A response to Nick Smith
Regarding the long comment left by Nick Smith on 28 January 2006 (in response the post written by ‘Hope’ and titled “A hungry man is an angry manâ€)
Nick Smith’s comments are interesting; however, I’m not sure that they fully apply to the Zimbabwe economy.
There has been much talk about “dollarisation†of our economy – meaning the effective linking of the prices of all goods and services to a stable currency such as the US Dollar. What must be realized, though, is that virtually no sector of our economy is free from government control. This applies to the price of mealie meal, forex, AND interest rates.
In terms of interest rates: yes, we have a banking system, but because of financial regulation (common in principle but not in method in all societies) interest rates have been held at artificially low percentages. When, for short periods, as happened in early 2004, the rates become market driven, chaos is unleashed in the commercial sector, as companies suddenly have to find much more money to repay the interest on their loans. There is also the further complication of PSF (Productive Sector Funding) – government backed loans at much reduced interest rates of 30% and 50%.
The other point to make is that IAS29 (inflation accounting) sorts out the accounting side of things, but makes no difference at all to the man on the street. What sort of challenges is he faced with?
- A salary that, if he is lucky, increases by the official rate of inflation
- Locally produced items in the shops, the prices of which increase by something between the official rate of inflation and the rate of the decline in value of the Zim dollar on the parallel market (remember that all the packaging or transport component will almost certainly be imported)
- Imported goods in the shops, which are priced at replacement cost, using the latest parallel market exchange rates
- Fuel which costs roughly USD 1 per litre, calculated of course at the parallel rate
So the gap between his income and his expenses is steadily increasing, he can’t make ends meet, and he neither understands nor cares about inflation accounting.
February 10th, 2006 17:53
It is quite a challenge to explain Real Value Accounting as well as a revolutionary change in our global 700 year old Historical Cost Accounting model in a few paragraphs on this excellent blog. Maybe we should do it in a series of articles dealing with one aspect at a time.
Some comments on your article:
Real Value Accounting is not inflation accounting since it is to be applied in all economies: economies operating at two percent per annum inflation (Europe)or at 1000 percent per annum (Zimbabwe). The essential feature of Real Value Accounting is the revoking of the seven centuries old stable measuring unit assumption.
Accounting does make a difference: you put 10 000 US Dollars in a bank account in Zimbabwe on 1st January as the opening capital in your company formed on that day. You account it at
10 000 times 100 000 at the parallel rate = 1 000 000 000 Z$ for 1USD= 100 000 Z$. When at 31 December the parallel rate is 1USD = 1 000 000 Z$ you have to account your capital at 10 000 times 1 000 000 = 10 000 000 000 Z$ and no other value. When the opening amount is represented by product worth USD 10 000 on 1st Jan then those products will still be worth USD10 000 on 31st Dec equivalent to 10 000 000 000 Z$ – all else being equal. There should be no other way.
When you sell your products priced at the parallel rate and you make an overall profit in your business while you are at the same time paying your man in the street who earns his living at the rate of USD1000 per month as a member of your staff, you will always be able to keep his or her salary at USD1000 per month – as long as you keep on selling your products at the parallel rate at an overall profit. When you sell on credit the credit value is always updated at the parallel rate.
You have to always know what the real value of all transactions as well as the value of your business is – but always at today´s parallel rate and to be updated every time the parallel rate change.
I claim that I can run any business at real values. I have to find someone – preferably in Zimbabwe – to give me a chance to prove it.
Please contact me at realvalueaccounting@yahoo.com for us to arrange a series of articles on this blog.
February 12th, 2006 16:25
Let´s get real – Part 2.
The basic problem is that Zimbabweans (like everyone else in other economies) think in nominal or Historical Cost terms in stead of real terms.
You mention Historical or Nominal values all the time in your post, but, YOU live in a REAL ECONOMY with REAL VALUES. So, why do you mention nominal values all the time? Why would you normally quote me a value when the parallel rate WAS 100 000, but, today, the parallel rate is 150 000? It is impossible for me or anyone else in the world to put my understanding, my mind, my senses backwards. Today I know that 1 US Dollar buys 150 000 Zim Dollars. When you mention a value of 100 000 Zim Dollars to me and to everyone else in Zimbabwe today, I know and they know that you are talking about a value that is 100 000/150 0000 the value of 1 US Dollar, or 66 US Cents.
Who is interested in nominal values? No-one is – when it is pointed out to you – as I am doing to you now.
You wrote: “virtually no sector of our economy is free from government control. This applies to the price of mealie meal, forex, AND interest rates.â€
So?
What are the real values of these items?
Everything has a real value. In Zimbabwe it is the Zim Dollar value divided by the parallel rate. (The US Dollar being used as a relatively stable and easily understandable unit of measure for comparison purposes only.)
Today´s price of mealie meal (forex, interest rate) divided by today´s parallel rate indicates mealie meal´s (forex, interest rate) real price today compared to mealie meal´s (forex, interest rate) real price last month divided by last month´s parallel rate.
The parallel rate increased by 1 325 per cent in 2005.
When you have
“PSF (Productive Sector Funding) – government backed loans at much reduced interest rates of 30% and 50%â€
you have to understand that these are not loans but grants. Money for nothing or almost nothing. You have to determine the “loans†real values by dividing what you got as loan by the parallel rate you got it at and then determining what you pay back in the same way when you pay the “loan†back. Divide what you pay back by the parallel rate on that day. You pay back very much less than you received. So, you received a grant of maybe 90% of the initial real value. So it is a grant and not a loan. Let´s get real.
February 12th, 2006 17:15
Let´s get real – Part 3 : IAS 29
You wrote: “The other point to make is that IAS29 (inflation accounting) sorts out the accounting side of things, but makes no difference at all to the man on the street.†And “he neither understands nor cares about inflation accounting.â€
Thank you for pointing out a fact that the International Accounting Standards Board’s highly educated, highly experienced (in low inflationary economies) and highly professional members do not seem to grasp after more than 16 years of failed implementation of IAS 29. (I think IAS29 was only successfully applied in 2004 in Turkey.)
I call for an eventual complete annulment of IAS 29, but, for a different reason.
A modified IAS 29 can be applied for an officially authorized way to maintain real values in a hyperinflationary economy. That is what I want to do in Zimbabwe.
But, who really cares about being officially authorized by whoever or whatever International Board. You want to save your economy – whether it is “official†or not. Let´s get real.
The IASB do not even understand hyperinflation. They are locked into defending the very destructive stable measuring unit assumption, the cornerstone of the antiquated Historical Cost Accounting model. The stable measuring unit assumption that destroys 31 Billion US Dollars in shareholder value annually in the Dow companies´retained earnings and that they and their auditors simply ignore.
You are absolutely right. The futile way in which IAS 29 is being applied by PricewaterhouseCoopers, Deloitte & Touche and other audit firms “makes no difference at all to the man on the street.†They do it exactly in terms of IAS29. Unfortunately in many cases exactly wrong in real terms. But, they are covered: they do it exactly in accordance to an exactly wrong IAS29 in real terms. As it is well known: The Big Four audit firms are very risk averse.
Real Value Accountingâ„¢ is not inflation accounting. It is applied in low and hyperinflationary economies. IAS 29 is only applicable in hyperinflationary economies. The moment you are out of hyperinflation you are forced by the illogical rules of IAS 29 to go back to destroying your constant real value non-monetary items in terms of Historical Cost Accounting. That is why I call for its complete annulment. No IAS29 is required under Real Value Accounting.
Real Value Accountingâ„¢ is a fundamental accounting model with concepts that are more appropriate than those presented by the Historical Cost or Current Cost model in order to meet the objective of providing information that is useful for making economic decisions.
Real Value Accountingâ„¢ is based on recoverable real value and the constant real value capital maintenance concept founded on International Accounting Standards and International Financial Reporting Standards issued by the International AccountingStandards Board
– excluding
1. The stable measuring unit assumption,
2. IAS 29 Financial Reporting in Hyperinflationary Economies and
3. The definition of monetary items in IAS 21 The Effects of Changes in Foreign Exchange Rates.
Real Value Accountingâ„¢ is based on the Real Value Principleâ„¢.
Real Value Principleâ„¢
Constant real value non-monetary items are continuously updated in terms of the CPI (in low inflationary economies – the parallel rate in Zimbabwe) to today’s real value.
Variable real value non-monetary items valued in terms of IASB Standards – excluding the stable measuring unit assumption, IAS 29 and the definition of monetary items in IAS 21 – are continuously updated in terms of the CPI to today’s
RealValueAccounting.Com(The Book) – The next step in our fundamental model of accounting.
http://www.realvalueaccounting.com
February 12th, 2006 22:51
You wrote :”(The man in the street) neither understands nor cares about inflation accounting.”
It is not just the man in the street that does not understand even normal accounting – let alone inflation accounting. People in general (even many Historical Cost trained accountants and economists) do not understand two basic facts about accounting:
1. The double entry accounting model actually creates value, namely real value in constant real value non-monetary items.
For example: without double entry accounting there is no constant real value Retained Earnings. If we did not have double entry accounting your retained profits would be variable real value items.
Constant real value non-monetary items like Retained Earnings only exist because of double entry accounting.
Conclusion: accounting does matter – And: it is important that we get the accounting right because of the second hardly known fact about Historical Cost Accounting:
2. It is and has always been an inherent and absolutely unavoidable part of our economy – based on the Historical Cost Accounting model – that the stable measuring unit assumption destroys real value in constant real value non-monetary items not updated in companies without well maintained and well located land and/or buildings.
Not just in hyperinflationary economies, but, in all low inflationary economies too.
In short: the combination of hyperinflation and double entry accounting always destroys your real economic value when you use Historical Cost Accounting in your company with retained income when you own no land and buildings.
So, how are we going to use this knowledge to try and improve the situation in Zimbabwe?
It is not going to be an easy task, but I know there is a way to do it and I am determined to find it.
I am writing a short story about Mr Historical Cost and Mr Real Value both living in the same hyperinflationary economy. It starts off: Once upon a time there were two men in the street, the one named Mr. …..
December 21st, 2006 11:10
well you say ‘the man on the street does not understand hyper inflation let alone how it affects the accounting side of things’.you also include economists and accountants trained far back, this leaves me with a question as to how then do other people take for example investors, company directors who are not accountants by proffession make economic decisions based on inflation adjusted financial statements presented to them by the accountants. someone argued that inflation adjusting creates artificial figures at the end due to judgemental issues involved in their preparation, what do you say about that?
January 12th, 2007 14:45
Street vendors are streetwise.
A Zimbabwean who uses the internet nickname Bigbrother stated the following:
“Vendors update all their prices every time the parallel rate changes. They therefore understand the principles of “real values” regardless of exchange rate.”
In that statement lies the solution to Zimbabweans problems with hyperinflation.
Not the solution of how to stop hyperinflation. Dr Gono has to stop hyperinflation as all other African countries have done so this far.
I think Zimbabwe is, at the moment, the only country in the entire world economy with hyperinflation.
Bigbrother´s statement holds the solution of HOW TO DEAL WITH HYPERINFLATION at any level.
Street vendors update all their non-monetary prices every time the parallel rate changes. Excellent and 100% correct.
So they do not lose nor destroy real value in their non-monetary items. We all salute their ability to think for themselves.
However, your companies and central bankers do not follow the wisdom of your street vendors.
Your companies do not change ALL, and I mean ALL THEIR PRICES for all their non-monetary items in their businesses as represented in their accounting records and summarised in their balance sheets every time the parallel rate changes.
So the real values of ALL THOSE NON-MONETARY ITEMS are being destroyed by hyperinflation every time the parallel rate changes.
This does not bother your street vendors. They simply update their non-monetary prices every time the parallel rate changes and they never lose nor destroy real value in their non-monetary items . A very intelligent and streetwise section of your society. Your street vendors. They have all my praise and respect.
Unfortunately your accountants, financial directors, managing directors, bookkeepers, financial managers, financial controllers, company directors, bankers, audit partners, audit managers, audit clerks, central bankers and all your other business people in your society are not cut from the same cloth as your street vendors. They are equally as intelligent as your street vendors but they are not as streetwise as your street vendors.
Not one of them can see that they have to copy the street vendors non-monetary item for non-monetary item in their businesses every time the parallel rate changes and in their accounting records and on their balance sheets and profit and loss accounts.
Monetary items can not be updated. Monetary items are money held and accounted monetary values pertaining only to money where money is the functional currency in your economy.
All other items are non-monetary items and have to be updated (change their prices) every time the parallel rate changes.
When simply all accountants and business people in Zimbabwe follow the example of your street vendors they will save Zimbabwe no matter what the rate of inflation.
I don´t know whether you know exactly what that would mean.
Nicolaas Smith