Constant purchasing power accounting

Constant purchasing power accounting is an accounting model approved by the International Accounting Standards Board (IASB) as an alternative to traditional historical cost accounting under hyper-inflationary environments.[1]) Under this system, 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. CMUCPP implements financial CMUCPP – as originally authorized in IFRS in the Framework (1989), Par 104 (a) [now Conceptual Framework (2010), Par 4.59 (a)[2]] 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 - except current period items - are 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 daily 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)[3][4] 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.[5]

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 - 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.

Authorized by the IASB during low inflation

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 worldwide currently choose the traditional HCA model.

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

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

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:

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:

The IASB's Framework

Framework for the preparation and presentation of financial statements[3][4]

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 maintenance and the determination of profit

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

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

[16]

See also

References

  1. "IFRS Interpretations Committee Meeting : IAS 29 Financial Reporting in hyperinflationary Economies" (PDF). Ifrs.org. Retrieved 24 February 2015.
  2. "Access the unaccompanied Standards". IFRS. Retrieved 2015-02-24.
  3. 1 2 3 Archived 21 May 2009 at the Wayback Machine.
  4. 1 2 3 "IFRS - Home". Iasb.org. Retrieved 2015-02-24.
  5. "EUR-Lex - 32003R1725 - EN - EUR-Lex". Eur-lex.europa.eu. Retrieved 2015-02-24.
  6. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 102
  7. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 103
  8. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 104
  9. Constant Purchasing Power Accounting
  10. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 105
  11. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 106
  12. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 107
  13. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 108
  14. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 109
  15. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 110
  16. IFRS, Framework for the Preparation and Presentation of Financial Statements, Par. 102 – 110
  17. IFRS, Framework for the Preparation and Presentation of Financial Statements
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