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March 29, 2011 in Uncategorized

Constant items under hyperinflation

Accountants are required by the IASB to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. The IASB considers hyperinflation to be an exceptional circumstance. Hyperinflation is defined by the IASB as a cumulative inflation rate approaching or exceeding 100% over three years, i.e. 26% annual inflation for three years in a row.

Cagan defined the other popular definition of hyperinflation. Cagan (1951) defined hyperinflation to be present when monthly inflation equals or exceed 50%. The IASB´s definition will be followed in this work.

As per IAS 29, accountants have to restate their Historical Cost or Current Cost financial statements by applying the period-end CPI during hyperinflation to make the HC or CC financial statements more useful. They have to value all non-monetary items (both variable and constant real value non-monetary items) in units of constant purchasing power by applying the CPI at the period-end date. The restated values of HC or CC financial statements in terms of IAS 29 in a hyperinflationary economy are only valid new real values when the tax authorities accept the restated values for the calculation of taxes due.

“Regarding to tax regulation, I want to emphasize that tax regulation required restatement of assets and liabilities according to inflation (in terms of IAS 29) for the date of 31.12.2003 but taxes were not taken according to restated values in 2003. In 2004, financial statements were restated and taxes were taken based on restated values.”

Cemal KÜÇÜKSÖZEN, Ph.D, Head of Accounting Standards Department, Capital Markets Board of Turkey

Difference between CIPPA and CPPA

Constant Purchasing Power Accounting (CPPA) as defined in IAS 29 [not Constant ITEM Purchasing Power Accounting (CIPPA) as authorized in the Framework (1989), Par 104 (a)] is a complete price-level inflation accounting model only to be used during very high and hyperinflation where under all non-monetary items (variable and constant real value non-monetary items) are inflation-adjusted by means of the CPI at the period-end date during hyperinflation to make financial statements more useful. Constant ITEM Purchasing Power Accounting is also a price-level accounting model, but, only constant items (not variable items) are inflation adjusted during low inflation and deflation in terms of the change in the monthly CPI. CIPPA is not an inflation accounting model to be used during very high and hyperinflation. CIPPA is the IASB´s authorized alternative to the traditional Historical Cost Accounting model during low inflation and deflation.

IAS 29 can also be used to maintain the non-monetary economy relatively stable in a hyperinflationary economy. This is only possible when all non-monetary items (variable and constant items) are valued daily at the daily parallel US Dollar (or other hard currency) exchange rate instead of simply restating HC or CC financial statements at the period-end (normally year-end) CPI rate to make them more useful as required by IAS 29. Brazilian accountants did this very successfully from 1964 to 1994 without IAS 29 (IAS 29 was approved in 1989) by valuing all non-monetary items daily in term of a daily non-monetary index based almost entirely on the US Dollar exchange rate with their currency as supplied daily by various governments during those 30 years.

The constant item economy in a hyperinflationary environment would not be completely stable as in the case of financial capital maintenance in units of constant purchasing power applying the CPI during low inflation. Applying the daily USD parallel rate in the valuation of all non-monetary items (constant and variable items) during hyperinflation would still result in real value destruction of constant items, but, only at a rate equal to the inflation rate in the parallel hard currency used, normally the US Dollar. If this was done in the case of Zimbabwe it would have resulted in real value destruction in constant items of about 2% per annum – a rate equal to the USD inflation rate – instead of 89,700,000,000,000,000,000,000% in case of the Zimbabwe Dollar hyperinflation rate.

Constant items during low inflation

Only continuous financial capital maintenance in units of constant purchasing power as approved by the IASB in the Framework for the Preparation and Presentation of Financial Statements (1989), Par 104 (a) which states the principle which is the basis for the Constant ITEM Purchasing Power Accounting model and which is applicable – by free choice – in all entities applying IFRS since there are no specific IFRS relating to capital maintenance and the valuation of specific constant items, would enable accountants to automatically maintain the real value of all income statement and balance sheet constant items constant in the constant item economy for an indefinite period of time. This would be possible in all entities that at least break even during low inflation and deflation whether they own revaluable fixed assets or not and without requiring extra money for additional capital contributions or additional retained profits just to maintain the constant real value of existing constant items (e.g. shareholders´ equity) constant forever – all else being equal. The Constant ITEM Purchasing Power Accounting model is the only accounting model authorized in IFRS that automatically maintains the real value of all constant items constant forever as qualified above. There is no other way to do this automatically during low inflation and deflation.

The real value of equity (a constant item) is decreased when an entity makes a loss whether it applies financial capital maintenance in units of constant purchasing power or not.

Automatically maintaining the real value of all constant items constant – as stated above – in the economy is not possible, at present, while accountants implement the generally accepted traditional HCA model under which they apply the very erosive stable measuring unit assumption also authorized by the IASB in the Framework, Par 104 (a) in 1989. Implementing the HCA model unnecessarily, unknowingly and unintentionally erodes real value on a significant scale in the constant item economy when accountants measure financial capital maintenance in nominal monetary units in entities with insufficient revaluable fixed assets. This unnecessary, unknowing and unintentional erosion in the real value of constant items not fully or never maintained amounts to hundreds of billions of USD per annum in the world economy for as long as accountants choose to implement very erosive financial capital maintenance in nominal monetary units during inflation. When they freely choose to measure financial capital maintenance in units of constant purchasing power, also authorized by the IASB in the Framework, Par 104 (a) in 1989, they would knowingly maintain hundreds of billions of USD in existing real value per annum by not eroding existing constant item real value of, for example, retained profits, with their very erosive stable measuring unit assumption during low inflation.

The real value of equity never maintained constant with equivalent real value revaluable fixed assets under HCA can be maintained constant with continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation under IFRS in entities that at least break even, but, not under HCA. The HC model is also authorized under IFRS. Both the erosion and the maintenance of the existing real value of equity never maintained and all other constant items never maintained during low inflation are, paradoxically, authorized under IFRS. Accountants are free to choose the one or the other. Both are compliant with IFRS.

The specific choice of continuously measuring financial capital maintenance in units of constant purchasing power (the Constant ITEM Purchasing Power Accounting model) at all levels of inflation and deflation as contained in the Framework for the Preparation and Presentation of Financial Statements Par 104 (a), was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS Plus, Deloitte. Date: 21st March, 2010 http://www.iasplus.com/standard/framewk.htm

There are no applicable IFRS or Interpretations regarding the valuation of the constant real value non-monetary items issued share capital, retained earnings, capital reserves, share premium, share discount, the concepts of capital, the capital maintenance concepts, the determination of profit/loss concept, etc. The measurement concepts and direct and indirect definitions of these items in the Framework are thus applicable as per IAS8.11. There are Standards relating to the constant items trade debtors, trade creditors, other non-monetary payables, other non-monetary receivables, deferred tax assets, deferred tax liabilities, taxes payable and taxes receivable. In terms of IAS 8.11 the Standards take precedence over the Framework in the case of these items.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Constant real value non-monetary items

March 24, 2011 in Uncategorized

Constant real value non-monetary items

 

Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction makes no sense and leads to results that are void of meaning. (Massone, 1981a. p.6)

http://books.google.com/books?id=WXwfMDDYOdkC&pg=PA259&lpg=PA259&dq=inflation+destroys+historical+cost+values&source=web&ots=YMBICCQr42&sig=lsiPcViCm3RhVQXwrigJK675RC8&hl=en&sa=X&oi=book_result&resnum=9&ct=result

The Taxation of Income from Business and Capital in Colombia: Fiscal Reform in the Developing World, By Charles E. McLure, John Mutti, Victor Thuronyi, George R. Zodrow, Contributor Charles E. McLure, Published by Duke University Press, 1990, ISBN 0822309254, 9780822309253, Page 259

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

The double entry accounting model was first comprehensively codified by the Italian Franciscan monk, Luca Pacioli in his book Summa de arithmetica, geometria, proportioni et proportionalita, published in Venice in 1494.

Accountants use the Consumer Price Index to maintain the real values of certain – not all – income statement constant items, e.g. salaries, wages, rentals, etc stable during low inflationary periods. They value these particular constant items in units of constant purchasing power while they generally implement the Historical Cost Accounting model. The Framework, Par 101 states that the measurement basis most often used by companies in preparing their financial reports is historical cost. This is normally used together with other measurement bases.

Constant items during Hyperinflation

Accountants are required by the IASB to implement IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation being an exceptional circumstance. Hyperinflation is defined by the IASB as a cumulative inflation rate approaching or exceeding 100% over three years, i.e. 26% annual inflation for three years in a row. Accountants have to restate their HC or Current Cost financial statements by applying the period-end CPI during hyperinflation to make the HC or CC financial statements more useful. They have to value all non-monetary items (both variable real value non-monetary items and constant real value non-monetary items) in units of constant purchasing power by applying the CPI at the period-end date. The restated values of HC or CC financial statements in terms of IAS 29 in a hyperinflationary economy are only valid new real values when the tax authorities accept the restated values for the calculation of taxes due.

“Regarding to tax regulation, I want to emphasize that tax regulation required restatement of assets and liabilities according to inflation (in terms of IAS 29) for the date of 31.12.2003 but taxes were not taken according to restated values in 2003. In 2004, financial statements were restated and taxes were taken based on restated values.”

Cemal KÜÇÜKSÖZEN, Ph.D, Head of Accounting Standards Department, Capital Markets Board of Turkey

Constant Purchasing Power inflation accounting (not Constant ITEM Purchasing Power Accounting) as defined in IAS 29 is a complete price-level inflation accounting model where under all variable and constant real value non-monetary items are inflation-adjusted by means of the CPI at the period-end date during hyperinflation to make financial statements more useful.

IAS 29 can also be used to maintain the non-monetary economy relatively stable in a hyperinflationary economy. This is only possible when all non-monetary items (variable and constant items) are valued daily at the daily parallel US Dollar (or other hard currency) exchange rate instead of simply restating HC or CC financial statements at the period-end (normally year-end) CPI rate to make them more useful as required by IAS 29. Brazilian accountants did this very successfully from 1964 to 1994 without IAS 29 (IAS 29 was approved in 1989) by valuing all non-monetary items daily in term of a daily non-monetary index based almost entirely on the US Dollar exchange rate with their currency as supplied daily by various governments during those 30 years.

The constant item economy in a hyperinflationary environment would not be completely stable as in the case of financial capital maintenance in units of constant purchasing power applying the CPI during low inflation. Applying the daily USD parallel rate in the valuation of all non-monetary items (constant and variable items) during hyperinflation would still result in real value destruction of constant items, but, only at a rate equal to the inflation rate in the parallel hard currency used, normally the US Dollar. If this was done in the case of Zimbabwe it would have resulted in real value destruction in constant items of about 2% per annum – a rate equal to the USD inflation rate – instead of 89,700,000,000,000,000,000,000% ( 89.7 sextillion%) in case of the Zimbabwe Dollar hyperinflation rate.

Nicolaas Smith

International Blog Constant Item Purchasing Power Accounting – CIPPA

Wikipedia Constant Item Purchasing Power Accounting – CIPPA

Copyright (c) 2005 – 2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IFRS should not be based on fallacies

March 23, 2011 in Uncategorized

IFRS should not be based on fallacies

The International Accounting Standards Board is a private, independent accounting standards board based in London. The mission of the IASB is to develop a single set of global accounting standards. The IASB cooperates with national accounting standard boards for international convergence of accounting standards.

The IASB should not authorize and approve International Financial Reporting Standards based on significantly erosive accounting fallacies, e.g. real value eroding financial capital maintenance in nominal monetary units per se and the very erosive stable measuring unit assumption during inflation which is based on a fallacy which costs the world economy hundreds of billions of USD per annum in real value unnecessarily, unknowingly and unintentionally eroded by the implementation of the traditional HCA model in the existing real value of constant real value non-monetary items (e.g. shareholders equity) never or not fully maintained. Currently the IASB is doing exactly that in the Framework, Par 104 (a) which states:

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

It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation since money is not perfectly stable in real value during inflationary and deflationary periods. However, accountants and financial statement users have been educated with the Historical Cost Accounting model of financial reporting which includes the stable measuring unit assumption as stated by the FASB in FAS 89. Financial capital maintenance in nominal monetary units per se is a fallacy during inflation and deflation while the stable measuring unit assumption is based on the fallacy that changes in the purchasing power of money are not sufficiently important to require continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation.

The real value of existing constant items never maintained constant is unknowingly, unnecessarily and unintentionally eroded as a result of the implementation of the HCA model with the very erosive stable measuring unit assumption during low inflation because accountants generally measure financial capital maintenance in banks and companies in nominal monetary units as part of traditional HC accounting based on those two very popular IASB-approved and authorized accounting fallacies.

Accountants who prepare their financial reports in terms of International Financial Reporting Standards generally choose to measure financial capital maintenance in nominal monetary units, the accounting fallacy as approved by the International Accounting Standards Board in the Framework for the Preparation and Presentation of Financial Statements, Par 104 (a) which they apply in the absence of specific IFRS relating to the concept of capital, the concept of capital maintenance, the concept of profit/loss determination and in the absence of specific IFRS for the valuation of specific constants items, e.g. Shareholders´ Equity items, etc.

Astonishingly, the IASB authorized both the HCA model stated in terms of the very popular accounting fallacy that financial capital maintenance can be measured in nominal monetary units as well as its only and perfect remedy (the remedy is perfect, not the resulting values) during inflation and deflation in one and the same statement in 1989. It is impossible to maintain the real value of financial capital stable by measuring it in nominal monetary units per se during inflation and deflation. The statement in the Framework, Par 104 (a) that financial capital maintenance can be measured in nominal monetary units is only true – per se – at sustainable zero inflation – a monetary environment never achieved over any significant period in the past and not soon to be achieved over a significant period in the future. The IASB statement that financial capital maintenance can be measured in nominal monetary units is a fallacy under all other economic environments: low inflation, hyperinflation and deflation. IFRS should not be based on fallacies as they currently are.

Accountants who prepare financial reports in terms of IFRS have to make the choice presented to them in the Framework, Par 104 (a). The boards of directors actually have to make the choice; their accountants being the accounting experts, obviously, advise them about the appropriate choice to make. Financial capital maintenance in nominal monetary units is a very popular accounting fallacy authorized by the IASB in the Framework, Par 104 (a) in 1989. It is, certainly, not an appropriate accounting policy for companies during inflation and deflation. Unfortunately most, if not all boards of directors choose financial capital maintenance in nominal monetary units as part of the traditional HCA model which includes the very erosive stable measuring unit assumption in the world economy. This results in the unnecessary, unknowing and unintentional eroding of hundreds billions of USD in the real value of existing constant items never or not fully maintained, e.g. retained profits, in the world´s real economy each and every year.

Accountants preparing financial reports of unlisted companies generally also choose to measure financial capital maintenance in nominal monetary units and implement the HCA model since it is the generally accepted traditional accounting model.

Nicolaas Smith

International Blog Constant Item Purchasing Power Accounting – CIPPA

Wikipedia Constant Item Purchasing Power Accounting – CIPPA

Copyright (c) 2005 – 2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Two systemic processes of real value erosion

March 22, 2011 in Uncategorized

There was only one systemic process of real value erosion operating only in the monetary economy before the invention of double entry accounting. The economic process of inflation only eroded the real value of depreciating money and other depreciating monetary items equally throughout only the monetary economy at that time as it does today in economies subject to inflation and hyperinflation.

There was no simultaneous second systemic real value erosion process, as we experience it today, whereby the Historical Cost Accounting model unknowingly, unnecessarily and unintentionally erodes significant amounts of real value of existing constant real value non-monetary items never or not fully maintained, e.g. Retained Profits, only in the constant item economy because accountants freely choose to implement their very erosive stable measuring unit assumption during inflation. The reason was that the traditional IFRS authorized Historical Cost Accounting model which includes the very erosive stable measuring unit assumption (based on a fallacy) and which is founded on financial capital maintenance in nominal monetary units (another very popular accounting fallacy) was not yet invented at that time.

Nicolaas Smith

International Blog Constant Item Purchasing Power Accounting – CIPPA

Wikipedia Constant Item Purchasing Power Accounting – CIPPA

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Accounting fallacies not yet extinct

March 21, 2011 in Uncategorized

Economic history is replete with fallacies which became extinct with the development of economic understanding.

Three accounting fallacies not yet extinct are:

1. Financial capital maintenance in nominal monetary units authorized in IFRS in the Framework (1989), Par 104 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.”

It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation.

2. The stable measuring unit assumption is based on the fallacy that changes in the purchasing power of money are not sufficiently important to require continuous financial capital maintenance in units of constant purchasing power during low inflation and deflation.

Changes in the purchasing power of money logically require continuous financial capital maintenance in units of constant purchasing power during inflation and deflation.

3. Accountants´ belief that the erosion of companies´ profits and capital is caused by inflation. This is fully supported by the IASB and the US Financial Accounting Standards Board.

The traditional Historical Cost Accounting model unknowingly, unnecessarily and unintentionally erodes the real value of companies´ profits and capital never maintained constant with the implementation of the stable measuring unit assumption during inflation. Inflation can only erode the real value of money and other monetary items. Inflation has no effect on the real value of non-monetary items.

The erosion of companies´ capital and profits by inflation is a very popular accounting fallacy stated by, for example, the US Financial Accounting Standards Board:

Mr. Mosso dissents because he believes that the Statement does not bring the basic problem it addresses — measuring the effect of inflation on business operations — into focus. Because of that he doubts that it will effectively communicate the erosive impact of inflation on profits and capital and the significance of that erosion on all who have an investment stake in business enterprises. FAS 33 (superseded by FAS 89), Par 67, P 22, 1979.

The FASB blamed inflation for the erosion of companies´ capital and profits, but, admitted that the traditional HCA model, or, specifically the stable measuring unit assumption, actually does the eroding:

Because most accountants and users of financial statements have been inculcated with a model of financial reporting that assumes stability of the monetary unit, accepting a change of this consequence would take a lengthy period of time under the best of circumstances. FAS 89, Par 4, P6, 1986.

The IASB also blames inflation in IAS 29 Financial Reporting in Hyperinflationary Economies:

In most countries, financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued. IAS 29 Par 6

Both shareholders´ equity being a company’s capital as well as retained profits – as a separate item – are constant real value non-monetary items.

Inflation has no effect on the real value of non-monetary items: Milton Friedman famously stated that “inflation is always and everywhere a monetary phenomenon.”

This is confirmed by two Turkish academics as follows:

“Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005, Page 9.

http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=100

Nicolaas Smith

Wikipedia Constant Item Purchasing Power Accounting

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation

March 18, 2011 in Uncategorized

Inflation is always and everywhere a monetary phenomenon: Milton Friedman.

 

Inflation is a sustained rise in the general price level of goods and services inside a national economy or monetary union (e.g. the European Monetary Union) over a period of time. Prices are normally expressed in terms of unstable money (the unstable functional currency) which results in the unit of measure or unit of account being an unstable measuring unit in an economy or monetary union. Inflation always and everywhere erodes the real value of the depreciating functional currency (money) and other depreciating monetary items over time. Inflation has no effect on the real value of non-monetary items. Disinflation is a decrease in the rate of increase of the general price level; i.e. disinflation is lower inflation. Inflation still erodes the real value of depreciating money and other depreciating monetary items during disinflation – just at a slower rate than before.

 

Deflation is a sustained absolute decrease in the general price level. Deflation creates real value in appreciating money and other appreciating monetary items over time, recently mainly seen in the Japanese economy.

 

Inflation reared its ugly head soon after the invention of unstable money. It only eroded the real value of depreciating money and other depreciating monetary items at that time as it does today. Inflation did not and can not erode the real value of non-monetary items – either variable or constant real value non-monetary items.

 

Nicolaas Smith

 

Copyright (c) 2005 – 2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Monetary items

March 17, 2011 in Uncategorized

Money was invented over a long period of time. Eventually money came to fulfil the following three functions during inflation and deflation:

a. Unstable medium of exchange

b. Unstable store of value

c. Unstable unit of account

Non-monetary items which are all items which are not monetary items were only defined in monetary terms after the invention of money. The economy came to be divided in the monetary economy and the non-monetary or real economy. There were only unstable monetary items and variable real value non-monetary items. There were no constant real value non-monetary items yet. The non-monetary or real economy consisted of only variable real value non-monetary items. Non-monetary items are all items that are not monetary items.

Monetary items are money held and items with an underlying monetary nature.

Examples of monetary items in today’s economy are bank notes and coins, bank loans, bank savings, other monetary savings, other monetary loans, bank account balances, treasury bills, commercial bonds, government bonds, mortgage bonds, student loans, car loans, consumer loans, credit card loans, notes payable, notes receivable, etc.

Unstable money and other unstable monetary items´ real values are continuously being eroded by inflation over time. Inflation only erodes the real value of unstable money and other unstable monetary items. Inflation has no effect on the real value of non-monetary items.

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

Non-monetary items in today’s economy are divided into two sub-groups:

a) Variable real value non-monetary items

b) Constant real value non-monetary items

There were still no units of constant purchasing power because there was still no Consumer Price Index at that time. There was still no Historical Cost Accounting model, no very erosive stable measuring unit assumption based on a fallacy and no financial capital maintenance in nominal monetary units fallacy during inflation and deflation. There was still no price-level accounting, no constant purchasing power (CPPA) inflation accounting model for hyperinflationary economies and no real value maintaining continuous financial capital maintenance in units of constant purchasing power basic accounting model (CIPPA) for low inflationary and deflationary economies. There were still no financial reports.

Nicolaas Smith

Constant Item Purchasing Power Accounting - CIPPA

Copyright (c) 2005-2011 Nicolaas Smith. All rights reserved. No reproduction without permission.

Variable real value non-monetary items

March 16, 2011 in Uncategorized

Variable items are non-monetary items with variable real values over time.

Examples of variable items in today’s economy are property, plant, equipment, inventories, quoted and unquoted shares, raw material stock, finished goods stock, patents, trademarks, foreign exchange, etc.

Variable items are everything you can see around you generally bought/sold (traded) in markets/shops excluding money and anything to do with money, e.g. bank statements, loan statements, etc.

The first economic items were variable real value items. Their values were not yet expressed in terms of money because money was not yet invented at that time. There was no inflation because there was no money. Inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items. There was no unstable monetary medium of exchange. There was no unstable monetary unit of account. There was no unstable monetary store of value.

There was no double entry accounting model at that time. There were no historical cost items. There was no very destructive stable measuring unit assumption approved by the International Accounting Standards Board whereby accountants assume the unit of measure is stable, i.e., they consider that changes in the general purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. The stable measuring unit assumption is based on a very popular accounting fallacy since the real value of money is never absolutely stable on a sustainable basis during inflation and deflation. There was no Historical Cost Accounting model and no financial capital maintenance in nominal monetary units per se (another very popular IFRS-authorized accounting fallacy) during inflation; that is to say: there were no Historical Cost accounting fallacies. There was no value based accounting. There was also no Consumer Price Index at that time. Consequently there were no units of constant purchasing power and no price-level accounting.

There was no International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies supplying us with the current definition of inflation accounting. There was thus no Constant Purchasing Power Accounting (CPPA) IFRS-approved inflation accounting model under which all non-monetary items (variable and constant real value non-monetary items) in Historical Cost and Current Cost financial statements were required to be restated by means of the period-end CPI to make these restated HC and CC financial statements more useful during hyperinflation.

There was also no real value maintaining financial capital maintenance in units of constant purchasing power accounting model – Constant ITEM Purchasing Power Accounting (CIPPA) – as an official IFRS-approved alternative basic accounting model to the traditional HCA model during low inflation and deflation. There was no IFRS compliant basic accounting option where under only constant items are continuously measured in units of constant purchasing power during low inflation and deflation. There was no option of continuously measuring only constant items in units of constant purchasing power by applying the monthly change in the CPI during low inflation and deflation in order to implement a constant purchasing power financial capital concept of invested purchasing power by continuously measuring financial capital maintenance in units of constant purchasing power and continuously determining profit/loss in units of constant purchasing power.

There were no financial reports: e.g. no income statements, no balance sheets, no cash flow statements, no statements of changes in shareholders´ equity, etc. There were no monetary items and no constant items. There were only variable real value items not yet expressed in monetary terms.

Nicolaas Smith

Constant Item Purchasing Power Accounting - CIPPA

Copyright (c) Nicolaas J Smith 2005-2011. All rights reserved. No reproduction without permission.

Three economic items

March 15, 2011 in Uncategorized

Science is simply common sense at its best – that is, rigidly accurate in observation, and merciless to fallacy in logic. Thomas Huxley

The economy consists of economic entities and economic items.

Economic items have economic value. Accountants do not simply record what happened in the past. Accountants are not simply scorekeepers. Accountants value economic items every time they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.

It is generally accepted that there are only two basic, fundamentally different economic items in the economy; namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. That is a fallacy.

The three fundamentally different basic economic items in the economy are:

a) Monetary items
b) Variable real value non-monetary items
c) Constant real value non-monetary items

The economy consequently consists of not just two – the monetary and non-monetary economies, but, three parts:

1. Monetary economy

The monetary economy within an economy or monetary union consists of functional currency bank notes and coins (which generally make up about 7% of the overall money supply) and other functional currency monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds and other functional currency monetary items making up the fiat money supply created in the banking system by means of fractional reserve banking.

2. Variable item non-monetary economy

The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, raw material, etc.

3. Constant item non-monetary economy

The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.

The variable and constant item non-monetary economies in combination make up the non-monetary or real economy. The real and monetary economies constitute the economy.

Nicolaas Smith

Constant Item Purchasing Power Accounting - CIPPA

 

© 2005-2011 by Nicolaas J Smith. All rights reserved. No reproduction without permission.

Constant Item Purchasing Power Accounting – CIPPA

March 14, 2011 in Uncategorized

Constant Item Purchasing Power Accounting (CIPPA) is the International Accounting Standards Board’s basic accounting alternative authorized in International Financial Reporting Standards in the Framework for the Preparation and Presentation of Financial Statements (1989), Paragraph 104 (a) which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” It is the IASB-approved alternative to traditional Historical Cost Accounting whereunder ONLY constant real value non-monetary items (NOT variable real value non-monetary items) are measured in units of constant purchasing power; i.e. continuously inflation-adjusted or updated or measured in units of constant purchasing power by applying the monthly change in the Consumer Price Index, during low inflation and deflation.

Monetary items, variable real value non-monetary items and constant real value non-monetary items are the three fundamentally different basic economic items in the economy.

Examples of constant items are issued share capital, retained income, capital reserves, all other items in shareholders´ equity, trade debtors, trade creditors, provisions, deferred tax assets and liabilities, all other non-monetary payables, all other non-monetary receivables, salaries, wages, rentals, all other items in the income statement, etc. valued in units of constant purchasing power during low inflation and deflation when financial capital maintenance in units of constant purchasing power (CIPPA) is implemented during low inflation and deflation.

Examples of variable items are property, plant, equipment, listed and unlisted shares, inventory, foreign exchange, etc. Variable items are valued in terms of IFRS at for example fair value, market value, recoverable value, present value, net realizable value, etc. during non-hyperinflationary periods.

Monetary items are always valued at their original nominal HC monetary values in nominal monetary units during the current accounting period under all accounting and economic models because it is impossible to inflation-adjust or update or measure in units of constant purchasing power money and other monetary items; monetary items being money held and other items with an underlying monetary nature. Examples of monetary items are bank notes and coins, bank account balances, all monetary loans owed or granted, housing loans, car loans, consumer loans, student loans, government and commericial bonds, ets.

CIPPA is a price-level accounting model which implements the principle of financial capital maintenance in units of constant purchasing power during low inflation and deflation. It automatically maintains the real value of all existing constant real value non-monetary items constant in all entities that at least break even, including banks´ and companies´ capital base, for an unlimited period of time (forever) – all else being equal – whether these entities own revaluable fixed assets or not and without the requirement of additional capital from capital providers in the form of extra money or extra retained profits simply to maintain the existing constant real non-monetary value of existing constant real value capital constant. This is opposed to the traditional Historical Cost Accounting model which unknowingly, unnecessarily and unintentionally erodes the real value of that portion of shareholders´equity never maintained constant as a result of insufficient revaluable fixed assets (revalued or not) during low inflation. The IASB´s Framework, Par 104 (a) is applicable as a result of the absence of specific IFRS relating to the concepts of capital and capital maintenance and the valuation of specific constant real value non-monetary items.

Constant Item Purchasing Power Accounting (CIPPA) is NOT an inflation accounting model. It is the IASB´s alternative to Historical Cost Accounting authorized in IFRS in the Framework (1989), Par 104 (a) during LOW inflation and deflation.

Constant Purchasing Power Accounting (CPPA) inflation accounting as defined in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the IASB´s inflation accounting model required to be implemented ONLY during hyperinflation under which ALL non-monetary items (variable and constant real value non-monetary items) are measured in units of constant purchasing power by applying the change in the period-end CPI.

Accountants can freely choose the Constant Item Purchasing Power Accounting model to implement a financial capital concept of invested purchasing power. They will thus implement a constant purchasing power financial capital maintenance concept and they will implement a constant purchasing power profit/loss determination concept in units of constant purchasing power instead of in real value eroding nominal monetary units during low inflation.

Nicolaas Smith

Constant Item Purchasing Power Accounting - CIPPA

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