Constant Purchasing Power Accounting

Constant-purchasing-power accounting (CPPA) is:

a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."

International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies is the International Accounting Standards Board

International Accounting Standards Board

The International Accounting Standards Board is an independent, privately funded accounting standard-setter based in London, England.The IASB was founded on April 1, 2001 as the successor to the International Accounting Standards Committee...

´s inflation accounting
Inflation accounting
Inflation accounting is a term describing a range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation. Inflation accounting is used in countries experiencing high inflation or hyperinflation...

model under which all non-monetary items (variable and constant real value non-monetary items) in historical cost or current cost period-end financial statements are restated in terms of the period-end consumer price index

Consumer price index

A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...

(CPI) only during hyperinflation

Hyperinflation

In economics, hyperinflation is inflation that is very high or out of control. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases...

which the IASB describes as an exceptional circumstance. IAS 29 does not require valuation of non-monetary items in units of constant purchasing power on a daily basis during the accounting period. IAS 29 does not require consistent daily indexing by means of a general index which reflects daily or even hourly changes in the purchasing power of money during hyperinflation. It simply requires restatement of HC and CC period-end financial statements.

Constant item purchasing power accounting (CIPPA) is the IASB's basic accounting model originally authorized in IFRS in 1989 as an alternative to traditional historical cost accounting where under constant real value non-monetary items are always and everywhere measured in units of constant purchasing power in terms of a daily index or monetized daily indexed unit of account (e.g. the Unidad de Fomento

Unidad de Fomento

The Unidad de Fomento is a Unit of account that is used in Chile. The exchange rate between the UF and the Chilean peso is now constantly adjusted to inflation so that the value of the Unidad de Fomento remains constant on a daily basis during low inflation...

in Chile) during low inflation

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

and deflation because there is no stable measuring unit assumption under CIPPA. Net constant item losses and gains are calculated and accounted whenever constant items are not measured in units of constant purchasing power. Variable real value non-monetary items are valued in terms of IFRS. Historical variable items are updated in terms of a Daily Index because there is no stable measuring unit assumption under CIPPA. Monetary items are always and everywhere (current period and historical monetary items) inflation-adjusted in terms of a Daily Index since the stable measuring unit assumption is rejected under financial capital maintenance in units of constant purchasing power. Net monetary losses and gains are calculated and accounted whenever monetary items are not inflation-adjusted. CIPPA is a price-level accounting model which implements the principle of financial capital maintenance in units of constant purchasing power as originally authorized in IFRS in the Framework (1989), Par 104 (a).

CIPPA automatically maintains the constant purchasing power of capital constant forever in all entities that at least break even in real value during inflation and deflation – ceteris paribus – whether they own any revaluable fixed asset or not.

CPPA 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 simply requires the restatement of Historical Cost or Current Cost period-end financial statements in terms of the period-end Consumer Price Index to make these financial statements more useful during hyperinflation. IAS 29 does not require daily valuation of all non-monetary items in units of constant purchasing power. IAS 29 thus does not require the implementation of financial capital maintenance in units of constant purchasing power. PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:
"Inflation–adjusted financial statements are an extension to, not a departure from, historic cost accounting."
CIPPA was authorized in IFRS in the IASB's original Framework for the Preparation and Presentation of Financial Statements, Par. 104 (a) in 1989. In terms of the original Framework, (1989) Par 104 (a) accountants choose CIPPA to implement a financial capital concept of invested purchasing power, i.e. financial capital maintenance in units of constant purchasing power during low inflation and deflation instead of the traditional HC concept of invested money. They thus implement a Constant Purchasing Power financial capital maintenance concept by measuring financial capital maintenance in units of constant purchasing power instead of traditional HC nominal monetary units and they implement a Constant Purchasing Power profit/loss determination concept in units of constant purchasing power instead of in real value eroding nominal monetary units during low inflation. 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. They are valued in terms of International Financial Reporting Standards

International Financial Reporting Standards

International Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....

(IFRS) at for example fair value, market value, recoverable value, present value, net realizable value, etc. or Generally Accepted Accounting Principles

Generally Accepted Accounting Principles

Generally Accepted Accounting Principles refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards...

(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.

CIPPA automatically maintains the real value of all constant items constant in all entities that at least break even including banks´ and companies´ capital base, for an unlimited period of time (forever) – 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 constant items 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 during low inflation. CIPPA 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.

The Framework, Par. 104 (a) states:

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

It does not state "during hyperinflation." That is stated in IAS 29 Financial Reporting in Hyperinflationary Economies. The original Framework (1989), Par 104 (a) is thus applicable at all levels of inflation and deflation: i.e., during low inflation too.

Discredited 1970-style CPPA was a form of inflation accounting

Inflation accounting

Inflation accounting is a term describing a range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation. Inflation accounting is used in countries experiencing high inflation or hyperinflation...

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 CPI in an unsuccessful attempt to correct the real value eroding effect of the stable measuring unit assumption during high inflation (but not yet hyperinflation) in the 1970´s. CPPA is not the same as CIPPA. CIPPA is not inflation-accounting. Under successful CPPA 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 only during hyperinflation.

The CIPPA 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.

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 CPI, that is, valued or measured in units of constant purchasing power 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 monthly.

1970-style CPPA was a failed inflation accounting model

South African Institute of Chartered Accountants
South African Institute of Chartered Accountants
The South African Institute of Chartered Accountants , South Africa’s pre-eminent accountancy body, is widely recognized as one of the world’s accounting institutes....

: "Yes, this does have conceptual appeal and was experimented with in the UK and US in the 1970s, when inflation was high. Yet the markets brushed aside the inflation-adjusted figures because:

• "The capital markets are acutely aware of the extent of inflation and are perfectly capable of allowing for this in determining the value of shares; and

• "Businesses are affected by the specific price changes of the products with which they are dealing; changes that may bear little relationship to a general price index like the CPI.

"It therefore made little practical sense to introduce CPI-based adjustments. Indeed, when the CPI-based approach was included in supplementary accounts, business generally objected on the grounds that the adjusted numbers did not reflect the impact of specific inflation.

"Eventually, with inflation abating in the UK and US, and accountants engaging in increasingly technical dead-end debates, the use of CPI-adjusted numbers was abandoned.

"Self-evidently, inflation adjustments that apply accounting standard IAS 29 are essential in hyperinflationary environments, in which historic numbers are meaningless. Even then, the adjusted figures have little meaning, since by the time they see the light of day they are already out of touch with reality.

International Accounting Standard 29, Par. 6: "In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held, except to the extent that property, plant and equipment and investments may be revalued. Some entities, however, present financial statements that are based on a current cost approach that reflects the effects of changes in the specific prices of assets held."

The following quote from Geoffrey Whittington's book Inflation Accounting – An Introduction to the Debate, published in 1983, reflects the above position:

"Constant Purchasing Power Accounting (CPP) is a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the value of the currency. It attempts to deal with this problem by converting all of the currency unit measurement in accounts into units at a common date by means of the index."

CIPPA implements financial capital maintenance in units of constant purchasing power during low inflation and deflation.

The specific choice of measuring financial capital maintenance in units of CPP (the CIPPA model) during non-hyperinflationary periods as authorized in the original Framework (1989), was approved by the IASB’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.

"In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."

IAS8, 11:

“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

There is no applicable IFRS or Interpretations regarding the capital concept, the capital maintenance concept and the valuation of all constant real value non-monetary items. The original Framework (1989), Par 104 (a) is thus applicable.

CIPPA is not an inflation accounting model. IAS 29 is the inflation-accounting model defined in IFRS. CIPPA by measuring financial capital maintenance in units of CPP incorporates an alternative CPP capital concept, CPP financial capital maintenance concept and CPP profit determination concept to the HC capital concept, HC financial capital maintenance concept and HC profit determination concept. CIPPA only requires all constant items always and everywhere to be valued in units of CPP in terms of a Daily Index because there is no stable measuring unit assumption under this accounting model. Variable items are valued in terms of IFRS or GAAP. Historical variable items are updated in terms of a Daily Index as a result of the absence of the stable measuring unit assumption under CIPPA.

CIPPA is authorized by the IASB during low inflation

The statement "Financial capital

Financial capital

Financial capital can refer to money used by entrepreneurs and businesses to buy what they need to make their products or provide their services or to that sector of the economy based on its operation, i.e. retail, corporate, investment banking, etc....

maintenance can be measured in either nominal monetary units or units of constant purchasing power,"' in the IASB´s original Framework (1989), Par 104 (a), means that CIPPA has been authorized by the IASB since 1989 as an alternative to the traditional HCA model, i.e. during periods of low inflation and deflation. This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of CPP during low inflation and deflation since 1989. It also means that CIPPA and the updating of constant items to automatically maintain their real values constant in a low inflationary environment are 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

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 or monthly 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 CIPPA model as per the original Framework (1989) during low inflation 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 CIPPA 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 world wide currently choose the traditional.

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 CIPPA model and measure financial capital maintenance in units of constant purchasing power 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.

It is an inexplicable contradiction that net monetary gains and losses are required by the IASB to be calculated and accounted during hyperinflation but not during non-hyperinflationary periods, especially when the IASB approved alternative to HCA, namely CIPPA does require their calculation and accounting during low inflation.

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 capital maintenance in units of constant purchasing power 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:

Accrual basis: the effect of transactions and other events are recognized when they occur, not as cash is gained or paid.
Going concern
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...

: an entity will continue for the foreseeable future.
Stable measuring unit assumption: financial capital maintenance in nominal monetary units or traditional Historical cost accounting; i.e., accountants consider changes in the purchasing power of the functional currency up to but excluding 26% per annum for three years in a row (which would be 100% cumulative inflation over three years or hyperinflation as defined in IFRS) as immaterial or not sufficiently important for them to choose financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized in IFRS in the Framework (1989), Par 104 (a).

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 Constant Item Purchasing Power Accounting the underlying assumptions in IFRS are:

Accrual basis: the effect of transactions and other events are recognized when they occur, not as cash is gained or paid.
Going concern
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...

: an entity will continue for the foreseeable future.
Measurement in units of constant purchasing power of all constant real value non-monetary items automatically remedies the erosion caused by the stable measuring unit assumption (Historical Cost Accounting) of the real non-monetary values of all constant real value non-monetary items never maintained constant during low inflation. It is not inflation doing the eroding. It is the implementation of the stable measuring unit assumption during inflation. Only constant real value non-monetary items are updated during low inflation and deflation. All non-monetary items (variable real value non-monetary items and constant real value non-monetary items) are updated during hyperinflation as required in IAS 29 Financial Reporting in Hyperinflationary Economies.

CIPPA as per the IASB's Framework

Framework for the preparation and presentation of financial statements

- Concepts of Capital and Capital Maintenance

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 capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) in 1989.

- Concepts of capital

Par 102 A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.

Par 103 The selection of the appropriate concept of capital by an entity should be based on the needs of the users of its financial statements. Thus, a financial concept of capital should be adopted if the users of financial statements are primarily concerned with the maintenance of nominal invested capital or the purchasing power of invested capital. If, however, the main concern of users is with the operating capability of the entity, a physical concept of capital should be used. The concept chosen indicates the goal to be attained in determining profit, even though there may be some measurement difficulties in making the concept operational.

Concepts of capital maintenance and the determination of profit

Par 104 The concepts of capital give rise to the following concepts of capital maintenance:

- (a) Financial capital maintenance. Under this concept a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.
- (b) Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

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

(A) Physical capital. See paragraph 102.
(B) Nominal financial capital. See paragraph 104 (a).
(C) Constant purchasing power financial capital. See paragraph 104 (a). This capital concept is unique to IFRS. It is not authorized under US GAAP.

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

(1) Physical capital maintenance: optional during low inflation and deflation. Current Cost Accounting model prescribed by IFRS. See Par 106.
(2) Financial capital maintenance in nominal monetary units (Historical cost accounting): authorized by IFRS but not prescribed—optional during low inflation and deflation. See Par 104 (a) Historical cost accounting. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy
Fallacy
In logic and rhetoric, a fallacy is usually an incorrect argumentation in reasoning resulting in a misconception or presumption. By accident or design, fallacies may exploit emotional triggers in the listener or interlocutor , or take advantage of social relationships between people...

: it is impossible to maintain the real value of financial capital constant with measurement in nominal monetary units per se during inflation and deflation.
(3) Financial capital maintenance in units of constant purchasing power (Constant Item Purchasing Power Accounting – CIPPA): authorized by IFRS but not prescribed—optional during low inflation and deflation. See Par 104 (a). Prescribed in IAS 29 http://www.iasb.org/IFRSs/IFRs.htm during hyperinflation: Constant Purchasing Power Accounting – CPPA Only financial capital maintenance in units of constant purchasing power per se automatically maintains the real value of financial capital constant during inflation and deflation in all entities that at least break even—ceteris paribus—for an indefinite period of time. This happens whether these entities own revaluable fixed assets or not and without the requirement of more capital or additional retained profits to simply maintain the existing constant real value of existing shareholders´ equity constant.

Par 105 The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between an entity’s return on capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed income the residual amount is a loss.

Par 106 The physical capital maintenance concept requires the adoption of the current cost basis of measurement. The financial capital maintenance concept, however, does not require the use of a particular basis of measurement. Selection of the basis under this concept is dependent on the type of financial capital that the entity is seeking to maintain.

Par 107 The principal difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities of the entity. In general terms, an entity has maintained its capital if it has as much capital at the end of the period as it had at the beginning of the period. Any amount over and above that required to maintain the capital at the beginning of the period is profit.

Par 108 Under the concept of financial capital maintenance where capital is defined in terms of nominal monetary units, profit represents the increase in nominal money capital over the period. Thus, increases in the prices of assets held over the period, conventionally referred to as holding gains, are, conceptually, profits. They may not be recognised as such, however, until the assets are disposed of in an exchange transaction. When the concept of financial capital maintenance is defined in terms of constant purchasing power units, profit represents the increase in invested purchasing power over the period. Thus, only that part of the increase in the prices of assets that exceeds the increase in the general level of prices is regarded as profit. The rest of the increase is treated as a capital maintenance adjustment and, hence, as part of equity.

Par 109 Under the concept of physical capital maintenance when capital is defined in terms of the physical productive capacity, profit represents the increase in that capital over the period. All price changes affecting the assets and liabilities of the entity are viewed as changes in the measurement of the physical productive capacity of the entity; hence, they are treated as capital maintenance adjustments that are part of equity and not as profit.

Par 110 The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements. Different accounting models exhibit different degrees of relevance and reliability and, as in other areas, management must seek a balance between relevance and reliability. The Framework is applicable to a range of accounting models and provides guidance on preparing and presenting the financial statements constructed under the chosen model. At the present time, it is not the intention of the Board of IASC to prescribe a particular model other than in exceptional circumstances, such as for those entities reporting in the currency of a hyperinflationary economy. This intention will, however, be reviewed in the light of world developments.

The IASB Framework was approved by the IASC Board in April 1989 for publication in July 1989, and adopted by the IASB in April 2001.

CPPA is required by the IASB during hyperinflation

The IASB authorized the CIPPA model during low inflation in the original Framework (1989) as an alternative to the HCA model. The IASB, however, specifically requires the implementation of their inflation accounting model during hyperinflation as per IAS 29.

Internet resources

Irving Fisher (1911) The Purchasing Power of Money

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