The second enemy
There are two processes of systemic real value erosion in the economy, although everybody thinks there is only one economic enemy. The one enemy is very well known. It is inflation. Inflation manifests itself in money´s store of value function and only erodes the real value of money and other monetary items in the monetary economy (the money supply). Inflation is the enemy only in the monetary economy and the Governor of the Reserve Bank is the enemy of inflation.
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.
Inflation cannot erode the real value of variable real value non–monetary items or constant real value non–monetary items. It is impossible. Inflation is always and everywhere a monetary phenomenon per Milton Friedman. Inflation is eroding the real value of money and other monetary items only in the SA monetary economy at the rate of 4.6 % per annum (value date: May, 2011). The actual amount of value eroded in the real value of Rand notes and coins and other monetary items (bank loans, other monetary loans and deposits, etc.) over the twelve months to May, 2011 amounted to about R100 billion.
The second process of systemic real value erosion – the second enemy – is a generally accepted accounting principle, namely the stable measuring unit assumption: the unknowing, unintentional and unnecessary erosion by the stable measuring unit assumption (the HCA model) of the existing constant real value of only constant items never maintained constant only in the constant item economy.
“The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”
Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.
Increases in the general price level (inflation) erode the real value of money and other monetary items with an underlying monetary nature (e.g. loans and bonds) only in the internal monetary economy. Inflation has no effect on the real value of variable items (e.g. land, buildings, goods, commodities, cars, gold, real estate, inventories, finished goods, foreign exchange, etc.) and constant items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc.).
Entities generally choose then traditional HCA model which includes the stable measuring unit assumption during low inflation and deflation. They value constant items never maintained constant, e.g. that portion of companies´ shareholders´ equity never covered by sufficient revaluable fixed assets (revalued or not), in nominal monetary units; i.e. they choose to measure financial capital maintenance in nominal monetary units which is a popular accounting fallacy authorized in IFRS: in fact, it is impossible to maintain the real value of financial capital constant with financial capital maintenance in nominal monetary units per se during inflation and deflation. Entities´ choice of implementing financial capital maintenance in nominal monetary units instead of measuring constant items´ real values in units of constant purchasing power also authorized in IFRS results in the real values of these constant items never maintained constant being eroded by the stable measuring unit assumption at a rate equal to the annual rate of inflation.
It is not inflation doing the eroding as the IASB, the FASB, economists and most people mistakenly believe. It is entities´ free choice of the very erosive stable measuring unit assumption during low inflation as it forms part of financial capital maintenance in nominal monetary units – the Historical Cost Accounting model – authorized in IFRS in the original Framework (1989), Par 104 (a).
For example: SA companies would knowingly maintain the real value of all constant items constant forever (amounting to about R200 billion per year while inflation stays at about 4.6% per annum) in all entities that at least break even – ceteris paribus – no matter what the level of inflation when they reject the stable measuring unit assumption and implement financial capital maintenance in units of constant purchasing power during inflation (CIPPA). This is done without requiring extra money or extra retained profits simply to maintain the existing constant real value of existing constant real value non–monetary items (e.g. shareholders´ equity) constant. This is also possible in an entity with no fixed assets at all.
Constant items never maintained constant are treated like monetary items when their nominal values are never updated as a result of the implementation of the stable measuring unit assumption during low inflation and deflation.
The second enemy operating only in the constant item economy is the implementation of the stable measuring unit assumption during inflation. In principle, it is assumed that the unit of measure (money) is perfectly stable during low inflation and deflation; that is, it is assumed that changes in money´s general purchasing power are not sufficiently important to require the updating of the nominal values of all constant items in the constant item economy in order to maintain their real values constant. In so doing, the implementation of the HCA model unknowingly, unintentionally and unnecessarily erodes the real values of constant items never maintained constant during low inflation to the amount of about R200 billion in the SA constant item economy and hundreds of billions of US Dollars in the rest of the world´s constant item economy each and every year while the stable measuring unit assumption is being implemented as part of the traditional HCA model.
The stable measuring unit assumption is a stealth enemy very effectively camouflaged by GAAP, IASB authorization which makes it IFRS compliant and the generally accepted accounting fallacy that the erosion of companies´ capital and profits is caused by inflation: hardly anyone knows or understands that when the very erosive stable measuring unit assumption is implemented, the HCA model is unknowingly, unintentionally and unnecessarily eroding the real values of constant items never maintained constant at a rate equal to the annual rate of inflation during low inflation. The fact that the stable measuring unit assumption erodes about R200 billion per annum in the SA real economy and hundreds of billions of US Dollars in the rest of the world´s constant item economy year after year, does make a difference.
There are thus two enemies eroding real value systematically in the economy. The first enemy, inflation, is an economic process. The second enemy, the stable measuring units assumption, is a generally accepted accounting practice under the current Historical Cost paradigm.
The second economic enemy is the very erosive stable measuring unit assumption. This generally accepted accounting practice of systemic real value erosion operates only in the constant item part of the non–monetary or real economy when it is freely chosen to measure financial capital maintenance in nominal monetary units when entities implement the traditional HCA model during inflation as approved in IFRS in the original Framework (1989), Par 104 (a).
Everyone makes the mistake of blaming the erosion of companies´ profits and capital by the stable measuring unit assumption on inflation.
The problem is known and identified; namely, the real value of companies´ profits and capital is being eroded over time when implementing the HCA model during inflation. The mistake is made of blaming inflation instead of the free choice of the stable measuring unit assumption. It is impossible for inflation to erode the real value of any non-monetary item. Companies´ issued share capital and retained profits (as well as all other items in shareholders´ equity) are constant real value non-monetary items. This is very effectively camouflaged by IFRS approval in the original Framework (1989), Par 104 (a) which states “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power”. The stable measuring unit assumption: the stealth enemy in the economy wreaking more havoc than inflation, its convenient cover.
The US Financial Accounting Standards Board also blames inflation:
“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
Everyone only sees one enemy being responsible for all of the invisible and untouchable systemic real value erosion in the economy. It is mistakenly thought that inflation is responsible for all real value erosion in the economy. It is mistakenly thought that the cost of the stable measuring unit assumption (the erosion by the stable measuring unit assumption of the real value of constant items never maintained constant) is the same as the net monetary loss from holding an excess of monetary items assets over monetary item liabilities, i.e., the cost of the inflation (the erosion of the real value of money and other monetary items by inflation).
It is not inflation eroding the real value of companies´ profits and capital. It is the choice of traditional HCA which includes the very erosive stable measuring unit assumption. This second enemy is a stealth enemy camouflaged by IFRS approval since the way it operates is not realized. If it were realized, it would have been stopped by now with financial capital maintenance in units of constant purchasing power (CIPPA) as authorized in IFRS.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monday 11 July 2011
Friday 8 July 2011
Price stability
Price stability
When we discuss, write about, talk about or analyse this monetary item described above, we call it money and describe it using the term money with the implicit assumption that this money we are dealing with is stable – as in fixed – in real economic value in our low inflationary economies. We thus assume at the same time that prices are more or less stable in low inflationary economies too.
The term stable is normally accepted by the public at large to indicate a permanently fixed situation or position or state or price or value. A stable – as in fixed – price over time would be drawn as a horizontal line on a chart. A slowly increasing price over time would be drawn as a slightly rising line on a chart. A slowly decreasing value over time would be drawn as a slightly declining line on a chart. When we say production of a commodity is stable we accept that the absolute number of items being produced is not fluctuating but is at the same level all the time.
The term stable as used by economists, however, does not mean a fixed price or level, even though that is what the public in general thinks it means. The term stable in economics today means slowly increasing or slowly decreasing – depending on what it is being applied to. The term price stability as used by economists today does not mean that prices in general stay the same, but that prices in general are rising slowly – which is, as we are all taught, the popular definition of inflation.
The term stable money as used by economists equally does not mean that the real value of national monetary units they are talking about stays the same in the internal economy – even though that is what the public in general thinks it means. What they mean with stable money is that the real value of a national monetary unit is slowly being eroded by inflation over time in the internal economy.
When a central bank governor says that the central bank’s primary task or objective is price stability what she or he means is that the central bank would be fulfilling its primary task, in an economy with low levels of inflation, when prices in general are slowly rising over time (that well known definition of inflation again). The flip side of that statement is that the real value of national monetary units is slowly being eroded by inflation over time.
A central bank’s primary task being price stability is the same as saying a central bank’s main responsibility is ensuring that inflation is maintained at a very low level. This low level was generally accepted in first world economies to be 2 per cent per annum. The latest sub–prime crisis raised doubts about the 2% level being sufficient in the event of large shocks to the economy.
“In a world of small shocks, 2 per cent inflation seemed to provide a sufficient cushion to make the zero lower bound unimportant.” P4
“Should policymakers therefore aim for a higher target inflation rate in normal times,
in order to increase the room for monetary policy to react to such shocks? To be concrete, are the net costs of inflation much higher at, say, 4 per cent than at 2 per cent, the current target range?” P11
Rethinking Monetary Policy, IMF Staff Position Note, Olivier Blanchard, Giovanni Dell´Ariccia and Paulo Mauro, Feb, 2010.
We know that inflation is always and everywhere the erosion of the real value of money and other monetary items over time. We also know that inflation has no effect on the real value of non–monetary items over time.
The maintenance of a high degree of price stability (still) means that the primary task of a central bank in a first world economy is to limit the erosion of real value in money and other monetary items by inflation to a maximum of 2 per cent per annum within an economy or monetary union. Continuous two per cent annual inflation erodes 2% of the real value of money and other monetary items per annum and 51% over 35 years. Under the current Historical Cost paradigm it also means that the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional HCA model unknowingly, unintentionally and unnecessarily erodes 2% of the real value of constant real value non–monetary items never maintained constant, e.g. that portion of companies´ shareholders´ equity (their capital) never maintained constant with sufficient revaluable fixed assets, per annum and 51% over 35 years´ time. This unknowing, unintentional and unnecessary erosion by the HCA model is eliminated completely when it is freely chosen to measure financial capital maintenance in units of constant purchasing power during low inflation (freely choosing CIPPA) as it has been authorized in IFRS in the original Framework (1989), Par 104 (a).
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
When we discuss, write about, talk about or analyse this monetary item described above, we call it money and describe it using the term money with the implicit assumption that this money we are dealing with is stable – as in fixed – in real economic value in our low inflationary economies. We thus assume at the same time that prices are more or less stable in low inflationary economies too.
The term stable is normally accepted by the public at large to indicate a permanently fixed situation or position or state or price or value. A stable – as in fixed – price over time would be drawn as a horizontal line on a chart. A slowly increasing price over time would be drawn as a slightly rising line on a chart. A slowly decreasing value over time would be drawn as a slightly declining line on a chart. When we say production of a commodity is stable we accept that the absolute number of items being produced is not fluctuating but is at the same level all the time.
The term stable as used by economists, however, does not mean a fixed price or level, even though that is what the public in general thinks it means. The term stable in economics today means slowly increasing or slowly decreasing – depending on what it is being applied to. The term price stability as used by economists today does not mean that prices in general stay the same, but that prices in general are rising slowly – which is, as we are all taught, the popular definition of inflation.
The term stable money as used by economists equally does not mean that the real value of national monetary units they are talking about stays the same in the internal economy – even though that is what the public in general thinks it means. What they mean with stable money is that the real value of a national monetary unit is slowly being eroded by inflation over time in the internal economy.
When a central bank governor says that the central bank’s primary task or objective is price stability what she or he means is that the central bank would be fulfilling its primary task, in an economy with low levels of inflation, when prices in general are slowly rising over time (that well known definition of inflation again). The flip side of that statement is that the real value of national monetary units is slowly being eroded by inflation over time.
A central bank’s primary task being price stability is the same as saying a central bank’s main responsibility is ensuring that inflation is maintained at a very low level. This low level was generally accepted in first world economies to be 2 per cent per annum. The latest sub–prime crisis raised doubts about the 2% level being sufficient in the event of large shocks to the economy.
“In a world of small shocks, 2 per cent inflation seemed to provide a sufficient cushion to make the zero lower bound unimportant.” P4
“Should policymakers therefore aim for a higher target inflation rate in normal times,
in order to increase the room for monetary policy to react to such shocks? To be concrete, are the net costs of inflation much higher at, say, 4 per cent than at 2 per cent, the current target range?” P11
Rethinking Monetary Policy, IMF Staff Position Note, Olivier Blanchard, Giovanni Dell´Ariccia and Paulo Mauro, Feb, 2010.
We know that inflation is always and everywhere the erosion of the real value of money and other monetary items over time. We also know that inflation has no effect on the real value of non–monetary items over time.
The maintenance of a high degree of price stability (still) means that the primary task of a central bank in a first world economy is to limit the erosion of real value in money and other monetary items by inflation to a maximum of 2 per cent per annum within an economy or monetary union. Continuous two per cent annual inflation erodes 2% of the real value of money and other monetary items per annum and 51% over 35 years. Under the current Historical Cost paradigm it also means that the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional HCA model unknowingly, unintentionally and unnecessarily erodes 2% of the real value of constant real value non–monetary items never maintained constant, e.g. that portion of companies´ shareholders´ equity (their capital) never maintained constant with sufficient revaluable fixed assets, per annum and 51% over 35 years´ time. This unknowing, unintentional and unnecessary erosion by the HCA model is eliminated completely when it is freely chosen to measure financial capital maintenance in units of constant purchasing power during low inflation (freely choosing CIPPA) as it has been authorized in IFRS in the original Framework (1989), Par 104 (a).
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
CIPPA equals automatic zero erosion in constant item economy
CIPPA equals automatic zero erosion in constant item economy
We do not have stable – as in fixed real value – money. The real value of money is generally accepted by the public at large to be stable – as in fixed – in low inflation economies, but this is not true. The belief that we have stable – as in fixed real value – money is an illusion, namely the notorious money illusion.
Central banks and monetary authorities have monetary policies that often create the impression that money is stable in real economic value. They implement monetary policies that include the tolerance of low inflation limits of up to two per cent per annum. Then they assure everybody that “price stability” is guaranteed and assured. The public at large mistakenly assume that this means stable – as in fixed – prices. We regularly read in inflation reports that low inflation targets have been met and that “price stability” is assured.
In a low inflationary economy this appears to be true. But in reality it is not true. Yes, money illusion makes us believe that our depreciating money maintains its real value stable, while it actually halves in real value over 35 years with constant two per cent per annum inflation – the generally accepted level of “price stability.” All currently existing bank notes and coins will eventually arrive at a point of being almost completely worthless in real value during indefinite inflation. How quickly depends on the level of inflation.
In Zimbabwe hyperinflation reached such high levels that the real value of the country’s entire money supply was wiped out when the ZimDollar had no exchangeability with any foreign currency in November 2008. Towards the end of the hyperinflationary spiral the real value of the ZimDollar halved every 24.7 hours according to Steve Hanke from Cato Institute.
There is no money illusion in hyperinflationary economies. People know that hyperinflation erodes the real value of their money very quickly.
Central bank governors aid and abet money illusion by regularly stating in their monetary policy statements that they are “achieving and maintaining price stability.”
“The MPC remains fully committed to its mandate of achieving and maintaining price stability.”
TT Mboweni, Governor. 2009–06–25: Statement of the Monetary Policy Committee, SARB.
It is not always pointed out by governors of central banks that the “price stability” they mention, refers to their definition of “price stability”. Jean–Claude Trichet, the President of the European Central Bank, is a central bank governor who regularly mentions that 2% inflation is their definition of price stability. Absolute price stability is a year–on–year increase in the Consumer Price Index of zero per cent. The SARB´s definition of “price stability” “is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”
The SARB would aid in reducing money illusion in the SA economy by stating:
The MPC remains fully committed to its mandate of achieving and maintaining the SARB´s chosen level of price stability which is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. Absolute price stability is a year–on–year increase in the CPI of zero per cent. Current 4.6 % annual inflation eroded about R100 billion of the real value of the Rand over the past 12 months to the end of May, 2011. The stable measuring unit assumption as applied as part of the traditional Historical Cost Accounting model used by SA companies unnecessarily eroded about R200 billion of the real value of constant real value non-monetary items never maintained constant in SA companies at a rate equal to the current 4.6% annual inflation rate.
A one per cent decrease in inflation (disinflation) maintains about R20 billion per annum of real value only in the SA monetary economy as a result of the decrease in the level of inflation. At the same time, about R33 billion is maintained in the non–monetary economy as a result of the reduction in the level of unknowing, unintentional and unnecessary erosion by the traditional HCA model in the real value of constant real value non–monetary items never maintained constant in consequence of the implementation of the very erosive stable measuring unit assumption; i.e. financial capital maintenance in nominal monetary units during low inflation as authorized in IFRS in the original Framework (1989), Par 104 (a).
All that has to be done is to freely change over to IFRS compliant IASB–approved financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) and the SA real economy will automatically be boosted by about R200 billion per annum forever in all entities that at least break even - ceteris paribus as long as the SARB maintains its chosen level of “price stability” between 3 and 6% inflation per annum.
As the Deutsche Bundesbank stated:
“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”
Deutsche Bundesbank, 1996 Annual Report, P 83.
All SA companies changing over to CIPPA means automatic zero erosion of constant items´ real values forever in the SA economy in all entities that at least break even during inflation and deflation – ceteris paribus. The same principle applies to all other economies.
Gill Marcus, the current governor of the SARB, will have to bring inflation down to zero per cent per annum on a permanent basis to have the same effect in the real economy. CIPPA does this automatically at any level of inflation or deflation. Zero per cent inflation is not currently advisable in the monetary economy because governments and central banks still do not know how to run an economy at sustainable zero per cent annual inflation. It is very easy to automatically run the constant item economy in any country or monetary union at sustainable zero percent erosion in constant items forever: just choose the other option: real value maintaining CIPPA. It is compliant with IFRS and has been authorized by the IASB in 1989.
CIPPA is a basic accounting model approved in 1989 that results in the automatic maintenance – without additional capital contributions or extra retained profits – of the real value of constant real value non–monetary items in the constant item economy for an unlimited period of time in all companies that at least break even during inflation and deflation – ceteris paribus. The principle applies when any economy - currently implementing the very erosive stable measuring unit assumption as part of the traditional HCA model – changes over to CIPPA.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
We do not have stable – as in fixed real value – money. The real value of money is generally accepted by the public at large to be stable – as in fixed – in low inflation economies, but this is not true. The belief that we have stable – as in fixed real value – money is an illusion, namely the notorious money illusion.
Central banks and monetary authorities have monetary policies that often create the impression that money is stable in real economic value. They implement monetary policies that include the tolerance of low inflation limits of up to two per cent per annum. Then they assure everybody that “price stability” is guaranteed and assured. The public at large mistakenly assume that this means stable – as in fixed – prices. We regularly read in inflation reports that low inflation targets have been met and that “price stability” is assured.
In a low inflationary economy this appears to be true. But in reality it is not true. Yes, money illusion makes us believe that our depreciating money maintains its real value stable, while it actually halves in real value over 35 years with constant two per cent per annum inflation – the generally accepted level of “price stability.” All currently existing bank notes and coins will eventually arrive at a point of being almost completely worthless in real value during indefinite inflation. How quickly depends on the level of inflation.
In Zimbabwe hyperinflation reached such high levels that the real value of the country’s entire money supply was wiped out when the ZimDollar had no exchangeability with any foreign currency in November 2008. Towards the end of the hyperinflationary spiral the real value of the ZimDollar halved every 24.7 hours according to Steve Hanke from Cato Institute.
There is no money illusion in hyperinflationary economies. People know that hyperinflation erodes the real value of their money very quickly.
Central bank governors aid and abet money illusion by regularly stating in their monetary policy statements that they are “achieving and maintaining price stability.”
“The MPC remains fully committed to its mandate of achieving and maintaining price stability.”
TT Mboweni, Governor. 2009–06–25: Statement of the Monetary Policy Committee, SARB.
It is not always pointed out by governors of central banks that the “price stability” they mention, refers to their definition of “price stability”. Jean–Claude Trichet, the President of the European Central Bank, is a central bank governor who regularly mentions that 2% inflation is their definition of price stability. Absolute price stability is a year–on–year increase in the Consumer Price Index of zero per cent. The SARB´s definition of “price stability” “is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”
The SARB would aid in reducing money illusion in the SA economy by stating:
The MPC remains fully committed to its mandate of achieving and maintaining the SARB´s chosen level of price stability which is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. Absolute price stability is a year–on–year increase in the CPI of zero per cent. Current 4.6 % annual inflation eroded about R100 billion of the real value of the Rand over the past 12 months to the end of May, 2011. The stable measuring unit assumption as applied as part of the traditional Historical Cost Accounting model used by SA companies unnecessarily eroded about R200 billion of the real value of constant real value non-monetary items never maintained constant in SA companies at a rate equal to the current 4.6% annual inflation rate.
A one per cent decrease in inflation (disinflation) maintains about R20 billion per annum of real value only in the SA monetary economy as a result of the decrease in the level of inflation. At the same time, about R33 billion is maintained in the non–monetary economy as a result of the reduction in the level of unknowing, unintentional and unnecessary erosion by the traditional HCA model in the real value of constant real value non–monetary items never maintained constant in consequence of the implementation of the very erosive stable measuring unit assumption; i.e. financial capital maintenance in nominal monetary units during low inflation as authorized in IFRS in the original Framework (1989), Par 104 (a).
All that has to be done is to freely change over to IFRS compliant IASB–approved financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) and the SA real economy will automatically be boosted by about R200 billion per annum forever in all entities that at least break even - ceteris paribus as long as the SARB maintains its chosen level of “price stability” between 3 and 6% inflation per annum.
As the Deutsche Bundesbank stated:
“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”
Deutsche Bundesbank, 1996 Annual Report, P 83.
All SA companies changing over to CIPPA means automatic zero erosion of constant items´ real values forever in the SA economy in all entities that at least break even during inflation and deflation – ceteris paribus. The same principle applies to all other economies.
Gill Marcus, the current governor of the SARB, will have to bring inflation down to zero per cent per annum on a permanent basis to have the same effect in the real economy. CIPPA does this automatically at any level of inflation or deflation. Zero per cent inflation is not currently advisable in the monetary economy because governments and central banks still do not know how to run an economy at sustainable zero per cent annual inflation. It is very easy to automatically run the constant item economy in any country or monetary union at sustainable zero percent erosion in constant items forever: just choose the other option: real value maintaining CIPPA. It is compliant with IFRS and has been authorized by the IASB in 1989.
CIPPA is a basic accounting model approved in 1989 that results in the automatic maintenance – without additional capital contributions or extra retained profits – of the real value of constant real value non–monetary items in the constant item economy for an unlimited period of time in all companies that at least break even during inflation and deflation – ceteris paribus. The principle applies when any economy - currently implementing the very erosive stable measuring unit assumption as part of the traditional HCA model – changes over to CIPPA.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday 7 July 2011
Items with an underlying monetary nature
Items with an underlying monetary nature
Houses, cars, mobile phones, raw materials, etc. have monetary values, but they are not monetary items. They are variable real value non–monetary items whose real values are expressed in terms of depreciating or appreciating money depending on whether the economy is in a state of inflation or deflation.
Likewise salaries, wages, rentals, pensions, interest, taxes, retained earnings, issued share capital, capital reserves, all other shareholder equity items, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, etc. have depreciating or appreciating monetary values, but they are not monetary items. They are constant real value non–monetary items whose constant real non–monetary values are expressed in terms of depreciating or appreciating money. Constant real value non–monetary items´ real values are maintained constant with financial capital maintenance in units of purchasing power during inflation and deflation, i.e., with Constant Item Purchasing Power Accounting.
Government Bonds
Commercial Bonds
Treasury Bills
Consumer loans
Bank loans
Car loans
Student loans
Credit card loans
Notes Payable
Notes Receivable
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value. All economic items are exchangeable and money is generally the medium of exchange. All economic items thus have monetary values in an economy using money as the monetary unit of account. Both monetary items and non–monetary items are expressed in monetary terms; i.e. in terms of the monetary unit. The monetary unit is used as the medium of exchange, unit of account and store of value. Variable real value non–monetary items, constant real value non–monetary items and monetary items are all expressed in terms of money and have monetary values.
There is, however, a difference between having a monetary value and being a monetary item. All economic items have monetary values, but, only money and items with an underlying monetary nature are monetary items. Non–monetary items have monetary values: they have their values expressed in terms of money, but, they are not monetary items.
Houses, cars, mobile phones, raw materials, etc. have monetary values, but they are not monetary items. They are variable real value non–monetary items whose real values are expressed in terms of depreciating or appreciating money depending on whether the economy is in a state of inflation or deflation.
Likewise salaries, wages, rentals, pensions, interest, taxes, retained earnings, issued share capital, capital reserves, all other shareholder equity items, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, etc. have depreciating or appreciating monetary values, but they are not monetary items. They are constant real value non–monetary items whose constant real non–monetary values are expressed in terms of depreciating or appreciating money. Constant real value non–monetary items´ real values are maintained constant with financial capital maintenance in units of purchasing power during inflation and deflation, i.e., with Constant Item Purchasing Power Accounting.
Examples of items with an underlying monetary nature
Money loans
Mortgage bondsGovernment Bonds
Commercial Bonds
Treasury Bills
Consumer loans
Bank loans
Car loans
Student loans
Credit card loans
Notes Payable
Notes Receivable
They are accounted monetary items of money lent or borrowed, payable or receivable in money. Only monetary items to be paid or received in money are monetary items. Variable real value non–monetary items and constant real value non–monetary items to be paid or received in money remain variable real value non–monetary items and constant real value non–monetary items. Money is simply the monetary medium of exchange used to transfer the ownership of a variable real value non–monetary item or constant real value non–monetary item from one entity to another.
Items with an underlying monetary nature have exactly the same attributes as money held with the exception that they are not 100% liquid.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday 6 July 2011
The definitive proof that trade debtors / creditors are non-monetary items
The definitive proof that trade debtors / creditors are non-monetary items
Monetary items are money held and items with an underlying monetary nature.
Money is the monetary unit.
Trade debtors and trade creditors are defined incorrectly in IFRS, by the FASB and by PricewaterhouseCoopers to be monetary items. They are constant real value non–monetary items. All street vendors in hyperinflationary economies know by experience - even when some of them have never been to school - that paying for a non–monetary item on credit means the value at the date of the sale has to be updated (measured in units of constant purchasing power) over time. The IASB, the FASB and PricewaterhouseCoopers still get this wrong.
Trade debtors and trade creditors are constant real value non-monetary items but are treated like monetary items under the current Historical Cost paradigm. If they were, in fact, monetary items they would behave like monetary items under inflation and deflation. They would always lose real value under inflation: however, Brazil measured trade debtors and trade creditors in units of constant purchasing power by updating them in terms of a daily index value during 30 years of very high inflation and hyperinflation. That is complete proof that trade debtors, trade creditors, all non-monetary payables and all non-monetary receivables are not monetary items, but, constant real value non-monetary items; namely, the fact that they can be updated (measured in units of constant purchasing power) during the current financial period because monetary items cannot be updated under any accounting or economic model during the current accounting period.
I updated all trade debtors in terms of the daily US Dollar parallel rate in Auto-Sueco (Angola) during 1996. All our trade debtors accepted that and paid the updated amount in Angolan Kwanzas. That is complete proof that trade debtors and trade creditors are constant item real value non-monetary items. If they were monetary items I would not have been able to update them and our trade debtors would not have accepted it.
Trade debtors and trade creditors are incorrectly treated as monetary items in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. All calculations done since 1989 in terms of IAS 29 of monetary losses and gains as well as profit calculations are thus wrong.
Money is a monetary item that is generally accepted as a medium of exchange, store of value and unit of account within an economy or monetary union. Only an economic item that fulfils all three functions of money at the same time can be the monetary unit in a specific economy or monetary union. Fulfilling only two of the three functions does not qualify an item as the monetary unit. See Foreign Exchange.
A foreign currency is not the monetary unit in a non–dollarized economy since it is not the monetary unit of account.
Money held are bank notes and coins on hand and demand deposits in banks and financial institutions.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monetary items are money held and items with an underlying monetary nature.
Money is the monetary unit.
Trade debtors and trade creditors are defined incorrectly in IFRS, by the FASB and by PricewaterhouseCoopers to be monetary items. They are constant real value non–monetary items. All street vendors in hyperinflationary economies know by experience - even when some of them have never been to school - that paying for a non–monetary item on credit means the value at the date of the sale has to be updated (measured in units of constant purchasing power) over time. The IASB, the FASB and PricewaterhouseCoopers still get this wrong.
Trade debtors and trade creditors are constant real value non-monetary items but are treated like monetary items under the current Historical Cost paradigm. If they were, in fact, monetary items they would behave like monetary items under inflation and deflation. They would always lose real value under inflation: however, Brazil measured trade debtors and trade creditors in units of constant purchasing power by updating them in terms of a daily index value during 30 years of very high inflation and hyperinflation. That is complete proof that trade debtors, trade creditors, all non-monetary payables and all non-monetary receivables are not monetary items, but, constant real value non-monetary items; namely, the fact that they can be updated (measured in units of constant purchasing power) during the current financial period because monetary items cannot be updated under any accounting or economic model during the current accounting period.
I updated all trade debtors in terms of the daily US Dollar parallel rate in Auto-Sueco (Angola) during 1996. All our trade debtors accepted that and paid the updated amount in Angolan Kwanzas. That is complete proof that trade debtors and trade creditors are constant item real value non-monetary items. If they were monetary items I would not have been able to update them and our trade debtors would not have accepted it.
Trade debtors and trade creditors are incorrectly treated as monetary items in terms of IAS 29 Financial Reporting in Hyperinflationary Economies. All calculations done since 1989 in terms of IAS 29 of monetary losses and gains as well as profit calculations are thus wrong.
Money is a monetary item that is generally accepted as a medium of exchange, store of value and unit of account within an economy or monetary union. Only an economic item that fulfils all three functions of money at the same time can be the monetary unit in a specific economy or monetary union. Fulfilling only two of the three functions does not qualify an item as the monetary unit. See Foreign Exchange.
A foreign currency is not the monetary unit in a non–dollarized economy since it is not the monetary unit of account.
Money held are bank notes and coins on hand and demand deposits in banks and financial institutions.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Tuesday 5 July 2011
Legal tender
Legal tender
Money derives its nominal value from being declared by government to be legal tender. It does not mean economic entities will accept it as money. Zimbabwe declared 100 trillion Zimbabwe Dollar notes as legal tender, but the population in Zimbabwe refused to accept it as legal tender after a very short time because hyperinflation in the millions of per cent per annum made the notes almost worthless. The Zimbabwe Government withdrew the ZimDollar from circulation when they dollarized their economy with multi–currencies after the Reserve Bank of Zimbabwe wiped out all the real value represented by the Zimbabwe Dollar in their economy by printing excessive amounts of extremely high nominal value bank notes till the currency had no exchangeability with any other foreign currency.
Fiat money’s real value is determined by all the underlying value systems in the economy. Changes in money’s real value over time are indicated by the rate of annual inflation or deflation. Money has the legal backing of being legal tender. Legal tender is an offered payment that, by law, cannot be refused in settlement of a debt. Credit cards, personal cheques and similar non–cash methods of payment are not usually legal tender. The law does not relieve the debt until payment is accepted which explains the practice in some economies of making out receipts for most payments. Bank notes and coins are usually defined as legal tender.
Monetary items are defined incorrectly in IAS 21 The Effects of Changes in Foreign Exchange Rates, Par 8:
Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.
Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se. Non–monetary items are often paid in a fixed or determinable number of units of currency. Fixed salary, wage and rental payments do not transform these constant real value non–monetary items into monetary items. Salaries, wages, rentals, etc are constant real value non–monetary items. They are not monetary items. They are simply paid in money as the medium of exchange. They are sometimes paid in a fixed or determinable number of units of currency because they are measured in nominal monetary units under the current Historical Cost paradigm during low inflation and not in units of constant purchasing power. This does not transform them into monetary items simply because they are paid in fixed historical cost values. They remain constant real value non–monetary items.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Money derives its nominal value from being declared by government to be legal tender. It does not mean economic entities will accept it as money. Zimbabwe declared 100 trillion Zimbabwe Dollar notes as legal tender, but the population in Zimbabwe refused to accept it as legal tender after a very short time because hyperinflation in the millions of per cent per annum made the notes almost worthless. The Zimbabwe Government withdrew the ZimDollar from circulation when they dollarized their economy with multi–currencies after the Reserve Bank of Zimbabwe wiped out all the real value represented by the Zimbabwe Dollar in their economy by printing excessive amounts of extremely high nominal value bank notes till the currency had no exchangeability with any other foreign currency.
Fiat money’s real value is determined by all the underlying value systems in the economy. Changes in money’s real value over time are indicated by the rate of annual inflation or deflation. Money has the legal backing of being legal tender. Legal tender is an offered payment that, by law, cannot be refused in settlement of a debt. Credit cards, personal cheques and similar non–cash methods of payment are not usually legal tender. The law does not relieve the debt until payment is accepted which explains the practice in some economies of making out receipts for most payments. Bank notes and coins are usually defined as legal tender.
Monetary items are defined incorrectly in IAS 21 The Effects of Changes in Foreign Exchange Rates, Par 8:
Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.
Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se. Non–monetary items are often paid in a fixed or determinable number of units of currency. Fixed salary, wage and rental payments do not transform these constant real value non–monetary items into monetary items. Salaries, wages, rentals, etc are constant real value non–monetary items. They are not monetary items. They are simply paid in money as the medium of exchange. They are sometimes paid in a fixed or determinable number of units of currency because they are measured in nominal monetary units under the current Historical Cost paradigm during low inflation and not in units of constant purchasing power. This does not transform them into monetary items simply because they are paid in fixed historical cost values. They remain constant real value non–monetary items.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monday 4 July 2011
Definition of monetary item
Definition of monetary item
The correct definition of monetary items is critical for the correct classification of non–monetary items since the latter are correctly defined as all items that are not monetary items. If the definition of monetary items is wrong – as it currently is in IFRS – then some constant real value non–monetary items are incorrectly classified as monetary items. This happens mainly with the incorrect classification of trade debtors and trade creditors as monetary items under current IFRS. This affects the correct valuing of these items, the calculation of the net monetary gain or loss and consequently the profit or loss for the reporting period which influences the correctness of the financial statements in terms of IAS 29 during hyperinflation. In an amazing contradiction of basic economic logic, there is no net monetary gain or loss calculation required when the traditional HCA model is chosen during low inflation and deflation. The calculation of the net monetary gain or loss is an essential part of the CIPPA model while it is non–existent under the HCA model. This is one of the fundamental failures of the HCA model which is corrected under the CIPPA model.
The incorrect treatment of the constant real value non–monetary items trade debtors and trade creditors and other non–monetary payables and receivables as monetary items is mainly due to the incorrect definition of monetary items in International Financial Reporting Standards.
It is taught that there are only two distinct economic items in the economy, namely, monetary and non–monetary items and that the economy is divided in the monetary and non–monetary or real economy.
Monetary items are defined by the International Accounting Standards Board in IAS 21 The Effects of Changes in Foreign Exchange Rates, Par 8 as follows:
“Monetary items are units of currency held and assets and liabilities to be
received or paid in a fixed or determinable number of units of currency.”
and in IAS 29 Financial Reporting in Hyperinflationary Economies, Par 12 as follows:
“Monetary items are money held and items to be received or paid in money.”
The correct defintion of Monetary Items
Monetary items constitue the Money supply.
Updated on 11-05-2013
The US Financial Accounting Standards Board and PricewaterhouseCoopers also define trade debtors and trade creditors incorrectly as monetary items. PwC is simply following the IASB lead.
The second part of the IAS 29 definition is not correct. When a non–monetary item, e.g. raw material, is bought on credit, the trade debtor amount in the supplier’s accounts is not a monetary item just because it will be paid in money or because it will be paid in a fixed or determinable number of units of currency. It can be paid in strawberries or diamonds too, if the supplier will accept strawberries or diamonds as a medium of payment. That will not make the non–monetary raw material a strawberry item or diamond item, just like payment in money does not make non–monetary raw material a monetary item. Money or strawberries or diamonds are simply used as the mutually agreed medium of exchange. The constant real value non–monetary trade debtor amount relates to the sale of a non–monetary item, namely the non–monetary raw material. The trade debt has an underlying non–monetary nature. All items – monetary and non–monetary items – are normally received or paid in money.
The buyer did not decide or agree to borrow money – exactly equal to the amount of the trade debt – from the supplier the moment the buyer decided not to pay the purchase cash on delivery or even if it was beforehand agreed that the buyer would not pay cash on delivery, but, would be granted credit. The supplier did not decide or agree to lend the buyer money– exactly equal to the amount of the trade debt – the moment the buyer did not pay the purchase cash on delivery. The trade debt relates to a non–monetary item: raw material. The trade debt is thus a constant real value non–monetary item the moment it comes about. The underlying non–monetary nature of the debt (raw material, furniture, vehicle, etc.) results in it being a constant real value non–monetary item the moment the debt comes about which has to be updated – over time – during low inflation, hyperinflation and deflation. Street vendors in hyperinflationary economies – some of whom have never been to school – know this instinctively.
When inflation erodes the real value of the monetary medium of exchange at 2% per annum, 2% more money has to be paid over a year to pay off the constant real value non–monetary item, the trade debtor amount.
Inflation is always and everywhere a monetary phenomenon – as per Milton Friedman. Money is only the monetary medium of exchange used for payment. Inflation can only erode the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non–monetary items. The debt is for the constant real non–monetary value of a non–monetary item mutually agreed and generally accepted to be paid in money: not for a monetary item. Money is simply the medium of exchange. No–one lent any money to anyone else. There is generally no money loans involved with trade creditors and trade debtors.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The correct definition of monetary items is critical for the correct classification of non–monetary items since the latter are correctly defined as all items that are not monetary items. If the definition of monetary items is wrong – as it currently is in IFRS – then some constant real value non–monetary items are incorrectly classified as monetary items. This happens mainly with the incorrect classification of trade debtors and trade creditors as monetary items under current IFRS. This affects the correct valuing of these items, the calculation of the net monetary gain or loss and consequently the profit or loss for the reporting period which influences the correctness of the financial statements in terms of IAS 29 during hyperinflation. In an amazing contradiction of basic economic logic, there is no net monetary gain or loss calculation required when the traditional HCA model is chosen during low inflation and deflation. The calculation of the net monetary gain or loss is an essential part of the CIPPA model while it is non–existent under the HCA model. This is one of the fundamental failures of the HCA model which is corrected under the CIPPA model.
The incorrect treatment of the constant real value non–monetary items trade debtors and trade creditors and other non–monetary payables and receivables as monetary items is mainly due to the incorrect definition of monetary items in International Financial Reporting Standards.
It is taught that there are only two distinct economic items in the economy, namely, monetary and non–monetary items and that the economy is divided in the monetary and non–monetary or real economy.
Monetary items are defined by the International Accounting Standards Board in IAS 21 The Effects of Changes in Foreign Exchange Rates, Par 8 as follows:
“Monetary items are units of currency held and assets and liabilities to be
received or paid in a fixed or determinable number of units of currency.”
and in IAS 29 Financial Reporting in Hyperinflationary Economies, Par 12 as follows:
“Monetary items are money held and items to be received or paid in money.”
The correct defintion of Monetary Items
Monetary items constitue the Money supply.
Updated on 11-05-2013
The US Financial Accounting Standards Board and PricewaterhouseCoopers also define trade debtors and trade creditors incorrectly as monetary items. PwC is simply following the IASB lead.
The second part of the IAS 29 definition is not correct. When a non–monetary item, e.g. raw material, is bought on credit, the trade debtor amount in the supplier’s accounts is not a monetary item just because it will be paid in money or because it will be paid in a fixed or determinable number of units of currency. It can be paid in strawberries or diamonds too, if the supplier will accept strawberries or diamonds as a medium of payment. That will not make the non–monetary raw material a strawberry item or diamond item, just like payment in money does not make non–monetary raw material a monetary item. Money or strawberries or diamonds are simply used as the mutually agreed medium of exchange. The constant real value non–monetary trade debtor amount relates to the sale of a non–monetary item, namely the non–monetary raw material. The trade debt has an underlying non–monetary nature. All items – monetary and non–monetary items – are normally received or paid in money.
The buyer did not decide or agree to borrow money – exactly equal to the amount of the trade debt – from the supplier the moment the buyer decided not to pay the purchase cash on delivery or even if it was beforehand agreed that the buyer would not pay cash on delivery, but, would be granted credit. The supplier did not decide or agree to lend the buyer money– exactly equal to the amount of the trade debt – the moment the buyer did not pay the purchase cash on delivery. The trade debt relates to a non–monetary item: raw material. The trade debt is thus a constant real value non–monetary item the moment it comes about. The underlying non–monetary nature of the debt (raw material, furniture, vehicle, etc.) results in it being a constant real value non–monetary item the moment the debt comes about which has to be updated – over time – during low inflation, hyperinflation and deflation. Street vendors in hyperinflationary economies – some of whom have never been to school – know this instinctively.
When inflation erodes the real value of the monetary medium of exchange at 2% per annum, 2% more money has to be paid over a year to pay off the constant real value non–monetary item, the trade debtor amount.
Inflation is always and everywhere a monetary phenomenon – as per Milton Friedman. Money is only the monetary medium of exchange used for payment. Inflation can only erode the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non–monetary items. The debt is for the constant real non–monetary value of a non–monetary item mutually agreed and generally accepted to be paid in money: not for a monetary item. Money is simply the medium of exchange. No–one lent any money to anyone else. There is generally no money loans involved with trade creditors and trade debtors.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Friday 1 July 2011
Money illusion and Historical Cost values
Money illusion and Historical Cost values
(The following is adapted from a live–event on US TV. Any resemblance to a living person is purely coincidental ;–)
Let us assume a highly respected 75–year–old grandfather tries to encourage his grandson to accept a low starting salary in a very good company as a good starting point for the youngster’s career. The grandfather may mention that when he started work he earned 25 Dollars per week – meaning that he also started with a low salary and worked his way up. Stating his starting salary at its original historical cost value of maybe more than 50 years ago completely falsified the example he gave. He was trying to say – and he certainly did, incorrectly (unintentional though it may have been) create the impression – that he started work at a low salary and had to work his way up. When the original historical cost value of 25 US Dollars of the grandfather’s first weekly pay packet is updated in units of constant purchasing power for real value erosion in the US Dollar during the fifty or more years of his working life till the date of his comments on TV, we find that he started work at a monthly salary of about 5 000 US Dollars current at the date of his comments. So, at 60 000 US Dollar per year the grandfather had a very good starting salary – which is exactly the opposite of what he was trying to say to his grandson.
That is money illusion at work. Money illusion is so pervasive in our low inflation societies that we do not even notice it any more. It is a complete state of mind – a way of thinking.
We have to stop thinking in nominal terms and start thinking in real value terms. As long as there is inflation in an economy, the national currency created and used in that inflationary economy is not a store of perfectly stable real value. It is a store of decreasing real value. Money is losing real value all the time when an economy is in a state of inflation. 2% inflation is not price stability; 2% inflation is a high degree of price stability. It is some countries´ definition of price stability. It is not absolute price stability. All currently existing bank notes and coins will actually be completely worthless sometime in the future when an economy remains in an inflationary mode for a long enough period of time.
Money developed upon the mistaken belief that it is stable – as in fixed – in real value in the short to medium term in economies with low inflation. The term stable money is seen as meaning that money’s real value stays intact over the short to medium term in low inflationary economies. Money illusion is still very evident today in most economies in money, other monetary items and constant real value non–monetary items that are mistakenly considered to be monetary items under the Historical Cost paradigm; for example, trade debtors, trade creditors, dividends payable, dividends receivable, taxes payable, taxes receivable, etc.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
(The following is adapted from a live–event on US TV. Any resemblance to a living person is purely coincidental ;–)
Let us assume a highly respected 75–year–old grandfather tries to encourage his grandson to accept a low starting salary in a very good company as a good starting point for the youngster’s career. The grandfather may mention that when he started work he earned 25 Dollars per week – meaning that he also started with a low salary and worked his way up. Stating his starting salary at its original historical cost value of maybe more than 50 years ago completely falsified the example he gave. He was trying to say – and he certainly did, incorrectly (unintentional though it may have been) create the impression – that he started work at a low salary and had to work his way up. When the original historical cost value of 25 US Dollars of the grandfather’s first weekly pay packet is updated in units of constant purchasing power for real value erosion in the US Dollar during the fifty or more years of his working life till the date of his comments on TV, we find that he started work at a monthly salary of about 5 000 US Dollars current at the date of his comments. So, at 60 000 US Dollar per year the grandfather had a very good starting salary – which is exactly the opposite of what he was trying to say to his grandson.
That is money illusion at work. Money illusion is so pervasive in our low inflation societies that we do not even notice it any more. It is a complete state of mind – a way of thinking.
We have to stop thinking in nominal terms and start thinking in real value terms. As long as there is inflation in an economy, the national currency created and used in that inflationary economy is not a store of perfectly stable real value. It is a store of decreasing real value. Money is losing real value all the time when an economy is in a state of inflation. 2% inflation is not price stability; 2% inflation is a high degree of price stability. It is some countries´ definition of price stability. It is not absolute price stability. All currently existing bank notes and coins will actually be completely worthless sometime in the future when an economy remains in an inflationary mode for a long enough period of time.
Money developed upon the mistaken belief that it is stable – as in fixed – in real value in the short to medium term in economies with low inflation. The term stable money is seen as meaning that money’s real value stays intact over the short to medium term in low inflationary economies. Money illusion is still very evident today in most economies in money, other monetary items and constant real value non–monetary items that are mistakenly considered to be monetary items under the Historical Cost paradigm; for example, trade debtors, trade creditors, dividends payable, dividends receivable, taxes payable, taxes receivable, etc.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday 30 June 2011
Money illusion
Money illusion
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Definition: Money illusion is the mistaken belief that money is stable in real value over time.
Money illusion is primarily evident in low inflation countries. In hyperinflationary countries there is absolutely no money illusion as far as the hyperinflationary national currency is concerned. Everyone knows as a fact that the local hyperinflationary currency loses value day by day and even hour by hour. In low inflationary countries people are vaguely aware that money loses value over a long period of time. Money in a low inflationary economy is often used as if its real value is completely stable over the short term. That is money illusion.
Money illusion is evident everywhere in low inflationary economies. TV presenters reporting on historical events regularly quote Historical Cost values as the most natural thing to do. “Marble Arch was built for 10 000 Pounds ” the TV reporter states with sincere knowledge that his audience is being well entertained with correct facts and figures. It is a figure very difficult to instantaneously value today. 10 000 British Pounds was the original cost in historical terms but we live today and absolutely no–one can immediately imagine what the construction cost of Marble Arch was in current terms. It is the same as saying that something cost one Pound 300 years ago. It is impossible to immediately value it now. We live now and not 300 years in the past. We don’t know what some–one bought for a Pound 300 years ago. People in the United Kingdom know what a person can buy for one Pound now – and the Pound’s value changes month after month within the UK
Companies report an unending stream of information about their performance and results. Sales increased by 5 per cent over last year’s figures, for example. Are these historical cost comparisons or real value comparisons? It is more never than hardly ever stated.
Money illusion is very, very common in our low inflationary economies. Another example: The BBC ran a program about the fantastic E–Type Jaguar. The presenter stated that one of the many reasons why the E–type Jag – the best car ever, according to the presenter – was such a success, was its original nominal price of 2 500 Pounds at the time of its first introduction into the market. Towards the end of the program it is then stated that a number of years later these same original E–Type Jags sold at a nominal price at that time of 25 000 Pounds . It is thus implied to be 10 times more than the original price of 2 500 Pounds . In nominal terms, yes. We all agree. Certainly not in real terms and we are interested in real values. Nominal profits – however fantastic they may look – are misleading the longer the time period and the higher the rate of inflation or hyperinflation in the transaction currency during the time period involved.
In this example we are all led to believe that the E–Type Jag was sold at a real value 10 times its original real value. It is notorious money illusion at work. The real value in a sale like that certainly would not be 10 times the original real value once the original nominal price is adjusted for the effect of the stable measuring unit assumption – the assumption that money is stable in real value over time – as related to the British Pound over the years in question.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Tuesday 28 June 2011
Deflation
Deflation
Deflation is a sustained absolute annual decrease in the general price level of goods and services. Deflation happens when the annual inflation rate falls below zero percent (a negative annual inflation rate), resulting in an increase in the real value of money and all other monetary items. Deflation allows one to buy more goods with the same amount of money. This should not be confused with disinflation, a slow–down in the annual inflation rate (i.e. when annual inflation decreases, but still remains positive). Disinflation is a decrease in the annual rate of increase in the general price level. Annual inflation erodes the real value of money and other monetary items over time; conversely, annual deflation increases the real value of money and other monetary items in a national or regional economy over a period of time.
Inflation and deflation are both undesirable economic processes. As far as the understanding of inflation and deflation allows us at the moment, it can be stated that whatever level of deflation – however low – is to be avoided completely. A low level of inflation in an economy with financial capital maintenance in units of constant purchasing power (CIPPA) as the fundamental model of accounting implementing IFRS, is the best practice: a low level of inflation (best practice is currently regarded as 2% annual inflation) to limit the erosion of real value in money and other monetary items; IFRS for the correct valuation of variable real value non–monetary items and, thirdly, financial capital maintenance in units of constant purchasing power (CIPPA) as authorized in IFRS for automatically maintaining the existing constant real values of existing constant real value non–monetary items constant forever during low inflation and deflation in all entities that at least break even – ceteris paribus - without the requirement for extra capital or extra retained profits simply to maintain the existing constant real value of existing constant real value non–monetary items (e.g. equity) constant. Net monetary losses and gains are calculated and accounted in the income statement during low inflation and deflation when CIPPA is implemented: basically, the cost of inflation is accounted as a loss and deducted from profit before tax. Reducing the holding of monetary items (cash and other monetary items) over time would reduce the net monetary loss to a minimum during low inflation.
Entities do their best to compensate for the net monetary loss from holding cash and other monetary items by trying to invest them at rates higher than the expected inflation rate. Obviously, it is not possible before the event to know what the inflation rate will be during any future period. It is possible to invest money in some economies in inflation–proof investments: the interest paid is stated at the start of the contract to be equal to the inflation rate plus 2 or 3 or 4 per cent to give a real return on the investment.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Deflation is a sustained absolute annual decrease in the general price level of goods and services. Deflation happens when the annual inflation rate falls below zero percent (a negative annual inflation rate), resulting in an increase in the real value of money and all other monetary items. Deflation allows one to buy more goods with the same amount of money. This should not be confused with disinflation, a slow–down in the annual inflation rate (i.e. when annual inflation decreases, but still remains positive). Disinflation is a decrease in the annual rate of increase in the general price level. Annual inflation erodes the real value of money and other monetary items over time; conversely, annual deflation increases the real value of money and other monetary items in a national or regional economy over a period of time.
Inflation and deflation are both undesirable economic processes. As far as the understanding of inflation and deflation allows us at the moment, it can be stated that whatever level of deflation – however low – is to be avoided completely. A low level of inflation in an economy with financial capital maintenance in units of constant purchasing power (CIPPA) as the fundamental model of accounting implementing IFRS, is the best practice: a low level of inflation (best practice is currently regarded as 2% annual inflation) to limit the erosion of real value in money and other monetary items; IFRS for the correct valuation of variable real value non–monetary items and, thirdly, financial capital maintenance in units of constant purchasing power (CIPPA) as authorized in IFRS for automatically maintaining the existing constant real values of existing constant real value non–monetary items constant forever during low inflation and deflation in all entities that at least break even – ceteris paribus - without the requirement for extra capital or extra retained profits simply to maintain the existing constant real value of existing constant real value non–monetary items (e.g. equity) constant. Net monetary losses and gains are calculated and accounted in the income statement during low inflation and deflation when CIPPA is implemented: basically, the cost of inflation is accounted as a loss and deducted from profit before tax. Reducing the holding of monetary items (cash and other monetary items) over time would reduce the net monetary loss to a minimum during low inflation.
Entities do their best to compensate for the net monetary loss from holding cash and other monetary items by trying to invest them at rates higher than the expected inflation rate. Obviously, it is not possible before the event to know what the inflation rate will be during any future period. It is possible to invest money in some economies in inflation–proof investments: the interest paid is stated at the start of the contract to be equal to the inflation rate plus 2 or 3 or 4 per cent to give a real return on the investment.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Monday 27 June 2011
Net monetary gains and losses
Net monetary gains and losses
“Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical–cost basis.”
Harvey Kapnick, Chairman of Arthur Anderson & Company, Value based accounting: Evolution or revolution, Saxe Lecture, 1976, Page 6.
Net monetary gains and losses are constant real value non–monetary items once they are accounted in the income statement. All items accounted in the income statement are constant real value non–monetary items.
This omission under the Historical Cost paradigm to compute the gains and losses from holding monetary items is one of the consequences of the stable measuring unit assumption as implemented as part of the traditional Historical Cost Accounting model.
The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.
Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting,New York
Entities with net monetary item assets (weighted average of monetary item assets greater than weighted average of monetary item liabilities) over a period of time, e.g. a year, will suffer a net monetary loss (less real monetary item value owned/more real monetary item value – real monetary item assets – eroded) during inflation – all else being equal. Companies with net monetary item liabilities (weighted average of monetary item liabilities greater than the weighted average of monetary item assets) will experience a net monetary gain (less real monetary item value owed/more real monetary item liabilities eroded) during inflation – ceteris paribus. The opposite is true during deflation.
Net monetary gains and losses are calculated and accounted during hyperinflation as required by IAS 29 Financial Reporting in Hyperinflationary Economies. The calculation and accounting of net monetary gains and losses have also been authorized in IFRS with the measurement of financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par 104 (a) during low inflation and deflation, i.e. under the Constant Item Purchasing Power Accounting model. Net monetary gains and losses are not required to be computed under the traditional Historical Cost Accounting model although it can be done.
“Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical–cost basis.”
Harvey Kapnick, Chairman of Arthur Anderson & Company, Value based accounting: Evolution or revolution, Saxe Lecture, 1976, Page 6.
Net monetary gains and losses are constant real value non–monetary items once they are accounted in the income statement. All items accounted in the income statement are constant real value non–monetary items.
This omission under the Historical Cost paradigm to compute the gains and losses from holding monetary items is one of the consequences of the stable measuring unit assumption as implemented as part of the traditional Historical Cost Accounting model.
The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.
Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting,
The practice of calculating and accounting net monetary gains and losses during hyperinflation and during low inflation and deflation only with the implementation of IFRS–authorized financial capital maintenance in units of constant purchasing power (CIPPA), but, not during the implementation of the Historical Cost Accounting model during low inflation and deflation is one of the various confounding generally accepted perplexities in traditional Historical Cost Accounting.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Saturday 25 June 2011
Inflation is always and everywhere a monetary phenomenon
Inflation is always and everywhere a monetary phenomenon
Milton Friedman, A monetary history of the United States 1867 – 1960 (1963)
Inflation is a sustained annual increase in the general price level of goods and services in an economy. Prices are generally quoted in terms of money. During inflation each unit of the monetary unit buys fewer goods and services; consequently, annual inflation only erodes the real value of each monetary medium of exchange unit evenly over time. Inflation has no effect on the real value of non–monetary items.
Inflation erodes real value evenly in money and other monetary items over time. There are, consequently, hidden monetary costs to some and hidden monetary benefits to others from this erosion in purchasing power in monetary items that are assets to some while – a the same time – liabilities to others; e.g. the capital amount of a loan. The debtor (in the case of a monetary loan) gains during inflation since he, she or it (a company) has to pay back the nominal value of the loan, the real value of which is being eroded by inflation. The debtor (of a monetary loan) pays back less real value during inflation. The creditor (in the case of a monetary loan) loses out because he, she or it receives the nominal value of the loan back, but, the real value paid back is lower as a result of inflation. Efficient lenders recover this loss in real value by charging interest at a rate they hope will be higher than the actual inflation rate during the period of the loan.
An increase in the general price level (inflation) erodes the real value of money and other monetary items with an underlying monetary nature, e.g. the capital values of bonds and loans. However, inflation has no effect on the real value of variable real value non–monetary items (e.g. property, plant, equipment, cars, gold, inventories, finished goods, foreign exchange, etc.) and constant real value non–monetary items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, dividends payable, dividends receivable, etc.).
Fixed constant real value non–monetary items never updated are effectively treated as monetary items when the stable measuring unit assumption is implemented as part of the HCA model during low inflation. Implementing the HCA model unknowingly, unintentionally and unnecessarily erodes their real values at a rate equal to the annual rate of inflation because they are measured in nominal monetary units during low inflation. Inflation only erodes the real value of money which is the nominal monetary unit of account in the economy. This unknowing, unintentional and unnecessary erosion in fixed constant real value non–monetary items never maintained constant during low inflation stops when financial capital maintenance is measured in units of constant purchasing power during low inflation; i.e., implementing the CIPPA model. It is thus the implementation of financial capital maintenance in nominal monetary units in terms of the Historical Cost Accounting model and not inflation that is doing the eroding.
The generally accepted measure of inflation in low inflationary economies is the annual inflation rate, calculated from the annualized percentage change in a general price index – normally the Consumer Price Index – published on a monthly basis. The correct measure of inflation in a hyperinflationary economy is a Brazilian-style daily index value almost entirely based on the daily parallel rate (normally the US Dollar parallel rate) – where a parallel rate is in use, officially or unofficially. The CPI published a month and a half to two months after the hyperinflationary changes in the real value of the monetary unit actually happened, is completely impractical and totally ineffective as a measure of inflation when the aim is to stabilize the real economy during hyperinflation as Brazil so effectively did with daily indexation during 30 years of high and hyperinflation. This is only possible with daily indexing of all non–monetary items as was done in Brazil from 1964 to 1994 or with measuring financial capital maintenance in units of constant purchasing power during hyperinflation, i.e. updating all non–monetary items (variable real value non–monetary items and constant real value non–monetary items) on a daily basis applying the daily change in the parallel rate and not the period–end CPI as currently required by IAS 29.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Milton Friedman, A monetary history of the United States 1867 – 1960 (1963)
Inflation is a sustained annual increase in the general price level of goods and services in an economy. Prices are generally quoted in terms of money. During inflation each unit of the monetary unit buys fewer goods and services; consequently, annual inflation only erodes the real value of each monetary medium of exchange unit evenly over time. Inflation has no effect on the real value of non–monetary items.
Inflation erodes real value evenly in money and other monetary items over time. There are, consequently, hidden monetary costs to some and hidden monetary benefits to others from this erosion in purchasing power in monetary items that are assets to some while – a the same time – liabilities to others; e.g. the capital amount of a loan. The debtor (in the case of a monetary loan) gains during inflation since he, she or it (a company) has to pay back the nominal value of the loan, the real value of which is being eroded by inflation. The debtor (of a monetary loan) pays back less real value during inflation. The creditor (in the case of a monetary loan) loses out because he, she or it receives the nominal value of the loan back, but, the real value paid back is lower as a result of inflation. Efficient lenders recover this loss in real value by charging interest at a rate they hope will be higher than the actual inflation rate during the period of the loan.
An increase in the general price level (inflation) erodes the real value of money and other monetary items with an underlying monetary nature, e.g. the capital values of bonds and loans. However, inflation has no effect on the real value of variable real value non–monetary items (e.g. property, plant, equipment, cars, gold, inventories, finished goods, foreign exchange, etc.) and constant real value non–monetary items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, dividends payable, dividends receivable, etc.).
Fixed constant real value non–monetary items never updated are effectively treated as monetary items when the stable measuring unit assumption is implemented as part of the HCA model during low inflation. Implementing the HCA model unknowingly, unintentionally and unnecessarily erodes their real values at a rate equal to the annual rate of inflation because they are measured in nominal monetary units during low inflation. Inflation only erodes the real value of money which is the nominal monetary unit of account in the economy. This unknowing, unintentional and unnecessary erosion in fixed constant real value non–monetary items never maintained constant during low inflation stops when financial capital maintenance is measured in units of constant purchasing power during low inflation; i.e., implementing the CIPPA model. It is thus the implementation of financial capital maintenance in nominal monetary units in terms of the Historical Cost Accounting model and not inflation that is doing the eroding.
The generally accepted measure of inflation in low inflationary economies is the annual inflation rate, calculated from the annualized percentage change in a general price index – normally the Consumer Price Index – published on a monthly basis. The correct measure of inflation in a hyperinflationary economy is a Brazilian-style daily index value almost entirely based on the daily parallel rate (normally the US Dollar parallel rate) – where a parallel rate is in use, officially or unofficially. The CPI published a month and a half to two months after the hyperinflationary changes in the real value of the monetary unit actually happened, is completely impractical and totally ineffective as a measure of inflation when the aim is to stabilize the real economy during hyperinflation as Brazil so effectively did with daily indexation during 30 years of high and hyperinflation. This is only possible with daily indexing of all non–monetary items as was done in Brazil from 1964 to 1994 or with measuring financial capital maintenance in units of constant purchasing power during hyperinflation, i.e. updating all non–monetary items (variable real value non–monetary items and constant real value non–monetary items) on a daily basis applying the daily change in the parallel rate and not the period–end CPI as currently required by IAS 29.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Friday 24 June 2011
CIPPA update: June 2011
CIPPA update: June 2011
The proposal for publishing the book "Constant Item Purchasing Power Accounting" is with a publisher in SA for more than two months by now. I think this editor is seriously looking at publishing the book. The editor asked me for SA and overseas reviewers. I fortunately managed to get David Mosso to read a 10 page abstract of the book and to agree to write a review for the publisher. David Mosso is almost the US equivalent of Sir David Tweedie, the chairman of the IASB. David Mosso was one of the three dissenting votes with US FAS 89 which made measurement in units of constant purchasing power voluntary for US companies. He and the other two dissenting votes wanted it to be compulsary. He stated in FAS 89 that dealing with the effect of "inflation" in accounting "is the most important item the US FASB will deal with this century." He now agrees that it is not inflation but the stable measuring unit assumption that is doing the damage. His remarks to me after reading the abstract was "Good work" and he agreed to write the review for the publisher.
I am absolutely sure that financail capital maintenance in units of constant purchasing power (CIPPA) will eventually prevail over financial capital maintenance in nominal monetary units (HCA) which is - in fact - a fallacy since it is impossible to maintain the constant purchasing power of capital constant with financial capital maintenance in nominal monetary untis - per se - during inflation and deflation.
Both financial capital maintenance in nominal monetary units (traditional HCA) and in units of constant purchasing power (CIPPA) have been authorized in IFRS in the original Framework (1989), Par 104 (a).
The reason capital maintenance in units of constant purchasing power never went ahead was because non-monetary items were not yet split in variable and constant items in 1986. I identified the split in 2005 and it was peer reviewed (three times) and published in SAICA´s journal Accountancy SA in 2007. (see link on the right).
What is missing now is for the due process of CIPPA to be completed. IFRS authorization in 1989 was only the start: a very important start. Due process for CIPPA to be completed requires peer review, publication, discussion, practical implementation, software updates, education, staff training, etc.
A lot of that is still to come.
IFRS authorization was a very important first step. The IFRS Foundation (IASB) has done its part brilliantly in 1989.
The split of non-monetary items in variable and constant items enabled the completion of the constant item purchasing power accounting (CIPPA) model.
The publication of the book will be an important third step.
Then practical implementation.
Education, adaptation of accounting software packages, development of auditing of CIPPA, etc, etc will then follow.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The proposal for publishing the book "Constant Item Purchasing Power Accounting" is with a publisher in SA for more than two months by now. I think this editor is seriously looking at publishing the book. The editor asked me for SA and overseas reviewers. I fortunately managed to get David Mosso to read a 10 page abstract of the book and to agree to write a review for the publisher. David Mosso is almost the US equivalent of Sir David Tweedie, the chairman of the IASB. David Mosso was one of the three dissenting votes with US FAS 89 which made measurement in units of constant purchasing power voluntary for US companies. He and the other two dissenting votes wanted it to be compulsary. He stated in FAS 89 that dealing with the effect of "inflation" in accounting "is the most important item the US FASB will deal with this century." He now agrees that it is not inflation but the stable measuring unit assumption that is doing the damage. His remarks to me after reading the abstract was "Good work" and he agreed to write the review for the publisher.
I am absolutely sure that financail capital maintenance in units of constant purchasing power (CIPPA) will eventually prevail over financial capital maintenance in nominal monetary units (HCA) which is - in fact - a fallacy since it is impossible to maintain the constant purchasing power of capital constant with financial capital maintenance in nominal monetary untis - per se - during inflation and deflation.
Both financial capital maintenance in nominal monetary units (traditional HCA) and in units of constant purchasing power (CIPPA) have been authorized in IFRS in the original Framework (1989), Par 104 (a).
The reason capital maintenance in units of constant purchasing power never went ahead was because non-monetary items were not yet split in variable and constant items in 1986. I identified the split in 2005 and it was peer reviewed (three times) and published in SAICA´s journal Accountancy SA in 2007. (see link on the right).
What is missing now is for the due process of CIPPA to be completed. IFRS authorization in 1989 was only the start: a very important start. Due process for CIPPA to be completed requires peer review, publication, discussion, practical implementation, software updates, education, staff training, etc.
A lot of that is still to come.
IFRS authorization was a very important first step. The IFRS Foundation (IASB) has done its part brilliantly in 1989.
The split of non-monetary items in variable and constant items enabled the completion of the constant item purchasing power accounting (CIPPA) model.
The publication of the book will be an important third step.
Then practical implementation.
Education, adaptation of accounting software packages, development of auditing of CIPPA, etc, etc will then follow.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday 22 June 2011
Money makes the world go round
Money makes the world go round
Money is the greatest economic invention of all time. Money did not exist and was not discovered. Money was invented over a long period of time.
Money is not perfectly stable in real value even though all historical cost accounting world-wide is done assuming that when the stable measuring unit assumption is implemented for the valuation of most – not all – constant real value non-monetary items during low inflation and deflation. It is assumed, in principle, that money is perfectly stable when all balance sheet constant real value non–monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in shareholders´ equity, provisions, trade debtors , trade creditors, all non–monetary payables, all non–monetary receivables and all income statement items (excluding constant real value non–monetary items like salaries, wages, rentals, transport fees, etc. which are correctly updated annually) are valued at their historical costs when financial capital maintenance in nominal monetary units (the Historical Cost Accounting model) is implemented during low inflation and deflation as authorized in IFRs in the original Framework (1989), Par 104 (a).
Money is not the same as constant real value during inflation and deflation. Money only has a constant real value over time during sustainable zero annual inflation which has never been achieved in the past and is not likely soon to be achieved in the future.
Bank notes and coins are physical tokens of money. Money is a monetary item which is used as a monetary medium of exchange and serves at the same time as a monetary store of value and as the monetary unit of account for the accounting of economic activity in a country or a monetary union. All three basic economic items – monetary items, variable real value non–monetary items and constant real value non–monetary items – are valued in terms of money. The European Monetary Union uses the Euro as its monetary unit. The US Dollar is the monetary unit most widely traded internationally. The Rand Common Monetary Area which includes South Africa, Namibia, Swaziland and Lesotho employs the Rand as the common monetary unit and monetary unit of account.
An earlier form of money was commodity money; e.g. gold, silver and copper coins. Today money is generally fiat money created by government fiat or decree.
Money is a medium of exchange which is its main function. Without that function it can never be money. The historical development of money led it also to be used as a store of value and as the unit of measure to account the values of economic items.
Money is the only unit of measure that is not a stable value under all circumstances. Money is only perfectly stable in real value at zero per cent annual inflation. This has never been achieved over a sustainable period of time. All other units of measure are fundamentally stable units of measure, e.g. inch, centimetre, ounce, gram, kilogram, pound, etc.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Money is the greatest economic invention of all time. Money did not exist and was not discovered. Money was invented over a long period of time.
Money is not perfectly stable in real value even though all historical cost accounting world-wide is done assuming that when the stable measuring unit assumption is implemented for the valuation of most – not all – constant real value non-monetary items during low inflation and deflation. It is assumed, in principle, that money is perfectly stable when all balance sheet constant real value non–monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in shareholders´ equity, provisions, trade debtors , trade creditors, all non–monetary payables, all non–monetary receivables and all income statement items (excluding constant real value non–monetary items like salaries, wages, rentals, transport fees, etc. which are correctly updated annually) are valued at their historical costs when financial capital maintenance in nominal monetary units (the Historical Cost Accounting model) is implemented during low inflation and deflation as authorized in IFRs in the original Framework (1989), Par 104 (a).
Money is not the same as constant real value during inflation and deflation. Money only has a constant real value over time during sustainable zero annual inflation which has never been achieved in the past and is not likely soon to be achieved in the future.
Bank notes and coins are physical tokens of money. Money is a monetary item which is used as a monetary medium of exchange and serves at the same time as a monetary store of value and as the monetary unit of account for the accounting of economic activity in a country or a monetary union. All three basic economic items – monetary items, variable real value non–monetary items and constant real value non–monetary items – are valued in terms of money. The European Monetary Union uses the Euro as its monetary unit. The US Dollar is the monetary unit most widely traded internationally. The Rand Common Monetary Area which includes South Africa, Namibia, Swaziland and Lesotho employs the Rand as the common monetary unit and monetary unit of account.
An earlier form of money was commodity money; e.g. gold, silver and copper coins. Today money is generally fiat money created by government fiat or decree.
Money is a medium of exchange which is its main function. Without that function it can never be money. The historical development of money led it also to be used as a store of value and as the unit of measure to account the values of economic items.
Money is the only unit of measure that is not a stable value under all circumstances. Money is only perfectly stable in real value at zero per cent annual inflation. This has never been achieved over a sustainable period of time. All other units of measure are fundamentally stable units of measure, e.g. inch, centimetre, ounce, gram, kilogram, pound, etc.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Tuesday 21 June 2011
CIPPA increases a company’s net asset value
CIPPA increases a company’s net asset value over time as compared to carrying on with implementing the very erosive stable measuring unit assumption as it forms part of the Historical Cost Accounting model. The stable measuring unit assumption is never implemented under CIPPA.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Saturday 18 June 2011
HCA is not an appropriate accounting policy
HCA is not an appropriate accounting policy
Auditors state in the audit report that the directors´ responsibility for the financial statements includes selecting and applying appropriate accounting policies. The audit report also normally states under the Auditors´ Responsibility that an audit includes evaluating the appropriateness of accounting policies used in a company. So, both the directors and the auditors have a responsibility with regards to the appropriateness of accounting policies for a company.
The implementation of the very erosive stable measuring unit assumption which is based on a fallacy and financial capital maintenance in nominal monetary units per se which is a fallacy during inflation and deflation means that the use of the HCA model is – in principle - not an appropriate accounting policy for companies during inflation and deflation.
The IASB, on the one hand, agrees that the stable measuring unit assumption and financial capital maintenance in nominal monetary units per se are not appropriate accounting policies in hyperinflationary economies.
IAS 29 Financial Reporting in Hyperinflationary Economies states that:
“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2
Very unfortunately, the IASB, on the other hand – in the same standard, authorizes and supports the use of the HCA model during hyperinflation:
“The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.” IAS 29, Par 8
Big Four audit firms, e.g. PricewaterhouseCoopers, also support the use of HCA during hyperinflation:
“Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting.”
Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.
When it is clearly demonstrated and the board of directors knows that a company’s HC accounting policy - freely selected by the board - continuously erodes a significant amount of the existing constant real non-monetary value of the company´s Shareholders´ Equity as a result of the company’s implementation of the very erosive stable measuring unit assumption when the company assumes that it would be for an unlimited period of time during indefinite inflation, then the traditional HCA model is , in principle, not an appropriate accounting policy. When the board knows that financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) - as approved by the IASB in the original Framework (1989), Par 104 (a) - is an IFRS–compliant alternative freely available to the company and when the board knows that CIPPA would automatically stop the unnecessary erosion of existing constant real non–monetary value in existing constant items never maintained constant for an indefinite period of time in all entities that at least break even during low inflation – ceteris paribus - then the traditional HCA model is , in principle, not an appropriate accounting policy.
The principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation has been subjected to a “thorough, open, participatory and transparent, due process” at the IASB, and elsewhere, before it was approved in the original Framework (1989), Par 104 (a) twenty two years ago. The principle is thus generally accepted in the accounting and auditing professions. However, the practice of financial capital maintenance in unit of constant purchasing power during low inflation and deflation (CIPPA) is not yet generally accepted sine the due process is not yet complete. Neither have accounting software packages been adapted for the implementation of CIPPA, nor has accounting personnel been trained to implement financial capital maintenance in units of constant purchasing power during low inflation and deflation, nor have audit procedures been adapted by auditors to audit companies implementing the Constant Item Purchasing Accounting model. That is: the due process is not yet complete for CIPPA.
Currently financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is thus an appropriate accounting policy in principle but is not yet generally implemented in practice. HCA is thus not an appropriate accounting policy, in principle, but, is generally implemented in practice. The current implementation of the HCA model is thus still an appropriate (very costly to the world economy) accounting policy, in practice, but not in principle. However, as soon as the practical implementation of financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (CIPPA) has passed proper due process; accounting software packages have been adapted to CIPPA; accounting personnel have been trained to implement CIPPA and audit procedures have been adapted by audit firms to audit companies implementing CIPPA, then the HCA model will certainly not be an appropriate accounting policy – in principle and in practice.
This will not happen overnight. As was stated in US FAS 89 in 1986:
“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.”
and
“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.”
Any single entity can now implement CIPPA since non-monetary items have been properly split in variable and constant items since 2005.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Auditors state in the audit report that the directors´ responsibility for the financial statements includes selecting and applying appropriate accounting policies. The audit report also normally states under the Auditors´ Responsibility that an audit includes evaluating the appropriateness of accounting policies used in a company. So, both the directors and the auditors have a responsibility with regards to the appropriateness of accounting policies for a company.
The implementation of the very erosive stable measuring unit assumption which is based on a fallacy and financial capital maintenance in nominal monetary units per se which is a fallacy during inflation and deflation means that the use of the HCA model is – in principle - not an appropriate accounting policy for companies during inflation and deflation.
The IASB, on the one hand, agrees that the stable measuring unit assumption and financial capital maintenance in nominal monetary units per se are not appropriate accounting policies in hyperinflationary economies.
IAS 29 Financial Reporting in Hyperinflationary Economies states that:
“In a hyperinflationary economy, reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.” IAS 29 Par 2
Very unfortunately, the IASB, on the other hand – in the same standard, authorizes and supports the use of the HCA model during hyperinflation:
“The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.” IAS 29, Par 8
Big Four audit firms, e.g. PricewaterhouseCoopers, also support the use of HCA during hyperinflation:
“Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting.”
Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.
When it is clearly demonstrated and the board of directors knows that a company’s HC accounting policy - freely selected by the board - continuously erodes a significant amount of the existing constant real non-monetary value of the company´s Shareholders´ Equity as a result of the company’s implementation of the very erosive stable measuring unit assumption when the company assumes that it would be for an unlimited period of time during indefinite inflation, then the traditional HCA model is , in principle, not an appropriate accounting policy. When the board knows that financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) - as approved by the IASB in the original Framework (1989), Par 104 (a) - is an IFRS–compliant alternative freely available to the company and when the board knows that CIPPA would automatically stop the unnecessary erosion of existing constant real non–monetary value in existing constant items never maintained constant for an indefinite period of time in all entities that at least break even during low inflation – ceteris paribus - then the traditional HCA model is , in principle, not an appropriate accounting policy.
The principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation has been subjected to a “thorough, open, participatory and transparent, due process” at the IASB, and elsewhere, before it was approved in the original Framework (1989), Par 104 (a) twenty two years ago. The principle is thus generally accepted in the accounting and auditing professions. However, the practice of financial capital maintenance in unit of constant purchasing power during low inflation and deflation (CIPPA) is not yet generally accepted sine the due process is not yet complete. Neither have accounting software packages been adapted for the implementation of CIPPA, nor has accounting personnel been trained to implement financial capital maintenance in units of constant purchasing power during low inflation and deflation, nor have audit procedures been adapted by auditors to audit companies implementing the Constant Item Purchasing Accounting model. That is: the due process is not yet complete for CIPPA.
Currently financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) is thus an appropriate accounting policy in principle but is not yet generally implemented in practice. HCA is thus not an appropriate accounting policy, in principle, but, is generally implemented in practice. The current implementation of the HCA model is thus still an appropriate (very costly to the world economy) accounting policy, in practice, but not in principle. However, as soon as the practical implementation of financial capital maintenance in units of constant purchasing power accounting during low inflation and deflation (CIPPA) has passed proper due process; accounting software packages have been adapted to CIPPA; accounting personnel have been trained to implement CIPPA and audit procedures have been adapted by audit firms to audit companies implementing CIPPA, then the HCA model will certainly not be an appropriate accounting policy – in principle and in practice.
This will not happen overnight. As was stated in US FAS 89 in 1986:
“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.”
and
“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.”
Any single entity can now implement CIPPA since non-monetary items have been properly split in variable and constant items since 2005.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Friday 17 June 2011
Nine requirements for audited HC financial statement to fairly present an entity´s financial position
Nine requirements for audited HC financial statement to fairly present an entity´s financial position
Audited annual financial statements provided by companies which prepare them using the traditional Historical Cost Accounting model, i.e., when the board of directors choose to measure financial capital maintenance in nominal monetary units during low inflation and deflation instead of in units of constant purchasing power in terms of the IASB´ original Framework (1989), Par 104 (a), are compliant with IFRS, but, do not - in principle - fairly present the financial position of the companies.
The SA Companies Act, No 71 of 2008, Article 29.1 (b), for example, states:
“If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must –
(b) present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company;”
Audited financial statements prepared in terms of the HCA model do not - in principle - fairly present the financial position of companies during low inflation when the directors do not:
(1) state in the annual financial statements that their choice of the traditional Historical Cost Accounting model which includes the very erosive stable measuring unit assumption, erodes the constant real value of constant real value non–monetary items never maintained constant at a rate equal to the annual rate of inflation;
(2) state that this includes the erosion of the constant real value of Shareholders´ Equity when the company does not have sufficient revaluable fixed assets that are or can be revalued via the Revaluation Reserve with an updated fair value equal to the updated original constant real non-monetary value of all contributions to Shareholders’ Equity under the HCA model during low inflation;
(3) state the percentage and updated amount of constant real non-monetary value of Shareholders´ Equity that are not being maintained constant; i.e., the percentage and updated amount of constant real non-monetary value of Shareholders´ Equity that are subject to constant real value erosion at a rate equal to the annual inflation rate because of the directors´ free choice, in terms of the original Framework (1989), Par 104 (a), to measure financial capital maintenance in nominal monetary units (which is a popular accounting fallacy since it is impossible per se during inflation) – i.e. their free choice to implement the very erosive stable measuring unit assumption during inflation - instead of automatically maintaining the constant real value of Shareholders´ Equity constant for an indefinite period of time in units of constant purchasing power (both methods being compliant with IFRS) when their companies at least break even – ceteris paribus.
(4) state the amount of updated constant real non-monetary value eroded during the last and previous financial year in Shareholders´ Equity and all other constant real value non–monetary items never maintained constant because of the directors´ free choice to implement the Historical Cost Accounting model;
(5) state the updated total amount of constant real non-monetary value eroded from the company’s inception to date in this manner in at least Shareholders´ Equity never maintained constant as described above;
(6) state the change in the updated constant real non-monetary value of Shareholders´ Equity if the directors should decide – as they are freely allowed to do at any time – to measure financial capital maintenance in units of constant purchasing power which would automatically maintain the constant purchasing power of Shareholders´ equity constant forever in entities that at least break even during inflation and deflation – ceteris paribus - instead of in nominal monetary units also authorized in IFRS in the original Framework (1989), Par 104 (a);
(7) state the directors´ estimate of the amount of constant real non-monetary value to be eroded by their free choice to implement the very erosive stable measuring unit assumption (which is based on the popular accounting fallacy - also approved by the IASB - that changes in the purchasing power of money are not sufficiently important during low inflation and deflation to require financial capital maintenance in units of constant purchasing power) during the following accounting year under the HC basis;
(8) state that the updated constant real non–monetary value calculated in (7) represents the amount of constant real non–monetary value the company would gain during the following accounting year and every year thereafter for an unlimited period of time as long as the company at least break even during inflation and deflation – ceteris paribus – when the directors choose to measure financial capital maintenance in units of constant purchasing power as authorized in IFRS in the original Framework (1989), Par 104 (a) - which they are free to choose any time they decide;
(9) state the directors´ reason(s) for freely choosing financial capital maintenance in constant real value eroding nominal monetary units which is a fallacy since it is impossible per se during inflation and deflation instead of in real value maintaining units of constant purchasing power which would automatically maintain the constant purchasing power of Shareholders´ Equity constant forever in all entities that at least break even during inflation and deflation – ceteris paribus.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Audited annual financial statements provided by companies which prepare them using the traditional Historical Cost Accounting model, i.e., when the board of directors choose to measure financial capital maintenance in nominal monetary units during low inflation and deflation instead of in units of constant purchasing power in terms of the IASB´ original Framework (1989), Par 104 (a), are compliant with IFRS, but, do not - in principle - fairly present the financial position of the companies.
The SA Companies Act, No 71 of 2008, Article 29.1 (b), for example, states:
“If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must –
(b) present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company;”
Audited financial statements prepared in terms of the HCA model do not - in principle - fairly present the financial position of companies during low inflation when the directors do not:
(1) state in the annual financial statements that their choice of the traditional Historical Cost Accounting model which includes the very erosive stable measuring unit assumption, erodes the constant real value of constant real value non–monetary items never maintained constant at a rate equal to the annual rate of inflation;
(2) state that this includes the erosion of the constant real value of Shareholders´ Equity when the company does not have sufficient revaluable fixed assets that are or can be revalued via the Revaluation Reserve with an updated fair value equal to the updated original constant real non-monetary value of all contributions to Shareholders’ Equity under the HCA model during low inflation;
(3) state the percentage and updated amount of constant real non-monetary value of Shareholders´ Equity that are not being maintained constant; i.e., the percentage and updated amount of constant real non-monetary value of Shareholders´ Equity that are subject to constant real value erosion at a rate equal to the annual inflation rate because of the directors´ free choice, in terms of the original Framework (1989), Par 104 (a), to measure financial capital maintenance in nominal monetary units (which is a popular accounting fallacy since it is impossible per se during inflation) – i.e. their free choice to implement the very erosive stable measuring unit assumption during inflation - instead of automatically maintaining the constant real value of Shareholders´ Equity constant for an indefinite period of time in units of constant purchasing power (both methods being compliant with IFRS) when their companies at least break even – ceteris paribus.
(4) state the amount of updated constant real non-monetary value eroded during the last and previous financial year in Shareholders´ Equity and all other constant real value non–monetary items never maintained constant because of the directors´ free choice to implement the Historical Cost Accounting model;
(5) state the updated total amount of constant real non-monetary value eroded from the company’s inception to date in this manner in at least Shareholders´ Equity never maintained constant as described above;
(6) state the change in the updated constant real non-monetary value of Shareholders´ Equity if the directors should decide – as they are freely allowed to do at any time – to measure financial capital maintenance in units of constant purchasing power which would automatically maintain the constant purchasing power of Shareholders´ equity constant forever in entities that at least break even during inflation and deflation – ceteris paribus - instead of in nominal monetary units also authorized in IFRS in the original Framework (1989), Par 104 (a);
(7) state the directors´ estimate of the amount of constant real non-monetary value to be eroded by their free choice to implement the very erosive stable measuring unit assumption (which is based on the popular accounting fallacy - also approved by the IASB - that changes in the purchasing power of money are not sufficiently important during low inflation and deflation to require financial capital maintenance in units of constant purchasing power) during the following accounting year under the HC basis;
(8) state that the updated constant real non–monetary value calculated in (7) represents the amount of constant real non–monetary value the company would gain during the following accounting year and every year thereafter for an unlimited period of time as long as the company at least break even during inflation and deflation – ceteris paribus – when the directors choose to measure financial capital maintenance in units of constant purchasing power as authorized in IFRS in the original Framework (1989), Par 104 (a) - which they are free to choose any time they decide;
(9) state the directors´ reason(s) for freely choosing financial capital maintenance in constant real value eroding nominal monetary units which is a fallacy since it is impossible per se during inflation and deflation instead of in real value maintaining units of constant purchasing power which would automatically maintain the constant purchasing power of Shareholders´ Equity constant forever in all entities that at least break even during inflation and deflation – ceteris paribus.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Thursday 16 June 2011
Three concepts of capital maintenance under IFRS
Three concepts of capital maintenance under IFRS
IFRS authorized financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par. 104 (a) which means that there are three concepts of capital maintenance authorized in IFRS since 1989.
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Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
IFRS authorized financial capital maintenance in units of constant purchasing power in the original Framework (1989), Par. 104 (a) which means that there are three concepts of capital maintenance authorized in IFRS since 1989.
Buy the ebook for $2.99 or £1.53 or €2.68
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday 15 June 2011
Nominal financial capital maintenance concept commonly chosen
Nominal financial capital maintenance concept commonly chosen by entities in the world economy implementing the very erosive stable measuring unit assumption as it forms part of the HCA model responsible for hundreds of billion of US Dollars of erosion of constant item real value per annum in the world´s constant item economy.
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Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Buy the ebook for $2.99 or £1.53 or €2.68
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Tuesday 14 June 2011
No revaluable fixed assets required per se to automatically maintain capital constant forever
No revaluable fixed assets required per se to automatically maintain capital constant forever
A company’s capital is synonymous with its Net Assets or Shareholder´s Equity under a financial concept of capital such as invested money or invested purchasing power.
100% of the updated original constant real value of all contributions to Shareholders´ Equity have to be invested in revaluable fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) in order not to erode any Shareholders´ Equity’s existing constant real non–monetary value during low inflation under the traditional Historical Cost Accounting model – i.e. measuring financial capital maintenance in nominal monetary units as implemented by most entities.
The existing constant real non–monetary value of that portion of existing shareholders´ equity not invested in revaluable fixed assets (revalued or not) is currently unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation when the constant real value non–monetary item shareholders equity is measured in nominal monetary units, i.e. implementing the very erosive stable measuring unit assumption as done by most entities when they implement the HCA model for an unlimited period of time during indefinite low inflation.
Most entities do not meet the requirement to investment 100% of the updated original real value of all contributions to Shareholders´ Equity in revaluable fixed assets. Entities that possibly meet the 100% of the updated original real value of all contributions to shareholder´s equity requirement are hotel, hospital, property and similar companies. In practice this means that the real value of Retained Earnings never maintained constant of most companies and banks are unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation by entities implementing the IFRS–approved traditional HCA model during low inflation.
Implementing the IFRS–authorized alternative, namely, financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) as authorized in 1989 in the original Framework (1989), Par 104 (a), automatically stops this unknowing, unintentional and unnecessary erosion by the implement of the stable measuring unit assumption forever at all levels of inflation in all entities that at least break even – ceteris paribus – whether they own revaluable fixed assets or not and without the requirement of more money or more Retained Earnings just to maintain the existing constant real non–monetary value of existing Shareholders´ Equity constant.
No–one will disagree that inflation and not the stable measuring unit assumption erodes the real value of money and other monetary items in the monetary economy despite the fact that central banks and monetary authorities regard the erosion of from 2 to 6% per annum of the real value of the monetary unit as the achievement and maintenance of “price stability” in the economic system. Obviously it is not price stability at all. It is 2 to 6% per annum away from price stability. It is the central bank´s choice of “price stability”: their definition of “price stability”. Absolute price stability is a year–on–year increase of zero percent in the Consumer Price Index. Positive annual inflation of up to 2% is a high degree of price stability. It is not absolute price stability.
The IASB only requires the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. The IASB defines hyperinflation as cumulative inflation over three years approaching or equal to 100%, i.e. annual inflation of 26% for three years in a row. This means that central banks could define “price stability” as annual inflation at any rate from 0.001 to 25.99% per annum.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
A company’s capital is synonymous with its Net Assets or Shareholder´s Equity under a financial concept of capital such as invested money or invested purchasing power.
100% of the updated original constant real value of all contributions to Shareholders´ Equity have to be invested in revaluable fixed assets with an equivalent maintained fair value (revalued or with unrecorded hidden holding gains) in order not to erode any Shareholders´ Equity’s existing constant real non–monetary value during low inflation under the traditional Historical Cost Accounting model – i.e. measuring financial capital maintenance in nominal monetary units as implemented by most entities.
The existing constant real non–monetary value of that portion of existing shareholders´ equity not invested in revaluable fixed assets (revalued or not) is currently unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation when the constant real value non–monetary item shareholders equity is measured in nominal monetary units, i.e. implementing the very erosive stable measuring unit assumption as done by most entities when they implement the HCA model for an unlimited period of time during indefinite low inflation.
Most entities do not meet the requirement to investment 100% of the updated original real value of all contributions to Shareholders´ Equity in revaluable fixed assets. Entities that possibly meet the 100% of the updated original real value of all contributions to shareholder´s equity requirement are hotel, hospital, property and similar companies. In practice this means that the real value of Retained Earnings never maintained constant of most companies and banks are unknowingly, unintentionally and unnecessarily being eroded at a rate equal to the annual rate of inflation by entities implementing the IFRS–approved traditional HCA model during low inflation.
Implementing the IFRS–authorized alternative, namely, financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) as authorized in 1989 in the original Framework (1989), Par 104 (a), automatically stops this unknowing, unintentional and unnecessary erosion by the implement of the stable measuring unit assumption forever at all levels of inflation in all entities that at least break even – ceteris paribus – whether they own revaluable fixed assets or not and without the requirement of more money or more Retained Earnings just to maintain the existing constant real non–monetary value of existing Shareholders´ Equity constant.
No–one will disagree that inflation and not the stable measuring unit assumption erodes the real value of money and other monetary items in the monetary economy despite the fact that central banks and monetary authorities regard the erosion of from 2 to 6% per annum of the real value of the monetary unit as the achievement and maintenance of “price stability” in the economic system. Obviously it is not price stability at all. It is 2 to 6% per annum away from price stability. It is the central bank´s choice of “price stability”: their definition of “price stability”. Absolute price stability is a year–on–year increase of zero percent in the Consumer Price Index. Positive annual inflation of up to 2% is a high degree of price stability. It is not absolute price stability.
The IASB only requires the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. The IASB defines hyperinflation as cumulative inflation over three years approaching or equal to 100%, i.e. annual inflation of 26% for three years in a row. This means that central banks could define “price stability” as annual inflation at any rate from 0.001 to 25.99% per annum.
Nicolaas Smith
Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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