IAS 29 requires financial statements that are prepared in the currency of a hyper-inflationary economy to be stated in terms of the purchasing power at the end of the reporting period. This provides useful information about an entity’s financial position, performance and changes in financial position to a wide range of users in order to make economic decisions.
This is because money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, are likely to be misleading.
Prices change over time as the result of political, economic and social factors. Two phenomena should be distinguished:
(1) changes in supply and demand and technological changes that might cause prices of individual items to increase or decrease independently of each other (‘specific price changes’); and
(2) other factors in the economy that might result in changes in the general level of prices and therefore in the general purchasing power of money (‘general price changes’).
The purchasing power of money declines as the level of prices of goods and services rises. The purchasing power of money in an inflationary environment and the price level are interdependent.
The historical cost measurement and hyper-inflation Inflation-adjusted financial statements are an extension to, and not a departure from, historical cost accounting. IAS 29 aims to overcome the limitations of historical cost financial reporting in hyper-inflationary environments, but it does not reflect specific price changes in assets and liabilities.
Usefulness of inflation accounting Financial statements that are expressed under IAS 29 in a measuring unit that is current at the balance sheet date provide several benefits for users:
They provide management, shareholders and other users with comparable information from period to period, relating to the underlying results of operations, capital maintenance and trends in performance.
They enable management to make more reliable decisions on capital expenditure plans, because the financial statements are more relevant.
Financial statements become comparable with other companies in the same industry, disregarding location.
The IAS 29 approach is to restate all balances recognised in the financial statements (including comparatives) to the year-end general purchasing power of the functional currency. The impact of the IAS 29 restatement on the financial statements will depend on the magnitude of inflation and the composition of the entity’s assets and liabilities.
The restatement process requires the application of judgement as well as certain required procedures. Consistency is more important than the precise accuracy of the resulting amounts included in the restated financial statements.
IAS 29 is applied to the financial statements, including the consolidated financial statements, of any entity whose functional currency is the currency of a hyper-inflationary economy.
IAS 29 applies to an entity’s financial statements from the beginning of the reporting period in which it identifies the existence of hyper-inflation in the country of its functional currency. Reporting entities in the same country preferably should start applying IAS 29 at the same time, in order to achieve comparability.
There is no absolute rate at which hyper-inflation is deemed to arise. It is a matter of judgement when restatement of financial statements in accordance with IAS 29 becomes necessary. Hyper-inflation is indicated by characteristics of the economic environment of a country which include, but are not limited to, the following:
Characteristics of a hyper-inflationary economy A cumulative three-year inflation rate exceeding 100% is a strong indicator of hyper-inflation, but the qualitative factors should also be considered.
The factors have to be carefully weighed, because it is not desirable to move into and out of hyper-inflationary reporting within a short period. Other characteristics that are not mentioned, but that can be useful in determining the presence of hyper-inflation, include:
- Severe exchange controls to protect the local currency.
- Frequent central bank intervention in the currency.
It is useful (but not required) to disclose the three-year cumulative inflation at the balance sheet date for each period presented in the financial statements.
High inflation economies Question
Can a country whose economy has a cumulative inflation rate over three years of 70% apply IAS 29?
Background
In country X, under the local accounting principles and for tax purposes, when the accumulated inflation over a year is more than 20%, companies are required to apply inflation accounting, independently of whether the characteristics of hyper-inflation are present.
Because the cumulative inflation over the last three years was, say, 70%, management wants to apply IAS 29 accounting for IFRS purposes, to avoid having two sets of financial statements that are substantially different.
Answer
No. When a company of a high inflation economy applies IAS 29 accounting, its financial statements do not comply with IFRS. IAS 29 should only be applied to financial statements when the currency of its economy meets the definition of hyper-inflationary.
To identify whether a country has hyper-inflation, IAS 29 requires an assessment of certain indicators, including the 100% inflation threshold in three years. The 100% inflation threshold is a strong indicator even if there might be qualitative factors to be considered.