IFRS Reporting in Hyperinflationary Economy (IAS 29)
It seems that these days everything changes and goes south as a consequence of a pandemic.
And yes, it seems yet another country is undergoing economic collapse, albeit perhaps not as a direct result of the pandemic.
This time, it is Lebanon – it is imploding fast.
Not only economic experts warn that the financial collapse is just around the corner, but some of my friends living there described their daily reality these days (I am writing this in late July 2021).
The economic data confirm the sad situation: Lebanese pound loses its value, Lebanese GDP has gone down by 40% and inflation went crazy hitting its high of 120% a year ago.
This has a painful effect on Lebanese people. The prices of food and gas went up and according to one survey I read, 3 out of 4 Lebanese families struggle to afford food (if they can even find it at stores).
Also, infrastructure seems to suffer, too – sometimes, power outages can last hours and hours. If you happen to be in Lebanon (or other hyperinflationary country), by the way, please leave us a comment below this article and let us know your view on the current situation.
Yet, what does the Lebanese government do?
They print more money, of course. But the Lebanon is not the only one trying to solve this economic misery by printing money. In fact, almost every single government does that and it starts to resemble a runaway freight train.
Therefore I suspect that the economic set up of this world will change in the near future and one of the possible outcomes is massive hyperinflation in some countries.
Sure, I am not a macroeconomic expert; I am just using my common sense and basic university knowledge.
However, one thing that we, the accountants, CFOs, auditors and other people around financial reporting should do, is to get ready and updated.
The thing is that hyperinflationary reporting is often omitted and we are quite oblivious about it because we perceive it as some distant, remote thing not affecting us.
But, as the world economy sinks further, I do believe it is time to get ready and refresh our memories.
That’s why today I pulled the standard IAS 29 Financial Reporting in Hyperinflationary Economies to the light.
Objective of IAS 29
The standard IAS 29 is quite an old standard, issued in 1989 for the first time with a few subsequent amendments.
The main objective of IAS 29 is to provide guidance on the financial reporting of the entity whose functional currency is the currency of hyperinflationary economy.
The reason is to show how much purchasing power the company lost on monetary items and gained on non-monetary items, simply speaking.
Albeit, I would NOT say that you “gain” purchasing power on non-monetary items in hyperinflation; rather you preserve it.
Functional currency, not location!
It is crucial to realize that the functional currency matters, not the country suffering from the hyperinflation.
What’s the difference?
Let me shortly illustrate:
There could be a company located in Argentina due to pleasant labor cost and yes, Argentina currently is a hyperinflationary economy.
But, the same company operates in USD that is its functional currency.
In this case, IAS 29 does not apply because it is tied to the functional currency, not the location, all right?
That company would simply prepare its financial statements without all the restatements to reflect hyperinflation, all in USD.
Now, I am not saying that USD will not be a hyperinflationary currency, who knows, but for now it is not.
What is hyperinflationary economy?
The standard IAS 29 does NOT define what the hyperinflationary economy is.
Also, IAS 29 does not provide the list of hyperinflationary countries, but IAS 29 contains certain characteristics of hyperinflationary economies as guidance.
The most exact indicator is that the cumulative inflation rate over 3 years of this country approaches to or exceeds 100%.
Currently, International Monetary Fund publishes the information about the inflation and its forecasts. According to the information updated at the end of 2020, there are 8 hyperinflationary countries including Argentina, Iran, Lebanon, South Sudan, Sudan, Syria, Venezuela and Zimbabwe.
How to report in hyperinflationary economy
The results reported in hyperinflationary currency are no longer useful for the readers of the financial statements, because current prices are changing crazy.
Just imagine you bought an asset for 1 000 CU (=currency unit) last year, the inflation rate reached 100% and as a result the same asset costs 2 000 CU at the end of this year.
Perhaps it is more relevant to state that asset in the amount of 2 000 CU rather that in its original cost of 1 000 CU, because it better reflects the company assets in terms of its purchasing power.
Therefore, the results should be reported in terms of measuring unit current at the end of the reporting period.
It means you actually need to restate the numbers in your financial statements to reflect hyperinflation.
The three basic steps are:
- Determine the general price index (GPI);
- Restate the financial statements at the end of the current reporting period using that GPI; and
- Restate the comparative information at the end of the previous reporting period.
Let’s break this down.
Step #1: Determine the general price index (GPI)
General price index (GPI) is a certain measure of the inflation.
In other words, it is a factor by which you would restate the historical information to reflect the change in the purchasing power.
In most cases, consumer price index (CPI) represents generally accepted measure of inflation, however it is crucial that selected CPI is representative of the hyperinflationary currency.
It practically means that different kinds of goods and services representative of that economy are included in its calculation. Usually, you can get it from the local institutions like national or central banks, statistical offices, or even IMF (International Monetary Fund) provides useful information about CPI in many different countries.
However, it can happen that a reliable CPI or GPI is simply not available.
In this case, you can impute the index by comparing the movement in the exchange rate between some solid currency (e.g. EUR…) and the hyperinflationary currency.
Step #2: Restate the financial statements at the end of the current reporting period
I will split this step into smaller portions to make it more digestible as it can go quite messy.
Step #2.1: Decide on monetary vs. non-monetary items
The first thing you do, after selecting your GPI, is to determine which assets and liabilities are monetary and which are non-monetary.
Leave out equity items for now; we will deal with these later.
Many items are straightforward:
- Monetary items are: cash, cash equivalents, loans, receivables, debt securities, payables, borrowings, taxes payable.
- Non-monetary items are: property, plant and equipment, intangible assets, biological assets, investment property, equity investments (e.g. ordinary shares), inventories, deferred income, some provisions, etc.
Some items are not that straightforward and we need to help ourselves with the definition of monetary items directly from IAS 29.12: “money held and items to be received or paid in money”.
You can find further guidance in IAS 21 and I recommend reading this article stating more details.
There will still be troubles. For example, deferred tax assets and liabilities are quite difficult to assess because there are arguments for stating they are either one, so just be aware it requires careful assessment and restatement here, especially when they are related to temporary differences of different nature.
Step #2.2: Restate assets and liabilities
The rules for restatement of assets and liabilities are:
- Monetary assets and liabilities: Do NOT restate at all, because they already reflect the purchasing power at the end of the reporting period.
The exception here are inflation-linked items like inflation linked-bonds that you need to adjust in line with terms of that instrument.
- Non-monetary items carried at current cost: Do NOT restate them at all. The current cost simply means the value reflecting the current purchasing power of these items at the end of the period. For example, items revalued at the year-end to the fair value are at their current cost.
- Non-monetary items carried at historical cost: Restate them using the formula below.
Please be careful with the distinction of non-monetary items at current cost vs. at historical cost.
To illustrate: let’s say you apply revaluation model for your property, plant and equipment and you revalued your assets few months ago to the fair value.
At the end of the reporting period, they are no longer expressed at fair value, because some time has passed since recent revaluation and yes, inflation might have eaten some portion of the purchasing power, thus you need to restate them as if they were at historical cost.
If you revalued your PPE at the year-end, that’s fine.
Let me add one small note to the application of that GPI formula above.
It is quite challenging to apply because you need to get a good track on acquisition dates and then applicable GPIs.
Also, there might be certain specific calculations and adjustments to the borrowing cost, impairment and other items.
So, the restatement is not simply a mathematical recalculation in the current period. I will try to publish numerical example in the near future.
Step #2.3: Restate equity items
Here it goes a bit tricky again, because you actually need to determine WHEN you are making a restatement:
- Equity components at the beginning of the first period when IAS 29 is applied:
- Revaluation surplus: eliminate that completely;
- Retained earnings: derive from all the other amounts in the restated statement of financial position. In other words, this will be your balancing figure;
- Other equity components: restate by the application of GPI from the dates of contribution or other acquisition whatever way that component of equity was created.
- Equity components at the end of the first period when IAS is applied AND subsequently: restate by the application of GPI from the beginning of the period or from the date of contribution if the component arose during the year.
Step #2.4: Restate profit or loss and other comprehensive income
The rule is very simple here: restate all the amounts by applying the general price index from the transaction date.
The formula to use:
A few notes:
- Use of GPI fraction:
Let me draw your attention to the GPI – it is expressed as a fraction because you would have GPI for certain period that might not be the same as the period passed between the transaction date and the year-end.
This fraction expresses just that and some literature and practice call it the conversion factor.
It might be quite a challenge to gather GPI’s for every single day, but you can use approximation, for example some average weekly GPI if it is appropriate.
However, if inflation soars out of the roof and the prices change like crazy, that would NOT be appropriate to use, so you need to use your judgment.
- Different restatement of some items:
Also, some items are calculated in a different way.
For example, deferred tax is derived from the changes in the temporary differences.
- Gain or loss on the net monetary position:
You will have that as a separate line item in your profit or loss.
This is the number that expresses how much purchasing power you lost to inflation during the period on your monetary assets (if they are greater than non-monetary assets) or how much you gained if the situation is the opposite.
It is calculated as a change in GPI applied to the weighted average of a difference between your monetary assets and monetary liabilities.
It is extremely impractical to calculate that way and therefore in practice, it is assumed that gain or loss on the net monetary position is simply the opposite of the gain or loss on non-monetary items – which is the sum of your restatement adjustments, very simply said.
Well, that takes practical exercise to verify though and it is playing with numbers and calculations a lot.
Step #2.5: Restate cash flows
The standard IAS 29 does not say much about the restatement of cash flows, but it does require that all items should be expressed in the measuring unit that is current at the end of the reporting period.
It practically means that you need to restate all the amounts, similarly as with profit or loss and other comprehensive income.
Many practical issues and dilemmas may arise here and it requires lots of judgment, too.
Step #3: Restate the financial statements at the end of the previous reporting period (comparatives)
Again, the same principle applies: all items should be expressed in the measuring unit that is current at the end of the reporting period.
In this case, you would simply apply GPI to all comparative numbers.
This time it will be much easier than with statement of cash flows and profit or loss, because you just take GPI and apply it to all the numbers by simple mathematical calculation.
The reason is that all items were there at the beginning of the period and none of them arose during the year, so no fraction is necessary to use.
You can watch the video summing this all up here:
Please if you wish to share any of your experiences with hyperinflation and its reporting, feel free to add comment below. Thank you!
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