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Thursday 12 January 2012

Attributes of CIPPA - Part 2 of 3:  Variable items updated daily

[Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily]

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

Selling prices of variable items in shops and restaurants, etc. are not updated on a daily basis during low inflation and deflation. They are set in a free market.  Keeping them the same during a period is a marketing strategy. Selling prices depend on demand and supply. McDonalds´ prices would not be updated daily in terms of a DCPI or a monetized daily indexed unit of account during low inflation and deflation under CIPPA.

They would be updated daily under financial capital maintenance in units of constant purchasing power during hyperinflation which requires daily updating of all non–monetary items (variable and constant items) in terms of a daily parallel rate (normally the daily US Dollar parallel rate), a Brazilian–style URV daily index or a monetized daily indexed unit of account like the UF in Chile. That happened at McDonalds in Harare, Zimbabwe; i.e. the daily updating in terms of the US Dollar parallel rate, not the implementation of financial capital maintenance in units of constant purchasing power during hyperinflation. Implementing IAS 29 did not result in financial capital maintenance in units of constant purchasing power during hyperinflation in Zimbabwe.

IAS 29 simply requires the restatement of period–end HC or CC financial statements in terms of the period–end monthly published CPI to supposedly make these statements more useful during hyperinflation. The implementation of IAS 29 had no effect on the economic collapse in Zimbabwe. IAS 29 could not stop the economic collapse of the non–monetary or real economy during hyperinflation in Zimbabwe. IAS 29 could not and the 2011 version cannot do what Brazil did during 30 years of very high inflation and hyperinflation of up to 2000 per cent per annum.

Hyperinflation destroyed the Zimbabwe Dollar. The implementation of the HCA model and the stable measuring unit assumption during hyperinflation destroyed the Zimbabwean non–monetary economy. That did not happen during 30 years of very high inflation and hyperinflation in Brazil.

Daily updating of non–monetary items in terms of a daily non–monetary index supplied by different Brazilian governments during 30 years of very high and hyperinflation resulted in a relatively stable real economy with periods of economic growth in GDP – during hyperinflation. Daily updating of non–monetary items in terms of a daily index almost entirely based on the daily US Dollar exchange rate that was completely ignored by the IASB in the formulation of IAS 29 in 1989. Brazil indexed non–monetary items on a daily basis during 30 years from 1964 to 1994. IAS 29 was authorized in 1989.

[Attributes of CIPPA - Part 1: Monetary items inflation-adjusted daily]

Nicolaas Smith

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

Wednesday 11 January 2012

IFRIC 7 relates to the stable measuring unit assumption and not inflation

IFRIC 7 relates to the stable measuring unit assumption and not inflation

IFRIC Interpretation 7, Par. 3

Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies states:

‘Consensus

In the reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency, not having been hyperinflationary in the prior period, the entity shall apply the requirements of IAS 29 as if the economy had always been hyperinflationary. Therefore, in relation to non-monetary items measured at historical cost, the entity’s opening statement of financial position at the beginning of the earliest period presented in the financial statements shall be restated to reflect the effect of inflation from the date the assets were acquired and the liabilities were incurred or assumed til the end of the reporting period. For non-monetary items carried in the opening statement of financial position at amounts current at dates other than
those of acquisition or incurrence, that restatement shall reflect instead the effect of inflation from the dates those carrying amounts were determined until the end of the reporting period.’ 

Milton Friedman stated more than 50 years ago:

‘Inflation is always and everywhere a monetary phenomenon.’

Profs Gucenme and Arsoy state:

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

Conclusion to be reached from Milton Friedman´s and Profs Gucenme´s and Arsoy´s statements:

Inflation has no effect on the real value of non-monetary items. It is impossible for inflation to have any effect on non-monetary items. Inflation only has an effect on money and other monetary items. Nothing else.
What IFRIC 7 is referring to is not the effect of inflation on non-monetary items, but, the effect of the stable measuring unit assumption, the underlying principle of Historical Cost Accounting, on non-monetary items.
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Tuesday 10 January 2012

Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily


Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily

[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]

Financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation (CIPPA), under which the very erosive stable measuring unit assumption is never applied, requires the following:

Monetary items inflation–adjusted daily

Variable items updated daily

Constant items measured in units of constant purchasing power daily

(a)    Monetary items inflation–adjusted daily

 All monetary items – historical and current period monetary items – are required to be inflation–adjusted daily in terms of a Daily CPI or monetized daily indexed unit of account during low inflation, high inflation and deflation and daily in terms of a daily hard currency parallel rate or daily index rate during hyperinflation.

Inflation-adjusting all monetary items daily would result in the complete elimination of the cost of inflation (zero cost of inflation), but not the elimination of actual low inflation, high inflation or hyperinflation in the unstable monetary unit. There would be no net monetary loss or gain in the entire monetary economy excluding in actual bank notes and coins, only with complete co-ordination in inflation-adjusting all monetary items daily. Daily updating of a part of the money supply is currently being done in Chile in terms of the UF and in countries with inflation-indexed bond markets, e.g. the US, UK, Turkey, France, Mexico, Poland, Columbia, South Korea, Brazil, Italy, Japan, Germany, Canada, Sweden, etc. under the HC paradigm.

Monetary items would be required to be inflation–adjusted daily because there is no stable measuring unit assumption under CIPPA, or it is already a generally accepted monetary practice for part of the money supply, e.g. the daily inflation-indexing of 20 to 25 per cent of the broad M3 money supply in Chile in terms of the UF or as a result of inflation–indexed bond markets in countries like the US, UK, France, etc. implementing HCA, i.e. implementing the stable measuring unit assumption in the valuation of the greater part of the money supply in the economy.

Net monetary losses and gains are not calculated during low inflation, high inflation and deflation in terms of IFRS and US GAAP under the current HC paradigm. They are, however, required to be calculated during hyperinflation under the same HC paradigm in terms of IAS 29. This is one of the various contradictions under HCA corrected under CIPPA. Net monetary gains and losses are – very logically – calculated and accounted at all levels of inflation and deflation because they do in fact exist whenever monetary items are not inflation-adjusted and deflation-adjusted under CIPPA. There is no stable measuring unit assumption under CIPPA.

Complete co-ordination in implementing CIPPA in an economy would most probably not be achieved right from the start. Banks, companies and private individuals will take time to learn to inflation–adjust all monetary items in the economy when they do not yet understand all the benefits of inflation–adjusting all monetary items daily as well as the benefits of financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation as authorized in IFRS as far back as 1989. Chilean banks operate profitably with inflation–adjusting a portion (currently 20 to 25 per cent of their broad M3 money supply) of deposits from clients since 1967. They inflation–index daily, for example mortgages, car loans, student loans, consumer loans, business loans, personal loans, etc., which include their profit margins, to clients in terms of the UF.

‘Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances.’ (FAS 89, Par. 4)

Nevertheless, entities may start financial capital maintenance in units of constant purchasing power in terms of a daily rate (CIPPA) at all levels of inflation and deflation without inflation–adjusting or deflation-adjusting any more or all monetary items. They may be motivated by one or more of the following: the invisible hand of self–interest, shareholder pressure or more financial crises caused by often undercapitalized banks and companies. They may wish to immediately benefit from automatically maintaining the constant purchasing power of their own shareholders´ equity constant for an indefinite period of time as long as they break even in real value at all levels of inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not.

The full cost of or gain from low and high inflation and deflation – net monetary loss or gain – would be recognized by these entities in their operations. It would be calculated and accounted in financial reports prepared under CIPPA. Under partial inflation–adjustment of monetary items – e.g. in Chile, the US, UK, Canada and all countries issuing inflation–indexed sovereign and commercial bonds  – the net monetary loss or gain would be calculated and accounted for the part not inflation–indexed; i.e. currently for the greater part of the money supply under CIPPA. This is presently not being done in Chile, the US, UK, Canada, etc. because these countries implement the HCA model under which net monetary losses and gains are not calculated and accounted during low inflation, high inflation and deflation. They are required under IFRS to be calculated during hyperinflation under the same HC paradigm.

The constant purchasing power of capital can automatically be maintained constant for an indefinite period of time in entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not, only when they implement financial capital maintenance in units of constant purchasing power in terms of a daily rate (CIPPA) because the constant purchasing power of capital is equal to the real value of net assets - as qualified - in a double entry accounting model. Financial capital maintained in nominal value by means of measurement in nominal monetary units is always equal to net assets in nominal value per se, but it is not equal to net assets in real value per se even though IFRS and US GAAP authorized financial capital maintenance in nominal monetary units (the HCA model) and even though it is the 3000–year–old, generally accepted, globally implemented, traditional accounting model used by most entities during low inflation and deflation. Financial capital maintenance in nominal monetary units during inflation and deflation per se is a popular accounting fallacy approved in IFRS.

Under HCA the cost of inflation in the monetary economy is not calculated and accounted because the books are not being balanced in real terms but in nominal monetary terms. Historical Cost illusion that it is possible to maintain the real value of capital in nominal monetary units per se during inflation and deflation makes HCA a very erosive and, in principle, an inappropriate accounting policy.

Entities, on the one hand, apply the stable measuring unit assumption under HCA in the valuation of their own shareholders´ equity in their own financial reports in nominal monetary units under which they may not take into account unreported hidden reserves for fixed assets not revalued when they apply the HC approach to the valuation of fixed assets in terms of IFRS. On the other hand, they always value third parties´ shareholders´ equity taking into account unreported hidden reserves for fixed assets not revalued, e.g. in the share price of listed companies which they value at market value in terms of IFRS, as well as in their valuations of unlisted companies.

This means that under HCA only entities with revaluable fixed assets (revalued or not) with an updated fair value equal to 100 per cent of the updated original constant real value of all contributions to shareholders´ equity maintain the real non-monetary value of their capital under the concept of nominal financial capital is equal to net assets with financial capital maintenance measured in nominal monetary units during low and high inflation and deflation. This may only be the case in hotel, hospital and other property–intensive entities. CIPPA, on the other hand, automatically maintains the constant purchasing power of financial capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not. This requires the calculation and accounting of net monetary losses and gains as well as net constant item losses and gains (a new accounting concept) because the books are being balanced in real terms for the first time; i.e. the stable measuring unit assumption is never applied under CIPPA.

This also means that, under HCA, the portion of shareholders´ equity never covered by sufficient revaluable fixed assets (revalued or not) has always been and is still – currently –  unnecessarily, unintentionally and unknowingly being eroded at a rate equal to the annual rate of inflation; not by inflation, but by the implementation of the stable measuring unit assumption during inflation.

The erosion is equal to the annual rate of inflation because economic items are valued in terms of unstable money which is the legal unstable monetary unit of account and inflation erodes the real value of only unstable money and other unstable monetary items.

Shareholders´ equity is a constant real value non–monetary item. This unnecessary erosion in constant item real value by the implementation of the stable measuring unit assumption under HCA amounts to hundreds of billions of US Dollars per annum in the world´s capital investment base at the current level of world inflation. The US definition of a billion, 1 000 000 000, is followed in this book.

Financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation (CIPPA) would stop this erosion for an indefinite period of time and would instead maintain hundreds of billions of US Dollars per annum in the world´s capital investment base for as long as world inflation remains at current levels.

Prof. Rachel Baskerville, Associate Professor, School of Accounting and Commercial Law at the Victoria University in Wellington, New Zealand, changed her publication 100 Questions (and Answers) about IFRS on the Social Science Research Network to confirm that there are three concepts of capital maintenance authorized in IFRS after I pointed it out to her. Prof Baskerville discussed the change with her colleague Prof Kevin Simpkins before changing her article. He is the Chairman of the New Zealand Accounting Standards Review Board. She then pointed her readers to my SA blog and added this conclusion:

‘There is much to be gained from moving away from reporting on the basis  Financial Capital Maintenance in Nominal Monetary Units.’ (Baskerville, 2010)

The Deutsche Bundesbank very wisely 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)

[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]

Nicolaas Smith

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

Monday 9 January 2012

Elements of an economic item under CIPPA

Elements of an economic item under CIPPA


Under CIPPA an economic item consists of three elements:
(1)       the value of the item expressed in terms of unstable money,
(2)       the date of the event / exchange / transaction / contract and
(3)       the nominal value of the daily index or daily monetized indexed unit of account or daily relatively stable foreign currency parallel rate on that date.

All items are valued at the original date and thereafter daily (more often during severe hyperinflation when the parallel rate can change more than once a day) at all future dates in terms of IFRS, excluding the stable measuring unit assumption and the IFRS definitions of monetary items in 2011, implementing financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation always with reference to the daily rate at the original date.
The nominal monetary value of, for example a constant item changes daily in terms of the daily rate, but its real value is maintained constant over time at all levels of inflation and deflation under CIPPA.

Nicolaas Smith

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

Friday 6 January 2012

Examples of constant real value non–monetary items

Examples of constant real value non–monetary items
Definition Constant items are non–monetary items with constant real values over time.

Examples are salaries, wages, pensions and other employee benefits to be settled in cash; provisions that are to be paid in cash, dividends to be paid in cash that are recognised as liabilities, prepaid amounts for services and goods (e.g. rent prepaid), wages,  rentals, all other income statement items as well as balance sheet constant items, e.g. issued share capital, retained earnings, capital reserves, share issue premiums, share issue discounts, revaluation surplus, all other shareholder’s equity items, provisions, trade debtors, trade creditors, provisions, taxes payable and receivable, deferred tax assets and liabilities, dividends payable and receivable, royalties payable and receivable, all other non–monetary payables and receivables, etc.

Constant items are fixed in terms of real value while their nominal values change daily in terms of a Daily Consumer Price Index (DCPI) during low inflation, high inflation and deflation.

Nicolaas Smith

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

Thursday 5 January 2012

Monetary items as per IAS 21 and CIPPA

Monetary items as per IAS 21 and CIPPA

Updated on 4 July 2013

IAS 21 defines monetary items 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."

Here follows the correct definition of monetary items:

Monetary items constitute the money supply.

Buy the ebook for $29.90 or £15.30 or €26.80






Nicolaas Smith

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

Wednesday 4 January 2012

High inflation


High inflation

High inflation is experienced in a functional currency of an economy suffering from high inflation, but which is not hyperinflationary.

Functional currency

Functional currency is the currency of the primary economic environment in which the entity operates. IAS 21, Par 8


Nicolaas Smith

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

Tuesday 3 January 2012

Differences betweetn CIPPA and CPPA

Differences betweetn CIPPA and CPPA

CIPPA                                                                          CPPA  

1.      When implemented


Implemented at all levels of inflation and deflation.                                             


Only implemented during hyper-  inflation as required by IAS 29


2.      Stable measuring unit assumption


The stable measuring unit assumption is never implemented.                            


The stable measuring unit assumption is implemented in the preparation of Historical Cost or Current Cost financial reports which are then restated in terms                                                                                      of the period-end monthly published CPI only during hyperinflation.


3.      Non–monetary items 


Non–monetary items are split in variable 
and constant real value non–monetary
items.


No split in non–monetary items.

4.      Capital concept 


Constant purchasing power financial    capital concept implemented.                         


Nominal financial capital concept imple-mented in HC or CC financial reports then restated in terms of the period–end monthly published CPI only during hyper-inflation.


5.      Capital maintenance concept


Financial capital maintenance in units   
of constant purchasing power concept       
implemented: i.e., shareholders´ equity     
is measured in units of constant purch–     
asing power in terms of a daily rate at     
all levels of inflation and deflation.          


Nominal financial capital maintenance concept implemented: shareholders´ equity is measured in nominal monetary units in HC or CC financial reports during the accounting period which are then
restated in terms of the period–end monthly published CPI only during hyperinflation.


6.       Inflation–accounting model or not?


A basic accounting model implemented 
at all levels of inflation and deflation in-       
cluding during hyperinflation.               


An inflation–accounting model imple-mented only during hyperinflation.  

7.       IFRS authorization


Originally authorized in IFRS in the Framework (1989), Par 104 (a).                 


Authorized in IFRS in IAS 29 in 1989.



8.      Measurement


Daily measurement of all items in terms of a daily rate as detailed below.                 


Non-monetary items in HC or CC financial reports are restated at the end of the accounting period in terms of the period-end monthly published CPI.     
                                                                

9.      Measurement of monetary items


Historic and current period monetary   
items are inflation–adjusted daily in terms of a daily rate. When not inflation
 –adjusted daily during the current
 period, the net monetary loss or gain 
 is calculated and accounted.                                              


Monetary items are measured in      
nominal monetary units. They are not
inflation–adjusted or restated. The net
monetary loss or gain is calculated and
accounted in terms of incorrectly defined monetary and non-monetary items.                                                                       

10.   Measurement of variable items


Variable items are measured in terms of
IFRS and updated daily in terms of  a daily rate when not measured daily in terms of IFRS.                                                         


Non–monetary items are not split in
variable and constant items. All non–monetary items in HC or CC financial reports are restated in terms of the period–end monthly published CPI.


11.  Measurement of constant items


Historic and current period constant  items are measured in  units of constant purchasing power  on a daily basis in terms of a daily rate.                                              



Non–monetary items are not split in
variable and constant items. All non–monetary items in HC or CC financial reports are restated in terms of the period–end monthly published CPI.     
           

12.  Net constant item loss or gain


Net constant item loss or gain calculated
and accounted. This is a new accounting
concept.                                                        
   

A net constant item loss or gain concept does not exist under HCA, CPPA and IFRS.

13.  Measurement of trade debtors and trade creditors


Constant real value non–monetary pay–
ables and receivables (e.g. trade debtors  
and trade creditors) are measured in
terms of a daily rate. The net constant    
item loss or gain is accounted where           
applicable.                                                


Trade debtors and trade creditors and other payables and receivables are treated as monetary items and measured in nominal monetary units in HC or CC financial reports. They are not restated. The net real value loss or gain during
hyperinflation is incorrectly accounted as a net monetary loss or gain in terms of IAS 29. It is a netconstant item loss or gain.   
  

14.  Consumer Price Index 


Daily Consumer Price Index or a monetized daily indexed unit of account used during low and high inflation and deflation. Daily US Dollar parallel or daily index rate used during hyperinflation.         


Monthly Consumer Price Index used
during hyperinflation as per IAS 29.

15.  Parallel rate


Daily hard currency parallel rate used 
during hyperinflation.                                       


Daily hard currency parallel rate not used during hyperinflation.                

16.  Indexation


Daily indexation can be used during       
hyperinflation, e.g. in terms of a Brazilian-                
style Unidade Real de Valor.


No daily indexation used during
hyperinflation.
              

17.   Monetized daily indexed unit of account


A monetized daily indexed unit of account
can be used at all levels of inflation and deflation.                                                                


A monetized daily indexed unit of account not used during hyperinflation.

Nicolaas Smith

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