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Wednesday 9 January 2013

IAS 29 guarantees the erosion of the internal economy during hyperinflation


IAS 29 guarantees the erosion of the internal economy during hyperinflation

 

The implementation of IAS 29 Financial Reporting in Hyperinflationary Economies automatically causes the internal economy in a hyperinflationary economy to contract as a result of the fact that it requires the use of the monthly CPI to measure items that are valued at a daily changing price level. See Hyperinflation examplecomparing IAS 29 and Capital Maintenance in Units of Constant Purchasing Powerwith Zimbabwe data as presented to the IASB on 8 January 2013.

 

Balance sheet non-monetary assets and liabilities can be measured at any time at their fair values. During inflation and hyperinflation, price setters in the free market automatically adjust variable items´ prices to account for the lower value of the monetary unit of account.  The free market price of a  building would automatically be adjusted in the free market to reflect the change in the real value of the monetary unit of account over time.

 

The stable measuring unit assumption, causing the cost of inflation and the cost of hyperinflation,  effects the real value of monetary items over time. It also effects the real value of constant real value non-monetary items. Inflation and hyperinflation would have no cost without the implementation of the stable measuring unit assumption; i.e., without the implementation of Historical Cost Accounting. Capital Maintenance in Units of Constant Purchasing Power was authorised in IFRS in 1989 as an alternative to HCA at all levels of inflation and deflation, including during hyperinflation. The failed IAS 29 is not required during hyperinflation when an entity implements CMUCPP because the latter is not a HCA model and only HC and CC financial statements can be restated in terms of the failed IAS 29.

 

The real value of variable real value non-monetary items are thus continuously adjusted to reflect (1) the change in demand and supply for the item and (2) the change in the real value of the monetary unit of account; i.e., every time the general price level changes. When the general price level changes daily, the price level component of the price is adjusted daily; i.e., every time the general price level changes which may be more than once a day during severe hyperinflation.

 

This price level adjustment for a variable item´s real value does not have to accompany every change of the general price level as long as the item is not being exchanged. The moment it is valued in a period end financial report, the item´s real value can be stated, it can be fair valued, at the measuring unit current at the end of the financial period. The fact that it has not been fair valued during the entire financial year before the period end date (or during a very long period before), does not effect its real value: the stable measuring unit assumption has no effect on the real value of non-monetary items.

 

This is true for balance sheet constant real value non-monetary items too. For example, capital can be measured at the measuring unit current at the balance sheet date. Capital is equal the real value of net assets.

 

This happens naturally in a free market for variable real value non-monetary items where their prices are determined by supply and demand for an item. See the free market price for quoted shares, commodities and most variable items in the world economy. For example, the change in the price of oil is indicated by its daily quotation in the free market.

 

During hyperinflation the general price level changes daily at a rate as indicated by the daily US Dollar free-market exchange rate or a URV based Daily Index. Where a government in a hyperinflationary economy fixes the country´s exchange rate with the US Dollar, this daily change in the general price level is indicated by the US Dollar daily parallel or black market rate.

 

The internal economy, internal demand is mostly automatically eroded by the fact that salaries, wages, rentals, etc. are paid during hyperinflation at a price level generally behind the actual price level at the time of payment when the monthly published CPI is used as required by IAS 29. See hyperinflation example above. The monthly CPI is normally not available at month end. It only becomes available, generally at the earliest, by the 7th of the following month.

 

The implementation of IAS 29 thus guarantees the erosion of the internal economy in this manner. This can not be stopped under IAS 29 with the use of the monthly published CPI.

 

IAS 29 is an inappropriate accounting model.

 

Capital Maintenance in Units of Constant Purchasing Power in terms of a daily index as authorised in IFRS in 1989 at all levels of inflation and deflation, including during hyperinflation, would automatically maintain the constant purchasing power of capital (equity) constant for an indefinite period of time in all entities that at least break even in real value – all else being equal.

 

It would also stabilise the constant item economy at all levels of inflation and deflation, including during hyperinflation.

 

Inflation-indexing the entire money suppply on a daily basis with complete co-ordination would eliminate the total cost of inflation or cost of hyperinflation (not actual inflation and hyperinflation) from the monetary economy.
 




Nicolaas Smith

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

IAS 29 not required with Capital Maintenance in Units of Constant Purchasing Power


IAS 29 not required with Capital Maintenance in Units of Constant Purchasing Power

 

IFRS authorised Financial Capital Maintenance in Units of Constant Purchasing Power at all levels of inflation and deflation including during hyperinflation - as an alternative to Historical Cost Accounting in the original Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a) in 1989 – now the Conceptual Framework (2010), Par. 4.59 (a) - which states:

 

“Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

 

The Conceptual Framework, Par. 4.59 (a) does not state that it (Par. 4.59 (a)) only applies to low inflationary and deflationary economies. It applies to all levels of inflation and deflation, including during hyperinflation.

 

An entity in a hyperinflationary economy is thus authorised in IFRS to measure financial capital maintenance in units of constant purchasing power; i.e., authorised in IFRS to implement Capital Maintenance in Units of Constant Purchasing Power during hyperinflation.
 




Nicolaas Smith

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

IASB not to include Capital Maintenance in Units of Constant Purchasing Power difference with IAS 29 in IFRS


IASB not to include Capital Maintenance in Units of Constant Purchasing Power difference with IAS 29 in IFRS

 

 

 

‘ “IAS 29 is not required during hyperinflation when an entity implements CMUCPP because this model is not a HCA model and only HC or CC financial statements are restated as required in IAS 29.” ‘

 

Communication from the IASB, 2013

 

The issue treated in the above statement is not to be added to IFRS as an IFRIC or an addition to IAS 29 because “the issue is not widespread” as stated by the IASB in a teleconference in December 2012 and again in a second teleconference on 8 January 2013.

 

We are all very thankful that hyperinflation is not widespread in the world economy. That does not mean that we should be satisfied with the fact that the failed IAS 29 has no positive effect during hyperinflation as fully proven during the 8 years that it was implemented in Zimbabwe´s hyperinflation with no positive effect - in the way the IASB indicated that the Board is satisfied with the fact that IAS 29 had no positive effect in Zimbabwe, that nothing needs to be done about it and that it would most probably be maintained in the future replacement of IAS 29: implementing the failed IAS 29 model even at lower levels of inflation as proposed by the Argentinean Accounting Federation.

 

It is correct to depart from Historical Cost Accounting at 10% annual inflation and at 26% cumulative high inflation over three years instead of only at hyperinflation of 100% cumulative inflation over three years as required in IAS 29, but not maintaining the failed IAS 29 model since  “Inflation-adjusted financial statements are an extension to, not a departure from historical cost accounting” as correctly stated by PricewaterhouseCoopers: the failed IAS 29 requires the inflation-adjustment of Historical Cost and Current Cost financial statements during hyperinflation.The implementation of the failed IAS 29 had no positive effect during 8 years of implementation in the Zimbabwe economy.


 

Although the IASB indicated that the above issue would not be included in IFRS because it is not “wide spread”, the future replacement of IAS 29, which deals with financial reporting during hyperinflation – an economic environment which falls in the same not “wide spread” category – is nevertheless being submitted to research by the IASB.

 

The IASB thus, luckily, does not have a consistent basis for deciding what to deal with and what not to deal with in IFRS. The above two issues deal with the same topic.
 



 


Nicolaas Smith

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

IASB satisfied with IAS 29 having no effect during hyperinflation



IASB satisfied with IAS 29 having no positive effect during hyperinflation

 


The IASB is satisfied with the way IAS 29 was implemented during the last 8 years of hyperinflation in Zimbabwe with no positive effect. Nothing needs to be done about that matter according to the IASB. According to the IASB, actual financial reporting (accounting) does not affect the economy! A senior IASB director indicated this in a teleconference on 8 January 2013 in relation to measurement in units of constant purchasing power in terms of an Unidade-Real-de-Valor-based Daily Index as proposed under Capital Maintenance in Units of Constant Purchasing Power as an IFRS-authorised alternative to IAS 29. According to the IASB, it is what users do with financial reports that affects the economy.

 

The above IASB indicated position regarding the fact that the Board is satisfied with IAS 29 having no positive effect during hyperinflation is not a very good sign for the research authorised by the IASB regarding the replacement of the failed IAS 29 standard. It thus appears that the IASB would prefer the Argentinean Federation´s proposal to simply carry on with the failed IAS 29-style restatement of period-end financial statements in terms of the measuring unit current at the end of the reporting period – the monthly published CPI available by the earliest 7 days after the month-end - when actual prices change daily – often at a significant daily percentage - during hyperinflation. This was the failed IAS 29 model used during the last 8 years of hyperinflation in Zimbabwe with no positive effect which the IASB is satisfied with. Hyperinflation ended in Zimbabwe in 2008.

 

An amendment to the Argentinean Federation´s 2010 proposal as a replacement of the failed IAS 29 was submitted to the IASB in January 2012. The amendment is based on and changed the title of the Argentinean Accounting Federation´s proposed new IFRS from IFRS ´X` INFLATION to IFRS ´X´ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER after it was pointed out to the IASB and the Argentinean Accounting Federation that inflation has no effect on the real value of non-monetary items. A copy of the amended IFRS `X´ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER is available here.

 

It now seems that there is a very good chance that the failed fundamental IAS 29 restatement model – that had no positive effect during 8 years of implementation in Zimbabwe´s hyperinflation – would be followed in the future replacement of IAS 29 instead of the real value maintaining IFRS-authorised – but little (not) understood at the IASB - Capital Maintenance in Units of Constant Purchasing Power model.

 

See:

 

 




Nicolaas Smith

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

Tuesday 8 January 2013

Hyperinflation example comparing IAS 29 and Capital Maintenance in Units of Constant Purchasing Power

Hyperinflation example comparing IAS 29 and Capital Maintenance in Units of Constant Purchasing Power.

As presented to the IASB on 8 January 2013.



Nicolaas Smith

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

Monday 7 January 2013

Erosion of real value of monetary and constant items caused by Historical Cost Accounting


Cost of inflation and hyperinflation caused by Historical Cost Accounting

 

 

It is possible to have inflation and hyperinflation with no erosion in the real value of monetary items: simply inflation-adjust all monetary items daily: do not implement the stable measuring unit assumption: i.e., do not implement Historical Cost Accounting: implement its alternative authorised in IFRS: Capital Maintenance in Units of Constant Purchasing Power: i.e. never implementing the stable measuring unit assumption.

 

The same is true for constant real value non-monetary items.

 

Erosion of the real value of monetary and constant items over time during inflation and hyperinflation is caused by HCA: i.e., the implementation of the stable measuring unit assumption.

 

Inflation and hyperinflation only necessitate the updating - in terms of a changing nominal monetary unit of account - of the nominal value of the same real value because (1) the real value of money is determined by the change in the CPI in the case of monetary items´ real value during low inflation (USD parallel rate during hyperinflation) and (2) because money is the monetary unit of account in the measurement of constant real value non-monetary items.

 

 

Inflation and hyperinflation only have a cost in the economy under Historical Cost Accounting: HCA causes the cost of inflation and hyperinflation: i.e., when the stable measuring unit is implemented: when it is assumed (for practical or lack of the necessary instantaneous update technology) that money is perfectly stable over time.

 

When the stable measuring unit assumption is never implemented during inflation, there is no cost of inflation.

 

Historical Cost Accounting is the cause of the erosion of real value in monetary and constant items in the economy.

 

Inflation and hyperinflation are harmless without Historical Cost Accounting. Inflation and hyperinflation are toothless without the stable measuring unit assumption implemented under Historical Cost Accounting.

 

The cost of inflation and the cost of hyperinflation are caused by Historical Cost Accounting: by the implementation of the stable measuring unit assumption.

 

Actual inflation and hyperinflation are caused by an increase in the general price level. An increase in the general price level is caused by various economic factors, an important one being an excessive increase in the money supply.

 

Inflation and hyperinflation are an increase in the nominal value of the same real value over time.

 

Stop Historical Cost Accounting (implement Capital Maintenance in Units of Constant Purchasing Power as authorised in IFRS twenty three years ago) and there are:

 

  1. no stable measuring unit assumption,
  2. no cost of inflation – no erosion of the real value of monetary items during inflation,
  3. no cost of hyperinflation – no erosion of the real value of monetary items during hyperinflation,
  4. no erosion of constant real value non-monetary items (e.g., capital, non-monetary receivables, non-monetary payables, etc.) during inflation and hyperinflation,
  5. no creation of real value in monetary items during deflation and
  6. no creation of real value in constant real value non-monetary items (capital, non-monetary receivables, non-monetary payables, etc.) treated as monetary items during deflation.

 

Stop HCA and you fix erosion caused by the stable measuring unit assumption in the world economy during inflation and hyperinflation.

 

There will be no erosion of real value caused by the stable measuring unit assumption in the world economy when there is no HCA - when HCA is replaced by CMUCPP as authorised in IFRS twenty three years ago.

 

The stable measuring unit assumptiom is a much bigger enemy than inflation and hyperinflation. Inflation is toothless without HCA. HCA causes the cost of inflation. Without HCA there is no cost of inflation.


Without HCA there is no cost of inflation PLUS  no cost of the erosion of constant items by the stable measuring unit assumption.

 

Historical Cost Accounting causes the cost of inflation and the cost of hyperinflation in the monetary economy.

 

The cost of the stable measuring unit assumption is made up as follows:

 

  1. The cost of stable measuring unit assumption in constant real value non-monetary items never maintained constant under HCA during inflation and hyperinflation and
  2. The cost of inflation and the cost of hyperinflation.

 

The stable measuring unit assumption is the real enemy in the economy: double the size of the cost of inflation or hyperinflation. The cost of inflation or hyperinflation in the monetary economy is only half the problem.

 

Accounting always recognized the total cost of the stable measuring unit assumption: accounting confused it as all (100%)  being caused by inflation and hyperinflation. It is 100% caused by the stable measuring unit assumption: by HCA.

 

 

The cost of inflation / hyperinflation is caused by the implementation of the HCA model. The cost of inflation / hyperinflation is caused by the implementation of the stable measuring unit assumption under the HCA model.

 

Stop the stable measuring unit assumption (implement Capital Maintenance in Units of Constant Purchasing Power as authorised in IFRS twenty three years ago) and you stop the cost of inflation / hyperinflation – not actual inflation or hyperinflation. An increase in the general price level (inflation / hyperinflation) is the result of a combination of various economic factors: a very important one being an increase in the money supply.

 

The stable measuring unit assumption is a Generally Accepted Accounting Practice – also a US GAAP and UK GAAP - implemented by all accountants worldwide as authorised in IFRS and US GAAP.

 

Not implementing the stable measuring unit assumption stops the cost of inflation / hyperinflation at all levels of inflation and hyperinflation as proven by the daily inflation-indexing of government capital inflation-indexed bonds in low inflationary economies (e.g., USD 835 billion TIPS in the US – Jan 2013) and hyperinflationary economies: Venezuelan government capital inflation-indexed bonds. USD 3.5 trillion + of sovereign capital inflation-indexed bonds are currently inflation-indexed daily in the world economy (Jan 2013).

 

Inflation-index the entire money supply on a daily basis in an economy (Chile currently inflation-indexes 25% of its broad M3 money supply and Colombia inflation-indexes all mortgage bonds daily) and there would be inflation or hyperinflation in an economy, but no cost of inflation or hyperinflation; i.e., no erosion of the real value of monetary items excluding bank notes and coins with their nominal values permanently printed on them.

 

CMUCPP would stop the erosion of real value in monetary items (as qualified above) as well as in constant real value non-monetary items, but it would not necessarily stop inflation or hyperinflation. CMUCPP stops erosion – not inflation or hyperinflation – in the economy at all levels of inflation and hyperinflation. It would be as if there is no inflation or hyperinflation with actual inflation or hyperinflation.

 

The cost of inflation / hyperinflation (not inflation / hyperinflation) is caused by the HCA model. No HCA equals no cost of inflation / hyperinflation.

 

The HCA model is an inappropriate accounting model at all levels of inflation and deflation.
 






Nicolaas Smith

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

Wednesday 2 January 2013

URV based Daily Index

Capital Maintenance in Units of Constant Purchasing Power is implemented in terms of a Daily Index as follows:

1. During low inflation and high inflation: in terms of the Daily CPI
2. During hyperinflation: in terms of a URV based Daily Index

CMUCPP is implemented during hyperinflation as follows:

a) Based on a URV based Daily Index or
b) Based directly on the daily USD freemarket exchange rate, either the official daily USD rate or the unofficial daily USD parallel rate.

The Daily CPI is based on the monthly publised CPI.

The Daily Index used during hyperinflation is based on the Unidade Real de Valor used in Brazil prior to the Real Plan in 1994. The URV was almost entirely based on the daily USD freemarket exchange rate, either the official daily USD rate or the daily USD parallel rate.

The Daily CPI is a one or two month lagged daily interpolation of the monthly published CPI. This is not useful during hyperinflation such a daily index falls very much behind the daily USD rate.





Nicolaas Smith

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

Friday 14 December 2012

Introduction to Capital Maintenance in Units of Constant Purchasing Power


Introduction

 

Historical Cost Accounting is the globally implemented, generally accepted, traditional, basic accounting model used by entities to prepare their financial reporting. It was originally authorized in IFRS in 1989 as an optional (not required) accounting model at all levels of inflation and deflation (including during high inflation and hyperinflation) in the original Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a) which states:

 

‘Financial capital maintenance can be measured in either nominal monetary units or in units of constant purchasing power.’

 

HCA is thus not required by IFRS. It is an optional nominal financial capital maintenance basic accounting model. The other optional financial capital maintenance concept authorised in IFRS at all levels of inflation and deflation (including during high inflation AND HYPERINFLATION) is financial capital maintenance in units of constant purchasing power.

 

The exact wording of the original Framework (1989), Par. 104 (a) is maintained in the current Conceptual Framework (2010), Par. 4.59 (a).

 

Three concepts of capital maintenance authorised in IFRS

 

There are thus three concepts of capital and three concepts of capital maintenance authorised in IFRS since 1989 although both the original Framework (Par. 107) and the Conceptual Framework (Par. 4.62) mistakenly state:

 

‘The principle difference between the two capital maintenance concepts is the treatment of the effect of changes in the prices of assets and liabilities of the entity.’

 

the exact same wording maintained here too between the Framework (1989) and the Conceptual Framework (2010).

 

Capital concepts authorised in IFRS since 1989

 

The following three concepts of capital can be identified in the Conceptual Framework, Par. 4.57:

 

  1. Physical capital. See Par. 4.57 and 4.58
  2. Nominal financial capital. See Par. 4.59 (a)
  3. Constant purchasing power financial capital. See Par. 4.59 (a)

 

Capital maintenance concepts authorised in IFRS since 1989

 

The three concepts of capital identified in Par. 4.57 give rise to the following three concepts of capital maintenance during all levels of inflation and deflation, including during high inflation and hyperinflation:

 

  1. Physical capital maintenance concept. Optional at all levels of inflation and deflation. The Current Cost Accounting model is prescribed in IFRS when the physical capital maintenance concept is implemented. See Par. 4.56

 

  1. Financial capital maintenance in nominal monetary units. (HCA) Authorised in IFRS, but not prescribed. Optional at all levels of inflation and deflation, including during high inflation and hyperinflation. See Par. 4.59 (a)

 

  1. Financial capital maintenance in units of constant purchasing power. Authorised in IFRS, but not prescribed. Optional at all levels of inflation and deflation, including during high inflation and hyperinflation. See Par. 4.59 (a)

 

Constant real value non-monetary items inferred in IFRS

 

In terms of the Conceptual Framework (2010), Par. 4.59 (a), financial capital maintenance can be measured in units of constant purchasing power. There are thus actual economic items with constant real values over time.

 

Inflation erodes the real value of only monetary items over time.

 

‘Inflation is always and everywhere a monetary phenomenon.’

 

Milton Friedman

 

´The purchasing power of non monetary items does not change in spite of variation in national currency value.’

 

Gucenme U and Arsoy A P 2005 Changes in financial reporting in Turkey, Historical development of inflation accounting 1960 – 2005 Academy of Accounting Historians 2005 Research Conference 6-8 Oct 2005 Ohio State University Columbus Ohio USA

 

Low inflation, high inflation, hyperinflation and deflation thus affect the real value of only monetary items over time. Low inflation, high inflation, hyperinflation and deflation have, consequently, no effect on the real value of non-monetary items over time (and never had in the past and never will have in the future).

 

The above-mentioned economic items with constant real values over time are thus not monetary items. Consequently, they are non-monetary items with constant real values over time. They are thus constant real value non-monetary items or constant items.

 

When the stable measuring unit assumption is never implemented, i.e., under capital maintenance in units of constant purchasing power, these constant items have permanently fixed constant real values over time at all levels of inflation and deflation, including during high inflation and hyperinflation.

 

When, however, the stable measuring unit assumption is implemented, i.e., under traditional Historical Cost Accounting, and these constant items are not maintained constant in real value over time (because of the implementation of the stable measuring unit assumption – HCA - , not inflation), then the constant real non-monetary values of these constant items are eroded by the stable measuring unit assumption – HCA - (not by low inflation, high inflation or hyperinflation) over time at a rate equal to the annual rate of low inflation, high inflation or hyperinflation (because they are measured in terms of depreciating money, i.e., the depreciating monetary unit of account - and low inflation, high inflation and hyperinflation erode the real value of only money over time) and increased at a rate equal to the annual rate of deflation by the stable measuring unit assumption (not by deflation).

 

Examples of constant items are salaries, wages, rentals, pensions, borrowing costs, fees, royalties, employment benefits, interest received, interest paid, bank charges, issued share capital, retained income, retained losses, reserves, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, all items in the income statement, etc.

 

Definition: Constant real value non-monetary items are non-monetary items with constant real values over time.

 

Variable real value non-monetary items inferred in IFRS

 

Consequently, non-monetary items that are not constant real value non-monetary items are variable real value non-monetary items or variable items. They have variable real values over time generally determined by supply and demand in free markets.

 

Definition: Variable items are non-monetary items with variable real values over time generally determined in terms of demand and supply.

 

Examples of variable items are property, plant, equipment, inventories, foreign exchange, quoted and unquoted shares, goodwill, patents, copy right, trade marks, intellectual property rights, etc.

 

Non-monetary items

 

Definition: Non-monetary items are all items that are not monetary items.

 

Non-monetary items are sub-divided in:

 

  1. Variable real value non-monetary items
  2. Constant real value non-monetary items

 

Monetary Items

 

The definition of monetary items thus determines whether an item is a monetary or non-monetary item. When the definitions of monetary items need improvement as they currently do in IFRS in IAS 29, Par. 12:

 ‘Monetary items are money held and items to be received or paid in money,’

 

and IAS 21, Par. 8:

 

´Monetary items are units of currency held and assets and liabilities to be paid in a fixed or determinable number of units of currency.’  

 

then some monetary and non-monetary items would be mis-classified. This would result in the doubtful calculation and accounting of the net monetary item loss or gain and the net constant item loss or gain only under capital maintenance in units of constant purchasing power if the current definitions of monetary items in IFRS were to be followed. The overall net effect of such mis-classification on the financial statements would be nil: the net loss or gain would in any case be calculated and accounted, as either a net monetary item loss or gain, or a net constant item loss or gain only under capital maintenance in units of constant purchasing power since it is normally constant items (e.g., trade debtors and trade creditors) that are incorrectly treated as monetary items. It is, however, necessary to classify items correctly as monetary, constant or variable items.

 

Net monetary item losses and gains and net constant item losses and gains are not required (net constant item losses and gains are not even identified under HCA) to be calculated and accounted (although net monetary losses and gains can be calculated and accounted under HCA according to Harvey Kapnick in the 1976 Sax Lecture by the ex-Chairman of Arthur Andersen) under the Historical Cost Accounting model as a result of the implementation of the stable measuring unit assumption.  It is assumed, in practice,  that money is perfectly stable for the purpose of the measurement of constant items and constant items treated as monetary items (e.g., trade debtors and trade creditors, etc.) under HCA during low inflation, high inflation and deflation while under hyperinflation the measures in IAS 29 are required, but Pricewaterhousecoopers very correctly states:

 

‘Inflation-adjusted financial statements are an extension to, not a departure from, historic cost accounting.’

 

PricewaterhouseCoopers 2006 Understanding IAS 29 p 5

 

IAS 29 simply requires the restatement of Historical Cost or Current Cost financial statements in terms of the measuring unit current at the end of the reporting period to make them more meaningful. IAS is not a departure from Historical Cost Accounting, even during hyperinflation of hundreds of billions percent per annum.

 

‘The Measuring Unit Principle:

The unit of measure in accounting shall be the base monetary 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.’

 

Walgenbach, Dittrich and Hanson 1973 p 429

 

The implementation of the stable measuring unit assumption under the Historical Cost Accounting model, consequently leads to the erosion of the real value of constant real value non-monetary items never maintained constant during low inflation, high inflation, hyperinflation and deflation; e.g., that portion of an entity´s equity never maintained constant by the real value of its net assets over time - probably amounting to the unnecessary erosion of real value in the world’s capital investment base amounting to hundreds of billions of US Dollar per annum in the world economy. Replacing the Historical Cost Accounting model by adopting constant real value maintaining capital maintenance in units of constant purchasing power in terms of a daily index would automatically maintain the constant purchasing power of equity constant for an indefinite period of time in all entities that at least break even in real value – all else being equal – at all levels of inflation and deflation, including during high inflation and hyperinflation, whether these entities own any revaluable fixed assets or not. This would maintain hundreds of billions of US Dollar per annum in the world economy for as long as the current level of world inflation maintains.

 

Definition of Monetary items

 

Monetary items constitute the money supply.

 

Examples are local currency bank notes and coins and the local currency capital amounts of home loans, car loans, commercial loans, business loans, student loans, government bonds, commercial bonds, capital market investments, money market investments, notes payable, notes receivable, etc.

 

Three economic items

 

From the above it is absolutely clear that there are not just the generally accepted two economic items in the economy, namely monetary and non-monetary items, but three basic, fundamentally different economic items in the economy and that the economy is made up of three basic, fundamentally different parts as follows:

 

Three basic, fundamentally different economic items

 

  1. Monetary items
  2. Variable real value non-monetary items (variable items)
  3. Constant real value non-monetary items (constant items)

 

Three parts of the economy

 

  1. Monetary economy
  2. Variable item economy
  3. Constant item economy

 

Measurement under capital maintenance in units of constant purchasing power

 

Daily measurement required

 

Daily measurement of all items are required under capital maintenance in units of constant purchasing power since constant items like trade debtors and trade creditors can pay or be paid on any day of the month. The Daily Consumer Price Index is used for this purpose during low inflation, high inflation and deflation and the daily US Dollar parallel rate during hyperinflation. Most countries (representing about 95 percent, or more, of the world economy) issue capital inflation-indexed government bonds. These bonds trade on a daily basis and are priced in terms of a Daily CPI which is a one or two month lagged daily interpolation of the monthly published CPI available in all these countries.

 

Chile has been using an index, the Unidad de Fomento (UF), to index non-monetary and some monetary items since 1967. It has been published daily since 1977. Chile currently inflation-indexes 25 per cent of its money supply daily.

 

During hyperinflation, populations spontaneously start using the daily US Dollar parallel rate to index variable items.

 

Value date

 

The value date under capital maintenance in units of constant purchasing power is the current value of the daily index, that is, today´s value. Everything in a company and economy is always presented, accessed, valued, measured, treated, shown and printed in terms of the current, that is, today´s Daily CPI or daily US Dollar parallel rate (during hyperinflation). It changes every day. Financial statements are not printed on hard copy: they are kept in digital format and updated daily: they change every day in nominal value, but they stay the same in real value.

 

A person quickly learns during hyperinflation that the value date is today: everybody uses the current, today´s, value of the US Dollar parallel rate to price variable items: it changes every day during hyperinflation. On some days it changes more than once a day.

 

Financial statements are thus stated at the measuring unit current at the end of the accounting period, only at the end of the accounting period: on that day. The next day (and at all future dates) all items in the financial statements are updated in terms of the new Daily CPI or the new daily USD parallel rate (during hyperinflation). The real values in the financial statements stay the same, but their daily nominal values change daily- the same for all values in the economy.

 

Constant items

 

Constant items are the easiest to measure under capital maintenance in units of constant purchasing power in terms of a daily index. They are always and everywhere (current period and historical constant items) measured in terms of the Daily CPI at today´s rate. When they are not measured daily as decribed – during the current financial period, then the net constant item loss or gain is calculated and accounted in the income statement. Net constant item losses and gains are constant items once accounted and measured in units of constant purchasing power daily thereafter - like all constant items.

 

Variable items

 

Variable items are valued daily in terms of IFRS, e.g., at fair value, net realisable value, recoverable value, present value, etc., excluding the stable measuring unit assumption, i.e., excluding nominal historical cost. Nominal historical cost is only valid during zero inflation – an economic environment never achieved on a sustainable basis in the past and aparently not soon to be achieved in the future. When variable items are not valued daily in terms of IFRS, as qualified, they are updated (only monetary items can be inflation-adjusted – inflation only affects monetary items) daily in terms of the Daily CPI till they are again measured daily in terms of IFRS, as qualified. Impairment, losses and gains in variable items are treated in terms of IFRS, as qualified.

 

Monetary items

 

Monetary items are always and everywhere (historical and current period monetary items) inflation-adjusted on a daily basis. When they are not inflation-adjusted during the current accounting period, then the net monetary loss or gain is calculated and accounted.

 

Inflation-adjusting the entire money supply on a daily basis in terms of the Daily CPI compensates for (nullifies) the effect of low inflation, high inflation and deflation, and in terms of the Daily USD parallel rate, nullifies the effect of hyperinflation. However, this does not remove actual low inflation, high inflation, hyperinflation and deflation. This means that the monetary economy and constant item economy can be maintained stable with an IFRS. Normally it is seen that the stability of the monetary economy is the responsibility of the Central Bank. In fact it is not. It is the responsibility of the accounting profession to implement capital maintenance in units of constant purchasing power in terms of a daily index correctly under complete co-ordination (everyone doing it). No central bank intervention is actually required to stop the effect of the erosion of the real value of monetary items from the monetary economy. It can be done by accountants with an IFRS: with capital maintenance in units of constant purchasing power in terms of a daily index. Central bank intervention is only required to eliminate actual inflation and deflation. Correct accounting can compensate for (nullify) its effect in the economy.
 




Nicolaas Smith

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