring financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a). They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick. See Saxe Lecture, 1976.
Copyright (c) 2005-2010 Nicolaas J Smith
Value accounting
There is, on the other hand, also strong awareness in the accounting profession that accounting is really about value and not simply about Historical Cost.
"...it is really values that are the basic data of accounting, and costs are important only because they are the most dependable measures of initial values of goods and services flowing into the enterprise through ordinary market transactions”
Paton W. A., "Accounting Procedures and Private Enterprise", The Journal of Accountancy, April 1948, p.288.
Most SA accountants agree that accounting should be value based. By value based they mean that variable real value non-monetary items can not always be valued at Historical Cost and are to be valued in terms of specific standards formulated in IFRS or SA GAAP at, for example, market value, net realizable value, fair value, present value or recoverable value, etc.
Value accounting has been specifically defined in International Standards since 1976 via IAS and IFRS relating to variable items. Value accounting thus prevails in the valuation and accounting of variable items in terms of IAS and IFRS.
Value accounting also prevails as far as the accounting and valuing of monetary items during the current accounting period are concerned. Monetary items are measured in nominal monetary units no matter which accounting model is used. The real values of monetary items are kept always current by inflation and deflation since the nominal values of monetary items are normally not updated or inflation-adjusted during the current accounting period in any inflationary or deflationary economy. The real value of money and other monetary items generally changes monthly during inflation and deflation. It is destroyed during inflation and increased during deflation.
The nominal values of monetary items stay the same during the current financial period under any accounting model, but, their real values are automatically adjusted by inflation and deflation. The real value of money and other monetary items can be halved every 24.7 hours as has happened recently during hyperinflation in Zimbabwe. According to Prof Steve Hanke from John Hopkins University prices halved every 15.6 hours during hyperinflation in Hungary in 1946.
The net monetary loss or net monetary gain resulting from holding an excess of either monetary item assets or monetary item liabilities is currently only calculated and accounted during the implementation of Constant Purchasing Power inflation accounting as defined in IAS 29 in hyperinflationary economies. Net monetary gains and losses would also be calculated and accounted during low inflation and deflation when companies start measuring financial capital maintenance in units of constant purchasing power in terms of the Framework, Par 104 (a). They are not calculated and accounted under the traditional Historical Cost Accounting model, although it can be done according to Harvey Kapnick. See Saxe Lecture, 1976.
Copyright (c) 2005-2010 Nicolaas J Smith
Tuesday, 26 January 2010
SA accountants clueless about destruction by stable measuring unit assumption
The real values of many reported constant real value non-monetary items, for example, reported retained earnings never maintained, in the SA economy are currently not being maintained stable during low inflation. To the contrary: they are unnecessarily, unknowingly and unintentionally being destroyed at a rate equal to the annual rate of inflation by SA accountants implementing their very destructive stable measuring unit assumption when they measure financial capital maintenance in nominal monetary units – the accounting fallacy as authorized by the IASB in the Framework, Par 104 (a) in 1989 - for an unlimited period of time during indefinite inflation.
Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items stable during inflation and deflation is a basic objective of accounting. This is the result of:
(1) the three popular accounting fallacies; namely,
(a) the stable measuring unit assumption (authorized by the IASB) ,
(b) financial capital maintenance in nominal monetary units (authorized by the IASB) and
(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB, the FASB);
(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very destructive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied for an unlimited period of time during indefinite inflation and
(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant items of continuously measuring financial capital maintenance in units of constant purchasing power during low inflation as approved by the IASB in the Framework, Par 104 (a).
If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units by now.
This is what the International Accounting Standards Committee Board authorized 21 years ago in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a):
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
It was adopted by the IASB in 2001.
Amazingly the very popular accounting fallacy of financial capital maintenance in nominal monetary units and its perfect antidote are both authorized in the exact same IASB statement in 1989.
There are no specific IFRS relating to the concepts of capital or the concepts of capital maintenance. The Framework thus applies.
“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."
IAS Plus, Deloitte December 2009
Copyright © 2005 - 2010 Nicolaas J Smith
Many accountants see themselves as simply providing historic economic information. They do not understand the fact that continuously maintaining the constant purchasing power of capital which requires continuously maintaining the real values of all constant items stable during inflation and deflation is a basic objective of accounting. This is the result of:
(1) the three popular accounting fallacies; namely,
(a) the stable measuring unit assumption (authorized by the IASB) ,
(b) financial capital maintenance in nominal monetary units (authorized by the IASB) and
(c) the erosion of companies´ profits and capital by inflation (fully accepted by the IASB, the FASB);
(2) the fact that most accountants and accounting authorities do not understand the real value destroying effect of the very destructive stable measuring unit assumption on reported constant items never maintained during low inflationary periods when the stable measuring unit assumption/financial capital maintenance in nominal monetary units is applied for an unlimited period of time during indefinite inflation and
(3) the fact that most accountants and accounting authorities do not understand the real value maintaining effect on constant items of continuously measuring financial capital maintenance in units of constant purchasing power during low inflation as approved by the IASB in the Framework, Par 104 (a).
If they had understood the above, they would have stopped the stable measuring unit assumption / financial capital maintenance in nominal monetary units by now.
This is what the International Accounting Standards Committee Board authorized 21 years ago in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a):
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
It was adopted by the IASB in 2001.
Amazingly the very popular accounting fallacy of financial capital maintenance in nominal monetary units and its perfect antidote are both authorized in the exact same IASB statement in 1989.
There are no specific IFRS relating to the concepts of capital or the concepts of capital maintenance. The Framework thus applies.
“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."
IAS Plus, Deloitte December 2009
Copyright © 2005 - 2010 Nicolaas J Smith
It is not inflation doing the destroying
The understanding of the difference between the generally accepted accounting practice whereby SA accountants unnecessarily, unknowingly and unintentionally destroy the real values of only existing reported constant items never maintained only in the SA constant item economy with their free choice of implementing their very destructive stable measuring unit assumption during low inflation as authorized by the IASB when it approved the very popular accounting fallacy of financial capital maintenance in nominal monetary units during low inflation in the Framework, Par 104 (a) in 1989 and the destruction by the economic process of inflation of the real value of only money and other monetary items only in the monetary economy is an ongoing process. It has become clear to me, since September 2008, that inflation and hyperinflation only destroy the real value of money and other monetary items. Inflation and hyperinflation only have one – a monetary – component. It is clear to me now that it is not inflation that is causing (or hyperinflation that could cause) the destruction of the SA real economy or the real value of reported constant items never maintained in the SA real economy. It is clear to me now that inflation does not have a non-monetary component.
Copyright © 2005 - 2010 Nicolaas J Smith
Copyright © 2005 - 2010 Nicolaas J Smith
Friday, 22 January 2010
Economic fallacies not yet extinct
Economic history is replete with fallacies which became extinct with the developement of economic understanding.
The three economic fallacies not yet extinct are:
1. The stable measuring unit assumption.
2. Financial capital maintenance in nominal monetary units.
3. The erosion of companies´ profits and capital caused by inflation.
We all know that money is not perfectly stable and that it is impossible to maintain the real value of capital with financial capital maintenance in nominal monetary units per se during inflation and deflation.
SA accountants unknowingly destroy the real value of companies´ profits and capital never maintained with their free choice of implementing the stable measuring unit assumption during inflation. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.
The erosion of companies´ capital and profits by inflation is a very popular accounting fallacy stated by, for example, the US Financial Accounting Standards Board:
The basic proposition underlying Statement 33 — that inflation causes historical cost financial statements to show illusory profits and mask erosion of capital — is virtually undisputed. Financial Accounting Standard FAS 89 (voluntary disclosure), Par 4, P 5, 1986
and
Mr. Mosso dissents because he believes that the Statement does not bring the basic problem it addresses — measuring the effect of inflation on business operations — into focus. Because of that he doubts that it will effectively communicate the erosive impact of inflation on profits and capital and the significance of that erosion on all who have an investment stake in business enterprises. FAS 33 (superseded by FAS 89), Par 67, P 22, 1979.
The FASB blamed inflation for the erosion – which is the same as destruction – of companies´ capital and profits, but, in the same paragraph carried on to admit that the traditional Historical Cost Accounting model or, specifically, the stable measuring unit assumption does the destroying:
Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances. FAS 89, Par 4, P6, 1986.
The International Accounting Standards Board also blamed inflation in IAS 15 Information Reflecting the Effects of Changing Prices (withdrawn):
The information required by this standard is designed to make users of an enterprise’s financial statements aware of the effects of changing prices on the results of its operations. IAS 15, Par 7, 1983.
Both shareholders´ equity being a company’s capital as well as retained profits are constant real value non-monetary items.
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.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
The three economic fallacies not yet extinct are:
1. The stable measuring unit assumption.
2. Financial capital maintenance in nominal monetary units.
3. The erosion of companies´ profits and capital caused by inflation.
We all know that money is not perfectly stable and that it is impossible to maintain the real value of capital with financial capital maintenance in nominal monetary units per se during inflation and deflation.
SA accountants unknowingly destroy the real value of companies´ profits and capital never maintained with their free choice of implementing the stable measuring unit assumption during inflation. Inflation can only destroy the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.
The erosion of companies´ capital and profits by inflation is a very popular accounting fallacy stated by, for example, the US Financial Accounting Standards Board:
The basic proposition underlying Statement 33 — that inflation causes historical cost financial statements to show illusory profits and mask erosion of capital — is virtually undisputed. Financial Accounting Standard FAS 89 (voluntary disclosure), Par 4, P 5, 1986
and
Mr. Mosso dissents because he believes that the Statement does not bring the basic problem it addresses — measuring the effect of inflation on business operations — into focus. Because of that he doubts that it will effectively communicate the erosive impact of inflation on profits and capital and the significance of that erosion on all who have an investment stake in business enterprises. FAS 33 (superseded by FAS 89), Par 67, P 22, 1979.
The FASB blamed inflation for the erosion – which is the same as destruction – of companies´ capital and profits, but, in the same paragraph carried on to admit that the traditional Historical Cost Accounting model or, specifically, the stable measuring unit assumption does the destroying:
Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances. FAS 89, Par 4, P6, 1986.
The International Accounting Standards Board also blamed inflation in IAS 15 Information Reflecting the Effects of Changing Prices (withdrawn):
The information required by this standard is designed to make users of an enterprise’s financial statements aware of the effects of changing prices on the results of its operations. IAS 15, Par 7, 1983.
Both shareholders´ equity being a company’s capital as well as retained profits are constant real value non-monetary items.
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.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Thursday, 21 January 2010
Hegemony of Historical Cost Accounting
Monetary items
SA accountants value and account monetary items during the current accounting period at their original nominal monetary values under all accounting models during low inflation, hyperinflation and deflation. Inflation determines the always current real value of the Rand and other monetary items in the SA monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period.
The real value of the Rand and other monetary items in the SA monetary economy changes equally normally every month with the publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in SA´s low inflationary economy. The daily parallel rate is generally constantly available in a hyperinflationary economy. The CPI is the internal exchange rate between the value of the Rand and real value in the SA economy. The parallel rate fulfils this role in a hyperinflationary economy.
Variable items
Variable items in SA are continuously valued and accounted in terms of IFRS or SA GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc.
Constant items
Real values of constant real value non-monetary items in the SA constant item economy have to be continuously maintained stable during low inflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation by means of the CPI as authorized in the IASB´s Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in South Africa as well as in most other non-hyperinflationary economies.
Harvey Kapnick was correct when he stated in 1976: In the long run both value accounting and price-level accounting should prevail.
Saxe Lecture, 1976
Meanwhile the standards, twenty years ago, already provided the option to reject the stable measuring unit assumption in the Framework, Par 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
I want the International Accounting Standards Board to remove the accounting fallacy "financial capital maintenance can be measured in nominal monetary units" from the Framework, Par 104 (a). International Financial Reporting Standards should not be based on very popular accounting fallacies.
Hyperinflation
Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a country can maintain its non-monetary or real economy stable during hyperinflation is by measuring all non-monetary items in units of constant purchasing power; however, not by restating HC or current cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done, in principle, in Brazil - with indexation during the 30 years from 1964 to 1994.
IAS 29 was implemented by Zimbabwean companies listed on their stock exchange by applying the CPI at year-end as required by the IASB. Zimbabwean accountants unnecessarily, unknowingly and unintentionally destroyed their country’s real economy by implementing Historical Cost Accounting during the financial year, as supported by the IASB in IAS 29, and then restated their year-end Historical Cost financial statements in terms of the year-end CPI to make them more useful. That did not stop them from unknowingly destroying their real economy with HCA during hyperinflation.
PricewaterhouseCoopers state:
"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.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
SA accountants value and account monetary items during the current accounting period at their original nominal monetary values under all accounting models during low inflation, hyperinflation and deflation. Inflation determines the always current real value of the Rand and other monetary items in the SA monetary economy. This is the result of the fact that the real value of money and other monetary items cannot be updated or inflation-adjusted or valued in units of constant purchasing power during the current accounting period.
The real value of the Rand and other monetary items in the SA monetary economy changes equally normally every month with the publication of the new CPI value. Currently, the applicable CPI value can become available up to a month and a half after the date of a transaction in SA´s low inflationary economy. The daily parallel rate is generally constantly available in a hyperinflationary economy. The CPI is the internal exchange rate between the value of the Rand and real value in the SA economy. The parallel rate fulfils this role in a hyperinflationary economy.
Variable items
Variable items in SA are continuously valued and accounted in terms of IFRS or SA GAAP at, for example, fair value, market value, net realizable value, recoverable value, present value, etc.
Constant items
Real values of constant real value non-monetary items in the SA constant item economy have to be continuously maintained stable during low inflation by means of continuous financial capital maintenance in units of constant purchasing power, i.e. inflation-adjusting them monthly during low inflation by means of the CPI as authorized in the IASB´s Framework, Par 104 (a) in 1989. Annual inflation-adjustment is only currently being done in the case of certain income statement items, e.g., salaries, wages, rentals, etc. in South Africa as well as in most other non-hyperinflationary economies.
Harvey Kapnick was correct when he stated in 1976: In the long run both value accounting and price-level accounting should prevail.
Saxe Lecture, 1976
Meanwhile the standards, twenty years ago, already provided the option to reject the stable measuring unit assumption in the Framework, Par 104 (a) which states:
"Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power."
I want the International Accounting Standards Board to remove the accounting fallacy "financial capital maintenance can be measured in nominal monetary units" from the Framework, Par 104 (a). International Financial Reporting Standards should not be based on very popular accounting fallacies.
Hyperinflation
Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant items) by the IASB during hyperinflation as per the Constant Purchasing Power inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a country can maintain its non-monetary or real economy stable during hyperinflation is by measuring all non-monetary items in units of constant purchasing power; however, not by restating HC or current cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate, or - as was done, in principle, in Brazil - with indexation during the 30 years from 1964 to 1994.
IAS 29 was implemented by Zimbabwean companies listed on their stock exchange by applying the CPI at year-end as required by the IASB. Zimbabwean accountants unnecessarily, unknowingly and unintentionally destroyed their country’s real economy by implementing Historical Cost Accounting during the financial year, as supported by the IASB in IAS 29, and then restated their year-end Historical Cost financial statements in terms of the year-end CPI to make them more useful. That did not stop them from unknowingly destroying their real economy with HCA during hyperinflation.
PricewaterhouseCoopers state:
"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.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Wednesday, 20 January 2010
Monumental: The most critical set of issues this century
Here is some related information which highlights the problem:
The US Financial Accounting Standards Board tried to address the problem of accountants unknowingly destroying companies´ capital and profits by applying the stable measuring unit assumption (which is fallaciously believed by everyone to be caused by inflation: inflation can only destroy the real value of money and other monetary items – nothing else.) in their Financial Accounting Standard FAS 33 Financial Reporting and Changing Prices which was completely superseded by FAS 89 with the same title.
FAS 89
This Statement supersedes FASB Statement No. 33, Financial Reporting and Changing Prices, and its subsequent amendments, and makes voluntary the supplementary disclosure of current cost/constant purchasing power information. The Statement is effective for financial reports issued after December 2, 1986.
This Statement was adopted by the affirmative vote of four members of the Financial
Accounting Standards Board. Messrs. Lauver, Mosso, and Swieringa dissented.
Mr. Mosso dissented to the issuance of Statement 33 and he dissents to its rescission, both for the same reason. He believes that accounting for the interrelated effects of general and specific price changes is the most critical set of issues that the Board will face in this century.
It is too important either to be dealt with inconclusively as in the original Statement 33 or to be written off as a lost cause as in this Statement. The basic proposition underlying Statement 33—that inflation causes historical cost financial statements to show illusory profits and mask erosion of capital — is virtually undisputed.
(My note: Erosion is the same as destruction of capital.)
Specific price changes are inextricably linked to general inflation, and the combination of general and specific price changes seriously reduces the relevance, the representational faithfulness, and the comparability of historical cost financial statements.
Although the current inflation rate in the United States is relatively low in the context of recent history, its compound effect through time is still highly significant.
Mr. Lauver:
Relative to most changes in financial reporting, the changes required by Statement 33 were monumental.
Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.
The measures set out in FAS 33 were the start of the process – definitely not the final solution. I do not agree with the specifics of FAS 33. I do agree with the broad principle that accountants unnecessarily destroy companies´ capital and profits when they choose to implement the stable measuring unit assumption - which is virtually undisputed as stated by the FASB.
The International Accounting Standards Board also attempted a similar standard: IAS 15 Information Reflection the Effect of Changing Prices. It was also withdrawn.
“At its meeting in October 1989, the Board of IASC approved the following statement to be added to IAS 15:
“The international consensus on the disclosure of information reflecting the effects of changing prices that was anticipated when IAS 15 was issued has not been reached. As a result, the Board of IASC has decided that enterprises need not disclose the information required by IAS 15 in order that their financial statements conform with International Accounting Standards.
However, the Board encourages enterprises to present such information and urges those that do to disclose the items required by IAS 15.”
Copyright © 2005 - 2010 Nicolaas J Smith
The US Financial Accounting Standards Board tried to address the problem of accountants unknowingly destroying companies´ capital and profits by applying the stable measuring unit assumption (which is fallaciously believed by everyone to be caused by inflation: inflation can only destroy the real value of money and other monetary items – nothing else.) in their Financial Accounting Standard FAS 33 Financial Reporting and Changing Prices which was completely superseded by FAS 89 with the same title.
FAS 89
This Statement supersedes FASB Statement No. 33, Financial Reporting and Changing Prices, and its subsequent amendments, and makes voluntary the supplementary disclosure of current cost/constant purchasing power information. The Statement is effective for financial reports issued after December 2, 1986.
This Statement was adopted by the affirmative vote of four members of the Financial
Accounting Standards Board. Messrs. Lauver, Mosso, and Swieringa dissented.
Mr. Mosso dissented to the issuance of Statement 33 and he dissents to its rescission, both for the same reason. He believes that accounting for the interrelated effects of general and specific price changes is the most critical set of issues that the Board will face in this century.
It is too important either to be dealt with inconclusively as in the original Statement 33 or to be written off as a lost cause as in this Statement. The basic proposition underlying Statement 33—that inflation causes historical cost financial statements to show illusory profits and mask erosion of capital — is virtually undisputed.
(My note: Erosion is the same as destruction of capital.)
Specific price changes are inextricably linked to general inflation, and the combination of general and specific price changes seriously reduces the relevance, the representational faithfulness, and the comparability of historical cost financial statements.
Although the current inflation rate in the United States is relatively low in the context of recent history, its compound effect through time is still highly significant.
Mr. Lauver:
Relative to most changes in financial reporting, the changes required by Statement 33 were monumental.
Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.
The measures set out in FAS 33 were the start of the process – definitely not the final solution. I do not agree with the specifics of FAS 33. I do agree with the broad principle that accountants unnecessarily destroy companies´ capital and profits when they choose to implement the stable measuring unit assumption - which is virtually undisputed as stated by the FASB.
The International Accounting Standards Board also attempted a similar standard: IAS 15 Information Reflection the Effect of Changing Prices. It was also withdrawn.
“At its meeting in October 1989, the Board of IASC approved the following statement to be added to IAS 15:
“The international consensus on the disclosure of information reflecting the effects of changing prices that was anticipated when IAS 15 was issued has not been reached. As a result, the Board of IASC has decided that enterprises need not disclose the information required by IAS 15 in order that their financial statements conform with International Accounting Standards.
However, the Board encourages enterprises to present such information and urges those that do to disclose the items required by IAS 15.”
Copyright © 2005 - 2010 Nicolaas J Smith
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