Saturday, December 30, 2006

Should the Audit Report specify the real value destroyed in Retained Income by the global implementation of the Stable Measuring Unit Assumption?

Historical Cost Accounting is the global basic accounting model.

The International Accounting Standards Board recognize two economic items:

Monetary items: money held and "items to be received or paid in money" – in terms of the IASB definition.

Non-monetary items: All items that are not monetary items: They include variable real value non-monetary items valued for example, at fair value, market value, present value, net realizable value or recoverable value and Historical Cost items based on the stable measuring unit assumption which makes these items equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies with no well located and well maintained land and/or buildings or other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.

As a constant real value non-monetary item Retained Income is valued at Historical Cost which makes it subject to the destruction of its real value by cash inflation and cash hyperinflation.

It is an undeniable fact that the functional currency's internal real value is constantly being destroyed by cash inflation in the case of low inflation economies, but this is considered as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements – the universal stable measuring unit assumption.

The combination of the Historical Cost Accounting model and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is extremely easy to calculate in the case of each and very company in the world with Retained Income as well as the annual or accumulated or current or future compony or country totals.

Real value destroyed by the combination of low inflation and the Historical Cost Accounting model whereby everybody agrees that the destruction of the internal real value of the monetary unit of account is a very important matter and that cash inflation thus destroys the real value of all variable real value non-monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.

But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non-monetary item – the change in the real value of money is regarded as of not sufficient importance to update the real value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.

Yes, inflation is very important! All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter.

But, when it comes to constant real value non-monetary items:

No sir, inflation is not important! We happily destroy hundreds of billions of Dollars in Retained Income real value year after year after year.

However: When you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. Variable and constant real value non-monetary items.

But ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% - the rate required for the implementation of IAS 29. Once you are not in hyperinflation anymore, for example, anywhere from 2% to 20% annual inflation for as many years as you want, then you are not allowed to update constant real value non-monetary items any more. Then you must destroy their value again – at 2% to 20% per annum - as applicable!


For example:

Shareholder value permanently destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil’s Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).

http://www.prweb.com/releases/200632/2/prweb340868.htm

The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).

http://www.theopenpress.com/index.php?a=press&id=7394

Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during

http://www.theopenpress.com/index.php?a=press&id=7336


Trade debtors and trade creditors are non-monetary items. It is very easy to understand. When the trade debtor/creditor relates to a non-monetary item (amounts owing for purchases of non-monetary items eg, stock, services, raw materials, vehicles, property, etc) it is obviously a non-monetary item. These items have to be updated every time the Consumer Price Index change only during the period of the debt.

Monetary items are money held and accounted monetary values pertaining only to money -where money is the functional currency in an economy.

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

Non-monetary items are either variable real value non-monetary items or constant real value non-monetary items.

Variable real value non-monetary items are valued, for example, at fair value, market value, net realizable value, present value or recoverable value in terms of International Accounting Standards and International Financial Reporting Standards. Examples are stock, property, plant equipment, raw material, finished goods, services, vehicles, marketable securities, foreign exchange, etc.

Constant real value non-monetary items have constant real values and have to be continuously updated in terms of the change in the Consumer Price index in low cash inflationary economies and cash hyperinflationary economies.

Examples are trade receivables, trade payables, constant real value items valued at cost, issued share capital, retained earnings, provisions, reserves, taxes, dividends, salaries, wages, fees, interest received, interest paid, all profit and losss expenses and all profit and loss revenue and income.

Monetary loans (personal, national and international debt) are monetary items. They can not be updated and they are not updated.

Interest paid and interest received are non-monetary items. In your personal bank account interest is always immediately settled with the bank. Unpaid interest is thus a non-monetary item and have to be updated. Interest in the profit and loss account is a non-monetary item and have to be updated.

Personal debts for monetary loans are monetary items. Consumer debt for purchases of non-monetary items are non-monetary items. They have to be updated in hyperinflationary and low inflationary economies.

The prime beneficiary is everybody. Workers have their salaries and wages updated monthly as a matter of routine - they receive the same real wage. The nominal value is simply updated all the time. They will not receive any more real value. Their salaries and wages will simply be maintained at their real values all the time.

Companies - even ones with no fixed assets at all - will have their issued capital real values updated all the time. Companies with retained income will have the real value of their retained income maintained for an unlimited period of time - just like the real value of their issued share capital - all else except cash inflation and cash hyperinflation being equal.

For the first time ever, companies will really have an unlimited lifetime - as was originally intended with the creation of companies - all else except cash inflation and cash hyperinflation being equal.

All the above is actually allowed this very moment by International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary economies but ONLY for companies in hyperinflationary economies.

It is prohibited (not generally accepted) for companies that are not operating in a hyperinflationary economy.

That means the following at this very moment in time: Today all companies in only Zimbabwe (1000 % inflation) are allowed to update all their variable real value non-monetary items as well as all their constant real value non-monetary items:

But not the rest of the world.

The rest of the world is forced by current United States Generally Accepted Acccounting Principles and the International Accounting Standard Board´s International Accounting Standards and International Financial Reporting Standards to destroy their/our Retained Income balances each and every year at the rate of inflation because of the global implementation of the stable measuring unit assumption whereby we are all forced/agree to regard the change in the value of the unit of account - our low inflation currencies - as of not sufficient importance to update the values of constant real value non-monetary items in our financial statements.

We rather destroy them year after year at the rate of inflation till they will reach zero real value as in the case of Retained Income and the issued capital values of all companies with no well located and well maintained land and/or buildings at least equal to the original real value of each contribution of issued share capital.

The 30 Dow companies destroy $31bn annually in the real value of their Retained Income balances as a result of the implementation of the stable measuring unit assumption. Every single year.

Retained Income can be paid out to shareholders as dividens. Poor Dow company shareholders. They will never see that $31bn of dividens destroyed each and every year.

The same value is at least $100bn plus for the reat of the US economy.

As we have all been doing it for the last 700 years: from around the year 1300 when the double entry accounting model was perfected in Italy.

When we do this at the rate of 2% inflation ("price stability" as per the European Central Bank and as per Mr Trichet, the president of the European Central Bank) we purposefully destroy 51% of the real value of the retained income balances in all companies operating in the European Monetary Union over the next 35 years - when that Retained Income remains in the companies for the 35 years - all else except cash inflation being eqaul. Each and every one of those 35 years will be classified as a year of "price stability" by the ECB and Mr Trichet. He will not be the president of the ECB in 35 years time.

Should this value be showed in the Audit Report?

Maybe it should.

Read the book. It is for free.

Free Download : You can download the book: "RealValueAccounting.Com - The next step in our fundamental model of accounting." on the Social Science Research Network (SSRN) at http://ssrn.com/abstract=946775


Nicolaas Smith
RealValueAccounting.Com

1 Comments:

Blogger Nicolaas Smith said...

Turkey implemented IAS 29 in 2003 and 2004 while they were in hyperinflation. As from 2005 when their annual inflation rate was at 8% they had to and they did stop applying IAS 29. As from 2005 they went back to the stable measuring unit assumption.

I sent Dr Kucuksozen, the head of their International Accounting Standards Department, the manuscript to read before publication. This is what he states in public:

"I examined your book and understood that Real Value Accounting is based on the continuous updating of non-monetary units in terms of the Consumer Price Index to today’s real value.

Theoretically, I totally agree with you. But, as you know, there is a trend toward the acceptance of International Accounting Standards and International Financial Reporting Standards issued by the International Accounting Standards Board all over the world. For example, the International Organization of Securities Commissions (IOSCO) recommends harmonization of national accounting standards with IAS and IFRS. Also, the European Union introduced the requirement that from 2005 onwards, all listed companies have to prepare their consolidated accounts in accordance with IAS and IFRS adopted for application within the European Community. Considering international developments and as a candidate country for full membership, Turkey has issued a communiqué involving all IAS and IFRS and began application of them from the beginning of 2005 (As you know, we began application of IAS 29 in 2003).

In this regard, we can change over to real value accounting when there is a change in IAS/IFRS toward real value accounting or there is a trend toward real value accounting all over the world."

2:44 PM  

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