Inflation Accounting Update (IAS29/ASC 830) for entities using Argentina, South Sudan, Sudan, Venezuela and Zimbabwe functional currencies
One of the factors behind inflation is the increase of the general price level. Economists use Consumer Price Index (CPI) variances to assess and control this normal economic reality (deflation occurs when the general price level decreases).
However, certain countries may become « hyperinflationary » when their domestic currencies lose Their value due to an explosive and uncontrollable inflation. This phenomenon may reach such a magnitude than a local currency may become unusable. An increase in Money Supply and an uncontrollable exchange rate are generally the root cause of this situation.
On a macroeconomic point of view, Philip CAGAN defined the limit between inflation and hyperinflation when the monthly inflation rate reaches 50% on a monthly basis (« The Monetary Dynamics of Hyperinflation » in Milton Freedman, ed (1956), Studies in the Quality Theory of Money, Chicago, University of CHICAGO Press, P.25-117).
However, this definition is different from the IASB (International Accounting Standards Board, the organism responsible for monitoring International Financial Reporting Standards (IFRS) issued by IFRS Foundation) and the FASB one (Financial Accounting Standards Board, the entity responsible for monitoring US GAAP through FAS (Financial Accounting Standards) and ASC (Accounting Standard Code)). In fact, per IAS 29.3 and ASC 830.10.55, one of the major causes making an Economy highly inflationary is a three-year cumulative inflation rate over 100%. Since this article has been prepared for Finance/Accounting staff not for economists, we’ll focus on that definition and underline more how entities under IFRS may apply IAS 29 for the first time.
Some of the issues raised by that definition deal with identifying “when” an economy becomes hyperinflationary and “when” it ceases to be so.
One of the index used in practice to identify when an economy becomes highly inflationary is the Consumer Price Index (CPI). In fact, based on IAS 29.37, all entities of an economy should use the same index when it comes to restate their financial statements. Host Authorities are responsible for communicating which general price index should be used and for releasing regularly such one to facilitate the tough and time-consuming job triggered by IAS 29 or ASC 830 application. For instance, since CPI calculation as a national index for Argentina is not consistent for some periods, entities used a Wholesale Price Index (WPI) provided by host Authorities which is more reliable.
Hyperinflationary Economies for entities under US GAAP are monitored by IPTF (International Practical Task Force), a SEC Central of Audit Quality (Thecaq) institution. Their report updated twice a year (in May and November) and based on the International Monetary Fund (IMF) World Economic Outlook (WOE) report provides guidance on actual and future highly inflationary countries. Since IASB doesn’t monitor High Inflationary Economies, IPTF conclusions may also apply for entities under IFRS. Based on that report, the following countries are considered as hyperinflationary:
Argentina, South Sudan, Sudan and Venezuela and Zimbambwe.
The Democratic Republic of Congo is no more on the list as advised in their previous report due to some monetary data revisions by IMF since its cumulative three-year inflation rate is now between 70% and 100% and is expected to decrease by 2024. Zimbabwe has been added for the same grounds.
Iran (but no more Yemen and Zimbabwe) is expected to become hyperinflationary in 2019.
The latest IPTF report is available here. If you would like to deepen the analysis and know what looks like the three-year inflation rate by 2024 in your country based on IMF projections, you may order the entire template here ; unless you live in countries like Syria, Qatar or Bhoutan since their data are not available.
On the other hand, since the WEO report is updated only twice a year (in April and October), we’ll get actual data related to 2019 only After April 2020.
Once an economy is identified as hyperinflationary and a general price index is formally defined, the next step consists to restate Balance sheets, Income Statements, cash flows and comparative figures.
Restating Balance sheets involves reviewing statements changes in equity, Assets and Liabilities. Non-Monetary items should be differentiated from Monetary items for Assets and liabilities. Monetary items are defined as “units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency” (IAS 29.8). For instance, Cash and Cash equivalents, Debt securities, loans, Trade and other receivables are considered as monetary assets since they’re expected to be paid in a fixed number of units of the functional currency and are not supposed to be restated. Likewise, Trade and Other payables, Borrowings and Tax Payable are considered as monetary liabilities.
However, non-monetary items need to be restated since their historical costs are no longer valuable. Hence, Property, Plant and Equipment (PPE), Intangible assets, Inventories, WIP, Prepaid costs and investment properties are categorized as non-monetary assets. However, Provisions and deferred tax may be monetary and non-monetary items.
When it comes to restate PPE for instance, each asset (except those ones held under the fair value accounting policy) should be revalued by multiplying its historical acquisition cost by the General Price Index (by the time the process is implemented) divided by the General Price Index by the time it was acquired. You may find a template illustrating how to process here. At the end of the day, you may imagine the monumental work necessary to restate the financial position of an entity made up thousands of fixed assets… Even though an average factor is used in practice, this process remains time-consuming.
Similar logic is applied at the end of the reporting period to other non-monetary assets and liabilities, equity items (except revaluations), all statement of profit and loss and other comprehensive income items, and; most of the statement of cash flows items.
Subsidiaries using functional currencies of hyperinflationary economies with parent entities using other currencies have to restate their financial statements first before translating them under IAS 21 (The Effects of Changes in Foreign Exchange Rates)
At the end of the day, entities on the verge to apply IAS 29 or ACS 830 are recommended to look for an accounting firm assistance.