Pages

Wednesday 10 July 2013

Applicability of IAS 29 No 2


Applicability of IAS 29 No 2

06  November 2012

IASB Staff member April Pitman´s preliminary work on the Potential Agenda Item Request.


Hello Nicolaas
I have been asked to prepare a very simple summary of the nature of your agenda item request. Do you think this is a fair summary – or have I missed the point?
“The Conceptual Framework assesses whether profit has been earned in terms of whether the entity’s capital has been maintained. It states (CF 4.59 (a)) that for these purposes, financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.
IAS 29 Financial Reporting in Hyperinflationary Economies notes that reporting an entity’s operating result and financial position in a hyperinflationary economy is not helpful unless local currency values are restated.  Money loses purchasing power at such a rate that comparison of amounts from transactions that have occurred at different times are misleading.  The Standard requires that the financial statements should be stated in terms of the measuring unit current at the end of the reporting period (IAS 29.8).
The submitter raises queries about when it is appropriate to use units of constant purchasing power as a measurement basis and not apply the measuring unit current at the end of the reporting period as required by IAS 29.”
Thanks
April
------------------------------------------------------------------


April Pitman | Technical Manager


International Accounting Standards Board (IASB)
30 Cannon Street | London EC4M 6XH | UK
___________________________________________________________________________
From: Nicolaas Smith
Sent: 07 November 2012 17:06
To: Pitman April
Subject: IAS 29 Agenda proposal
Hello April,
Thank you for the opportunity to give you my input.
You are not actually quoting IAS 29 in the second paragraph of your summary. So, we may use correct concepts /principles where IAS 29 implies one incorrectly. In my opinion, the second sentence in the second paragraph of your summary is not entirely correct. You state (not officially quoting IAS 29): “Money loses purchasing power at such a rate that comparison of amounts from transactions that have occurred at different times are misleading.”
Your statement implies that comparisons of all amounts of all transactions that have occurred at different times are misleading as a result of money losing purchasing power. That is not correct. Onlycomparisons of amounts of transactions involving monetary items that have occurred at different times are misleading as a result of money losing purchasing power.
All economic items have monetary values since money is the monetary unit of account.
Monetary items are units of local currency held and other monetary items with an underlying monetary nature, being substitutes of the former. Non-monetary items are items that are not monetary items.
[This is a complex situation because we use different definitions for the same items as a result of the fact that there are two paradigms authorized in IFRS: the HC paradigm and the units of constant purchasing power paradigm. The above is the definition of monetary items under the second paradigm. Both paradigms are involved in this request.]
Money loses purchasing power as a result of inflation. Inflation only affects money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items.
“Inflation is always and everywhere a monetary phenomenon.”
Milton Friedman
“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
(It is the second last item on the link page.)
The stable measuring unit assumption affects the real value of only constant real value non-monetary items not maintained constant at all levels of inflation and deflation.
Comparisons of amounts from transactions involving constant real value non-monetary items in Historical Cost financial statements that have occurred at different times are misleading as a result of the implementation of the stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model under which financial capital maintenance in nominal monetary units is implemented.
The definition of constant real value non-monetary items is inferred in CF 4.59 (a) as follows: When financial capital maintenance can be measured in units of constant purchasing power it means logically that there are actual economic items with constant real values over time. They are certainly not monetary items. Thus, certain non-monetary items have constant real value values over time. They are thus constant real value non-monetary items (constant items).
Examples are salaries, wages, rents, all items in shareholders´ equity, provisions, trade debtors, trade creditors, all non-monetary payables and receivables, etc.
Thus, very logically, it also means that non-monetary items that are not constant real value non-monetary items are variable real value non-monetary items (variable items).
Examples are property, plant, equipment, inventories, quoted and unquoted shares, foreign exchange, etc.
Variable items are valued are in terms of IFRS at fair value, net realizable value, recoverable value, present value, etc. under the HC paradigm.
The stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power; under the second paradigm.
Although their real values are not affected by the stable measuring unit assumption, comparisons of amounts from variable item transactions that have occurred at different times are misleading as a result of the implementation of the stable measuring unit assumption (a GAAP) and not the fact that money loses real value over time, namely as a result of inflation – an economic process.
So, in my opinion the following may be a better statement:

“Money losing purchasing power at such a rate - as far as monetary items are concerned - and the implementation of the stable measuring unit assumption - as far as non-monetary items are concerned - make comparisons of amounts from monetary and non-monetary item transactions, respectively, that have occurred at different times, misleading.”
I - unintentionally - complicated my request by asking two questions.
To fix that problem we may, in my opinion, combine the two questions into one by stating
a)      the last sentence in your second paragraph as follows:
“The Standard requires that Historical Cost and Current Cost financial statements should be stated in terms of the measuring unit current at the end of the reporting period (IAS 29.8).” and
b)      your last paragraph as follows:
“The submitter raises queries about whether it is correct that IAS 29 is not required during hyperinflation when financial statements are prepared in terms of financial capital maintenance in units of constant purchasing power since all items in such financial statements would already be stated at the measuring unit current at the end of the reporting period.”
Explanation
All items in financial statements prepared in terms of financial capital maintenance in units of constant purchasing power are always stated in terms of the measuring unit current (the Daily – not monthly - CPI) at the end of the reporting period and after the date of the financial statements always automatically updated to today’s Daily CPI.
All items in these financial statements
(1. constant items always and everywhere measured in units of constant purchasing power in terms of the Daily CPI, including at the balance sheet date, with the calculation and accounting of the net constant item loss or gain when they are not measured in units of constant purchasing power during the financial period;
2. variable items valued in terms of IFRS-authorized measurement bases at the balance sheet date, excluding nominal Historical Cost, i.e., excluding the stable measuring unit assumption which is never implemented under this model – Historical Costs under this model always being updated Historical Costs and
3. monetary items inflation-adjusted daily in terms of the Daily CPI, with the calculation and accounting of the net monetary loss or gain when they are not inflation-adjusted daily in terms of the Daily CPI,)
are always, after the balance sheet date, automatically updated in terms of the current (today´s) Daily CPI (in electronic – digital – form: financial statements preferably never to be printed on hard copy).
All these items are only stated at the measuring unit current at the balance sheet (that day´s Daily CPI) on that specific day. Thereafter they are all updated to the current, today´s, Daily CPI, whenever they are accessed or read or dealt with thereafter.
Tomorrow they will all be different in nominal value (their nominal values will be updated in terms of tomorrow’s Daily CPI, which we all already know today), but they will always be the same in real or constant value: always to be automatically updated in nominal value at all future Daily CPIs.
In principle and practice, they will never be the same in nominal value from the one day to the next during all levels of inflation and deflation, including during high inflation and hyperinflation, but they will always be the same in real or constant value.
Regarding the first paragraph of your summary:
It is very useful to remember the following:
“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 Par. 24
I am sure the above quote makes you think about the credibility of financial capital maintenance in nominal monetary units (the 3000-year-old, globally implemented, generally accepted, traditional Historical Cost Accounting model, which IAS 29 promotes even during hyperinflation of millions percent per annum) when we acknowledge the fact that it is generally impossible to maintain the real value of financial capital (equity) constant in nominal monetary units during inflation and deflation resulting in the real value (constant purchasing power) of that portion of entities´ equity not maintained constant by the real value of their net assets, being eroded / destroyed by the stable measuring unit assumption, not by inflation and hyperinflation, although almost all accountants and economists would tell you that the erosion of companies´ capital and invested profits is caused by inflation as it is actually stated in US FASs and as implied in IFRS.
Especially when we also acknowledge that it is a fact that financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index automatically maintains 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, whether they own any fixed assets or not.
Not a single company in the world knows whether it has maintained the real value (constant purchasing power) of its equity constant over its lifetime.
Makes you think, doesn’t it?
FAS 33 Par. 24 would automatically eliminate Historical Cost Accounting as a choice as an appropriate accounting model at all levels of inflation.
I attached a Pdf copy of my e-book CONSTANT ITEM PURCHASING POWER ACCOUNTING per IFRS (Available at Amazon.com). Your systems blocked the email that had the Kindle file in a zip file.
The book is a comprehensive introduction to financial capital maintenance in units of constant purchasing power in terms of a daily CPI or other index.
I acknowledge your assistance in my project in the book.
Another mistake in my agenda item request was the title of the draft IFRS ´X`. It is not draft IFRS ´X` CONSTANT ITEM PURCHASING POWER ACCOUNTING, but draft IFRS ´X` CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER per IFRS. I would appreciate it very much if you could be so kind as to correct it.
When I was ready to send in my agenda item request I did not know at the time that there is an actual agenda item request form. I suddenly discovered it on your site and promptly completed it in about 30 minutes. I did not check it before I submitted it.
Thank you very much for the opportunity to give you my input. The IASB has tremendous credibility as an international accounting standard institution with this approach and especially with your very public and very prominent annual improvement process.
Best regards,
Nicolaas Smith

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


___________________________________________________________________________


09 November 2012


Thank you for this additional information. I’ve reflected your changes in our summary of work in project that goes to members of the Interpretations Committee.



April Pitman | Technical Manager


International Accounting Standards Board (IASB)
30 Cannon Street | London EC4M 6XH | UK

____________________________________________________________________________



Applicability of IAS 29 No 1

Applicability of IAS 29 No 1


Date 24 September 2012

The original IFRIC Potential Agenda Item Request

Michael Stewart
Director of Implementation Activities
International Accounting Standards Board
First Floor
30 Cannon Street
London EC4M 6XH
United Kingdom

Dear Mr Stewart,

Re: IFRIC Potential Agenda Item Request

Attached herewith please find the IFRIC Potential Agenda Item Request regarding the implementation of financial capital maintenance in units of constant purchasing power during hyperinflation.

Your sincerely,

Nicolaas Smith

_______________________________________________________________


IFRIC POTENTIAL AGENDA ITEM REQUEST

  

The Issue:



The Conceptual Framework (2010), Par. 4.59 states:

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

Par. 4.59 (a) does not specifically indicate whether financial capital maintenance in units of constant purchasing power is applicable during low inflation, high inflation, hyperinflation or deflation.

IAS 29 Financial Reporting in Hyperinflationary Economies, Par. 8 states:

‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.’

As a result of the fact that it is currently generally accepted by accountants in countries implementing IFRS that IAS 29 is always required during hyperinflation, please indicate whether the following two statements are valid or not:


1. In terms of The Conceptual Framework (2010), Par. 4.59 (a), financial capital maintenance in units of constant purchasing power is applicable during low inflation, high inflation, hyperinflation and deflation.


2. In terms of IAS 29 Financial Reporting in Hyperinflationary Economies, Par. 8, this standard is only required for the restatement of historical cost and current cost financial statements and not in the case of financial capital maintenance in units of constant purchasing power during hyperinflation since all items in the latter financial statements would already be measured either  (a) in terms of the measuring unit current at the balance sheet date (e.g., the CPI); or (b) in terms of IFRS-authorized measurement bases current at the end of the reporting period (e.g., fair value, net realizable value, recoverable value, present value, etc.), excluding nominal Historical Cost (updated Historical Cost to be used under financial capital maintenance in units of constant purchasing power), i.e., excluding the stable measuring unit assumption which is never implemented under financial capital maintenance in units of constant purchasing power.

Current Practice: 

It is currently generally accepted by accountants in countries implementing IFRS that IAS 29 is always required during hyperinflation.


Reasons for the IFRIC to address the issue:


(a) The issue is widespread: most accountants believe that IAS 29 is always required during hyperinflation. 

(b) The issue involves significantly divergent interpretations since a proposed emerging practice, namely, the Argentinean Federation´s 2010 proposal for a future replacement of IAS 29, in the form of a draft IFRS, entitled IFRS ‘X’ INFLATION, amended in January 2012 to IFRS ‘X’ CONSTANT ITEM PURCHASING POWER ACCOUNTING, is based on the core principle of financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation, including during hyperinflation. The IASB voted unanimously in May 2012 to submit the replacement of IAS 29 to research. 

(c) Financial reporting would be improved through the elimination of the diversity, namely, indicating now that financial capital maintenance in units of constant purchasing power during hyperinflation is already authorized in IFRS, namely, in The Conceptual Framework (2010), Par. 4.59 (a). In fact, it was authorized in April 1989, the date the original Framework (1989) was authorized. 

(d) The issue is sufficiently narrow in scope to be capable of interpretation within the confines of IFRSs and the Conceptual Framework, but not so narrow that it is inefficient to apply the interpretation process. 

(e) The issue relates to the current IASB research project regarding the replacement of IAS 29. There is a pressing need for guidance sooner than would be expected from the IASB research project regarding the replacement of IAS 29 especially with regard to hyperinflation in Venezuela and high inflation in, for example, countries like Ethiopia (20%),  Tanzania (15.7% ), Mongolia (15.6%), Nigeria (11.7%), Angola (10%) and Argentina (10 or 20%).
  
Submitted by

Name: Nicolaas Smith 
Organization: Constant Item Purchasing Power Accounting 
Address: Avenida dos Descobrimentos 10, 3 E, 2740-044 Porto Salvo, Portugal 
Telephone: +351 919471788 
Email: realvalueaccounting@yahoo.com 

Date 24 September 2012


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

Sunday 30 June 2013

Safest long-term investment

An inflation-linked bond will therefore be the safest investment option for a long-term investor looking to limit the uncertainty associated with the future real value of his capital. 


The market for inflation-linked bonds 

The combination of a long investment horizon, no short-term liquidity needs and a patient owner generally make the fund well-suited to bearing different types of systematic risk.

 Experience from the financial crisis in 2008 showed, however, that in periods of financial instability we cannot count on the same level of liquidity in the market for inflation-linked bonds. Tradability in these situations is lower, and we therefore bear a higher liquidity risk than for investments in nominal government bonds. 

 Linkers may, however, have a role in the operational management of the fund when it is possible to secure an attractive real return and inflation expectations are considered moderate.

Monday 17 June 2013

Capital maintenance in units of constant purchasing power is an objective of Accounting / Financial Reporting

The entity concept is only possible together with the capital concept. Capital being independent from the owner(s) of capital is only possible with double-entry accounting and this is not referring to Historical Cost Accounting.

The above concept of capital assumes that the constant purchasing power of capital is being maintained constant over time during inflation and deflation because capital is equal to the real value of net assets. This assumption is not part of HCA because HCA simply assumes money is perfectly stable as far as the measurement of monetary items and constant real value non-monetary items are concerned, i.e., the stable measuring unit assumption is implemented and net monetary losses and gains are not accounted under HCA. Net monetary losses and gains are accounted and the stable measuring unit assumption is never implemented under ideal Capital Maintenance in Units of Constant Purchasing Power.

If the constant purchasing power of capital were not maintained 100 percent constant and if its real value were completely eroded by the stable measuring unit assumption during hyperinflation, it would lead to the end of the existence of the entity - all else being equal - only in the case of entities with net assets made up of only monetary items and constant real value non-monetary items, e.g., trade debtors, other non-monetary receivables, etc. never maintained constant under HCA. Entities with net assets made up of variable real value non-monetary items (e.g., property, plant, equipment, inventory, shares, foreign exchange, etc.) would continue existing even when the real value of the entire local money supply is completely eroded by hyperinflation as in the case of Zimbabwe on 20 November 2008.

Capital maintenance in units of constant purchasing power is thus essential for the entity.

Double-entry accounting is not essential for business, for example in a business with no organised accounting. Double-entry accounting is not essential for the exchange of goods and services. A contract - implied or not - is essential for exchange (business). The measurement bases underlying the contract are generally implied or stated / agreed / assumed in the contract.

Double-entry accounting is essential for the existence of an entity with capital. The economic items constituting the entity need to be valued from time to time. Measurement bases thus need to be adopted by the entity besides the ones used in exchange contracts for variable real value non-monetary items.

The entity has to adopt a measurement basis for the measurement of monetary items and constant real value non-monetary items, e.g., all items in equity, trade debtors, trade creditors, all other non-monetary receivables, all other non-monetary payables, provisions, all items in the income statement, etc. Under HCA the measurement basis adopted for this purpose is the stable measuring unit assumption, i.e., changes in the purchasing power of the monetary unit of account are not considered sufficiently important to implement measurement in units of constant purchasing power in terms of an index that recognises all - normally daily - changes in the general price level. HCA thus simply ignores the fact that money is not stable in real value. HCA also ignores the net monetary losses and gains that result from the choice of financial capital maintenance in nominal monetary units.

The stable measuring units assumption is never implemented under ideal CMUCPP in terms of an index that recognises all - normally daily - changes in the general price level for the purpose of measuring constant real value non-monetary items and net monetary losses and gains in monetary items are accounted.

Measurement bases are adopted by an entity with capital for the valuation of the entity items via the capital maintenance concept adopted. The Conceptual Framework states this in another way, namely that the accounting model is decided by the capital maintenance concept and measurement bases adopted.

One of the objectives of accounting / general purpose financial reporting on a logical or scientific basis is thus the adoption of measurement bases that would ensure capital maintenance in units of constant purchasing power in terms of an index that recognises all - normally daily - changes in the general price level during inflation and deflation. This can only be achieved via the adoption of Capital Maintenance in Units of Constant Purchasing Power in terms of an index that recognises all - normally daily - changes in the general price level for both physical and financial capital maintenance. It is the only possible choice on a logical or scientific basis. HCA, i.e., financial capital maintenance in nominal monetary units being the traditional accounting model only came about because of generally accepted social and economic practice over the last 3000 years.

Maintaining the constant purchasing power of capital constant during inflation and deflation is generally impossible under traditional HCA, i.e., under financial capital maintenance in nominal monetary units - all else being equal. Entities increase their nominal equity under HCA (hoping to maintain the real value of their nominal capital in this way) with increases in capital and with retained earnings which are then again not maintained constant in real value over time which again needs new capital or retained earnings which again are not maintained constant, etc., etc., etc., ... in a never ending process during inflation. In general, no entity in the world knows whether it has in the past maintained or is currently maintaining the real value (constant purchasing power) of its capital constant. This calculation is generally not done or required to be done in entities.

Capital Maintenance in Units of Constant Purchasing Power in terms of an index that recognises all - normally daily - changes in the general price level would automatically maintain the constant purchasing power of capital constant under complete co-ordination  in all entities that at least break even in real value - all else being equal - for an indefinite period of time at all levels of inflation and deflation.

The objectives of accounting / general purpose financial reporting on a logical or scientific basis are thus:

1. Capital Maintenance in Units of Constant Purchasing Power in terms of an index that recognises all - normally daily - changes in the general price level.

2. “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.” Conceptual Framework, OB2  

Accounting / general purpose financial reporting is not normally implemented on a logical or scientific basis on the international accounting standard-setting level. International accounting standard-setting is highly politicised. (Bunting 2013)

However, accounting / general purpose financial reporting on a logical or scientific basis is not forbidden or illegal in most of the world economy. CMUCPP is authorised in IFRS on an optional basis at all levels of inflation and deflation [CF 4.59 (a)] for whoever wishes to choose it in terms of an index that recognises all - normally daily - changes in the general price level.

No-one chooses it because it is not prescribed in IFRS: it is optional.

If the IASB were to require a daily index in IFRS, it would stabilise the non-monetary economy in every entity or country or monetary union which implements it at all levels of inflation and deflation under complete co-ordination.

If a daily index had been prescribed in IAS 29 in 1989, the Zimbabwean economy would never have imploded in 2008. Brazil had a relatively stable non-monetary economy during the 30 years of high inflation and hyperinflation of up to 2000 percent per annum from 1964 till 1994 as the result of Capital Maintenance in Units of Constant Purchasing Power in the form of daily indexation or daily monetary correction (daily price-level accounting) in terms of various government supplied daily indices.

Nicolaas Smith

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