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: 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 Capital Maintenance in Units of Constant Purchasing Power 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: 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 at all levels of inflation and deflation. It is not low inflation, high inflation or hyperinflation doing the eroding. It is the implementation of the stable measuring unit assumption during low inflation, high inflation and hyperinflation. Constant real value non-monetary items are measured in units of constant purchasing power at in terms of a daily rate all levels of inflation and deflation. Monetary items are inflation-adjusted daily. Net monetary losses and gains are calculated when monetary items are not inflation-adjusted daily in terms of a daily rate. Variable items are measured in terms of IFRS and then updated daily in terms of a daily rate. All non-monetary items (variable real value non-monetary items 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 monthly published CPI during hyperinflation as required in IAS 29 Financial Reporting in Hyperinflationary Economies.
Read more about this topic: Constant Purchasing Power Accounting
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