Chapter 3: Application of IAS 29

IAS 29 requires management to restate the financial statements, including the cash flow statements, into the current purchasing power at the end of the reporting period. This requires a number of steps, and the application of judgement. The consistent application of the procedures is more important than the precise accuracy of the results.

The restatement procedures are discussed in the sections that follow, and can be summarised as follows:

• Selection of a general price index.
• Segregation of monetary and non-monetary items.
• Restatement of non-monetary items (excluding shareholders’ equity).
• Restatement of shareholders’ equity.
• Restatement of comprehensive income.
• Calculation and proof of the monetary gain or loss.
• Statement of cash flows.
• Group reporting.

Selection of a general price index

IAS 29 requires the use of a general price index to reflect changes in purchasing power. Most governments issue periodic price indices that vary in their scope, but all entities that report in the currency of the same economy should use the same index.

Selection of a general price index The consumer price index is the most reliable indicator of changes in general price levels, and it is normally closest to the concept of the general price index required by IAS 29. This is because it is at the end of the supply chain and it reflects the impact of prices on the general population’s consumption basket. Some important features of a reliable general price index are: A wide range of reference, such as inclusion of most of the goods and services produced in the economy, in order to reflect varying price fluctuations. An accurate reflection of price changes. The availability of prior year indices, as well as those of the current year. Regular (preferably monthly) updating. Consistency, uniformity and continuity.

Application of the conversion factor Conversion factors are calculated, based on the increase in the general price index, to restate historical cost amounts to current purchasing power. For example, an entity is restating for the first time the items of property, plant and equipment in 20X2. An item of property, plant and equipment was purchased in December 20X0 at a price of C200 million. The general price indices as at 10 December 20X0 and 20X2 are given below: General price index Conversion factor 10 December 20X0 54.224 4.114 (223.100 ÷ 54.224) 10 December 20X2 223.100 1.000 (223.100 ÷ 223.100) The restated fixed asset cost at 10 December 20X2, determined using the conversion factors below, is C200m × 4.114 = C822.8m.

Segregation of monetary and non-monetary items

Management should restate all balance sheet amounts that are not expressed in terms of the measuring unit current at the balance sheet date. Monetary items do not need to be restated, because they represent money held, to be received or to be paid. Monetary items are therefore already expressed in current purchasing power at the reporting date.

Segregation into monetary and nonmonetary items All balance sheet items should be segregated into monetary and non-monetary items. Monetary items are units of currency held, and assets and liabilities to be received or paid, in fixed or determinable number of units of currency, as discussed in IAS 21. Most balance sheet items are obviously monetary or non-monetary. In less straightforward cases, the determination as to whether a component is monetary depends on its underlying characteristics. For example, the provision for doubtful receivables is considered monetary, because receivables are monetary. The provision for inventory obsolescence is non-monetary, because inventory is non-monetary. Examples of monetary items are: Monetary assets Monetary liabilities Cash and amounts due from banks Trade payables Marketable debt securities Accrued expenses and other payables Trade receivables and provision for doubtful receivables Current income taxes and withholding taxes payable Notes receivables and other receivables Borrowings and notes payable Contract assets (except those that provide a right to a non-monetary asset) (IFRS 15) Lease liabilities Pensions and other employee benefits to be paid in cash Liabilities recognised for puttable equity instruments Refund liabilities (IFRS 15) Examples of non-monetary items are: Non-monetary assets Non-monetary liabilities Pre-paid expenses Deferred income (For example, government grants)   Inventories and provision for inventory obsolescence Shareholders’ equity Marketable equity securities Contract liabilities (IFRS 15) Investments in associates Property, plant and equipment Right-of-use assets (IFRS 16) Intangible assets

Construction work in progress Question An entity has significant amounts of construction work in progress. What indices should it use to restate the construction work in progress? How does the restatement of construction work in progress affect the future value of items of property, plant and equipment? Answer Construction work in progress is restated from the date on which the payment was made. An asset or project within construction work in progress is restated within construction work in progress. The related inflation adjustment should be added to the cost base of the item of property, plant and equipment when the asset is transferred to assets in use.

Impact of inventory cost method used Question Does the cost formula for inventory (For example, FIFO or weighted average) affect the restatement in accordance with IAS 29? Answer The cost formula for inventory should not affect the final restated value of the inventory if there are no price changes in real terms. In practice, however, there are likely to be different results, because the changes in the cost of inventory might not be equal to the change in the general price index.

Assets and liabilities linked by agreement to changes in prices, such as index-linked bonds and loans, are adjusted in accordance with the agreement, in order to determine the amount outstanding at the end of the reporting period. These items are carried at this adjusted amount in the restated balance sheet.

IFRIC 7 addresses accounting for deferred taxes where IAS 29 is applicable. An entity should calculate deferred taxes in accordance with IAS 12 after it has restated all non-monetary balances in accordance with IAS 29. Classification of deferred taxes as either monetary or non-monetary is not, therefore, relevant.

Restatement of non-monetary items (excluding shareholders’ equity)

Non-monetary assets and liabilities are restated in terms of the measuring unit current at the end of the reporting period. An entity should use the increase in the general price index from the transaction date when they were first recognised to the end of the reporting period.

No restatement is required for non-monetary assets and liabilities carried at amounts current at the end of the reporting period, such as net realisable value or fair value.

Non-monetary assets and liabilities carried at historical cost

Most non-monetary items are carried at cost, or cost less depreciation, and so they are expressed at amounts current at the date of acquisition. The restated cost, or cost less depreciation, of each item is determined by applying the change in a general price index from the date of acquisition to the end of the reporting period to the item’s historical cost and accumulated depreciation.

Property, plant and equipment (that is, carried at cost less depreciation), inventories of raw materials and merchandise, goodwill, patents, trademarks and similar assets are therefore restated from the dates of their purchase.

Partly finished and finished goods included in inventory are restated from the dates on which the costs of purchase and of conversion were incurred.

How does hyperinflation accounting impact borrowing costs? The impact of inflation is usually recognised in finance costs. It is not appropriate both to restate the capital expenditure financed by borrowing and to capitalise that part of the borrowing costs that compensates for the inflation during the same period. This part of the borrowing costs is recognised as an expense in the period in which the costs are incurred. So, entities should capitalise borrowing cost only for the amount that exceeds inflation. When inflation exceeds interest rates, no interest should be capitalised. This is covered in IAS 29.

Detailed records of the acquisition dates of items of property, plant and equipment might be unavailable or not possible to estimate. In such rare circumstances, it might be necessary to use an independent professional valuation of the items as the basis for their restatement in the first period of application of IAS 29.

It is expected that entities with effective internal controls over financial reporting would likely have the systems in place containing detailed records of property, plant and equipment.

Similarly, a general price index might not be available for the periods for which the restatement of property, plant and equipment is required.

In such circumstances, it might be necessary to use an estimate based, for example, on the movements in the exchange rate between the functional currency and a relatively stable foreign currency as a proxy for the inflation rate. In other situations, judgement is required for the application of specific indices.

If no specific indices are available, or it is not possible to estimate an index reliably, an entity should consider whether it might be subject to severe hyper-inflation.

Estimation of the general price index IAS 29 requires the use of a ‘general price index that reflects changes in general purchasing power’, and it states that it is preferable that ‘all entities that report in the currency of the same economy should use the same index’. It is possible, however, that in certain circumstances a general price index might not be available. In those circumstances, it might be necessary to use an estimate. The standard suggests that the inflation rate can be estimated based on the devaluation of the hyper-inflationary currency against a relatively stable foreign currency. It might also be possible that exchange rates are not available or do not provide reliable information, and so judgement will be required to estimate a general price index. That could be done, for example, by using external experts to estimate inflation. Alternatively, entities could estimate inflation internally, and validate the estimates by reference to the ranges estimated by experts and any other publicly available information, such as financial reports, or other economic information provided by official sources, etc.

Non-monetary assets that have been restated following the guidance in IAS 29 are still subject to impairment assessment in accordance with the relevant guidance.

If an asset’s recoverable amount is less than its restated amount, the asset is written down, even if no impairment of the asset was required in the historical cost financial statements. Any impairment charge is recognised in profit or loss.

What are the implications of impairment assessments on the initial application of IAS 29? Entities that have tested assets for impairment in previous reporting periods should consider whether the restatement of asset carrying values for inflation would affect the outcome of the impairment test. Adjustments to the outcome of a previous impairment test should be made without using hindsight. Entities should also consider whether there are any indicators suggesting that assets that were not tested in previous periods are impaired.

Non-monetary assets and liabilities carried at fair value or revalued

Some non-monetary items might be carried at amounts current at dates other than the acquisition date or the balance sheet date. This would include, for example, property, plant and equipment that has been revalued under the revaluation model allowed by IAS 16.

In such cases, the carrying amounts are updated so that they are expressed in terms of the measuring unit at the end of the reporting period by restating the revalued carrying amounts from the date of the revaluation.

Non-monetary assets and liabilities carried at fair value or revalued Some non-monetary assets and liabilities are carried at amounts, such as net realisable value and fair value. These are current as at the end of the reporting period. Such assets would include: Property, plant and equipment that has been revalued at the end of the reporting period and is carried at fair value, as permitted under IAS 16. Equity investments carried at fair value under IFRS 9 (IAS 39). Investment properties, carried at fair value under IAS 40. Biological assets, carried at fair value under IAS 41. There is, therefore, no need to restate such assets and liabilities.

Non-monetary assets revalued Non-monetary assets that are revalued to fair value every reporting date or periodically (For example, revaluation under IAS 16) are restated in terms of the measuring unit current at the end of the current reporting period or at the date of revaluation, if earlier. The restated amount is then compared to the fair value as at the end of the reporting period or at the date of revaluation. The difference between the restated amount and the fair value (assuming no additions or disposals) is accounted for as a revaluation increase or decrease in accordance with the applicable standard. For example, in the case of investments in equity instruments, for which the entity has (irrevocably) elected to present the fair value changes in other comprehensive income, the difference would be recognised in other comprehensive income in accordance with IFRS 9.

Revaluation of assets Question An entity has adopted the revaluation model in IAS 16 during the year. The assets have been remeasured for the first time, by an independent appraiser, in accordance with IAS 16. How are such assets treated when restating them in accordance with IAS 29? Answer The historical cost is restated up to the date of revaluation if assets are revalued during the reporting period. The restated cost should then be compared to the appraised amount and the difference treated as required by IAS 16. At the end of the reporting period, the revised carrying amount and any related revaluation reserve are restated from the date of the revaluation. The entity should consider the potential deferred tax related to the revaluation. For example, entity A acquired a property for C300 at 1 July 20X8. The property was revalued to C700 at 30 June 20Y1. Its historical cost restated to 30 June 20Y1 was C600. The restated historical cost of C600 is compared to the revalued amount of C700, and the difference is treated as required by IAS 16 (that is, revaluation reserve of C100). Any revaluation reserve recognised previously is eliminated. The revised carrying amount of C700 and the related revaluation reserve of C100 are restated in accordance with IAS 29 at 10 December 20Y1.

Inventory and related provisions on sale Question How are inventory and the related provision for net realisable value treated when the inventory is subsequently sold or disposed of? Answer Inventory is a non-monetary item. The carrying value of the inventory and any related provision for net realisable value are inflated up to the date of the sale or disposal using the general price index. The table below illustrates the restatement of inventories where finished goods were sold during the period: Holding period Conversion factor date HCU* Conversion factor 20Y0 CCU* CCU – HCU Opening balance in 20X9 CCU 2 months End December 20X9 8 1.25 10 2 (a) 20Y0 inflation of 50% End December 20Y0 1.5 15 5 (b) Opening balance in 20Y0 CCU 8 15 7 (c) Current year addition 2 months End December 20Y0 10 1.10 11 1 (d) Closing balance 2 months End December 20Y0 10 1.10 11 1 (e) Cost of goods sold 20Y0 8 15 7 (f)   Inventory restatement 20Y0 Dr Cr Reference Finished goods 1 (e) Cost of goods sold 5 (f) Net monetary gain 6 It is assumed that the difference of 2, between the opening balance of HCU 8 and CCU 10, has been recognised in 20X9. The finished goods at 31 December 20Y0 are calculated as follows: (a) Opening balance of finished goods restated for the changes in the purchasing power from the date of acquisition to 31 December 20X9. (b) The inflation effect for the restatement of opening inventories in the year 20Y0. (c) Opening balance of the finished goods restated to current year end purchasing power. (d) Current year additions are restated for the changes in the purchasing power from the date of acquisition to 31 December 20Y0. (e) Closing balance of the finished goods restated to the current year end purchasing power based on the holding period. (f) The resulting difference between CCU and HCU (c + d – e) of 7 is recognised in cost of goods sold. Note: The actual age of the inventories is determined based on the date of purchase or costs incurred. This example uses an average age of turnover, for simplicity. Average age of inventory might not be appropriate for use in the IAS 29 calculation in some circumstances. * HCU = Historical currency units; CCU = Current currency units Restatement of shareholders´ equity

Restatement of shareholders’ equity

At the beginning of the first period when IAS 29 is applied, the components of shareholders’ equity, excluding retained earnings and any revaluation surplus, are restated by applying a general price index from the dates on which the items were contributed or otherwise arose. This includes reserves created by amounts recognised in other comprehensive income.

Any revaluation surplus that arose in previous periods is eliminated. Retained earnings are restated for the balancing figure derived from the other amounts in the restated opening balance sheet.

At the end of the first period and in subsequent periods, all components of shareholders’ equity are restated by applying a general price index from the beginning of the period or the date of contribution, if later. The movements for the period in shareholders’ equity are disclosed in accordance with IAS 1.

Restatement of components of shareholders’ equity Question What are the components of shareholders’ equity that need to be restated? Which dates should be used for the restatement? Answer All components of shareholders’ equity, except retained earnings and any IFRS revaluation surplus, are restated on adopting IAS 29. Statutory reserves, such as legal and extraordinary reserves, are generally components of retained earnings in IFRS financial statements, and they are not considered for restatement purposes. Restated retained earnings are the balancing figure. It might be beneficial to disclose the historical statutory reserves in the notes to the financial statements. Capital increases are restated from the date on which the consideration was received. Capital decreases are taken into account up to the date on which the consideration was paid.

Restatement of share capital Question Can management present share capital at historical cost and the IAS 29 adjustment separately on the balance sheet? Answer Share capital presented on the balance sheet is expressed in terms of purchasing power at the end of the reporting period. It might be beneficial to disclose the historical cost share capital and the related IAS 29 adjustment separately, in the statement of changes in equity or in the notes, with the appropriate description.

Statutory revaluation reserve Question How is the statutory revaluation reserve in equity treated? Answer Statutory regulations for countries operating in a hyper-inflationary economy often allow entities to increase the carrying value of property, plant and equipment based on prescribed rules, with a corresponding increase in equity – usually the revaluation reserve. These statutory revaluation adjustments are not in accordance with IAS 16, and they are eliminated from the IFRS financial statements.

Share capital increase out of revaluation surplus Question How should a share capital increase by way of a transfer from the statutory revaluation surplus be treated? Answer The statutory revaluation surplus is eliminated from the IAS 29 restated financial statements, as noted above. A share capital increase by way of a transfer from the statutory revaluation surplus is, therefore, not considered in calculating the restated paid-in capital. The increase of the share capital is represented by a transfer from retained earnings to reflect the legal transaction. The amount of the transfer is the amount of the statutory revaluation reserve increase restated from the date of the authorisation of the share capital increase.

Dividends payable Question How are dividends payable treated? Answer The dividend amount is excluded from retained earnings at the date on which the dividend becomes payable. Any liability arising from an unpaid dividend is a monetary item and is, therefore, not restated.

Unpaid capital Question Should unpaid capital, that the shareholders have committed to pay, be inflated? Answer The treatment of the unpaid share capital depends on whether the shareholder is legally obligated to pay the capital. If the shareholder has no legal obligation to pay this capital, there would be no receivable recognised by the entity. The unpaid capital and commitment would be disclosed in the notes at the historical amount and/or other amount that better represents the commitment. This is the consideration expected to be received by the entity. There is no effect on monetary gain or loss, because the entity does not have an enforceable receivable. The entity would recognise a receivable from shareholders, with a corresponding increase in share capital, if the capital increase is legally binding. The share capital would be restated to account for any subsequent changes in inflation that create a monetary loss in the income statement – unlike the receivable which, as a monetary amount, is not restated. The fact that the share capital has not been paid would be disclosed.

Restatement of comprehensive income

All items in comprehensive income for the current year are restated by applying the change in the general price index from the dates when the items of income and expense were originally recorded. Current year restated net income is added to the balance of the restated opening retained earnings.

Restatement of components of comprehensive income The items within comprehensive income are restated from the date of the transaction. However, it is generally not practical to restate the items from the date of the transaction – average indices could be used as approximations. The selection of the indices depends on the frequency of the transactions (that is, sales earned evenly throughout the period) and whether inflation was relatively constant throughout the period. For example, the annual average index could be used for the restatement if the transactions occurred evenly throughout the year, without seasonal fluctuations, and inflation was relatively constant during the year. Quarterly or monthly indices would be more appropriate in periods of unstable inflation or where there have been seasonal fluctuations influencing comprehensive income.

Impairment reconciliation Question How should an entity reconcile the opening and closing balances for the provisions where the impairment loss on trade and other receivables is restated? Answer The provision for bad debt is a monetary item, because the underlying asset to which it relates is monetary. A monetary gain will therefore result from carrying this provision (which offsets the monetary loss being incurred as a result of holding the receivable). The impairment loss on trade and other receivables is restated from the date on which the provision was initially recognised. All items should be expressed in terms of the measuring unit current at the end of the reporting period, to ensure the reconciliation of the provisions. The difference between the restated opening balance, restated current period expense (net of any restated provision reversals) and the closing balance is a monetary gain. This example illustrates the impact of inflation on the reconciliation for the provision of receivables. The conversion factors for each period are as set out below: HCU* Conversion factor CCU* Opening balance provision Cr 1,500 1.33 Cr 2,000 Impairment charge Cr 1,000 1 Cr 1,000 Inflation effect on impairment provision – Monetary gain Dr 500 Closing balance provision Cr 2,500 1 Cr 2,500 Note: The entity only re-assesses its impairment loss provision once a year at the reporting date, which is the year end. Therefore, the impairment loss for the year was considered to be the year end purchasing power. * HCU = Historical currency units; CCU = Current currency units

Income statement items, such as interest income and expense, and foreign exchange differences related to invested or borrowed funds are adjusted for inflation and, although they are separately disclosed, it may be helpful to present them adjacent to the monetary gain or loss in the income statement, as they are associated with the net monetary position.

Restatement of finance income, expense and foreign exchange gains and losses Question Should finance income or expense and foreign exchange gains or losses be restated? Answer All items in the income statement are restated. There are no exceptions to this requirement.

Taxation

Current income tax expenses are restated for movements in the general price index. Most hyper-inflationary entities are likely to need to use a monthly or quarterly average.

This will require current tax to be calculated on the basis of the entity’s monthly or quarterly taxable income; this is then restated in terms of purchasing power at the end of the reporting period, using the increase in the general price index from the related month or quarter until the reporting date.

Calculation of deferred tax To calculate deferred tax, the following steps should be undertaken: Calculate deferred tax expense or income, and deferred tax liability or asset, by reference to the temporary differences and other tax attributes in the IFRS historical financial statements. Calculate deferred tax in relation to temporary differences arising from the restatement of non-monetary assets and liabilities. Deferred tax is calculated in full on the temporary differences arising from the restatement of non-monetary assets and liabilities. There is no need to adjust the closing deferred tax asset or liability for inflation. This is because the closing deferred tax position is calculated based on the temporary differences between the tax base and the IAS 29 adjusted IFRS balance sheet (that is, expressed in the measuring unit current at the end of the reporting period). Opening deferred tax is calculated as if IAS 29 had always been applied. It is calculated for temporary differences between tax bases of assets and liabilities and their carrying amounts expressed in the purchasing power at the start of the reporting period (opening balance sheet date). The balance tax is then inflated to the purchasing power at the end of the reporting period. The movement in the deferred tax balance for the reporting period includes a monetary gain or loss on tax bases of assets and liabilities. For example, if the opening tax base of property, plant and equipment is 100, inflation for the year is 50% and the income tax rate is 30%, the loss on the tax base of the property, plant and equipment in accordance with IFRIC 7 is 15, being 30% × (100 × 1.5 − 100). IFRIC 7 contains a detailed example showing how deferred tax is calculated and how the components of the income statement charge are determined. IFRIC 7 explains that these two components are: (a) the effect on deferred taxes of changes in the temporary difference; and (b) the loss/gain on the tax base because of inflation in the year.

Detailed calculation of deferred tax The following example illustrates the calculation of deferred tax when applying the restatement approach in IAS 29. At 10 December 20X9 Carrying IFRS value Tax base Temporary difference Deferred tax asset/ (Deferred tax liability) * 30% Property, plant and equipment 400 300 (100) (30) Investment in associate 200 150 (50) (15) Inventories 300 250 (50) (15) Deferred income (government grant) (200) (100) 100 30 Opening deferred tax (net) in 10 December 20X9 purchasing power (30) (a) 20Y0 inflation of 50% (from conversion factor 1.5) (15) (b) Opening deferred tax (net) in 10 December 20Y0 purchasing power (45) (c) At 10 December 20Y0 Property, plant and equipment 550 250 (300) (90) Investment in associate 250 150 (100) (30) Inventories 400 350 (50) (15) Deferred income (government grant) (250) (200) 50 15 Deferred tax (net) at 10 December 20Y0 (120) (d) Movement of deferred tax liability for the current period (75) (e) The deferred tax liability at 10 December 20Y0 is calculated as follows: (a) Opening balance of deferred tax liability of 30, calculated after restatement of non-monetary items by applying the measuring unit at 10 December 20X9. (b) Effect of inflation in the year 20Y0 on the opening balance of deferred tax liability. (c) Inflated opening balance of the deferred tax liability to 45. (d) Closing balance of the deferred tax liability of 120, calculated after restatement of non-monetary items by applying the measuring unit at 10 December 20Y0. (e) Movement in the deferred tax liability that reflects: (a) the effect on deferred taxes of a decrease/increase in the temporary differences; and (b) the loss/gain on the tax bases because of inflation in the year.