The Bottom Line / What's Two Plus Two?

When hyperinflation burst onto the Israeli scene in 1979, companies' financial reports lost all significance, because equating a shekel at the beginning of the year with a shekel at year's end was like plowing a field with a horse and donkey - it just doesn't work. Companies presented reports with shining profits, but this was all due to inflation, not real profits at all. This was nowhere more evident than in the banks' balance sheets, which showed massive profits in the early 1980s. Yet after careful checking, it turns out that the banks were actually making losses and eating up their own equity.

In order to cope with this problem, a new accounting system was invented that does not exist in any other country in the world: Company accounts are adjusted to take inflation into account. This system, which was meant to discount the effects of hyperinlfation on financial results, was implemented in 1985. But in July 1985, the plan for putting the brakes on hyperinflation was introduced, and annual inflation dropped to just 18 percent. For the past three years, we have been living in a regime of only 1 to 3 percent inflation.

So logic dictates that if the economy has returned to accepted norms, so too should company reports revert to the accounting standards used throughout the world: the nominal standard report. Then we will be able to compare financial results in Israel against those abroad, and then it will be easier to raise capital overseas - because as it stands today, not a single analyst anywhere can understand an Israeli accounting report.

Among those supporting a return to the nominal standard are the head of the Association of Certified Public Accountants, Ofer Menirav, the head of the Securities Authority, Miri Katz, and the chair of the committee on accounting standards, Professor Eli Amir. In the opposing corner stands the director of the Government Companies Authority, Yaron Jakobs, who opposes the change on behalf of those state-owned enterprises that will suffer the consequences. There are also accountants who prefer the status quo, because they have their computer software all set up nicely, and they cannot be bothered to make the changeover.

There are other accountants who oppose the switch back to nominal accounting because they claim that even with low inflation rates, the adjusted reports are more accurate. But their claim is wrong, because the adjusted reports contain many distortions (such as linking all assets to the CPI and not to more specific indices), so that with low inflation of 1 to 3 percent, nominal accounts (which also have distortions) are less misleading than the adjusted standard.

Which leaves us with just the one question. Have we finally reached the stability of western inflation levels? The answer is yes. Because inflation is in someone's control. Inflation could hit the skies again if the budget deficit is increased willy-nilly and monetary policy is loosened - but this lethal combination could not happen here. So Menirav should get his act together, reject all the pressures on him and withdraw his letter calling for a delay in the switch back to nominalism. And to improve the situation and prevent pressures in the future, the change should be implemented immediately - that is, from January 2002.