Accounting standards are applied on the assumption that the value of money (the unit of measurement) is constant over time, which normally is an acceptable practical assumption. However, when the effect of inflation on the value of money is no longer negligible, the usefulness of historical cost based financial reporting is often significantly reduced. High rates of inflation give rise to a number of problems for entities that prepare their financial statements on a historical cost basis, for example:
For entities used to working in economies with low inflation it is easy to overlook that there are countries where inflation is still a major economic concern. In some of these countries, inflation has reached such levels that (1) the local currency is no longer a useful measure of value in the economy and (2) the general population may prefer not to hold its wealth in the local currency. Instead, they hold their wealth in a stable foreign currency or in non-monetary assets. Such a condition is often referred to as hyperinflation.
Section 31 – Hyperinflation – sets out the accounting requirements for an entity that has a functional currency which is the currency of a hyperinflationary economy. It requires such an entity to prepare financial statements that have been adjusted for the effects of hyperinflation. [FRS 102.31.1]. These accounting requirements are set out at 3.4 below.
The UK clearly does not suffer from hyperinflation, but it would be theoretically possible, although extremely unlikely, for a UK company to have the functional currency of a hyperinflationary economy. In that case, the requirements of Section 31 would apply in full to the accounting and disclosures in that company's own financial statements.
A more likely scenario would be that of a UK based group preparing consolidated financial statements under FRS 102 with a subsidiary that operates in, and has a functional currency of, a country subject to hyperinflation. This is discussed at 3.5 below.
There is little substantive difference between the accounting and disclosure requirements in Section 31 compared to IFRS (IAS 29 – Financial Reporting in Hyperinflationary Economies). However, IAS 29 does contain more application guidance.
The Triennial review 2017 amended Section 31 to address situations where non-monetary items, such as property, plant and equipment have been revalued at an earlier date. Under Section 31, the revaluation reserve is not restated when adjustments are made for the effects of hyperinflation, the difference arising being included in retained earnings. This reflects the requirement under company law to maintain a revaluation reserve and is therefore a difference from IAS 29 (see 3.4.1 below).
The key terms used within Section 31 have the meanings specified in the following table: [FRS 102 Appendix I]
Term | Definition |
Functional currency | The currency of the primary economic environment in which the entity operates. |
Monetary items | Units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency. |
Presentation currency | The currency in which the financial statements are presented. |
Section 31 does not establish an absolute level at which an economy is deemed hyperinflationary. An entity should make that judgement by considering all available information including, but not limited to, the following possible indicators of hyperinflation: [FRS 102.31.2]
For reporting under US accounting standards, the International Practices Task Force (IPTF), a task force of the SEC Regulations Committee, monitors the inflation status of different countries. As the IPTF's criteria are similar to those used under IFRS, this provides a useful guide for entities reporting under IFRS, and hence would inform an assessment of whether an economy is hyperinflationary for FRS 102 purposes.
Section 31 requires the following approach: [FRS 102.31.3]
The restatement of financial statements in accordance with Section 31 requires the use of a general price index that reflects changes in general purchasing power. Section 31 says that in most economies there is a recognised general price index, normally produced by the government, which entities will follow. [FRS 102.31.4].
However, as noted below, in more extreme cases of hyperinflation such indices may not be available, especially if the prevailing circumstances that led to hyperinflation significantly impact the operation of governmental and/or social systems.
Section 31 provides no further guidance on what is meant by a general price index. It is generally accepted practice to use a Consumer Price Index (CPI) for this purpose, unless that index is clearly flawed. National statistical offices in most countries issue several price indices that potentially could be used for the purposes of Section 31. Important characteristics of a good general price index include the following:
The entity should assess the above characteristics and select the most reliable and most readily available general price index and use that index consistently. It is important that the index selected is representative of the real position of the hyperinflationary currency concerned.
If the general price index is not available for all periods for which the restatement of long-lived assets is required, then FRS 102 offers no guidance. However, using the FRS 102 hierarchy, an entity is permitted to refer to IAS 29 which requires an entity to make an estimate of the price index. The entity could base the estimate, for example, on the movements in the exchange rate between the functional currency and a relatively stable foreign currency. [IAS 29.17].
Entities could use a similar approach to estimating a price index when they cannot find a general price index that is sufficiently reliable (e.g. if the national statistical office in the hyperinflationary economy is subject to significant political bias). However, this would only be acceptable if all available general price indices are fatally flawed.
It should be noted that this method of determining the price index is only acceptable if the currency of the hyperinflationary economy is freely exchangeable, i.e. not subject to currency controls and ‘official’ exchange rates. Entities should be mindful that, especially in the short term, the exchange rate may fluctuate significantly in response to factors other than changes in the domestic price level.
Amounts in the statement of financial position that are not expressed in terms of the measuring unit current at the end of the reporting period are restated by applying a general price index as discussed below. [FRS 102.31.5].
Monetary items (money held and items to be received or paid in money) are not restated because they are expressed in terms of the measuring unit current at the end of the reporting period. [FRS 102.31.6].
Assets and liabilities linked by agreement to changes in prices, such as index-linked bonds and loans, are adjusted in accordance with the agreement and presented at this adjusted amount in the restated statement of financial position. [FRS 102.31.7].
All other assets and liabilities are non-monetary: [FRS 102.31.8]
At the beginning of the first period of application of Section 31, the components of equity, except retained earnings and any revaluation surplus, are restated by applying a general price index from the dates the components were contributed or otherwise arose. Any revaluation surplus that arose in previous periods is not restated. This is a new requirement brought in by the Triennial review 2017 reflecting the requirement under company law to maintain a revaluation reserve. Restated retained earnings are derived from all the other amounts in the restated statement of financial position, including the effect of not restating the revaluation reserve. Retained earnings is essentially the balancing figure after all other restatements. [FRS 102.31.9].
At the end of the first period in which hyperinflation arises and in subsequent periods, all components of owners' equity are restated by applying a general price index from the beginning of the period or the date of contribution, if later. The changes for the period in owners' equity are disclosed in accordance with Section 6 – Statement of Changes in Equity and Statement of Income and Retained Earnings (see Chapter 6). [FRS 102.31.10].
All items in the statement of comprehensive income (and in the income statement, if presented) should be expressed in terms of the measuring unit current at the end of the reporting period. Therefore, all amounts need to be restated by applying the change in the general price index from the dates when the items of income and expenses were initially recognised in the financial statements. If general inflation is approximately even throughout the period, and the items of income and expense arose approximately evenly throughout the period, an average rate of inflation may be appropriate. [FRS 102.31.11].
An entity should express all items in the statement of cash flows in terms of the measuring unit current at the end of the reporting period. [FRS 102.31.12].
In a period of inflation, an entity holding an excess of monetary assets over monetary liabilities loses purchasing power, and an entity with an excess of monetary liabilities over monetary assets gains purchasing power, to the extent the assets and liabilities are not linked to a price level. An entity should therefore include in profit or loss the gain or loss on the net monetary position, except that any unrealised gain shall be recognised in other comprehensive income. An entity should offset the adjustment to those assets and liabilities linked by agreement to changes in prices (see 3.4.1 above) against the gain or loss on net monetary position. [FRS 102.31.13].
As noted at 3.3 above, comparative information in financial statements should also be stated in terms of the measuring unit current at the end of the reporting period. [FRS 102.31.3]. This means the comparative information will require restatement using the relevant general price index.
When an economy ceases to be hyperinflationary and an entity discontinues the application of Section 31, it should treat the amounts expressed in the presentation currency at the end of the previous reporting period as the basis for the carrying amounts in its subsequent financial statements. [FRS 102.31.14].
As previously mentioned, a more likely scenario relevant to FRS 102 would be that of a UK based group preparing consolidated financial statements under FRS 102 with a subsidiary that operates in, and has a functional currency of, a country subject to hyperinflation. Section 30 – Foreign Currency Translation – requires the subsidiary's results and financial position to be adjusted using the procedures specified in Section 31 (see 3.4 above) before translating them into a different presentation currency using the following procedures (added by the Triennial review 2017): [FRS 102.30.21]
An entity which applies Section 31 in its own financial statements should disclose the following: [FRS 102.31.15]