Historical Cost Accounting is the global basic accounting model. It recognizes two economic items:

Monetary items (money and certain non-monetary items mistakenly classified as monetary items – in terms of the International Accounting Standards Board’s definition).

Non-monetary items: Variable real value non-monetary items valued 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 the issued capital of companies with no well located and well maintained land and/or buildings equal to the original real value of issued capital and in companies´ Retained Income balances.

The split between variable and constant real value non-monetary items is conveniently side-stepped by the accounting profession as a result of the stable measuring unit assumption.

It is known that the functional currency's real value is constantly being destroyed by cash inflation – but, this is mistakenly regarded as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements.

They are valued at HC which results in the destruction of the real value of issued capital and Retained Income (see above).

Accountants are 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/hyperinflation.

Should this value be specified in the Audit Report?

This is the situation with Exxon Mobil

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

BP

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

and Royal Dutch Shell.

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

Real Value Accounting

Three economic items:

I. Monetary items (only money and accounted monetary values pertaining only to money)
II. Variable real value non-monetary items (the same as under HCA excluding the stable measuring unit assumption).
III. Constant real value non-monetary items

Real Value Accounting stops the destruction of real value in constant real value non-monetary items.

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

Remembering the system for inflation accounting in 1970s and how that ended up as a three-ring circus of complete nonsense then the current cost accounting principles,I can only observe one thing:

The primary objective of a set of published accounts is to present a “true and fair view” of the affairs of the business.

Provisioning current assets, provisioning, amortization and depreciation of non-current assets and possibly contingent upon the exact state of pending disputes and disagreements. All of which make a “true and fair view” a subjective opinion.

OF your monetary and other items i: ii: and iii:

Monetary items are invariably current assets and liabilities, few businesses having any significant funds locked in long term deposits, desires for “liquidity” prevailing. And thus revaluation does not apply, everything is a monetary asset worth its face value.

A few items fall into ii: a bit of stock maybe and stuffing around with to determine the current value is generally discounted by concerns of obsolescence.

Converting a historic-cost set of accounts to “current replacement values” bears significance, generally, only on non-current assets, since these are the things which are acquired periodically and re not being continuously replaced, example factories and production equipment.

However, the “current replacement value” should be adjusted for changes in technology and construction processes between the date of the historic facility / equipment and current practice. More subjective opinion!

Non-monetary items, copyrights and other intellectual property like trademarks are “super-subjective”.

Your statement “They-are-valued-at-HC-which-results-in-the-destruction-of-the-real-value-of-issued-capital-and-Retained-Income”

My response

The antics of Enron prove that “creative accounting concepts” like “Mark to Market” spell the destruction of the basis of trust and prudence which Creditors and Investors rely upon from Andersens in their Audit reports of Enron.

Whilst HC is an imperfect method it has the single redeeming feature, the values can be tracked back to something real, acquired or traded;

rather than some bulldust from a corporate spin doctor talking up the stock for his own ends. Call me cynical if you like, I would respond, better be prudent and thought cynical than be fashionable and broke.

Col Rouge,

1. Do you think it is a “true and fair view” of Exxon’s business when it is not pointed out in the audit report that US $4.7bn in real value of their retained income was permanently destroyed and that they will never receive that $4.7bn in real value in dividends?

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 an 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 value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billion 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.

However, when you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything. 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.

But, once you are not in hyperinflation anymore, for example, 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 20% per annum!

Col Rouge,

The principles of Real Value Accounting are not “creative accounting concepts”.

Real Value Accounting is based on the International Accounting Standard Board’s International Accounting Standards and International Financial Reporting Standards with the exception of:

one assumption, namely, the stable measuring unit assumption – the stable measuring unit assumption is revoked under Real Value Accounting;

one definition, namely, the definition of monetary items – monetary items are not “money held and items to be received or paid in money” (the IASB definition) but money held and accounted monetary values only pertaining to money (money being the functional currency);

and one International Accounting Standard, namely, IAS 29 Financial Reporting In Hyperinflationary Economies – under Real Value Accounting all constant and variable non-monetary items are updated all the time and not only in a hyperinflationary economy.

I am a simple soul. I believe you should pay dividends out of realized retained earnings and not earnings from revaluation or other non-realised source.

Why do I believe that?

Well prudence for a start. Paying dividends out of unrealized profits defines that a negative cash flow will ensue. No point in paying dividends when there is no cashflow supporting them, better to pay less dividend and benefit from the capital growth in the stock price.

“If all Exxon Mobil’s activities had been conducted in a hyperinflationary economy over these last eight years they could have updated Retained Income in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. The $23bn would not have been permanently destroyed and in stead could have been paid out to shareholders in dividends”

A world driven by hyperinflation would be, long term, non-sustainable. Whilst the oil industry has seen their base prices of crude oil spiral upward in the past year, as they did in the early 1970s, they also fell, “deflated” in between.

I would dispute the notion that “$23 billion would not have been permanently destroyed”. Ultimately you are referring to a timing difference. That difference would conventionally be carried as an increased value on an inflated balance sheet. That it is not, under historic cost accounting rules, simply reflects the prudence of which I spoke of earlier.

Can you advise if you have any significant support for this concept from any of the major accounting bodies in Europe or USA or Australia.

You have not commented on the creative aspects of Enron, a company which I am sure would have jumped at your notion of “real value accounting”. They would have created value as retained earnings, immediately realizing an inflated stock price; shoveled the debt into a unconsolidated associate; financed the card trick by blowing some smoke in the faces of venture capitalists and cashed in their own stock options before the house of cards fell in a heap.

Playing smoke and mirrors with valuations is an easy slope to slide down and a bugger to recover from.

Col Rouge,

You wrote:

“Can you advise if you have any significant support for this concept from any of the major accounting bodies in Europe or USA or Australia.”

1. We have been implementing Historical Cost Accounting for the last 700 years. We are certainly not going to change that from one day to the next.

2. Turkey implemented IAS 29 Financial Reporting in Hyperinflationary Economies in 2003 and 2004. In 2005 they stopped because their cumulative inflation rate over three years did not add up to 100%. The head of their International Accounting Standards Department, Dr. Cemal Kukusozen, read the manuscript. This is what he stated in public:

“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.

In this regard, we (Turkey) 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.”

3. IAS 29 is the official acknowledgement of Real Value Accounting by the International Accounting Standards Board. Real Value Accounting is exactly equal to IAS 29 with the exception of:

a) one assumption, namely, the stable measuring unit assumption – the stable measuring unit assumption is revoked under Real Value Accounting (you have to always update all variable and constant real value non-monetary items – not only in a hyperinflationary economy); and

b) one definition, namely, the definition of monetary items – monetary items are not “money held and items to be received or paid in money” (the IASB definition) but money held and accounted monetary values only pertaining to money (money being the functional currency).

Read the book. It is for free. You will find it very easy to understand Real Value Accounting.

Happy Christmas.

Regards,

Nick Smith

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