Welcome to AccountingWEB's new "IFRS in Perspective" blog. I'm Bruce Pounder, and I'll be blogging about the role that International Financial Reporting Standards (IFRS) can and should play in the future of financial reporting in the United States. I don’t expect to end the debate over IFRS that exists within the U.S. accounting profession, but I do hope to influence that debate in a positive way. In this initial post, I'll summarize my point of view and explain why I want to share it with you.
As you may know, I frequently speak, write, and consult on financial reporting matters involving IFRS. In my travels and conversations, I find that U.S. accountants have a very poor understanding of IFRS and its implications. I continually see individuals and organizations make decisions about IFRS from a position of ignorance rather than a position of knowledge. And I continually see the adverse consequences that result from an incomplete and/or inaccurate understanding of the facts and issues involved. Because of my experiences, I have chosen to write this blog for the primary purpose of helping U.S. accountants un-learn the many myths and misconceptions that have been propagated about IFRS.
You'll benefit from reading my blog if you currently believe that it is realistic to expect U.S. companies to continue using U.S. GAAP as we know it today. Or if you currently believe that the United States should abandon U.S. GAAP in favor of IFRS. Or—most of all—if you think that sticking with U.S. GAAP or switching to IFRS are our only two options.
In the United States, we have the opportunity to create the future that we want with regard to financial reporting. We are not constrained to choose between two existing, immutable, exclusive alternatives. From my perspective, the optimal path forward for the United States with regard to IFRS does not come with simple choices nor guarantees, and it's important for U.S. accountants to understand that. Post by post, this blog will construct a “business case" for what individuals and organizations in the United States should do with regard to IFRS, what we shouldn’t do, and why.
To be clear, I don't claim to have a monopoly on the truth, nor do I claim to know everything there is to know about financial reporting in general or IFRS in particular. What I have is a unique perspective to share—a perspective that stems from a combination of three things:
- A comprehensive view of the facts supported by verifiable sources;
- A willingness to explicitly state my assumptions and the bases for them; and
- An intense commitment to applying facts and assumptions in a logical way in order to achieve the best outcome for the United States with regard to financial reporting.
I also have an overriding criterion for my posts: I want to write what I would want to read if someone else wrote it. Blogs that simply regurgitate press releases bore me. Blogs that attempt to make a point through fallacious reasoning annoy me. And blogs that get the facts wrong infuriate me. My promise to you is that this blog will be different from other blogs. In each of my posts, I’ll tell you something about IFRS that’s relevant, that’s reliable, and that you’re unlikely to have read or heard anywhere else. And if you have read or heard it before but don’t believe it, I’ll give you a new reason to change your mind.
In summary, this blog won't be an ongoing tutorial about the technical intricacies of IFRS. Instead, by dispelling the plethora of mis-information about IFRS, this blog will establish a rational foundation for Americans to make better personal, managerial, and public-policy decisions about our financial-reporting future—a foundation that's sorely needed today.
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This is not inflation-accounting - as you simply imagined.
Mr Pounder,
Thank you for responding to my comment.
You stated:
“Most participants in the financial reporting supply chain, including myself, believe that the disadvantages of constant-purchasing-power accounting outweigh the advantages except in cases of hyperinflation.
I was not referring to constant-purchasing-power accounting in my comment.
I will repeat what I stated:
“3. Financial capital maintenance in units of constant purchasing power ( Constant Item Purchasing Power Accounting )”
I clearly indicated Constant ITEM Purchasing Power Accounting and not constant-purchasing-power accounting. That is simply what you imagined. If you googled for Constant Item Purchasing Power Accounting you would have found a lot of information.
I supplied the link to Constant Item Purchasing Power Accounting. You unfortunately chose not to follow the link. You simply assumed I was referring to Constant Purchasing Power Accounting while I actually stated Constant ITEM Purchasing Power Accounting and I supplied the link for you to be informed about the latest development in accounting.
As you chose not to follow the link I will give you a brief summary of Constant ITEM Purchasing Power Accounting which is NOT Constant Purchasing Power Accounting:
Constant Purchasing Power Accounting – the accounting model you mistakenly imagined that I was referring to – is an inflation-accounting model as detailed in IAS 29 required ONLY during hyperinflation. Under Constant Purchasing Power Accounting ALL non-monetary items (constant real value non-monetary items and variable real value non-monetary items) have to be inflation-adjusted ONLY during hyperinflation.
Constant ITEM Purchasing Power Accounting – the one I am referring to – is the IASB approved alternative basic accounting model to traditional Historical Cost Accounting during low inflation and deflation and has been authorized in IFRS in the Framework, Par 104 (a) 21 years ago. It is quite evident that you do not realize that. Par 104 (a) states the following:
“Financial capital maintenance can be measured in nominal monetary units or units of constant purchasing power.”
It does not state “during hyperinflation.”
As you very well know, IFRS are principles-based standards. It states the principle.
It thus means that in terms of IFRS financial capital maintenance can be measured in units of constant purchasing power under all circumstances, i.e. under all levels of inflation and deflation: i.e. during LOW inflation and deflation as well as hyperinflation.
Please note: all non-monetary items are not the same. Non-monetary items are sub-divided in (a) variable real value non-monetary items and (b) constant real value non-monetary items.
Variable items are items like property, plant, equipment, raw material and finished goods stock, etc. IFRS and US GAAP are mainly concerned about their valuation.
Constant items are items like all the items in the income statement, all items in shareholders´ equity, etc.
Now: what you imagined I stated, namely, Constant Purchasing Power Accounting requires ALL non-monetary items (variable and constant items) to be inflation-adjusted ONLY during hyperinflation. This is only provided for in IFRS. It is not provided for under US GAAP although you imagine it is. It is not. US GAAP only provide for two concepts of capital maintenance: (1) Physical capital maintenance and (2) Financial capital maintenance in nominal monetary units (the “traditional” accounting model as specifically mentioned in the FASB Concepts Statement 5). Only IFRS authorize financial capital maintenance in units of constant purchasing power during LOW inflation, hyperinflation and deflation. US GAAP does not provide for that. See Par 45 to 48 in the FASB Concepts Statement 5.
You thus have to admit and it is very clear that you know nothing about Constant ITEM Purchasing Power Accounting. What are the advantages of Constant ITEM Purchasing Power Accounting when ONLY constant real value non-monetary items – please note NOT variable real value non-monetary items (e.g. property, plant, equipment, inventories, etc) – are inflation-adjusted during LOW inflation as authorized in IFRS?
The advantage – when accountants world wide freely choose Constant ITEM Purchasing Power Accounting as authorized in IFRS - is that they would stop their automatic, unknowing, unnecessary and unintentional destruction of the real value (amounting to hundreds of billion of USD per annum) of that portion of shareholders´ equity not backed by sufficient revaluable fixed assets (revalued or not) during low inflation as a result of their implementation of the stable measuring unit assumption as part of the traditional Historical Cost Accounting model in all entities that at least break even - whether these entities own any revaluable fixed assets or not – as well as without the requirement for additional money in the form of additional capital contributions by capital providers or additional retained profits simply to maintain the existing constant real value of existing shareholders equity constant. Accountants would thus automatically knowingly maintain – instead of automatically destroy - hundreds of billions of USD in existing real value in the world economy per annum – just by rejecting their assumption that money is perfectly stable during low inflation (i.e. any annual inflation up to 25% for three years in a row) only for the purpose of valuing constant real value non-monetary items.
Accountants all agree and admit to “the erosion of companies´ profits and invested capital caused by inflation” as stated by your Mr. Mosso in FAS 33 in 1979. However, it is not inflation, but their free choice of the stable measuring unit assumption, i.e. traditional Historical Cost Accounting during low inflation, doing the destroying. Inflation is always and everywhere a monetary phenomenon as stated by your late Nobel Laureate, Milton Friedman. Inflation can only destroy the real value of money and other monetary items – nothing else. It is impossible for inflation to destroy the real value of any non-monetary item ever.
I am not the only person understanding that and stating that.
This is what two Turkish academics state:
“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.
All items in shareholders´ equity are non-monetary items. Mr. Pounder, you and all accountants would confirm that. It is thus impossible for inflation per se to erode or destroy the real value of companies´ profits and invested capital as was stated by your Mr. Mosso in FAS 33 in 1979 and believed by you and most accountants.
Mr. Pounder, now that we have cleared up the confusion between what you imagined I meant and what I actually stated and provided you a link for (which you did not follow), and now that I have, briefly, explained the advantage of Constant ITEM Purchase Power Accounting, I ask you again:
Do you think the FASB (US companies) should adopt financial capital maintenance in units of constant purchasing power during low inflation: i.e. Constant ITEM Purchasing Power Accounting (NOT Constant Purchasing Power Accounting as you imagined I meant)?
Kindest regards,
Nicolaas Smith
http://blogs.fin24.com/realvalueaccounting
Thank You
Mr. Smith,
Thank you for taking the time to comment on my blog post. It is well-known in the United States and elsewhere in the world that financial-statement items can be measured in either nominal monetary units or units of constant purchasing power. The advantages of measuring financial-statement items in units of constant purchasing power are also well-known, as are the disadvantages of such a measurement method. Most participants in the financial reporting supply chain, including myself, believe that the disadvantages of constant-purchasing-power accounting outweigh the advantages except in cases of hyperinflation. Conversely, it is widely accepted that the advantages of measuring financial-statement items in nominal monetary units outweigh the disadvantages, again except in cases of hyperinflation. I am not aware of any new information that would cause me to reconsider whether the advantages of constant-purchasing-power accounting might outweigh the disadvantages under a broader set of circumstances, so my reply to the specific question that you asked is that I do not believe the FASB should adopt financial capital maintenance in units of constant purchasing power.
Best regards,
Bruce Pounder
Only IFRS authorize financial capital maintenance in units of constant purchasing power during low inflation and deflation.
Mr Pounder,
You state in your first post:
"In each of my posts, I’ll tell you something about IFRS that’s relevant, that’s reliable, and that you’re unlikely to have read or heard anywhere else."
Here is something about IFRS that is relevant, reliable and that you´re unlikely to have read or heard anywhere else:
US GAAP as stated by the FASB only recognize two forms of capital maintenance as stated in Par 45 to 48 of the FASB Concepts Statement 5, namely
(a) Financial capital maintenance in nominal monetary units applying the stable measuring unit assumption, i.e. the Historical Cost Accounting model, and
(b) Physical capital maintenance.
IFRS state in the Framework (1989), Par 104 (a)
"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."
IFRS thus recognize three concepts of capital maintenance during low inflation and deflation:
1. Physical capital maintenance
2. Financial capital maintenance in nominal monetary units (HCA)
3. Financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting)
Financial capital maintenance in nominal monetary units (as per US GAAP, for example) is a fallacy: it is impossible to maintain the real value of financial capital constant in nominal monetary units per se during inflation and deflation. Implementing traditional HCA (as all US companies do) results in the destruction of hundreds of billions of Dollars PER ANNUM in the real value of constant real value non-monetary items (e.g. shareholders´ equity) never maintain constant as a result of insufficient revaluable fixed assets (revalued or not) under the HCA model.
Financial capital maintenance as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago is the only way to stop this unknowing, unnecessary and unintentional destruction by US accountants forever.
US GAAP do not allow financial capital maintenance in units of constant purchasing power during low inflation and deflation.
Do you think the FASB (US companies) should adopt financial capital maintenance in units of constant purchasing power?
Nicolaas Smith
http://blogs.fin24.com/realvalueaccounting