IASB for the FIRST TIME officially confirms that IAS 29 implements capital maintenance in units of constant purchasing power

IASB for the FIRST TIME officially confirms that IAS 29 implements capital maintenance in units of constant purchasing power

Both the Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) model and IAS 29 implement financial capital maintenance in units of constant purchasing power as authorised in the Conceptual Framework, Par. 4.59 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

ON 3 September 2013, View 3 as stated in Par. 16 and 17 in Agenda Ref 12 correctly confirms for the first time that IAS 29 implements financial capital maintenance in units of constant purchasing power.

"View 3: The Conceptual Framework permits an entity to select the financial capital maintenance concept defined in constant purchasing power units if certain conditions are met, but should apply IAS 29 by analogy

16. Those who support this view also think that the Conceptual Framework permits an entity to select the financial capital maintenance concept that is defined in constant purchasing power units if such a capital maintenance concept best meets the needs of users. However, they think that the entity should use the accounting model described in IAS 29, by analogy, in accordance with paragraph 11 of IAS 8. They note that although the requirements in IAS 29 are only mandatory for entities reporting in a hyperinflationary currency, in their view, IAS 29 deals with a similar condition.


17. Accordingly they think that if a financial capital maintenance model defined in a measuring unit current at the reporting date is applied when preparing IFRS financial statements, that model should be the one described in IAS 29."

This is specifically stated for the first time at the IASB since the authorisation of IAS 29 in 1989 (24 years ago). It was something I also only realised in early 2013 after my collaboration with the IASB on this issue after I had submitted this IFRIC POTENTIAL AGENDA ITEM REQUEST to the IASB in Sept 2012.

Timeline

1 April 1989 IAS 29 authorised requiring the restatement of HC or CC financial statements in terms of the measuring unit current at the end of the reporting period during hyperinflation.

On 16 January 2013 the IASB staff stated:

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


On 21 January 2013 is sent an email to Hans Hoogervorst, the Chairman of the IASB in which I responded to Par. 10 above as follows:

[7] Incorrect: IAS 29 contains guidance on how to prepare financial statements in constant purchasing power units: many paragraphs in IAS 29 contain that guidance: they state which are monetary and non-monetary items, according to IAS 29, and how to measure items in units of constant purchasing power at the measuring unit current at the period-end date, but, IAS 29 does not result in “Financial capital maintenance ... in units of constant purchasing power” as defined in the CF, Par. 4.59 (a) because it is only possible to maintain a constant item constant when its constant real value is updated every time the URV-based Daily Index (or USD daily free-market rate) changes during hyperinflation. Values under IAS 29 are not continuously updated every time the URV-based Daily Index changes. The time variable (interval) should be: every time the URV-based Daily Index changes and not every time the monthly CPI changes. If IAS 29 were to be changed as such it would become “Financial capital maintenance ... in units of constant purchasing power” as defined in the Conceptual Framework, Par. 4.59 (a).

So, I informed the IASB for the first time on 21 January 2013. 

In April 2013 the IASB issued a Draft Discussion Paper: Capital Maintenance (not available online anymore) in which the IASB stated:

Par. "9.48 The concepts of capital maintenance are used in IAS 29 Financial Reporting in Hyperinflationary Economies."

The IASB did not indicate in April 2013 which concept(s??) of capital maintenance are used in IAS 29. 

On 7 June 2013 in my response to the Draft Discussion Paper: Capital Maintenance I informed the IASB again:

"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."

Finally, on 3 September the IASB correctly confirmed that financial capital maintenance in units of constant purchasing power is required in IAS 29, 24 years after its authorization on 1 April, 1989.

The Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) model implements financial capital maintenance in units of constant purchasing power in terms of a Daily Index (recognising at least the 365 daily changes in the general price level) which results in automatically maintaining the constant purchasing power (real value) of capital constant in all entities that at least break even in real value - ceteris paribus - for an indefinite period of time at all levels of inflation and deflation.

IAS 29 has been applied since 1990 implementing financial capital maintenance in units of constant purchasing power in terms of the 12 monthly published CPIs which ignores the at least 355 non-month-end daily changes in the general price level during hyperinflation (the general price level can change more than once a day during hyperinflation - (Shiller 1998)). This resulted over the last 24 years and currently results (e.g., in Venezuela and Belarus) in the destruction of the constant purchasing power (real value) - at the rate of hyperinflation - of that part of current year results (current profits and losses) and especially in trade debtors, trade creditors, other non-monetary receivables and payables that are not maintained constant as a result of the mistaken use of the monthly published CPI.

This was very evident during the last 8 years of Zimbabwe´s hyperinflation - something the IASB steadfastly refuses to admit although it is very clear to all accountants worldwide (except at the IASB) that IAS 29 had absolutely no positive effect in Zimbabwe. IAS 29 was implemented in terms of the monthly published CPI during those 8 years with absolutely no positive effect: the Zimbabwean economy nevertheless imploded on 20 November 2008. If IAS 29 were to have been implemented in terms of a Daily Index, e.g., the Daily US Dollar parallel rate, or the Old Mutual Implied Rate that was available till 19 November 2008 during those 8 years, then the Zimbabwean economy would never have imploded. Various Latin American countries implemented daily indexing or daily monetary correction or daily price level restatement which are all forms of financial capital maintenance in units of constant purchasing power in terms of a Daily Index with great success from 1964 till 1994. Brazil used their daily Unidade Real de Valor combined with their Real Plan to stop hyperinflation in April 1994. Brazil used daily indexation for 30 years from 1964 till 1994. This great Latin American success with daily indexation was ignored with the formulation of IAS 29 in 1989.

Changing IAS 29 as soon as possible to REQUIRE the use of a Daily Index would stabilise, for example, the Venezuelan constant real value non-monetary item economy over a short period of time.

Nicolaas Smith 

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

Daily indexing is simple enough and would work fine

m_astera:

I have understood your indexing idea since you first posted it here. It’s simple enough and would work fine.

The Devil´s Excrement

IAS 29 could stabilise the Venezuelan constant item economy

IAS 29 could stabilise the Venezuelan constant item economy


I am not proposing accounting dollarization in Venezuela as I invented and used it in Angola in 1996. I am also not proposing using the US Dollar´s daily rate as the Daily Index in Venezuela because I know that is illegal.

I am trying to get the IASB to understand capital maintenance in units of constant purchasing power in terms of a DAILY INDEX. Using a DAILY INDEX is what makes indexing or monetary correction or price level restatement - which are all forms of capital maintenance in units of constant purchasing power - work. The IASB does not understand that.

Latin American countries used it, but also did not understand the fundamentals involved. They did the right thing instinctively, like street vendors update their prices daily in terms of the US Dollar daily parallel rate during hyperinflation in all hyperinflationary economies.

If I could get the IASB to REQUIRE daily indexing in terms of the Daily CPI in IAS 29 it would be magic for Venezuela. It would stabilise Venezuela´s constant real value non-monetary economy in a very short period of time. It appears revolutionary because it would REQUIRE salaries, wages, rents, transport fees, all administered prices to be updated DAILY in terms of the Daily CPI. That is what Brazil and other LA countries did from 1964 till 1994.

This would not come from the Venezuelan government. It would come as a REQUIREMENT from the IASB via the implementation of IAS 29 which companies in Venezuela have been implementing since 2009.

The IASB knows very little about capital maintenance in units of constant purchasing power in terms of a daily index. Currently the IASB staff is attempting to ban its use during low and high inflation. Unbelievable, but true.


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

IASB claiming that changes in the carrying amounts of NON-MONETARY items are recognised as MONETARY gain or loss

IASB claiming that changes in the carrying amounts of NON-MONETARY items are recognised as MONETARY gain or loss

As the submitter of the IFRIC Potential Agenda Item Request I wish to make the following comments regarding STAFF PAPER Agenda ref 12 PROJECT IAS 29 Financial Reporting in Hyperinflationary Economies PAPER TOPIC Applicability of the concept of financial capital maintenance defined in constant purchasing power units:

1. In paragraph 6 it is stated:

“On the basis of our discussions with the submitter, we understand that the main differences between financial statements prepared using IAS 29 and those prepared using the CMUCPP are:

(a) the scope of monetary items; for example, trade receivables and

payables. These are classified as monetary items under IAS 29 but are

classified as non-monetary items under the CMUCPP. This difference

gives rise to a difference in the amount of net monetary gain or loss.

This is because, under both the CMUCPP and IAS 29, non-monetary

items are restated with changes in the carrying amounts being recognised as monetary gain or loss while monetary items are not restated; and” (I added bold type and underlining).

The part in bold type and underlined is not correct.

Changes in the carrying amounts of non-montary items are never recognised as monetary gain or loss under either Capital Maintenance in Units of Constant Purchasing Power or IAS 29.

Both CMUCPP and IAS 29 implement financial capital maintenance in units of constant purchasing power: CMUCPP in terms of a Daily Index (see several country Daily CPIs in the right side-bar) and IAS 29 in terms of the monthly published CPI as required in IFRS. IAS 29 had no positive effect during the 8 years it was implemented in Zimbabwe. The IASB refuses to acknowledge this very well known fact.

Changes in the real value (constant purchasing power) of monetary items - to the extent they are not linked to a general price level - during inflation and deflation are recognised as a net monetary gain or loss under both CMUCPP and IAS 29.

Nicolaas Smith 

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

IASB attempting to prohibit capital maintenance in units of constant purchasing power during low and high inflation

IASB attempting to prohibit capital maintenance in units of constant purchasing power during low and high inflation

Both US GAAP and IFRS authorise Capital Maintenance in Units of Constant Purchasing Power at all levels of inflation and deflation.

US GAAP

"Two major concepts of capital maintenance exist, both of which can be measured in units of either money or constant purchasing power: the financial capital concept and the physical capital concept (which is often expressed in terms of maintaining operating capability, that is, maintaining the capacity of an enterprise to provide a constant supply of goods or services)."

US GAAP Concepts Statement Nº 6, Par. 71 (Dec 1985)

IFRS

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

Initially authorised in the original Framework (1989), Par. 104 (a), now the Conceptual Framework (2010), Par. 4.59 (a).

Now an IASB staff paper states:


23. Consequently, we are of the view that IFRSs prohibit an entity from preparing its financial statements under the concept of financial capital maintenance defined in constant purchasing power units unless the entity falls within the scope of IAS 29.

STAFF PAPER Agenda ref 12 PROJECT IAS 29 Financial Reporting in Hyperinflationary Economies PAPER TOPIC Applicability of the concept of financial capital maintenance defined in constant purchasing power units

The IASB staff are completely mistaken in this respect.

Cost or historical cost is also a measurement basis under capital maintenance in units of constant purchasing power. It is not nominal cost as under HCA, but updated historical cost.

The Conceptual Framework also states:

4.65 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.


The IASB staff´s nominal cost argument as stated in Agenda Ref 12 is thus not valid.


Nicolaas Smith

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

Applicability of the concept of financial capital maintenance defined in constant purchasing power units

IFRS INTERPRETATIONS COMMITTEE MEETING

10–11 September 2013 

STAFF PAPER 

Agenda ref 12

PROJECT 

IAS 29 Financial Reporting in Hyperinflationary Economies

PAPER TOPIC 

Applicability of the concept of financial capital maintenance defined in constant purchasing power units

Agenda Reference Inquiry Submitter: Nicolaas Smith

See also: Timeline for Acceptability of IAS 29

IASB led revolution in Venezuela?

IASB led revolution in Venezuela?

“Because the problem is excess demand for foreign currency, generated in part by the artificial creation of money, while maintaining the official exchange rate constant.” Miguel Octavio

The problem with the parallel rate – not the economy as a whole – is twofold:

1. The one issue is International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies which is being implemented in Venezuela in terms of the month-end CPI since 2009.

Just like the US Dollar parallel rate changes DAILY (and can change more than once a day in the future at much higher rates of hyperinflation) so the CPI also changes DAILY. Venezuela has a Daily CPI. It is the DAILY INDEX used by the Venezuelan government to price Venezuela’s government capital inflation-indexed bonds issued in Bolivars DAILY. They can trade on a daily basis. This Venezuelan Daily CPI is available in Venezuela.

Implementing IAS 29 in terms of the month-end CPI destroys a part of current year results because the 355 non-month-end Daily CPI´s are being ignored. Only the 12 month-end CPI´s are being used under IAS 29. (I can supply an example if anyone is interested.)

What actually happens is that Venezuelan companies use Historical Cost Accounting for the 355 non-month-end transactions. Imagine using Historical Cost Accounting during hyperinflation! Very unfortunately the International Accounting Standards Board very mistakenly REQUIRES the use of HCA during hyperinflation. Under HCA it is ASSUMED that the Bolivar is PERFECTLY stable during those 355 non-month-end days. Imagine assuming the Bolivar is PERFECTLY stable during hyperinflation! Every company in Venezuela is doing that as far as transactions on the 355 non-month-end days are concerned!

When IAS 29 is implemented in terms of the Daily CPI, then the Venezuelan constant real value non-monetary item economy would stabilise over a very short period of time. For example, salaries, wages, rents, transport prices, all items in the income statement, capital, reserves, all items in shareholders equity, provisions, etc. would be measured in units of constant purchasing power in terms of the Daily CPI.

Variable real value non-monetary items, e.g., property, plant, equipment, inventory, stock, finished goods, consumer products, listed and unlisted shares, etc. would be measured in terms of International Financial Reporting Standards (at, e.g., fair value – market price) and then historical values would be updated DAILY in terms of the Daily CPI till they are again measured in terms of IFRS (e.g. market price).

This would stabilise the constant item economy over a very short period of time.

2. Secondly the Venezuelan Central Bank should issue a decree that ALL monetary items should be inflation-adjusted on a daily basis in terms of the Daily CPI. Chile is doing this with 25% of its broad M3 money supply for years already.

There would still be hyperinflation in Venezuela if the Central Bank keeps printing too many Bolivars. But, there would be no cost of or gain from hyperinflation when ALL monetary items are inflation-indexed daily in terms of the Daily CPI.

It would be a real revolution if Venezuela were to do this.

The above revolution in the constant real value non-monetary item economy (1) can be brought about by the IASB by a simple change in IAS 29 from using the month-end CPI to using the Daily CPI as was done in Brazil and other Latin American countries with daily indexation or daily monetary correction or daily price-level restatement from 1964 till 1994. Unfortunately the IASB knows very little about capital maintenance in units of constant purchasing power in terms of a daily index. Currently the IASB staff is attempting to ban its use during low and high inflation. Unbelievable, but true.

The IASB unfortunately does not understand capital maintenance in units of constant purchasing power in terms of a daily index although it was widely used in Latin America in the recent past. The IASB refuses point blank to acknowledge that IAS 29 in terms of the month-end CPI had absolutely no positive effect during 8 years of full implementation in Zimbabwe’s economy even though all accountants in the world – except at the IASB – have the common sense to see that it had no effect at all. The IASB only very recently very vaguely acknowledged that Capital Maintenance in Units of Constant Purchasing Power is being implemented in IAS 29 after I pointed it out to them. IAS 29 was authorized 24 years ago in 1989. The IASB does not yet understand the automatic constant purchasing power capital maintenance effect of using the Daily CPI instead of the monthly published CPI in IAS 29. They are slow learners. They are intoxicated with HCA and the stable measuring unit assumption.

The daily indexation of ALL monetary items (100%) is another revolutionary step not yet taken by any country although Chile has been doing it to 25% of its money supply for years as confirmed to me by the Central Bank of Chile.

Nicolaas Smith

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

Brazil should go back to banning Historical Cost Accounting

Brazil should go back to banning Historical Cost Accounting is the same as stating that Brazil should go back to Capital Maintenance in Units of Constant Purchasing Power or price-level restatement or indexation or monetary correction in terms of a daily index. It would have a very positive effect on Brazil´s currency. See "Can Brazil´s currency be saved."

Brazil effectively banned Historical Cost Accounting from 1964 till March 1994 and instead implemented CMUCPP in terms of a daily index when it used daily indexation or monetary correction in terms of a daily index during the above thirty years of very high inflation and hyperinflation. Brazil unnecessarily re-introduced HCA with the adoption of the Real after it very successfully stopped hyperinflation with daily indexation (the Unidade Real de Valor) and the Real Plan in 1994.

Most Latin American countries used CMUCPP in terms of a daily index during that period as well as afterwards. Chile only stopped in 2008 in order to "comply with" IFRS. Chile did not realise that CMUCPP in terms of a daily index at all levels of inflation and deflation (including during low inflation) had originally been authorised in IFRS in the Framework (1989), Par. 104 (a) - 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."

Re-introducing CMUCPP in terms of a daily index with its current "monetary stability" upper limit of 6.5% inflation would stabilise Brazil´s constant real value non-monetary item economy currently during low inflation, like it stabilised its entire non-monetary economy (both its variable real value non-monetary item economy and its constant item economy) and some of its monetary economy during those 30 years of high and hyperinflation from 1964 to 1994.

Brazil is a co-author of a 2010 proposal to the IASB under the chairmanship of the Argentinean Accounting Federation for the requirement of Capital Maintenance in Units of Constant Purchasing Power or price-level restatement at annual inflation of 10% or cumulative inflation of 26% over three years.

I suggest Brazil implements CMUCPP in terms of a daily index now at their 6.5% "price stability" level. It would stabilise its constant item economy over a short period of time. Brazil has 30 years of experience of daily indexation.

Inflation-indexing its entire money supply on a daily basis - as Chile has been doing for some time to at least 25% of its money supply - would eliminate the cost of and gain from low inflation of up to 6.5% inflation (or whatever other higher rate) from the entire Brazilian money supply. It would not eliminate inflation, but it would be inflation with no cost or gain.

Brazil (as well as Argentina, Chile and Mexico) already agreed to Capital Maintenance in Units of Constant Purchasing Power (price-level restatement) at 10% annual inflation or 26% cumulative inflation over three years.

Starting now at 6.5% inflation would benefit the Brazilian economy - and consequently its currency - greatly.

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

High inflation in India

High inflation in India

GDP (PPP)		2012 estimate
-	Total	$4.711 trillion[7] (3rd)
-	Per capita	$3,851[7] (129th)
GDP (nominal)		2012 estimate
-	Total	$1.947 trillion[8] (10th)
-	Per capita	$1,592[7] (140th)

Wikipedia

Population
-	2011 census	1,210,193,422[6] (2nd)

Wikipedia

Low inflation is inflation from 0.00001 to 9.99% per annum. High inflation is from 10 to 25.99% per annum or 26% cumulative inflation over three years. Hyperinflation is cumulative inflation of 100% over three years, i.e., annual inflation of 26% for three years in a row (for everyone in the world excluding Prof. Steve Hanke and a handful of other academics who steadfastly ignore the IFRS definition of hyperinflation followed by millions of accountants worldwide).

Indian year-on-year inflation during 2013

January  11.62%
February 12.06%
March     11.44%
April      10.24%
May       10.68%
June      11.06%

The Argentinean Accounting Federation, in collaboration with the Brazilian, Chilean and Mexican accounting authorities, proposed a new IFRS to the IASB namely Financial Reporting in High Inflationary Economies in 2010 in which they proposed a form of Capital Maintenance in Units of Constant Purchasing Power (restatement) in terms of the monthly published CPI similar to what is unsuccessfully used in IAS 29. 

I amended that proposal in January 2012 to use the Daily CPI since comprehensive CMUCPP is only possible with a Daily CPI and not a monthly CPI as unsuccessfully used in IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29 had absolutely no effect during 8 years of full implementation during Zimbabwe´s hyperinflation because of the use of the monthly CPI - something the IASB refuses to admit.

The IASB now (August 2013) still has to decide first whether it is going to have a research project to decide whether it should have a full-scale project to develop an IFRS for Financial Reporting in High Inflationary Economies. The IASB is currently in a "period of rest" (as they state it) after the first quarter of a century of setting IFRSs.

If the IFRS Financial Reporting in High Inflationary Economies with comprehensive CMUCPP (restatement) in terms of a Daily CPI as from the inflation thresholds as suggested in the Argentinean Proposal, namely as from annual inflation of 10% per annum or from 26% cumulative inflation over three years, were already authorized, then India would CURRENTLY be REQUIRED in terms of IFRS to implement the new IFRS (comprehensive CPMCPP) in terms of a Daily CPI. 

This would stabilize the Indian constant real value non-monetary economy over a very short period of time as India would be required to abandon the Historical Cost Accounting model and with it the stable measuring unit assumption, never to go back to it again.

India does not need the currently draft-only IFRS Financial Reporting in High Inflationary Economies to stabilize its constant real value non-monetary item economy in terms of a Daily CPI because capital maintenance in units of constant purchasing was authorized 24 years ago at all levels of inflation and deflation (including during low and high inflation) as an option to Historical Cost Accounting in IFRS in the original Framework (1989), Par. 104 (a) [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." 

India is thus currently authorized in IFRS to implement comprehensive CMUCPP in terms of a Daily CPI and therewith to stabilize its constant real value non-monetary item economy over a short period of time. India would never do it no matter what the enormous benefits would be simply because India is NOT REQUIRED to do it: it is AN OPTION in IFRS to India and India would not make that option.

Technical Issue: India does not issue government capital inflation-indexed bonds and thus does not currently have an official Daily CPI like all countries which do issue sovereign capital inflation-adjusted bonds. That is a very small technical issue. A Daily CPI can be set up in a few hours using the generally accepted Chilean Unidad de Fomento formula for that purpose (Shiller 1998). 

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

Serbian Daily CPI

Serbian Daily CPI

Addition to the Daily CPI links:

Serbian Daily CPI - see the Daily CPI links on the right on my main blog (not available on the SA blog).

I would appreciate it very much if anyone who has knowledge of the links to other countries´ Daily CPIs could be so kind as to send them to me at

realvalueaccounting@yahoo.com

to make as many as possible of these country Daily CPI links available here on one site.

All countries that issue government capital inflation-indexed bonds calculate and publish Daily CPIs. It is normally done by the central bank or the national statistics institute.

Thanking you in advance.

Nicolaas Smith




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

Automatic capital maintenance under CMUCPP

Automatic capital maintenance under CMUCPP

You do not maintain the real value (constant purchasing power) of your capital constant simply by measuring it in units of constant purchasing power by multiplying it by the rate of increase in inflation during the accounting period in isolation. You do it automatically by implementing Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily Index, for example, the Daily CPI during low inflation. 

This is possible because of double-entry accounting: for every credit (capital) there is an equivalent debit (e.g., trade debtor/inflation-adjusted monetary item/property). It is thus possible for capital maintenance to be automatic: it is automatic in NOMINAL (NOT REAL) VALUE under HCA and it is automatic IN REAL VALUE under CMUCPP, generally only in terms of a Daily Index. 

CMUCPP in terms of a Daily Index automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation. 

For example: When you have all your capital invested in a constant item, e.g., trade debtors, your capital is automatically maintained constant in real value over time during inflation and deflation because both the capital and the trade debtors are constant real value non-monetary items and both are always and everywhere measured in units of constant purchasing power in terms of a Daily Index. So it is automatic constant purchasing power capital maintenance.

When all your capital is invested in a variable real value non-monetary item, for example, a property in the middle of the financial district in London, then you would also have automatic constant purchasing power capital maintenance because you would measure your equity in units of constant purchasing power in terms of the Daily CPI in the UK (see link on the right side-bar) and the property would - generally - at least maintain its real value  in the always updated London property market. 

When all your capital is invested in a monetary item, for example, Treasury Inflation-Indexed Bonds (TIPS) in the American market, then the constant purchasing power of your capital would also automatically maintain its constant purchasing power over time. TIPS are inflation-adjusted daily in terms of the US Daily CPI (see link on the right side-bar). 

The requirement under CMUCPP in terms of a Daily Index that an entity has to break even in real value - ceteris paribus - ensures that capital maintenance is always automatic in real value (constant purchasing power) under this IFRS-authorized accounting model.

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

Differences in the three capital maintenance concepts

Differences in the three capital maintenance concepts

To form a company, you need capital. 

The company is a new legal entity even if you own 100% of the capital. You are a legal entity. You are not the company. The company is a new, separate legal entity. There are thus two legal entities or legal persons.

The company has to maintain its capital otherwise it will stop existing.

A long time ago in the past everybody believed that the real value of money is perfectly stable. They did not understand that inflation destroys the real value of money over time. 

So they thought that they were maintaining the real value of capital by simply doing their accounting in nominal monetary units. They used Historical Cost Accounting. 

Today the whole world still uses Historical Cost Accounting (except during hyperinflation  when a flawed form of CMUCPP is implemented, namely IAS 29), that is, traditional accounting: doing accounting in nominal monetary units, but, everybody knows that inflation destroys the real value of money over time.

During low inflation accountants know that inflation is destroying the real value of money, but, they assume that changes in the real value (purchasing power) of money are not sufficiently important to implement Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI. 

Everybody in low inflation economies worldwide thus implements traditional Historical Cost Accounting. That is (1) Financial Capital Maintenance in nominal monetary units. 

As you can see, it is impossible to maintain the real value of your capital in nominal monetary units over time during inflation and deflation. Companies bluff themselves that they overcome this problem by assuming that money is perfectly stable during low inflation and deflation. What they do is they do not declare all their profits in dividends to the owners of the capital. They retain profits hoping to maintain the real value of their capital. No-one knows for sure if the do or not.

Under financial capital maintenance in nominal monetary units (Historical Cost Accounting) a company - in theory - only maintains it capital when its nominal capital at the end of the accounting period is at least equal to its nominal capital at the start  - excluding contributions from and distributions to the shareholders.

You can see that is only true in theory. In reality it is not true. But, all accountants have been doing HCA like that for the last 3000 years, so they think it must be correct. You can see that it is not. However, it is very difficult to change something that all accountants worldwide have been doing for the last 3000 years. I think it will take about another 200 years to stop accountants doing Historical Cost Accounting while we have inflation and deflation. 

(2) Financial Capital Maintenance can also be measured in units of constant purchasing power in terms of a Daily CPI.

There are three basic economic items in the economy. They are all three stated in monetary units: they thus all have monetary values, but, they are not all monetary items. 

The three basic economic items are:

(i) Monetary items. 

(ii) Constant real value non-monetary items 

(iii) Variable real value non-monetary items

Monetary items constitute the money supply. If an item forms part of a country´s money supply as stated by the country´s central bank, then it is a monetary item. 

All items that are not monetary items are non-monetary items. 

Non-monetary items are split in two:

Constant real value non-monetary items  and

Variable real value non-monetary items.

Constant items are non-monetary items with constant real values over time. Examples are salaries, wages, rentals, interest paid, interest received, issued share capital, retained profits, retained losses, capital reserves, all other items in equity, provisions, all items in the income statement, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, etc.

Constant items are always and everywhere measured in units of constant purchasing power only under Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily CPI. 

Variable items are non-monetary items with variable real values over time. Examples are property, plant, equipment, quoted and unquoted shares, foreign exchange, inventory, raw materials, finished goods, patents, trademarks, etc. 

Under HCA variable items are measured in terms of International Financial Reporting Standards including the stable measuring unit assumption, that is, including nominal Historical Cost.

Under CMUCPP variable items are measured in terms of International Financial Reporting Standards excluding the stable measuring unit assumption, that is, excluding nominal Historical Cost.

How do you solve the problem of (1) the real value of monetary items being destroyed by inflation and (2) the real value of constant items being destroyed by the stable measuring unit assumption.

Inflation is always and everywhere a monetary phenomenon (Milton Friedman). Inflation only destroys the real value of monetary items not inflation-adjusted in terms of a daily index. Inflation has no effect on the real value of non-monetary items. Implementing the stable measuring unit assumption during inflation destroys the real value of constant items never maintained constant in real value. 

You can maintain the real value of monetary items during inflation by inflation-adjusting them in terms of the Daily CPI during low inflation. 

You maintain the real value (constant purchasing power) of constant items by measuring them in units of constant purchasing powe in terms of a daily index: that is, you DO NOT implement the stable measuring unit assumption. 

The stable measuring unit assumption is the assumption that money is perfectly stable. 

You measure, for example, capital in units of constant purchasing power by never implementing the stable measuring unit assumption; that is, you never assume money is perfectly stable. 

You measure capital of 100 in units of constant purchasing power over a year by multiplying it with the increase in inflation during that year. If inflation were 10% during the year, you multiply the 100 by 1.1 and you get 110. Now your capital is stated in units of constant purchasing power: the real value stays the same, but the nominal value changes daily in terms of the Daily CPI. At the end of the year the nominal value would be 110, but, the real value would be the same as the 100 at the BEGINNING of the year. Thus the REAL value remains the same over time (100 in BEGINNING of the year terms), but, the nominal value will change daily with daily inflation.

When this is done with all constant real value non-monetary items in the economy in terms of the Daily CPI, the constant real value non-monetary item economy would be stable.

When all monetary items are inflation-adjusted daily in terms of the Daily CPI during low inflation, then the monetary economy would be stable. There would still be inflation, but no cost of or gain from inflation.


Physical Capital Maintenance is maintaining the physical capital of a company in terms of physical units of output.

For example: if you have a factory that produces 1 million bricks per annum, you have maintained your physical capital (with on-going general maintenance during the year, preventative maintenance, replacement of old machinery, etc.) if the physical factory machines at the end of the year still have the capacity to produce 1 million bricks per annum. Physical capital maintenance is very different from financial capital maintenance. 

1. Financial capital maintenance in nominal monetary units 

2. Financial capital maintenance in units of constant purchasing power

3. Physical capital maintenance in physical units of output. 

Financial capital maintenance in units of constant purchasing power is fundamentally different from financial capital maintenance in nominal monetary units. Financial capital maintenance in nominal monetary units (HCA) implements the stable measuring unit assumption while the stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power in terms of a daily index. 

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

Where Venezuela is heading

Demystifying the burning process

The term "burning money" has become very common in Zimbabwe. It refers to the selling of Foreign Currency originally by Real Time Gross Settlement (RTGS) or Inter-Account Transfers, and now, through the use of cheques.

20.11.0808:29am

by MISA

[This was published in The Zimbabwean on 20 November 2008, the last day of hyperinflation of  89,700,000,000,000,000,000,000.00 percent per annum.

This is where Venezuela may be heading. Why be productive if you can multiply your salary six times by simple arbitrage.  Top people in Venezuela are getting fabulously rich from arbitrage. They are not going to stop the party. Why have an economy? There is absolutely no logical reason to have a productive economy when you can get fabulously rich from arbitrage. 

This will definitely destroy what is left of the Venezuelan economy.]

The rates have risen so high that it takes less than US$1 to pay the whole of the civil service. As evidenced by the ever winding cash queues at banks, a good number of Zimbabweans are participating directly or indirectly in the "burning process".

Most of the money in circulation comes from the sale of Old Mutual Shares and other dually listed counters. People sell the shares, use the money to buy hard currency and then repurchase shares on the Johannesburg Stock Exchange (JSE) or the London Stock Exchange (LSE). This process can earn one more than 1000 per cent return per week on investment.

For example, on November 11, 2008 the Old Mutual Implied Rate (OMIR) was at Z$22.39 quadrillion per US dollar, while the Cheque Rate was Z$500 trillion per US dollar.

This means one US dollar in the hands of a person with an Old Mutual share was worth 44.78 times more than dealers were paying for a dollar "burnt" using the Cheque Rate. In Zimbabwe, a cheque takes up to four days to clear. However, if one has "enough clout" they can request same-day value and the money clears the same day it is deposited.

Owners of the famed "pots", who sell shares, can get their money on the same day, allowing them to instantly start writing cheques.

The whole process fuels itself. After someone "burns" money, they get a lot of quadrillions they can't use because most people are no longer accepting cheque payments. They then buy shares.

Most businesses are using money in their banks to buy shares and in turn, ordinary people are not selling shares because they cannot use the proceeds in any way. This creates an

artificial Bull-run on the Zimbabwe Stock Exchange.

The whole process creates a very unnatural situation where those trading in the dually listed shares are benefiting while the rest of the country is crying foul.

Ordinary people who sell foreign currency are also benefiting. If someone sold a dollar on November 11, they would have got Z$500 trillion. The cash rate for the same day was Z$350,000.00 for one US dollar. They only need to go and queue for the Z$500 000 being given by banks, then use the money to buy 1 US dollar on the flourishing parallel

market.

The whole process is destroying the economy as most of the money in bank accounts is artificial. There is no-longer any incentive to work, because people make more from burning. Companies have money in their accounts that they can no longer use to make payments as the money cannot compete with proceeds from the burning process. Pricing of goods is no longer possible in Zimbabwe dollar terms.

Can companies rely on the OMIR when billing their clients or converting Financial Statements to US dollars? The OMIR is based on the "No Arbitrage Assumption" that the value of Old Mutual Shares is the same wherever the share trades, and one cannot make a risk-free-profit by buying and selling the share in a different currency. We have shown that this is very possible.

There are a number of possible solutions:

* Dollarising the trade in shares of dually listed companies. If these shares are traded in hard currency, this does away with the arbitrage opportunities addressed above.

* Dollarising the whole economy or using a more stable regional currency such as the rand.

The Zimbabwean 20 November 2008

[The Governor of the Zimbabwe Reserve Bank closed the Zimbabwe Stock Exchange on that day (20 November, 2008) which stopped trading in Old Mutual shares which provided the OMIR (Old Mutual Implied Rate) which was the last exchange rate of the Zimbabwe Dollar with the British Pound. No exchange rate completely ended the real monetary exchange value of the Zimbabwe Dollar. The economy was already at a very advanced stage of spontaneous Dollarization.

Let us wait and see what is going to happen in the Venezuelan economy. We have an excellent example to follow in what happened in Zimbabwe.]