Zero inflation, deflation and hyperinflation effect.
Implementing IFRS and US GAAP authorized Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI
during
1. low inflation results in zero low inflation effect,
2. high inflation results in zero high inflation effect,
3. hyperinflation results in zero hyperinflation effect and
4. deflation results in zero deflation effect.
South American countries´ central banks called it "monetary correction" in the 1970s to 1990s. The best example was the implementation of this principle with the use of the Daily Unidade Real de Valor in Brazil in 1994.
Zero monetary effect can only be achieved when CMUCPP is implemented to reflect every change in the general price level, that is, at least daily in terms of the Daily CPI in non-hyperinflationary economies.
CMUCPP also has to be implemented in terms of the Daily CPI or daily parallel rate when a Daily CPI is not available during hyperinflation.
However, it must be remembered that the general price level can and sometimes does change more than once a day during hyperinflation. This must be accompanied in the whole hyperinflationary economy, in accounting records and in contracts in order to correctly achieve zero hyperinflationary effect.
Under all the above circumstances, the constant purchasing power of all constant real value non-monetary items (e.g., all items in shareholders equity, trade debtors, trade creditors, salaries, wages, pensions, taxes payable, taxes receivable, etc.) would automatically be maintained constant - ceteris paribus.
Nicolaas Smith
Copyright (c) 2005-2018 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Sunday 14 January 2018
Tuesday 8 November 2016
Equity Equal to Net Assets Capital Maintenance Fallacy
Capital has never and is never and will never be maintained constant in real value by entities which prepare their financial statements on the nominal Historical Cost basis when it is taken into account that net monetary losses and gains are never accounted under this model and that sustainable zero inflation has never been achieved and will most likely never be achieved. It is also true that zero effect of inflation, hyperinflation and deflation is easily possible with daily indexing of all items in terms of the Daily CPI as used under Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI.
All nominal Historical Cost audit reports should start with the following standard statement:
"We confirm that the constant purchasing power (real value) of the entity's capital was not maintained during the last financial period as in its entire existence to date under the nominal Historical Cost basis because
(1) the stable measuring unit assumption was implemented resulting in constant real value non-monetary items (e.g., shareholders´ equity, taxes, debtors, creditors, profits, losses, salaries, wages, etc.) not being maintained in real value and
(2) no account was taken of changes in the inflation/deflation rate with net monetary gains and losses not accounted for in the preparation of the financial reports.
The financial statements balance in nominal value but not in real value."
Current shareholders, creditors, employees, the authorities, prospective investors and all stakeholders should be made fully aware of the fact that it is impossible for the entity to maintain the real value (constant purchasing power) of its capital under the nominal Historical Cost basis.
It is obvious that Historical Cost Accounting´s fundamental mistake - the stable measuring unit assumption - can be used in the Equity Equal to Net Assets Capital Maintenance Fallacy Proof.
The accounting profession generally argues that the fact that it is impossible to maintain the real value or constant purchasing power of capital under the nominal Historical Cost basis under non-zero inflationary conditions is not important since capital is always equal to net assets.
Yes, it is mathematically correct that nominal capital is always equal to net assets under the nominal Historical Cost basis - in nominal monetary units, that is all. However, that is not equal to capital maintenance (see FAS 33 above) as the profession - excluding the US contingent - so fraudulently implies.
Maintaining the constant purchasing power (real value) of capital always was, is and will always be impossible during non-zero inflationary conditions under the nominal Historical Cost basis.
Capital maintenance is impossible under the nominal Historical Cost basis. Period. State it openly in the financial statements and audit report.
The statement in the IFRS Conceptual Framework that "Financial capital maintenance can be measured in nominal monetary units" is thus completely dishonest, false, fake, misleading and fraudulent. That statement should at least state: "Only nominal financial capital maintenance can be measured in nominal monetary units" if IFRS were to be to be honest, true, real, not misleading and valid - in this respect.
Every past, present and future member of the IASB knows that generally no balance sheet prepared under the nominal Historical Cost basis has ever balanced, balances or ever will balance in real value during non-zero inflationary conditions.
Fortunately the IFRS Conceptual Framework also authorizes: "Financial capital maintenance can be measured in units of constant purchasing power".
However, it only works when it is done in terms of the Daily CPI. Using the monthly CPI does not result in real capital maintenance since it has to be done in terms of all changes in the general price level. The general price level does not change monthly as it appears as a result of the original (historical) monthly publication of the CPI figures. It changes daily in all economies. Economic transactions are executed every day of the month. The general price level can - and often does - change more than once a day in hyperinflationary economies.
The absolute proof that daily updating is required? All government inflation-indexed bonds are updated daily in terms of the Daily CPI because they trade daily on the trillion Dollar global sovereign inflation-indexed bond markets, for example US Treasury Inflation Protected Securities or TIPS. They need updated prices daily - not monthly. People and governments trade these inflation-indexed bonds daily, not monthly. The general price level changes at least daily. Daily CPI figures are thus generally available. See the examples on the right margin of this site.
Definition
Nicolaas Smith
Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
All nominal Historical Cost audit reports should start with the following standard statement:
"We confirm that the constant purchasing power (real value) of the entity's capital was not maintained during the last financial period as in its entire existence to date under the nominal Historical Cost basis because
(1) the stable measuring unit assumption was implemented resulting in constant real value non-monetary items (e.g., shareholders´ equity, taxes, debtors, creditors, profits, losses, salaries, wages, etc.) not being maintained in real value and
(2) no account was taken of changes in the inflation/deflation rate with net monetary gains and losses not accounted for in the preparation of the financial reports.
The financial statements balance in nominal value but not in real value."
Current shareholders, creditors, employees, the authorities, prospective investors and all stakeholders should be made fully aware of the fact that it is impossible for the entity to maintain the real value (constant purchasing power) of its capital under the nominal Historical Cost basis.
It is obvious that Historical Cost Accounting´s fundamental mistake - the stable measuring unit assumption - can be used in the Equity Equal to Net Assets Capital Maintenance Fallacy Proof.
‘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.’
US FASB Financial Accounting Standard 33 (1979) Paragraph 24
[There is nothing like the above in IFRS. The Americans often seem to be just that little bit better. It is a good thing they have not adopted IFRS as is. :-) ]
[There is nothing like the above in IFRS. The Americans often seem to be just that little bit better. It is a good thing they have not adopted IFRS as is. :-) ]
The accounting profession generally argues that the fact that it is impossible to maintain the real value or constant purchasing power of capital under the nominal Historical Cost basis under non-zero inflationary conditions is not important since capital is always equal to net assets.
Yes, it is mathematically correct that nominal capital is always equal to net assets under the nominal Historical Cost basis - in nominal monetary units, that is all. However, that is not equal to capital maintenance (see FAS 33 above) as the profession - excluding the US contingent - so fraudulently implies.
Maintaining the constant purchasing power (real value) of capital always was, is and will always be impossible during non-zero inflationary conditions under the nominal Historical Cost basis.
Capital maintenance is impossible under the nominal Historical Cost basis. Period. State it openly in the financial statements and audit report.
The statement in the IFRS Conceptual Framework that "Financial capital maintenance can be measured in nominal monetary units" is thus completely dishonest, false, fake, misleading and fraudulent. That statement should at least state: "Only nominal financial capital maintenance can be measured in nominal monetary units" if IFRS were to be to be honest, true, real, not misleading and valid - in this respect.
Every past, present and future member of the IASB knows that generally no balance sheet prepared under the nominal Historical Cost basis has ever balanced, balances or ever will balance in real value during non-zero inflationary conditions.
Fortunately the IFRS Conceptual Framework also authorizes: "Financial capital maintenance can be measured in units of constant purchasing power".
However, it only works when it is done in terms of the Daily CPI. Using the monthly CPI does not result in real capital maintenance since it has to be done in terms of all changes in the general price level. The general price level does not change monthly as it appears as a result of the original (historical) monthly publication of the CPI figures. It changes daily in all economies. Economic transactions are executed every day of the month. The general price level can - and often does - change more than once a day in hyperinflationary economies.
The absolute proof that daily updating is required? All government inflation-indexed bonds are updated daily in terms of the Daily CPI because they trade daily on the trillion Dollar global sovereign inflation-indexed bond markets, for example US Treasury Inflation Protected Securities or TIPS. They need updated prices daily - not monthly. People and governments trade these inflation-indexed bonds daily, not monthly. The general price level changes at least daily. Daily CPI figures are thus generally available. See the examples on the right margin of this site.
Definition
Thursday 1 September 2016
Currency is either a monetary or non-monetary item
Example:
US Dollar as a monetary item
The US Dollar is a monetary item only inside the US economy. Its nominal price is the nominal interest rate initially set by the Federal Reserve Bank. Its real price inside the US economy is its real interest rate which is the nominal interest rate charged in a contract or transaction minus the daily changing rate of inflation or deflation as indicated by the US Daily Consumer Price Index.US - Daily Reference CPI-Us Official future United States Daily CPI Sept 2016
US Dollar as a non-monetary item
The US Dollar is generally a variable real value non-monetary item in the hands of entities/people outside the US economy. US Dollars outside the US economy are non-monetary items in all other non-US economies where they are held.
Outside the US economy the US Dollar´s non-monetary price (real value) is mainly determined nano-second by nano-second in the USD 5.6 trillion global 24-hour-per-day, 5-working-day-a-week foreign exchange market in terms of most other currencies as well as in many other street markets, etc. where it is traded on the black market also called the parallel market at the daily changing parallel rate or black market rate.
The daily rate (general price level) can change more than once a day during hyperinflation. The parallel/black market rate can also change on Saturdays and Sundays. This is not the case in the official foreign exchange market which is closed on Saturday and Sunday.
This generally applies to other national or regional currencies too.
Hyperinflationary currencies are often not traded internationally.
Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
US Dollar as a monetary item
The US Dollar is a monetary item only inside the US economy. Its nominal price is the nominal interest rate initially set by the Federal Reserve Bank. Its real price inside the US economy is its real interest rate which is the nominal interest rate charged in a contract or transaction minus the daily changing rate of inflation or deflation as indicated by the US Daily Consumer Price Index.US - Daily Reference CPI-Us Official future United States Daily CPI Sept 2016
US Dollar as a non-monetary item
The US Dollar is generally a variable real value non-monetary item in the hands of entities/people outside the US economy. US Dollars outside the US economy are non-monetary items in all other non-US economies where they are held.
Outside the US economy the US Dollar´s non-monetary price (real value) is mainly determined nano-second by nano-second in the USD 5.6 trillion global 24-hour-per-day, 5-working-day-a-week foreign exchange market in terms of most other currencies as well as in many other street markets, etc. where it is traded on the black market also called the parallel market at the daily changing parallel rate or black market rate.
The daily rate (general price level) can change more than once a day during hyperinflation. The parallel/black market rate can also change on Saturdays and Sundays. This is not the case in the official foreign exchange market which is closed on Saturday and Sunday.
This generally applies to other national or regional currencies too.
Hyperinflationary currencies are often not traded internationally.
Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday 31 August 2016
Negative rates only negative under Historical Cost paradigm
Negative interest rates are only negative under the nominal Historical Cost Accounting paradigm.
The effect of negative interest rates is always positive under the Units of Constant Purchasing Power in terms of the Daily CPI paradigm during deflation.
Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
The effect of negative interest rates is always positive under the Units of Constant Purchasing Power in terms of the Daily CPI paradigm during deflation.
Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Sunday 31 July 2016
An inconvenient accounting truth
No balance sheet has ever balanced in real value under Historical Cost Accounting and no balance sheet ever will while money, subject to inflation and deflation, is used as the unstable unit of measure.
Under IFRS and US GAAP authorised Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI the constant purchasing power of capital is automatically maintained constant in real value in all entities at all levels of inflation, hyperinflation and deflation - ceteris paribus.
Nicolaas Smith Copyright (c) 2005-2016 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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