Nicolaas Smith Comment Letter: IASB Exposure Draft: Management Commentary
Submitter
Organization
Date
Nicolaas Smith
Real Value Accounting
25th February, 2010
Ms Amy Schmidt
Project Manager: Management Commentary
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
United Kingdom
Attempted submission Via “Open to comment” page on www.iasb.org
Dear Ms Schmidt
Request for comment on IASB Exposure Draft: Manangement Commentry
Thank you for the opportunity to comment on the IASB Exposure Draft: Manangement
Commentry.
In my opinion the Board should develop an IFRS for the preparation and presentation of
management commentary to make it binding.
I suggest changes in the content elements related to the analysis of the adequacy of the
entity’s capital structure requiring details about real value unnecessarily being destroyed
because of the implementation of the stable measuring unit assumption; real value to be
gained by its rejection; related to plans to address this inadequacy and useful disclosure
regarding the entity’s justification for choosing financial capital maintenance in nominal
monetary units instead of in units of constant purchasing power during low inflation and
deflation as authorized by the IASB.
I do not agree with the Board’s decision not to include detailed application guidance and
illustrative examples in the final management commentary document. I suggest specific
guidance regarding management’s obligation to supply details about real value
unnecessarily destroyed as a result of their implementation of financial capital
maintenance in nominal monetary units and real value to be gained when they change over
to financial capital maintenance in units of constant purchasing power during low inflation.
My detailed answers to the questions in the Exposure Draft and my suggestions are
contained in the attached appendix.
If you have any questions regarding this submission, please do not hesitate to contact me at
realvalueaccounting@yahoo.com
Yours sincerely
Nicolaas Smith
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Nicolaas Smith Comment Letter: IASB Exposure Draft: Management Commentary
Appendix – Response to the questions asked in the Exposure Draft: Management Commentary
Status of the Final Work Product
Question 1
Do you agree with the Board’s decision to develop a guidance document for the
preparation and presentation of management commentary instead of an IFRS?
If not, why?
No, I do not agree. It should be an IFRS to make it binding. Optional implementation has in
the past meant “Keep the status quo” as far as IFRS are concerned. Financial capital
maintenance in units of constant purchasing power is a good example: The IASB approved
financial capital maintenance in units of constant purchasing power during low inflation
and deflation in the Framework, Par 104 (a) twenty one years ago. Its implementation would
stop the unnecessary destruction of hundreds of billions of Euros (probably much more) per
annum in the world economy in the real value of entities´ capital and profits never
maintained constant during low inflation. Its implementation would mean automatically
maintaining instead of destroying hundreds of billions of Euros (probably much more) per
annum in the real value of entities´ capital and profits in entities that at least break even
whether they own revaluable fixed assets or not - without extra money or additional retained
profits required to maintain existing capital - in the world economy during low inflation.
No-one chooses it during low inflation or deflation because it is not a binding IFRS: it is an
option. It is nullified as our Taiwanese friends so eloquently state. I would also point to the
waste of IASB resources in producing a document simply to be nullified by making it
optional as in the case of financial capital maintenance in units of constant purchasing
power during low inflation and deflation over the last 21 years.
Content elements of a decision-useful management commentary
Question 2
Do you agree that the content elements described in paragraphs 24–39 are
necessary for the preparation of a decision-useful management commentary?
If not, how should those content elements be changed to provide decision-useful
information to users of financial reports?
Yes, I agree, but, I suggest that the following (in italics) should be added to paragraphs 29
and 30:
Paragraph 29
Disclosure about resources depends on the nature of the entity and the
industry in which the entity operates. Management commentary should
set out the critical financial and non-financial resources available to the
entity and how those resources are used in meeting management’s stated
objectives for the entity. Analysis of the adequacy of the entity’s capital
structure,
“with reference to the concept of capital maintenance: in particular
(1) supplying details of the real value destroyed in shareholders´ equity never maintained
constant in real value as a result of insufficient revaluable fixed assets under Historical Cost
Accounting when the entity has chosen financial capital maintenance in nominal monetary
units as authorized by the IASB in the Framework, Par 104 (a) and
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Nicolaas Smith Comment Letter: IASB Exposure Draft: Management Commentary
(2) supplying details of the gain to the entity if it should choose continuous financial capital
maintenance in units of constant purchasing power during low inflation and deflation also
authorized by the IASB in the Framework, Par 104 (a). ”
“Analysis of” financial arrangements (whether or not recognised in the
statement of financial position), liquidity and cash flows, as well as plans
to address any identified inadequacies “- specifically the identified inadequacy of financial
capital maintenance in nominal monetary units per se to maintain the real value of
shareholders´ equity and other constant items constant during inflation and deflation taking
into account the fact that its remedy, namely, continuous financial capital maintenance in
units of constant purchasing power during low inflation and deflation has been authorized
by the IASB 21 years ago” - or surplus resources, are examples of disclosures that can
provide useful information.
Paragraph 33
Management commentary should include a clear description of the
entity’s financial and non-financial performance, the extent to which
that performance may be indicative of future performance and
management’s assessment of the entity’s prospects. Useful disclosure in
that area can help users to make their own assessments about the
assumptions and judgements used by management in preparing the
financial statements “specifically management’s justification in entities implementing the
HCA model for their choice to measure financial capital maintenance in nominal monetary
units during low inflation and deflation instead of in units of constant purchasing power in
terms of the IASB´s Framework, Par 104 (a).”
Application guidance and illustrative examples
Question 3
Do you agree with the Board’s decision not to include detailed application
guidance and illustrative examples in the final management commentary
guidance document? If not, what specific guidance would you include and why?
No, I do not agree. The Board should include detailed application guidance to cover the
items detailed in paragraphs 24-39 in the Exposure Draft as to be amended as suggested
above and specifically include the following:
Management have to:
(1) state in the Management Commentary that their choice of the traditional Historical Cost
basis which includes the stable measuring unit assumption, destroys the real value of
constant real value non-monetary items never maintained, at a rate equal to the annual
rate of inflation;
(2) state that this includes the destruction of the real value of Shareholders´ Equity when
the entity does not have sufficient fixed assets that are or can be revalued via the
Revaluation Reserve equal to the updated original real value of all contributions to
Shareholders’ Equity under the HC basis;
(3) state the percentage and amount of Shareholders´ Equity that are not being maintained;
i.e., the percentage and amount of Shareholders´ Equity that are subject to real value
destruction at a rate equal to the annual inflation rate because of management’s choice,
in terms of the Framework, Par 104 (a), to maintain financial capital maintenance in
nominal monetary units instead of in units of constant purchasing power – both
practices being compliant with IFRS;
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Nicolaas Smith Comment Letter: IASB Exposure Draft: Management Commentary
(4) state the amount of real value destroyed during the last and previous financial years in
Shareholders´ Equity and all other constant items never maintained because of
management’s choice to implement the Historical Cost Accounting model;
(5) state the updated total amount of real value destroyed from the entity’s inception to date
in this manner in at least Shareholders´ Equity never maintained as described above;
(6) state the change in the updated real value of Shareholders´ Equity if management
should decide – as they are freely allowed to do at any time - to measure financial capital
maintenance in units of constant purchasing power instead of in nominal monetary
units as authorized by the IASB in the Framework, Par 104 (a);
(7) state management’s estimate of the amount of real value to be destroyed by their
implementation of the stable measuring unit assumption during the following
accounting year under the HC basis;
(8) state that the real value calculated in (7) represents the amount of real value the entity
would gain during the following accounting year and every year there after for an
unlimited period of time – ceteris paribus – when management choose to measure
financial capital maintenance in units of constant purchasing power – which is
compliant with IFRS – as authorized by the IASB in the Framework, Par 104 (a) in
1989 which they are free to choose any time they decide;
(9) state management’s reason(s) for choosing financial capital maintenance in nominal
monetary units instead of in units of constant purchasing power in terms of the IASB´s
Framework, Par 104 (a).
Rationale for my answers and suggestions above:
It is relevant information for existing and potential capital providers that the real value of
the capital they provided - or are about to provide - to an entity as well as their share of
other items in shareholders´ equity, e.g. retained profits which are possible dividends to
them, are unnecessarily being destroyed - or would unnecessarily, be destroyed - at a rate
equal to the annual rate of inflation as a result of the implementation of the Historical Cost
Accounting model during low inflation for the portion of the real value of shareholders´
equity which is not maintained constant as a result of insufficient revaluable fixed assets
under HCA.
It is equally relevant information for existing and potential capital providers that
continuous financial capital maintenance in units of constant purchasing power which has
also been authorized by the IASB 21 years ago in the Framework, Par 104 (a) would
maintain the real value of shareholders´ equity and all other constant real value nonmonetary items constant at all levels of inflation and deflation for an unlimited period of
time in all entities that at least break even – ceteris paribus - irrespective of whether an
entity owns revaluable fixed assets or not. This would happen automatically as a result of a
correct IASB-authorized basic accounting model approved in 1989 at all levels of inflation
and deflation without requiring more money from capital providers for additional capital
contributions or additional retained profits to simply maintain existing equity’s existing
real value.
The Framework, Par 104 (a) states:
“Financial capital maintenance can be measured in either nominal monetary units or units
of constant purchasing power.”
Constant items are one of the three fundamentally different basic economic items in the
economy. The other two are monetary items and variable real value non-monetary items.
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Variable items are non-monetary items with variable real values over time. Examples are
property, plant, equipment, inventory, finished goods, foreign exchange, etc. Constant items
are non-monetary items with constant real values over time. Examples are all items in the
income statement, all items in shareholders´ equity, trade debtors, trade creditors, taxes
payable, taxes receivable, provisions, all non-monetary payables, all non-monetary
receivables, etc. Constant items have to be continuously valued in units of constant
purchasing power in order to maintain their real values constant during inflation and
deflation.
The generally accepted view under the HC paradigm that economic items consist of only
monetary and non-monetary items avoids the proper split of non-monetary items in
variable and constant items because of the implementation of the stable measuring unit
assumption. This results in variable items valued at HC (e.g. fixed assets, inventory, etc.)
and constant items currently also valued at HC (e.g. shareholders´ equity and most items in
the income statement – excluding salaries, wages, rentals and other items normally
inflation-adjusted) being classified as simply non-monetary items under HCA.
The real value of shareholders´ equity currently being valued at HC is only 100%
maintained constant in the rare cases where 100% of the updated original real values
of all contributions to shareholders´ equity are invested in revaluable fixed assets. It
is hardly ever the case that even 100% of the updated original real values of all
contributions to shareholders´ equity excluding retained profits are invested in revaluable
fixed assets. Retained profits in most entities are thus treated the same as monetary items
(cash) and their real values are being destroyed at a rate equal to the annual rate of
inflation when financial capital maintenance is measured in nominal monetary units in low
inflationary economies.
The stable measuring unit assumption is based on the fallacy that changes in the
purchasing power of money are not sufficiently important for entities to choose to
continuously measure financial capital maintenance in units of constant purchasing power
during low inflation and deflation as authorized by the IASB in the Framework, Par 104(a).
Hyperinflation is defined by the IASB as 100% cumulative inflation over three years, i.e.
26% annual inflation for 3 years in a row. Financial capital maintenance in units of
constant purchasing power is required by the IASB in IAS 29 during hyperinflation: it is
thus required at 26% annual inflation for 3 years in a row. It is, however, left as an option
at 20% or 15% or 6% or 2% for three years in a row or any number of years. Real value
destruction in constant items never maintained constant by the implementation of the
stable measuring unit assumption at continuous 20% inflation (which would wipe out 100%
of the real value of shareholders´ equity never maintained constant in 4 years) is currently
considered as not sufficiently important for the implementation of continuous financial
capital maintenance in units of constant purchasing power. Financial capital maintenance
in nominal monetary units per se currently unknowingly, unnecessarily and
unintentionally destroy 51% of the real value of shareholders´ equity and all other constant
items never maintained constant over 35 years in all economies with continuous 2% annual
inflation.
Financial capital maintenance in nominal monetary units per se as authorized by the IASB
in the Framework, Par 104 (a) is a fallacy during low inflation and deflation. IFRS should
not be based on fallacies as they currently are. It is impossible to maintain the real value of
entities´ capital and profits constant with financial capital maintenance in nominal
monetary units per se during inflation and deflation. The only way to maintain the real
value of capital and profits constant for an unlimited period of time in entities that at least
break even during low inflation and deflation – all else being equal - is with continuous
financial capital maintenance in units of constant purchasing power per se irrespective of
whether those entities own fixed assets or not. There is no other way.
“The erosion of business profits and invested capital caused by inflation” is generally
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Nicolaas Smith Comment Letter: IASB Exposure Draft: Management Commentary
accepted.
“In Mr. Mosso's view, conventional accounting measurements fail to capture the erosion of
business profits and invested capital caused by inflation.” FAS 33, 1979, P 24
(superseded by FAS 89)
There is absolutely no doubt in the accounting profession that real value is being destroyed
in entities´ capital and profits and there is equally absolutely no doubt in the accounting
profession that it is caused by inflation. In fact, “the erosion of business profits and invested
capital caused by inflation” is a fallacy. Inflation is always and everywhere a monetary
phenomenon as per the late American Nobel Laureate Milton Friedman. Inflation destroys
the real value of money and other monetary items – nothing else. Inflation has no effect on
the real value of non-monetary items. It is impossible for inflation per se to destroy the real
value of non-monetary items.
“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.
http://www.mufad.org/index2.php?option=com_docman&task=doc_view&gid=9&Itemid=1
00
It is not inflation doing the destroying: it is unnecessary, unknowing and unintentional
destruction by the implementation of the stable measuring unit assumption under financial
capital maintenance in nominal monetary units (the HCA model) during low inflation - as
authorized by the IASB in the Framework, Par 104 (a) - of the real value of constant items
never maintained constant amounting to hundreds of billions of Euros (probably much
more) in the world economy each and every year. It is relatively easy for individual entities
to calculate the amount of real value unnecessarily, unknowingly and unintentionally being
destroyed as indicated above during the current year in low inflationary economies. That
would give an estimate of the annual value to be gained from changing over to continuous
financial capital maintenance in units of constant purchasing power as authorized by the
IASB twenty one years ago. Basically it is Retained Earnings times the average rate of
annual inflation in most entities.
The real values of all constant items, e.g. shareholders´ equity, will knowingly be
maintained constant for an unlimited period of time in all entities that at least break even
with continuous financial capital maintenance in units of constant purchasing power –
ceteris paribus – amounting to hundreds of billions of Euros (probably much more) in the
world economy each and every year, no matter what the rate of inflation without requiring
more money for additional capital or additional retained profits to maintain the existing
real values of existing constant items constant - whether entities own revaluable fixed
assets or not. It is simply a matter of maintaining existing real value as indicated above
instead of currently unnecessarily, unknowingly and unintentionally destroying existing
real value.
Continuous financial capital maintenance in units of constant purchasing power only
results in zero destruction of real value in constant items for an unlimited period of time at
any level of inflation or deflation in entities that at least break even – ceteris paribus. It
has no direct effect on the rate of inflation or deflation.
The removal of the 5 words “either nominal monetary units or” from the IASB Framework,
Par 104 (a) would make this comment letter and appendix superfluous.
No other issues noted.
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