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CIPPA: What, how and why.

September 24, 2011 in Uncategorized

CIPPA: What, how and why.

What to do?

Stop the stable measuring unit assumption.

How?

Stop the Historical Cost Accounting model and implement financial capital maintenance in units of constant purchasing power as authorized in IFRS.

1. Value constant real value non-monetary items in units of constant purchasing power in terms of the Daily CPI as authorized in IFRs. The Net Constant Item Loss or Gain is calculated and accounted for constant items not measured in units of constant purchasing power.

2. Value variable real value non-monetary items in terms of IFRS and update them in terms of the Daily CPI. Impairment and revaluable gains and losses are treated in terms of IFRS.

3. Inflation-adjust monetary items in terms of the Daily CPI. The Net Monetary Loss or Gain is calculated and accounted for monetary items not inflation-adjusted.

Why?

The stable measuring unit assumption (Historical Cost Accounting) erodes hundreds of billions of US Dollars per annum in the real value of constant items never maintained constant in the world´s constant item economy. This is the result of the global implementation of financial capital maintenance in nominal monetary units during inflation and deflation which is a very popular accounting fallacy not yet extinct. It is impossible to maintain the real value of capital in nominal monetary units per se during inflation and deflation.

CIPPA automatically stops this erosion of constant item real value forever. Financial capital maintenance in units of constant purchasing power as authorized in IFRS automatically maintains the constant value of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribus- whether they own any revaluable fixed assets or not.

Nicolaas Smith

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

Fiat money has real value

September 23, 2011 in Uncategorized

Fiat money has real value

The actual material our
money is made of today has, for practical purposes, no intrinsic value in
itself. Our monetary unit is fiat money that is created by government fiat or
decree. The government declares fiat money to be legal tender. In the past
monetary coins were made of, for example, silver or gold which were valuable in
themselves. The actual metal of which the coin was made had a real or intrinsic
value supposedly equivalent to the nominal value inscribed on the coin. Today
fiat money is a government decreed and legally recognized unstable medium of
exchange, unstable unit of account and unstable store of value in the economy.

The actual material today´s fiat money is made of has no intrinsic value
as fiat money is the natural product of the development of the concept of money
through time. In the beginning a monetary unit was a (supposedly) full value
metal coin. Later it was not a full value metal coin but it was the next best
thing as far as economic agents were concerned: it was 100 per cent backed by
gold. Today the material fiat money is made of has no intrinsic value and the
monetary unit is not backed by gold but is backed by the combined macroeconomic
real value of all the underlying value systems in a particular economy or
monetary union. These underlying value systems include, but, are not limited to
sound governance, a sound economic system, a sound manufacturing system, a sound
industrial system, a sound monetary system, a sound political system, a sound
social system, a sound educational system, a sound defence system, a sound
health system, a sound security system, a sound legal system, a sound accounting
system and so on, to name but a few.

Changes in the real value of
unstable money – which is also the unstable accounting monetary unit of account
– are determined by inflation and deflation over time. The real value of money
and thus the monetary unit of account are not stable. The real value of money
and other monetary items are currently not updated or inflation-adjusted over
time in ledger and bank accounts.

Fortunately, (1) the generally
accepted accounting principle of financial capital maintenance in units of
constant purchasing power, (2) double entry accounting, (3) the fact that the
constant real non-monetary value of capital is equal to the real value of net
assets and (4) the fact that companies have unlimited lifetimes, make it
possible to automatically maintain the real value of constant items constant
forever in entities that at least break even – ceteris paribus – when they
implement Constant Item Purchasing Power Accounting during low inflation and
deflation as authorized in IFRS – whether they own any fixed assets or not.

The bank notes and coins that make up about 7% of the fiat money supply
can almost be stated to be created out of nothing – out of thin air – as a
result of the fact that the actual materials used to create physical bank notes
and coins have – in principle – almost no intrinsic value. The unstable real
value of the total fiat money supply is, however, backed by all – the sum total
of – the underlying value systems in an economy, namely sound governance, sound
economic policies, sound monetary policies, sound industrial policies, sound
commercial policies, etc. Positive annual inflation indicates the excess of fiat
money created in the banking system.

Fiat money is used every day by
almost 7 billion people to buy anything and everything in the world economy.
Fiat money has real value. All monetary units in the world are fiat money. Every
person knows exactly what he or she can buy with 1 or 10 or 100 or 1000 units of
fiat money in his or her economy – today. Many people also know that the real
value of fiat money is eroded over time in an inflationary economy and increases
over time in a deflationary economy.

Yes, the special bank paper that

fiat bank notes is made of and the metals that fiat bank coins are made of have
almost no intrinsic value as compared to the real value of the actual gold or
actual silver in gold and silver coins of commodity money in the past. That is
not a logical reason to state that fiat money has no value. Every fiat monetary
unit´s real value is determined by what it can buy today in an average consumer
basket of goods and services. That generally changes every month.

Fiat
money is money which generally has a monthly changing real value. Only the
actual bank notes and coins have insignificant intrinsic values. Bank notes and
coins constitute only about 7% of the US money supply.

All fiat monetary
units – whether notes and coins or simply electronically represented virtual
values – are legal tender in their respective economies.

All fiat
functional currencies within economies have international exchange rates with
the fiat functional currencies of other economies.

The fact that fiat
money is not legally convertible into gold on demand as it was done in the days
of the gold standard, is made irrelevant by the indisputable fact that fiat
money is legal tender. Fiat money is used to buy gold. The fact that fiat money
is not legally convertible into gold – an administrative process – is true: it
is a fact. That does not negate the fact that fiat money has real value, the
change of which is indicated monthly in the change in the Consumer Price Index.

The fact that fiat money has real value is so mainstream – almost 7
billion people know it and confirm it daily – 365 days a year – by using fiat
money to buy and sell everything in all economies. The fact that fiat money has
real value is confirmed once a month by about all economies world–wide when
monthly inflation indexes are published indicating the change in the real value
of fiat money. It is thus misleading to imply that because it is a fact that
fiat money cannot administratively be converted at the central bank or any other
bank into gold, that fiat money has no value.

It is an indisputable
mainstream fact that fiat money has real value despite the fact that it is not
legally convertible into gold on demand and that the bank paper bank notes and
metals bank coins are made of have no intrinsic value whereas historically gold
and silver coins had intrinsic values equal to the real value of the gold and
silver they were made of.

The numerous publications of CPI values
world–wide are the creditable references to the fact that fiat money has real
value. Statistics authorities are generally creditable
sources.

Nicolaas Smith

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

Foreign exchange

September 22, 2011 in Uncategorized

Foreign exchange

A foreign currency is not the monetary unit in a non–dollarized economy since it is not the generally accepted national monetary unit of account. The Rand is the monetary measuring unit of account in SA. The SA economy is not a Dollarized economy. The Rand is the monetary unit.

Money has three functions:

1. Unstable medium of exchange

2. Unstable store of value

3. Unstable unit of account

A foreign currency like the US Dollar or the Euro is, however, a medium of exchange in SA. Most businesses and individuals would accept the USD or the Euro as a means of payment; that is, as a medium of exchange because they can easily sell the foreign currency amounts they would receive in transactions at their local banks for Rands.

A hard currency is also a store of value in SA. The USD and the Euro are hard currencies with daily changing market values. They are generally accepted world–wide as a relatively stable store of value. People know there are normal daily small changes in their foreign exchange values.

The USD and the Euro are, however, not national units of account in SA. You cannot normally do your SA accounts in US Dollars or Euros for tax purposes during low inflation and deflation. You have to do your accounting in Rand values in the SA economy during low inflation and deflation. The USD and the Euro are not functional currencies in SA since they do not fulfil all three functions of a monetary unit within the SA economy. A foreign currency like the USD or the Euro only fulfils two functions of money, namely, unstable medium of exchange and unstable store of value. They therefore are not money or the monetary unit in SA from a strictly technical point of view. They are not monetary items in SA.

Foreign currencies are variable real value non–monetary items in a non–dollarized economy. They have variable real values which are determined in the foreign exchange markets daily.

The US Dollar is only a functional currency unit outside the United States of America in countries like Ecuador, Panama and Zimbabwe which have Dollarized their economies. They use the US Dollar as their functional currency unit. They do not have their own national currencies. That is not the case in non–dollarized economies.

It just appears very strange to say that the US Dollar or the Euro is not money in SA. Technically speaking that is correct because an economic item can only be money in a non–dollarized economy if it fulfils all three functions of money. The Euro is only money in the European Monetary Union (EMU) and the USD is only money in the US and in countries which have Dollarized their economies using the US Dollar as their functional currency.

The man and woman in the street, however, regard anything that is a medium of exchange as “money” in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.

The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. SA entities, however, classify foreign exchange as a variable real value non–monetary item stated at its current market value and not the same as the SA Rand, that is, not as a monetary item when they choose to implement financial capital maintenance in units of constant purchasing power in terms of IFRS as authorized in the original Framework (1989), Par 104 (a) during low inflation and deflation, i.e. when they implement Constant Item Purchasing Power Accounting.

Dollarization can be in currencies other than the US Dollar too.

Nicolaas Smith

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

Valuing revaluable fixed assets at HC does not erode their real values

September 21, 2011 in Uncategorized

Valuing revaluable fixed assets at HC does not erode their real values

The real values of revaluable fixed assets are not eroded by the stable measuring unit assumption when entities value these items at their original nominal HC values before the date that they are actually sold or exchanged during low inflation and deflation. They would be valued at their current market values on the date of exchange or sale in an open economy. During hyperinflation all non–monetary items (variable and constant real value non–monetary items) are required to be restated in terms of IAS 29 Financial Reporting in Hyperinflationary Economies to make these restated HC or Current Cost period-end financial reports more useful by applying the period-end CPI. A hard currency parallel rate – normally the US Dollar parallel rate – or a Brazilian-style index is applied on a daily basis when a country wishes to stabilize its real economy during hyperinflation.

This is not the case with constant items with real values never maintained constant during low inflation and deflation under the HCA model. The stable measuring unit assumption unknowingly, unintentionally and unnecessarily erodes the real values of constant items never maintained constant at a rate equal to the annual rate of inflation in a low inflationary environment when the HCA model is implemented.

Revaluable fixed assets, e.g., land and buildings´, real values are not being unknowingly eroded by the HCA model as a result of the implementation of IFRS since they exist independently of how we value them. Entities can value land and buildings in the balance sheet at their historical cost 50 years ago, but, when they are sold in the market today they would be transacted at the current market price. The real values of variable items are also not being eroded uniformly at, e.g., a rate equal to the annual inflation rate because of valuing them at original nominal HC. Inflation has no effect on the real values of non–monetary items.

Where real losses are made in dealing with variable items in the economy, these losses are the result of supply and demand or business or private decisions, e.g. selling at a bad price, obsolescence, stock market crashes, credit crunches, etc. They do not result from the implementation of the HC accounting model.

A house is a variable real value non–monetary item. Let us assume a house in Port Elizabeth, South Africa is fairly valued in the PE market at say R 2 million on 1st January in year one. With no change in the market a year later but with annual inflation at 6% in SA, the seller would increase his or her price to R2.12 million – all else being equal. The house’s real value remained the same. The depreciating monetary value of the house expressed in the depreciating Rand medium of exchange – all else being equal – was updated to compensate for the erosion of the real value of the depreciating Rand in the internal SA market by 6% annual inflation. It is clear that inflation does not affect the house’s variable non–monetary real value – all else being equal.

However much inflation rises, it can only erode the Rand´s real value at a higher rate and over a shorter period of time. As inflation rises the price of the house would rise to keep pace with inflation or value erosion in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non–monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.

The house´s real value is not a constant real value non–monetary item. It is only assumed in this example that only inflation changes with all else being equal. This is not normally the case in the market. The house´s real value is a variable real value non–monetary item.

When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 29 years since January, 1981 in the company’s balance sheet. When it is eventually sold today for R 1.4 million we can see that inflation did not erode the property’s variable real non–monetary value –all else being equal. Inflation only eroded the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 29 year period – all else being equal. This was taken into account by the buyer and seller at the time of the sale. The selling price in Rand was increased to compensate for the erosion of the real value of the Rand by inflation. R1.4 million today (2010) is the same as R100 000 inJanuary, 1981 – all else being equal.

As the two academics from Turkey state: “Purchasing power of non monetary items does not change in spite of variation in national currency value.”

Nicolaas Smith

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

Historical Cost Debate

September 19, 2011 in Uncategorized

Historical Cost Debate

The Historical Cost Debate is the debate over the last 100 years or so about the exclusive use of Historical Cost for all accounting purposes. The accounting profession has realized for a very long time that financial reports based on Historical Cost for all economic items do not fairly represent a company’s results and operations. As a result of this debate the pure Historical Cost Accounting model has been improved and changed dramatically during this time, so much so, that today we have a huge volume of IFRS where under variable real value non–monetary items are not all valued at HC but at, e.g., fair value or the lower of cost and net realizable value or market value or recoverable value or present value, etc. This debate has thus been a very valid and successful debate regarding the valuation of variable real value non–monetary items.

Unfortunately, the stable measuring unit assumption is still an IFRS–approved option that is used for the valuation of most constant real value non–monetary items (excluding annual valuation of salaries, wages, rents, etc.) during low inflation and deflation. Fortunately, the option of measuring financial capital maintenance in units of constant purchasing power during low inflation and deflation (CIPPA) has been approved in IFRS in the original Framework (1989), Par 104 (a).

Entities value variable real value non–monetary items in terms of IFRS when they implement both the traditional HCA model and when they measure financial capital maintenance in units of constant purchasing power during low inflation and deflation applying CIPPA. Inflation has no effect on the real values of variable real value non–monetary items. Inflation can only erode the real value of money and other monetary items: nothing else.

Nicolaas Smith

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

test

September 16, 2011 in Uncategorized

Daily US Dollar parallel rate or daily index required during hyperinflation

Hyperinflation is defined as an exceptional circumstance by the IASB. All non–monetary items – variable and constant items – in Historical Cost or Current Costs period-end financial statements are required to be restated in terms of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation by applying the period–end CPI to make the restated HC or CC financial reports more useful. This normally does nothing to the real values of the restated non–monetary items unless they are accepted by the tax authorities as the new real values for these companies.

The only way a country in hyperinflation can stabilize its real or non–monetary economy is by applying the daily US Dollar parallel rate or a Brazilian–style daily index supplied by the government in the valuing of all non–monetary items instead of the period–end CPI.

Nicolaas Smith

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

Measurement bases

September 14, 2011 in Uncategorized

Measurement bases

Measurement bases used in the valuation of variable items in terms of IFRS include – but are not limited to – the following:

Market value

Fair value

Historical Cost

Net realisable value

Present value

Recoverable value

Current cost

Carrying value

Residual value

Value in use

Settlement value

Replacement cost

Examples of variable real value non–monetary items

Property

Freehold Land

Buildings

Leasehold Improvements

Plant

Equipment

Equipment under Finance Lease

Investment Property

Other Intangible Assets

Capitalised Development Items

Patents

Trademarks

Licences

Investments in Associates

Joint Ventures

Foreign currency forward contracts

Available–for–sale investments

Quoted and Unquoted Shares

Inventories

Raw Materials

Work–in–progress

Finished Goods

Foreign currency

Nicolaas Smith

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

Books to be balanced in real terms

September 13, 2011 in Uncategorized

Books to be balanced in real terms

Constant items would always and everywhere be measured in units of constant purchasing power in terms of a Daily Consumer Price Index or monetized daily indexed unit of account under Constant Item Purchasing Power Accounting; i.e., implementing financial capital maintenance in units of constant purchasing power during inflation and deflation. This would eliminate the total cost of the stable measuring unit assumption (currently hundreds of billions of US Dollars per annum) from the constant item economy only in the unlikely case of complete coordination right from the start of changing over to financial capital maintenance in units of constant purchasing power.

Constant items within an entity with no third parties involved would always and everywhere be measured in units of constant purchasing power. This would include all items in shareholders´ equity, provisions, all items in the income statement, accounts payable, all other non–monetary payables, etc.

A new accounting item, net constant item loss or gain would be calculated and accounted where trade debtors and other third party entities due to pay other non–monetary receivables initially do not agree to measurement in units of constant purchasing power in terms of a Daily Consumer Price Index or monetized daily indexed unit of account. The real value loss is not a net monetary loss because it is not caused by inflation in the real value of a monetary item, but, by the application of the stable measuring unit assumption causing a loss in the real value of a constant real value non-monetary item. The calculation and accounting of the net constant item loss or gain is required because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power: the books would – for the first time – be balanced in real terms.

Nicolaas Smith

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

Variable items under CIPPA

September 12, 2011 in Uncategorized

Variable Items under CIPPA

Variable items are valued and accounted in terms of IFRS. Variable item revaluation losses and gains are treated in terms of IFRS. Variable items when not valued daily in terms of IFRS would be updated in terms of a Daily Consumer Price Index or a monetized daily indexed unit of account because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power.

Selling prices of items in shops and restaurants, etc. are not updated on a daily basis during low inflation and deflation. They are not historical prices. They are set in a free market. Keeping them the same during a period is a marketing strategy. Selling prices depend on demand and supply. McDonalds´ prices would not be updated daily in terms of a DCPI or a monetized daily indexed unit of account during low inflation and deflation.

They would be updated daily under financial capital maintenance in units of constant purchasing power during hyperinflation which requires daily updating of all non-monetary items (variable and constant items) in terms of a daily parallel rate (normally the daily US Dollar parallel rate), a Brazilian-style Unidade de Valor Realdaily index or a monetized daily indexed unit of account like the UF in Chile. That happened at McDonalds in Harare, Zimbabwe; i.e., the daily updating, not the implementation of financial capital maintenance in units of constant purchasing power during hyperinflation. Implementing IAS 29 Financial Reporting in Hyperinflationary Economies did not result in financial capital maintenance in units of constant purchasing power in Zimbabwe.

IAS 29 simply requires the restatement of period end HC or Current Cost financial statements in terms of the CPI to supposedly make these statements more useful during hyperinflation. The implementation of IAS 29 had no effect on the economic collapse in Zimbabwe.

Nicolaas Smith

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

Monetary items under CIPPA – Part 2

September 10, 2011 in Uncategorized

Monetary items under CIPPA – Part 2

The full cost of or gain from inflation – net monetary loss or gain – would be recognized by these entities in their operations. It would be calculated and accounted in financial reports prepared under CIPPA. Under partial inflation–adjustment of monetary items – e.g. in Chile, the US, UK, Canada and all countries issuing inflation–indexed bonds – the net monetary loss or gain would be calculated and accounted for the part not inflation–indexed. This is presently not being done in Chile, the US, UK, Canada, etc. because these countries implement the HCA model under which net monetary losses and gains are not calculated and accounted.

The calculation and accounting of net monetary losses and gains are required under CIPPA because the stable measuring unit assumption is never applied under financial capital maintenance in units of constant purchasing power during inflation and deflation.

The constant purchasing power of capital can automatically be maintained constant by the real value of net assets in entities that at least break even during inflation and deflation – ceteris paribus – whether they own any revaluable fixed assets or not – only when they implement financial capital maintenance in units of constant purchasing power. Capital is equal to the real value of net assets.

Under HCA the cost of inflation in the monetary economy is not calculated and accounted because the books are not being balanced in real terms but in nominal monetary terms with the implementation of the very erosive stable measuring unit assumption under financial capital maintenance in nominal monetary units. The concept of capital being equal to net assets is also applied under HCA, but, in illusionary nominal monetary terms. Historical Cost illusion that it is possible to maintain the real value of capital in nominal monetary units per se during inflation and deflation makes Historical Cost Accounting a very erosive and in principle inappropriate accounting policy.

Entities, on the one hand, apply the stable measuring unit assumption under HCA in the valuation of their own shareholders´ equity in their own financial reports in nominal monetary units under which they may nottake into account unreported hidden reserves for fixed assets not revalued when they apply the Historical Cost approach to the valuation of fixed assets in terms of IFRS. On the other hand, they always value third parties´ shareholders´ equity taking into account unreported hidden reserves for fixed assets not revalued, e.g. in the share price of listed companies which they value at market value in terms of IFRS, as well as in their valuations of unlisted companies.

This means that under HCA only entities with revaluable fixed assets (revalued or not) with an updated real value equal to 100% of the updated constant real value of shareholders´ equity maintain the real value of their capital under the concept of capital is equal to net assets measured in nominal monetary units during inflation and deflation. This may only be the case in property companies, hotel, hospital and other property–intensive entities. CIPPA maintains the constant purchasing power of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribuswhether they own any revaluable fixed assets or not. This requires the calculation and accounting of net monetary losses and gains as well as net constant item losses and gains (a new accounting term) because the books are being balanced in real terms; i.e. the stable measuring unit assumption is never applied.

This also means that, under HCA, the portion of shareholders´ equity never covered by sufficient revaluable fixed assets (revalued or not) has always been and is still currently unnecessarily, unintentionally and unknowingly being eroded at a rate equal to the annual rate of inflation; not by inflation, but, by the implementation of the stable measuring unit assumption during inflation.

The erosion is equal to the annual rate of inflation because economic items are valued in terms of money which is the legal monetary unit of account and inflation erodes the real value of only money and other monetary items. Inflation has no effect on the real value of non–monetary items. Shareholders´ equity is a constant real value non–monetary item. This unnecessary erosion in constant item real value amounts to hundreds of billions of US Dollars per annum in the worl
d´s constant item economy.

Financial capital maintenance in units of constant purchasing power (CIPPA) would stop that forever and would instead maintain hundreds of billions of US Dollars per annum in the world´s shareholders´ equity investment base for an unlimited period of time.

As the Deutsche Bundesbank stated:

The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.

Deutsche Bundesbank, 1996 Annual Report, P 83.

Nicolaas Smith

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