Constant purchasing power accounting

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Capital maintenance in units of constant purchasing power (CMUCPP[1]) is the International Accounting Standards Board (IASB) basic accounting model originally authorized in IFRS in 1989 as an alternative to traditional historical cost accounting. Under CMUCPP [2] financial capital maintenance is measured in units of constant purchasing power (CPP) in terms of a Daily CPI (consumer price index) during low inflation and deflation. It can also be measured in a monetized daily indexed unit of account (e.g. the Unidad de Fomento in Chile) and in terms of a daily relatively stable foreign currency parallel rate or daily index during high inflation and hyperinflation. The stable measuring unit assumption is never implemented under CMUCPP.[3][4] CMUCPP implements financial CMUCPP – as originally authorized in IFRS in the Framework (1989), Par 104 (a) [now Conceptual Framework (2010), Par 4.59 (a)[5]] which states: "Financial capital maintenance can be measured in either nominal monetary units or units of CPP" as an alternative to the 3000-year-old generally accepted globally implemented traditional historical cost accounting (HCA) model – with differentiated variable and constant real value non-monetary items in terms of a Daily CPI which automatically maintains the real value of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus. Net constant item losses and gains are calculated and accounted whenever constant items are not measured in units of CPP. Variable real value non-monetary items are valued in terms of IFRS and then updated daily in terms of the Daily CPI. Historical variable items are updated in terms of the Daily CPI because there is no stable measuring unit assumption under CMUCPP. Monetary items are always and everywhere (current period and historical monetary items) inflation-adjusted in terms of the Daily CPI since the stable measuring unit assumption is rejected under CMUCPP. Net monetary losses and gains are calculated and accounted whenever monetary items are not inflation-adjusted. CMUCPP is a price-level accounting model.

CMUCPP automatically maintains the CPP of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation (including during hyperinflation as guide-lined in IAS 29) – ceteris paribus – whether they own any revaluable fixed asset or not.

CMUCPP only maintains the real value of all non-monetary items (the entire real or non-monetary economy) relatively stable when these items are valued on a daily basis in terms of a Brazilian-style non-monetary index or daily parallel rate (normally the daily US Dollar parallel rate) during hyperinflation. IAS 29 requires the restatement of Historical Cost or Current Cost period-end financial statements in terms of the period-end monthly published Consumer Price Index during hyperinflation. IAS 29 should be implemented in terms of daily valuation of all non-monetary items in units of CPP in terms of the Daily CPI which would maintain 100 per cent of current period profits constant in real value. IAS 29 thus requires the implementation of financial CMUCPP.

CMUCPP was authorized in IFRS in the IASB's original Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a)[6][7] in 1989. In terms of the original Framework, (1989) Par 104 (a) accountants choose CMUCPP to implement a financial capital concept of invested purchasing power, i.e. financial CMUCPP at all levels of inflation and deflation instead of the traditional HC concept of invested money. They thus implement a CPP financial capital maintenance concept by measuring financial capital maintenance in units of CPP instead of traditional HC nominal monetary units and they implement a CPP profit/loss determination concept in units of CPP instead of in real value eroding nominal monetary units under HCA. 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. Examples of variable items are property, plant, equipment, listed and unlisted shares, inventory, foreign exchange, etc. Variable items are valued in terms of International Financial Reporting Standards (IFRS) at for example fair value, market value, recoverable value, present value, net realizable value, etc. or Generally Accepted Accounting Principles (GAAP) during non-hyperinflationary periods.

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.

CMUCPP automatically maintains the real value of capital constant in all entities that at least break even in real value including banks´ and companies' capital base, for an unlimited period of time – 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 capital constant. This is opposed to the traditional historical cost accounting model under which the real value of that portion of shareholders´ equity never maintained constant with sufficient revaluable fixed assets (revalued or not) are unknowingly, unnecessarily and unintentionally eroded at a rate equal to the annual rate of inflation as a result of the implementation of the very erosive stable measuring unit assumption under HCA. CMUCPP was authorized in IFRS in 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation in the original Framework (1989) and 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.[8]

The original framework (1989), Par 104 (a) is applicable at all levels of inflation and deflation, including during hyperinflation as specifically guide-lined in IAS 29.

Discredited 1970-style CPP accounting was a form of inflation accounting which tried unsuccessfully – by updating all non-monetary items (variable real value non-monetary items and constant real value non-monetary items) equally by means of the period-end monthly published CPI in an unsuccessful attempt to correct the real value eroding effect of the stable measuring unit assumption during high inflation (but not yet hyperinflation) in the 1970´s. Under CMUCPP, all non-monetary items – constant and variable items – are updated daily in terms of a Brazilian-style non-monetary index or a hard currency parallel rate during hyperinflation.

The CMUCPP model presents substantial benefits, for example, automatically maintaining banks' and companies' existing capital base constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation - ceteris paribus.

Certain income statement constant real value non-monetary items, most notably salaries, wages, rentals, etc. are updated on an annual basis by means of the monthly published CPI, that is, valued or measured in units of CPP during low inflation, in most economies implementing the traditional HCA model. They are, however, thereafter paid on a monthly basis by applying the stable measuring unit assumption; i.e. they are not updated daily as done under CMUCPP.

1970-style CPP accounting was a failed inflation accounting model[edit]

South African Institute of Chartered Accountants: "Yes, this does have conceptual appeal and was experimented with in the UK and US in the 1970s, when inflation was high. Yet the markets brushed aside the inflation-adjusted figures because:

• "The capital markets are acutely aware of the extent of inflation and are perfectly capable of allowing for this in determining the value of shares; and

• "Businesses are affected by the specific price changes of the products with which they are dealing; changes that may bear little relationship to a general price index like the CPI.

"It therefore made little practical sense to introduce CPI-based adjustments. Indeed, when the CPI-based approach was included in supplementary accounts, business generally objected on the grounds that the adjusted numbers did not reflect the impact of specific inflation.

"Eventually, with inflation abating in the UK and US, and accountants engaging in increasingly technical dead-end debates, the use of CPI-adjusted numbers was abandoned.

"Self-evidently, inflation adjustments that apply accounting standard IAS 29 are essential in hyperinflationary environments, in which historic numbers are meaningless. Even then, the adjusted figures have little meaning, since by the time they see the light of day they are already out of touch with reality.

[9]

International Accounting Standard 29, Par. 6: "In most countries, primary 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. Some entities, however, present financial statements that are based on a current cost approach that reflects the effects of changes in the specific prices of assets held."

[10]

The following quote from Geoffrey Whittington's[11] book Inflation Accounting – An Introduction to the Debate, published in 1983, reflects the above position:

"Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."[12]

At all levels of inflation[edit]

The specific choice of measuring financial CMUCPP (the CMUCPP model) as authorized in the original Framework (1989), was approved by the IASB'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 8."

[13]

IAS8, 11:

"In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:

(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and

(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework."

[14]

There is no applicable IFRS or Interpretations regarding the capital concept, the capital maintenance concept and the valuation of all constant real value non-monetary items. The original Framework (1989), Par 104 (a) is thus applicable.

CMUCPP is not only an inflation accounting model. CMUCPP is implemented at all levels of inflation and deflation. IAS 29 (requiring CMUCPP) is the inflation-accounting model defined in IFRS. CMUCPP by measuring financial capital maintenance in units of CPP incorporates an alternative CPP capital concept, CPP financial capital maintenance concept and CPP profit determination concept to the HC capital concept, HC financial capital maintenance concept and HC profit determination concept. CMUCPP requires all constant items always and everywhere to be valued in units of CPP in terms of the Daily CPI because there is no stable measuring unit assumption under this accounting model. Variable items are valued in terms of IFRS or GAAP and then updated in terms of the Daily CPI. Historical variable items are updated daily in terms of the Daily CPI as a result of the absence of the stable measuring unit assumption under CMUCPP.

Authorized by the IASB during low inflation[edit]

The statement "Financial capital maintenance can be measured in either nominal monetary units or units of CPP,"' in the IASB´s original Framework (1989), Par 104 (a), means that CMUCPP has been authorized by the IASB since 1989 as an alternative to the traditional HCA model at all levels of inflation and deflation, including during hyperinflation as required in IAS 29. This means that the international accounting profession has been in agreement regarding the use of financial capital maintenance in units of CPP during low inflation, high inflation, hyperinflation and deflation since 1989. It also means that financial CMUCPP to automatically maintain the real value of capital constant in all entities that at least break even - ceteris paribus - in a low inflationary environment is authorized in IFRS since the original Framework (1989) is applicable in the absence of specific IFRS.

Income statement constant items like salaries, wages, rents, pensions, utilities, transport fees, etc. are normally valued in units of CPP during low inflation in most economies as an annual update. Payments in money for these items are normally inflation-adjusted by means of the consumer price index (CPI) to compensate for the erosion of the real value of money (the monetary medium of exchange) by inflation only on an annual not daily basis. "Inflation is always and everywhere a monetary phenomenon" and can only erode the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not erode the real value of non-monetary items. Inflation has no effect on the real value of non-monetary items. Constant items´ real values are automatically maintained for an unlimited period of time in all entities that at least break even by the CMUCPP model as per the original Framework (1989) at all levels of inflation and deflation as authorized by the IASB since 1989 instead of currently being eroded by the implementation of the traditional HC model when the very erosive stable measuring unit assumption is applied. It is thus the stable measuring unit assumption and not inflation that erodes the real value of constant items never maintained constant at a rate equal to the inflation rate when the stable measuring unit assumption is implemented for an indefinite period of time during continuous low inflation.

Implementing the CMUCPP model means the stable measuring unit assumption is rejected. The stable measuring unit assumption is implemented when the HCA model is chosen where under financial capital maintenance is measured in nominal monetary units. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy since it is impossible to maintain the existing real value of capital constant with financial capital maintenance in nominal monetary units (the HCA model) per se during inflation and deflation. Accountants world wide currently choose the traditional HCA model.

Net monetary gains and losses authorized during low inflation and deflation in IFRS since 1989[edit]

Accountants have to calculate the net monetary loss or gain from holding monetary items when they choose the CMUCPP model and measure financial CMUCPP in the same way as the IASB currently requires its calculation and accounting during hyperinflation. The calculation and accounting of net monetary losses and gains during low inflation and deflation have thus been authorized in IFRS since 1989. There are net monetary losses and net monetary gains during low inflation too, but they are not required to be calculated when accountants choose the traditional HCA model.

Net constant item gains and losses are also calculated and accounted under CMUCPP.

Underlying assumptions[edit]

IFRS authorize two basic accounting models:

1. Financial capital maintenance in nominal monetary units or Historical cost accounting (see the Framework (1989), Par 104 (a)).

2. Financial CMUCPP or Constant Item Purchasing Power Accounting (see the Framework (1989), Par 104 (a)).

A. Under Historical cost accounting the underlying assumptions used in IFRS are:

  • Accrual basis: the effect of transactions and other events are recognized when they occur, not as cash is gained or paid.
  • Going concern: an entity will continue for the foreseeable future.
  • Stable measuring unit assumption: financial capital maintenance in nominal monetary units or traditional Historical cost accounting; i.e., accountants consider changes in the purchasing power of the functional currency up to but excluding 26% per annum for three years in a row (which would be 100% cumulative inflation over three years or hyperinflation as defined in IFRS) as immaterial or not sufficiently important for them to choose financial capital maintenance in units of CPP during low inflation and deflation as authorized in IFRS in the Framework (1989), Par 104 (a).

The stable measuring unit assumption (traditional Historical Cost Accounting) during annual inflation of 25% for 3 years in a row would erode 100% of the real value of all constant real value non-monetary items not maintained under the Historical Cost paradigm.

B. Under CMUCPP the underlying assumptions in IFRS are:

  • Accrual basis: the effect of transactions and other events are recognized when they occur, not as cash is gained or paid.
  • Going concern: an entity will continue for the foreseeable future.
  • Measurement in units of CPP of all constant real value non-monetary items automatically remedies the erosion caused by the stable measuring unit assumption (Historical Cost Accounting) of the real non-monetary values of all constant real value non-monetary items never maintained constant at all levels of inflation and deflation. It is not low inflation, high inflation or hyperinflation doing the eroding. It is the implementation of the stable measuring unit assumption during low inflation, high inflation and hyperinflation. Constant real value non-monetary items are measured in units of CPP at in terms of a daily rate all levels of inflation and deflation. Monetary items are inflation-adjusted daily. Net monetary losses and gains are calculated when monetary items are not inflation-adjusted daily in terms of a daily rate. Variable items are measured in terms of IFRS and then updated daily in terms of a daily rate. All non-monetary items (variable real value non-monetary items and constant real value non-monetary items) in Historical Cost or Current Cost period-end financial statements are restated in terms of the period-end monthly published CPI during hyperinflation as required in IAS 29 Financial Reporting in Hyperinflationary Economies.

The IASB's Framework[edit]

Framework for the preparation and presentation of financial statements[15][16]

    • Concepts of capital and capital maintenance

A major difference between US GAAP and IFRS is the fact that three fundamentally different concepts of capital and capital maintenance are authorized in IFRS while US GAAP only authorize two capital and capital maintenance concepts during low inflation and deflation: (1) physical capital maintenance and (2) financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) as stated in Par 45 to 48 in the FASB Conceptual Satement Nº 5. US GAAP does not recognize the third concept of capital and capital maintenance during low inflation and deflation, namely, financial CMUCPP as authorized in IFRS in the framework, Par 104 (a) in 1989.

    • Concepts of capital
  • Par 102 A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.[17]
  • Par 103 The selection of the appropriate concept of capital by an entity should be based on the needs of the users of its financial statements. Thus, a financial concept of capital should be adopted if the users of financial statements are primarily concerned with the maintenance of nominal invested capital or the purchasing power of invested capital. If, however, the main concern of users is with the operating capability of the entity, a physical concept of capital should be used. The concept chosen indicates the goal to be attained in determining profit, even though there may be some measurement difficulties in making the concept operational.[18]

Concepts of capital maintenance and the determination of profit[edit]

  • Par 104 The concepts of capital give rise to the following concepts of capital maintenance:
    • (a) Financial capital maintenance. Under this concept a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Financial capital maintenance can be measured in either nominal monetary units or units of CPP.
    • (b) Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.[19]

The three concepts of capital defined in IFRS during low inflation and deflation are:

  • (A) Physical capital. See paragraph 102.
  • (B) Nominal financial capital. See paragraph 104 (a).[20]
  • (C) Constant purchasing power financial capital. See paragraph 104 (a).[21]

The three concepts of capital maintenance authorized in IFRS during low inflation and deflation are:

  • (1) Physical capital maintenance: optional during low inflation and deflation. Current Cost Accounting model prescribed by IFRS. See Par 106.
  • (2) Financial capital maintenance in nominal monetary units (Historical cost accounting): authorized by IFRS but not prescribed—optional during low inflation and deflation. See Par 104 (a) Historical cost accounting. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy: it is impossible to maintain the real value of financial capital constant with measurement in nominal monetary units per se during inflation and deflation.
  • (3) Financial capital maintenance in units of CPP CMUCPP authorized in IFRS but not prescribed—optional during low inflation and deflation. See Par 104 (a). Prescribed in IAS 29 [16] during hyperinflation: CMUCPP[22] Only financial capital maintenance in units of CPP per se automatically maintains the real value of financial capital constant at all levels of inflation and deflation in all entities that at least break even—ceteris paribus—for an indefinite period of time. This happens whether these entities own revaluable fixed assets or not and without the requirement of more capital or additional retained profits to simply maintain the existing constant real value of existing shareholders´ equity constant.
  • Par 105 The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between an entity's return on capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed income the residual amount is a loss.[23]
  • Par 106 The physical capital maintenance concept requires the adoption of the current cost basis of measurement. The financial capital maintenance concept, however, does not require the use of a particular basis of measurement. Selection of the basis under this concept is dependent on the type of financial capital that the entity is seeking to maintain.[24]
  • Par 107 The principal difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities of the entity. In general terms, an entity has maintained its capital if it has as much capital at the end of the period as it had at the beginning of the period. Any amount over and above that required to maintain the capital at the beginning of the period is profit.[25]
  • Par 108 Under the concept of financial capital maintenance where capital is defined in terms of nominal monetary units, profit represents the increase in nominal money capital over the period. Thus, increases in the prices of assets held over the period, conventionally referred to as holding gains, are, conceptually, profits. They may not be recognised as such, however, until the assets are disposed of in an exchange transaction. When the concept of financial capital maintenance is defined in terms of constant purchasing power units, profit represents the increase in invested purchasing power over the period. Thus, only that part of the increase in the prices of assets that exceeds the increase in the general level of prices is regarded as profit. The rest of the increase is treated as a capital maintenance adjustment and, hence, as part of equity.[26]
  • Par 109 Under the concept of physical capital maintenance when capital is defined in terms of the physical productive capacity, profit represents the increase in that capital over the period. All price changes affecting the assets and liabilities of the entity are viewed as changes in the measurement of the physical productive capacity of the entity; hence, they are treated as capital maintenance adjustments that are part of equity and not as profit.[27]
  • Par 110 The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements. Different accounting models exhibit different degrees of relevance and reliability and, as in other areas, management must seek a balance between relevance and reliability. The Framework is applicable to a range of accounting models and provides guidance on preparing and presenting the financial statements constructed under the chosen model. At the present time, it is not the intention of the Board of IASC to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy. This intention will, however, be reviewed in the light of world developments.[28]

[29]

  • The IASB Framework was approved by the IASC Board in April 1989 for publication in July 1989, and adopted by the IASB in April 2001.[30]

Required by the IASB during hyperinflation[edit]

The IASB authorized the CMUCPP model during low inflation, high inflation, hyperinflation and deflation in the original framework (1989) as an alternative to the HCA model.

See also[edit]

External links[edit]

References[edit]

  1. ^ [1]
  2. ^ [2]
  3. ^ [3]
  4. ^ [4] Smith, NJ, 2012, Constant Item Purchasing Power Accounting per IFRS, Chapter 1.1.11 Monetary items inflation-adjusted daily
  5. ^ [5] Conceptual Framework (2010)
  6. ^ [6] Full text of the Framework
  7. ^ [7] IFRS link to full text
  8. ^ [8] IFRS Full texts.
  9. ^ South African Institute of Chartered Accountants, Education and training – Discussion Forum > Small Practices > R57.984 billion real value eroded by CAs in 169 JSE listed companies, Line 6 to 14, 12 August 2008. Statement about 1970-style inflation accounting originally made by Prof. Geoff Everingham, Accounting Department, University of Cape Town, South Africa in a letter to the Financial Mail, 23 May 2008 now only accessible on prescription. Statement restated by SAICA.
  10. ^ International Accounting Standard I AS 29, Par. 6. International Accounting Standards Committee, (1995), International Accounting Standards 1995, London, IASC, Page 502.[9] IAS 29 Full text.
  11. ^ [10] Curriculum Vitae
  12. ^ Inflation Accounting: An Introduction to the Debate, Geoffrey Whittington, Cambridge University Press, 1983, ISBN 0-521-27055-3, ISBN 978-0-521-27055-7, P. 73.[11]
  13. ^ IAS Plus, Deloitte
  14. ^ [12] IAS 8 Full Text.
  15. ^ [13] Full text of the Framework
  16. ^ [14] IFRS link to full text
  17. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 102
  18. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 103
  19. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 104
  20. ^ Historical cost accounting
  21. ^ Constant Purchasing Power Accounting
  22. ^ [15] Framework for the Preparation and Presentation of Financial Statements, Par 104
  23. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 105
  24. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 106
  25. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 107
  26. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 108
  27. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 109
  28. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 110
  29. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 102 – 110
  30. ^ IFRS, Framework for the Preparation and Presentation of Financial Statements