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Sunday 16 June 2013

IASB completely unaware of its social responsibility

Countries like Belarus and Venezuela - both in hyperinflation - are not the best examples of modern democracies. The president of Belarus describes himself as the last dictator in Europe.


The president of Belarus is also the only person with the power to authorise sweeping accounting changes that would stabilise Belarus´s economy. Sweeping changes like the adoption of a Daily Index with IAS 29 Financial Reporting in Hyperinflationary Economies which is not actually being implemented in the country although Belarus signed up to implement IFRS.


The only reason Venezuela´s non-monetary economy is not stable today, is because IAS 29 is being implemented in terms of a monthly CPI. Brazil had a relatively stable non-monetary economy during the 30 years of very high and hyperinflation from 1964 to 1994 because of the use of government-supplied daily indices with Capital Maintenance in Units of Constant Purchasing Power in the form of indexation or monetary correction which was also widely used in other Latin American countries during that period in the form of price-level restatement in terms of a daily index. IAS 29 requires Capital Maintenance in Units of Constant Purchasing Power. Unfortunately IAS 29 has been implemented since its inception in 1990 in terms of the monthly published CPI.


IAS 29 does not prescribe the use of the monthly published CPI. It is generally accepted to implement IAS 29 in terms of the monthly CPI, but it is not prescribed in IAS 29.  IAS 29 simply requires restatement in terms of the general price level. The Daily CPI is based on the general price level since it is simply a lagged, daily interpolation of the monthly published general price level CPI. IAS 29 can thus currently be implemented in terms of a Daily CPI or another Daily Index, for example, a Brazilian-style Unidade-Real-de-Valor-based Daily Index that was almost entirely made up of the US Dollar daily exchange rate - by any country with the political will to use a Daily Index with IAS 29 to stabilise its hyperinflationary economy.


In short: if the IASB were to add the two words “Daily Index” to IAS 29, it would immediately stabilise the Venezuelan non-monetary economy over a short period of time. It would also stabilise the Belarus non-monetary economy whenever Belarus would actually implement such a revised version of IAS 29. An IAS 29 requiring a Daily Index would thus currently stabilise Venezuela´s non-monetary economy, but not in the case of Belarus because Belarus is not actually implementing IAS 29 as per my American accredited source in Belarus.

According to my source: "the government has not recognized the existence of hyperinflation in the country."


If the IASB were to add the two words “Daily Index” to the future IFRS regarding Financial Reporting in High Inflationary Economies, it would stabilise the non-monetary economies of all countries with inflation in excess of 10 percent per annum or 26 percent cumulative inflation over three years.


Stable non-monetary economies would be a great benefit to the people of Venezuela and Belarus and of countries with high inflationary economies.


The IASB can thus with two words do what now would be required to be done by the last dictator in Europe and by the newly elected president in Venezuela.


Unfortunately the IASB is currently completely unaware of this social responsibility it has to the people of high inflationary and hyperinflationary economies to - where it could it should - authorise standards that would automatically stabilise a non-monetary economy because the IASB itself does not understand the stabilising effect in the non-monetary economy of  Capital Maintenance in Units of Constant Purchasing Power as required in IAS 29, but with requiring a Daily Index instead of the monthly published CPI . The power to automatically stabilise high inflationary and hyperinflationary economies thus lies in the hands of the IASB because most of these countries implement IFRS. All that is required is the addition of two words. All the rest of the requirements and authorisations are already in place in IFRS.


This is not something new. It was widely implemented in Latin America from the early 1960´s to the mid 1990´s.

The IASB are hoping to publish the Conceptual Framework discussion paper” regarding capital maintenance next month.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Saturday 15 June 2013

IFRS are based on a fallacy

Maintaining the constant purchasing power of capital in nominal monetary units is impossible during inflation (including during low inflation) when net assets include constant real value non-monetary items not measured in units of constant purchasing power and monetary items not inflation-adjusted - both in terms of an index which recognizes all changes in the general price level (normally a Daily Index).

It is generally assumed that capital maintenance means that the real value (constant purchasing power) of capital is maintained constant over time.

It is generally impossible to maintain the constant purchasing power of capital constant in nominal monetary units during inflation. The statement in IFRS in the Conceptual Framework, par. 4.59 (a) that “Financial capital maintenance can be measured in nominal monetary units” is thus a fallacy. IFRS are thus based on a fallacy which came about through social and economic practice over the last 3000 years. It may take another 200 years to undo that practice.


Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Thursday 13 June 2013

Constant purchasing power maintenance

‘It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.


FAS 33 1979: 24


The above statement clearly excludes a financial concept of capital such as invested money, i.e., Historical Cost Accounting or financial capital maintenance in nominal monetary units, from being part of what bestows credibility on financial reporting.


Capital is equal to the real value of net assets.


However, the Conceptual Framework states:


‘Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity.’


Conceptual Framework, par. 4.57


The CF mistakenly implies that under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the nominal net assets or equity of the entity.


This is obviously a mistake to be corrected in IFRS.


It is thus generally impossible to maintain the constant purchasing power of capital with Historical Cost Accounting, i.e., under financial capital maintenance in units of constant purchasing power per se.


However, “A financial concept of capital is adopted by most entities in preparing their financial statements.’


Conceptual Framework, par. 4.57


The CF assumes a nominal financial concept of capital - the traditional model in the world economy - since capital maintenance in units of contant purchasing power is only prescribed in IFRS (in IAS 29) in “exceptional circumstances.” CF par. 4.63.


Thus most entities do not maintain the purchasing power of their capital constant during low inflation, (high inflation and hyperinflation). It is very obvious during high inflation and hyperinflation. Financial capital maintenance in nominal monetary units is thus a fallacy since it is impossible - in general - to maintain the real value of capital constant in nominal monetary units per se during inflation. IFRS should not be based on generally accepted accounting fallacies.


The opening constant purchasing power of capital can be maintained constant in entities that at least break even in real value - all else being equal - with measurement in units of constant purchasing power in terms of the measuring unit current at the end of the reporting period during hyperinflation, i.e., with restatement as currently applied in IAS 29 in terms of the month-end CPI - because opening capital is a balance sheet item, i.e., it has an unlimited lifetime: it is not time dependent. Current year profits and losses are time-dependent. When they are not maintained - during the reporting period - in terms of every change in the general price level, then 100% of their constant purchasing power are not being maintained constant, e.g., currently in Venezuela and Belarus. The same has always happened during low inflation (all levels of inflation).


Current year results at the end of the reporting period pass to equity. Their constant purchasing power cannot be maintained 100% during the reporting period unless all changes in the general price level are recognized which is  impossible with restatement in terms of the month-end CPI as it is currently implemented under IAS 29. IAS 29 had no relevance in Zimbabwe.


Thus, what is important is constant purchasing power maintenance and not just capital maintenance. The two concepts are in fact the same under ideal capital maintenance in units of constant purchasing power. The two are the same only with measurement in units of constant purchasing power when all changes in the general price level are recognized - which does not happen under IAS 29 in terms of the month-end CPI. A Daily Index - as used very successfully from 1964 to 1994 in Brazil and in other Latin American countries during that period - is thus required.


Capital maintenance in units of constant purchasing power in terms of a Daily Index is not something new. It was widely used in Latin America in the period mentioned above. The very successful and wide use of daily indices over 30 years in Latin America was - very unfortunately (see Zimbabwe) ignored by the IASC - the IASB´s predecessor body - with the authorization of IAS 29 in 1989. The IASB plans to undertake research to determine whether to revise IAS 29.


Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Friday 7 June 2013

Comment letter to the IASB regarding Draft Discussion Paper: Capital Maintenance

Comment letter to the IASB regarding Draft Discussion Paper: Capital Maintenance

Rachel Knubley

IASB

cc Peter Clark


Dear Ms Knubley,




In my opinion the issues associated with capital maintenance are best dealt with in the Conceptual Framework.

Attached please find Appendix A with my detailed comments.


Yours sincerely,

Nicolaas Smith

Appendix A: Comment letter to the IASB regarding  Draft Discussion Paper: Capital Maintenance


A The Conceptual Framework states:


Scope

The Conceptual Framework deals with:
(d) concepts of capital and capital maintenance.

Purpose and status
The purpose of the Conceptual Framework is:
(a) to assist the Board in the development of future IFRSs and in its review of existing IFRSs;

The issues associated with capital maintenance are thus best dealt with in the Conceptual Framework.

B The Draft Discussion Paper states:

2. Most entities adopt a financial concept of capital maintenance.

In my opinion it would be more useful to state:

Most entities adopt a financial concept of capital maintenance, namely


(a) financial capital maintenance in nominal monetary units (Historical Cost Accounting) during low inflation, high inflation and deflation and

(b) financial capital maintenance in units of constant purchasing power as prescribed in IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation.

C The Draft Discussion Paper states:

2.  However, the existing Conceptual Framework does not prescribe a particular model of capital maintenance.

The Conceptual Framework does not prescribe a particular model of capital maintenance, but IAS 29 does - as indicated in the Draft Discussion Paper, par. 3.

The Conceptual Framework, par. 4.65 states:

At the present time, it is not the intention of the Board to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy.

Restatement of HC or CC financial statements in terms of the measuring unit current at the end of the reporting period as prescribed in IAS 29 and implemented in terms of the monthly published CPI is a form of financial capital maintenance in units of constant purchasing power, i.e., one of the concepts of capital maintenane referred to in the Draft Discussion Paper as follows:

3. The concepts of capital maintenance are used in IAS 29 Financial Reporting in Hyperinflationary Economies.

It is to be noted that


states:

Par. 10 Under current IFRS, there is no particular guidance on how to prepare financial statements stated in constant purchasing power units.

The above statement is obviously wrong as indicated in par. 3 in the Draft Discussion Paper.

There are thus important issues associated with capital maintenance to be dealt with.

D The Draft Discussion Paper states:

4. The IASB note that the concepts of capital maintenance are most relevant for entities operating in high inflation economies.

That is not correct.

The concepts of capital maintenance are most relevant for entities operating in hyperinflationary economies - when relevance is considered simply in terms of the percentage of real value eroded per annum (a) by the stable measuring unit assumption in the constant real value of constant real value non-monetary items never or not fully maintained constant and (b) by inflation in the real value of only monetary items not inflation-adjusted.

‘As of 14 November 2008, Zimbabwe’s annual inflation rate was 89.7 Sextillion per cent (89,700,000,000,000,000,000,000%).’

Hanke S H and Kwok A K F 2009 On the Measurement of Zimbabwe’s Hyperinflation Cato Journal 29 2

IAS 29 in terms of the monthly CPI was implemented during the last 8 years of hyperinflation in Zimbabwe (except during the last few months of severe hyperinflation when it could not be implemented because no CPI was available) with no positive effect at all. IAS 29 had no relevance in Zimbabwe: the Zimbabwean economy imploded on 20 November 2008.

The concepts of capital maintenance are most relevant for entities operating in low inflation economies when the absolute value of real value eroded per annum (a) by the stable measuring unit assumption in the constant real value of constant real value non-monetary items never or not fully maintained constant and (b) by inflation in the real value of only monetary items not inflation-adjusted, is considered.

It is generally impossible to maintain the real value (constant purchasing power) of capital constant with measurement in nominal monetary units per se during inflation and deflation.

‘It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.

FAS 33 1979: 24

Capital is equal to the real value of net assets.

E The Draft Discussion Paper states the principles related to the concepts of capital and capital maintenance as they appear in the Conceptual Framework. The CF only indicates the two broad categories of capital concepts and capital maintenance concepts: physical and financial.

However, the CF, Par. 4.59 (a) also states:

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

Financial capital maintenance in nominal monetary units (HCA) is fundamentally different from financial capital maintenance in units of constant purchasing power. The stable measuring unit assumption is implemented and net monetary losses and gains are not accounted under HCA while the stable measuring unit assumption is never implemented and net monetary losses and gains are accounted under ideal financial capital maintenance in units of constant purchasing power.

IAS 29 in terms of the monthly CPI is not ideal FCMUCPP since IAS 29 results in the erosion by the stable measuring unit assumption and inflation (see above) of current period results during the 353 different daily general price levels during the year when IAS 29 does not recognize these (at least) 353 different daily general prices level changes. IAS 29 can also have no positive effect at all. See Zimbabwe above. IAS 29 has been implemented recognizing only the 12 month-end CPI´s. IAS 29 does not prescribe the use of the month-end CPI. It simply requires restatement in terms of the general price level. The Daily CPI is a lagged, daily interpolation of the general price level monthly published CPI. The general price level can change more than once - even hourly - during hyperinflation (Hanke and Kwok 2009, p 359). This erosion is remedied with a daily index (e.g. the Daily CPI or a Brazilian-style Unidade Real-de-Valor-based daily index) as was used very successfully in Brazil during the 30 years of very high and hyperinflation from 1964 till 1994 as well as widely implemented in other Latin American countries during that period all using a form of capital maintenance in units of constant purchasing power in the form of indexation or monetary correction or price-level restatement.The latter described in detail by the Central Bank of Chile.

There are thus three concepts of capital and three concepts of capital maintenance authorised in IFRS.

Three concepts of capital
The concepts of capital in the Conceptual Framework (2010), Par. 4.57 give rise to the following three concepts of capital during inflation and deflation:
(i) Physical capital. Par. 4.57 & 4.58.

(ii) Nominal financial capital. Par. 4.59 (a).

(iii) Constant item purchasing power financial capital. Par. 4.59 (a).

Three concepts of capital maintenance

The concepts of capital in Par. 4.57 give rise to the following three concepts of capital maintenance during inflation and deflation:

(i)  Physical capital maintenance. Optional during inflation and deflation. The Current Cost Accounting model is prescribed in IFRS when the physical capital maintenance concept is implemented. Par. 4.61.

(ii)  Financial capital maintenance in nominal monetary units (HCA). Authorized in IFRS but not prescribed—optional during inflation and deflation. Par. 4.59 (a).  

(iii)  Financial capital maintenance in units of constant purchasing power. Authorized in IFRS, but not prescribed—optional during inflation and deflation. Par. 4.59 (a).

Conclusion: In my opinion the issues associated with capital maintenance are best dealt with in the Conceptual Framework.

Nicolaas Smith


 Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

__________________________________________________________________________________

10 June 2013

Dear Mr Smith

Thank you very much for your email and accompanying comments.

We are hoping to publish the Conceptual Framework discussion paper next month. The purpose of the discussion paper is to seek input on the issues discussed in the paper. The IASB will consider their preliminary views on how to deal with capital maintenance in the light of comments received on the discussion paper. Consequently, I would encourage you to submit a comment letter on the discussion paper once it is published.

Once again, thank you for your interest in our work.

Regards

Rachel Knubley


________________________________________________________________________




Thursday 30 May 2013

Example of CMUCPP with a Daily CPI versus IAS 29

Example of CMUCPP with a Daily CPI versus IAS 29

All non-monetary receivables and payable are treated as monetary items under Historical Cost Accounting. They are not monetary items. Monetary items are defined as constituting the money supply. Non-monetary receivables and payables are not part of the money supply. They are constant real value non-monetary items since they are linked to underlying non-monetary items.

IAS 29 does not specifically require the implementation of Historical Cost Accounting during hyperinflation. IAS 29 requires the implementation of Capital Maintenance in Units of Constant Purchasing Power in the form of the restatement of HC or CC financial statements in terms of the measuring unit current at the balance sheet date. All non-monetary receivables and payables are thus treated as monetary items under IAS 29 too. The net “monetary” gain or loss is calculated with reference to these items under IAS 29.

They are constant real value non-monetary items under CMUCPP and are accounted as such. There is no net constant purchasing power gain or loss under ideal CMUCPP with complete coordination. This results in the maintenance of 100% of the real value of all non-monetary receivables and payables instead of destroying their real values at the rate of hyperinflation with the implementation of the stable measuring unit assumption during the 353 days of the year that the daily general price level is not recognized under IAS 29. IAS 29 only recognizes the 12 month-end CPIs.

The following example clearly proves the above:

Hist Cost
Historical
 Cost




Zim$ Results
Date
Daily CPI
Z$/USD
Dr
Cr
Dr
Cr
Dr
Cr
Derived
Derived
USD
USD
Zim$
Zim$
USD
USD
1/11/07
4 387,69
43,8769
Capital

1000

43 877
133
1/11/07
4 387,69
43,8769
Stock
1000

43 877
133

1/11/07
4 387,69
43,8769
Debtors
4000

175 508
531

1/11/07
4 387,69
43,8769
Sales

4000

175 508
531
30/11/07
9 727,86
97,2786




31/12/07
33 080,55
330,8055
P+L –CoS
1000

43 877
133

31/12/07
33 080,55
330,8055
Stock

1000

43 877
133
31/12/07
33 080,55
330,8055
Sale
4000

175 508
531

31/12/07
33 080,55
330,8055
P+L – Sales

4000

175 508
531
31/12/07
33 080,55
330,8055
Net MonetaryLoss
-
-
-
-

31/12/07
33 080,55
330,8055
P+L - Net Mon Loss
-
-
-
-

31/12/07
33 080,55
330,8055
Net MonetaryLoss
-
-
-
-

31/12/07
33 080,55
330,8055
Dividend
3000

131 631
398

31/12/07
33 080,55
330,8055
Bank

3000

131 631

398

IAS 29 with the monthly CPI


Date
Daily CPI
Z$/USD
Conv
Dr
Cr
Dr
Cr
Derived
Derived
Factor
Zim$
Zim$
USD
USD
1/11/07
4 387,69
43,8769
Capital
3,40
149 208
451
1/11/07
4 387,69
43,8769
Stock
3,40
149 208
451

1/11/07
4 387,69
43,8769
Debtors
1,00
175 508
531

1/11/07
4 387,69
43,8769
Sales
3,40
596 831
1 804
30/11/07
9 727,86
97,2786
3,40

31/12/07
33 080,55
330,8055
P+L – CoS
3,40
149 208
451

31/12/07
33 080,55
330,8055
Stock
3,40
149 208
451
31/12/07
33 080,55
330,8055
Sale
3,40
596 831
1 804

31/12/07
33 080,55
330,8055
P+L - Sales
3,40
596 831
1 804
31/12/07
33 080,55
330,8055
Net MonetaryLoss

421 322
1 274

31/12/07
33 080,55
330,8055
P+L - Net Mon Loss

421 322
1 274

31/12/07
33 080,55
330,8055
Net MonetaryLoss

421 322
1 274
31/12/07
33 080,55
330,8055
Dividend

26 301
80

31/12/07
33 080,55
330,8055
Bank


26 301

80





CMUCPP (IAS 29) with Daily CPI




Date
Daily CPI
Z$/USD

Conv
Dr
Cr
Dr
Cr

Derived
Derived

Factor
Zim$
Zim$
USD
USD
1/11/07
4 387,69
43,8769
Capital
7,54
330 806
1000
1/11/07
4 387,69
43,8769
Stock
7,54
330 806
1000

1/11/07
4 387,69
43,8769
Debtors
7,54
1 323 222
4000

1/11/07
4 387,69
43,8769
Sales
7,54
1 323 222
4000
30/11/07
9 727,86
97,2786



31/12/07
33 080,55
330,8055
P+L - CoS
7,54
330 806
1000

31/12/07
33 080,55
330,8055
Stock
7,54
330 806
1000
31/12/07
33 080,55
330,8055
Sale
7,54
1 323 222
4000

31/12/07
33 080,55
330,8055
P+L - Sales
7,54
1 323 222
4000
31/12/07
33 080,55
330,8055
Net MonetaryLoss
7,54
-

31/12/07
33 080,55
330,8055
P+L - Net Mon Loss
7,54
-

31/12/07
33 080,55
330,8055
Net MonetaryLoss
7,54
-

31/12/07
33 080,55
330,8055
Dividend

992 417
3000

31/12/07
33 080,55
330,8055
Bank


992 417

3000

From the above we can see that:

1.       Under IAS 29 in terms of the monthly CPI – the way IAS 29 has been implemented since 1990 although a monthly CPI is not specifically required in the standard, 54.9% of the real value of whatever capital was still left in Zimbabwe was destroyed, not by hyperinflation, but the stable measuring unit assumption (HCA) during the two months of November and Dezember 2007 in the Zimbabwean economy. That is what happened in the whole economy.


2.       Under ideal Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI with complete coordination (everyone doing it – like in Brazil from 1964 to 1994), 100% of the real value of capital, all receivables and payables and all current year profits would have been maintained. That is, in principle, what happened during the very high and hyperinflation in Brazil from 1964 till 1994 when that country implemented a form of CMCUPP (indexation or monetary correction) in terms of a government supplied Daily Index. 

Nicolaas Smith

 Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.