IAS 29 FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES1

1 INTRODUCTION

IAS 29 comprises rules relating to financial reporting in hyperinflationary countries. In such countries 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 would be misleading (IAS 29.2). For most entities, the rules of IAS 29 are only relevant to their foreign operations (subsidiaries, associates or jointly controlled entities) whose functional currency is hyperinflationary. In such cases, the investee's financial statements should be adjusted before being translated and included in the investor's consolidated financial statements.

2 APPLICATION OF IAS 29 RELATING TO FOREIGN OPERATIONS: THE “7-STEP-APPROACH”

Step 1: Does hyperinflation exist?

The application of IAS 29 presupposes that there is hyperinflation. A cumulative inflation rate over three years that is approaching or exceeds 100% is the strongest indicator of hyperinflation (IAS 29.3e). An inflation rate of over 50% that is increasing massively can also be an indicator of hyperinflation.

Step 2: Determining the appropriate price index

A general price index is used with regard to the inflation adjustment. If there is more than one price index (e.g. a consumer price index (CPI) and a producer or wholesale price index (PPI or WPI)), determining the appropriate index is a matter of proper judgment (IAS 29.11 and 29.17).

Step 3: Adjustment of non-monetary items

With regard to the distinction between monetary items and non-monetary items, we refer to the chapter on IAS 21 (Section 2). Non-monetary items (e.g. inventories, property, plant, and equipment, and intangible assets including goodwill) measured on the basis of historical cost are adjusted by applying the price index to the costs of purchase or conversion (and to cumulative depreciation, amortization, and impairment losses). It is important to note that the change in the price index from the date of acquisition to the end of the reporting period is relevant and not the change in the index within the reporting period (IAS 29.15). By contrast, monetary items (e.g. cash and trade payables) are not adjusted.

Step 4: Adjustment of the statement of comprehensive income

All items in the statement of comprehensive income are expressed in terms of the purchasing power at the end of the reporting period (IAS 29.26). In the case of income and expenses that occur on a relatively regular basis during the period (this may be the case if there is no seasonal business), and an inflation rate that develops rather consistently during the period, the adjustment from the transaction date to the end of the reporting period might be possible by applying half of the inflation rate for the year.

Step 5: Gain or loss on the net monetary position

In a period of inflation, an entity holding an excess of monetary assets over monetary liabilities loses purchasing power, whereas 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. The gain or loss on the net monetary position is recognized in profit or loss (IAS 29.27–29.28).

In the system of double-entry book-keeping, the gain or loss on the net monetary position can be determined via a so-called “purchasing power account.” That account comprises the adjustment of all initial balances of and additions to non-monetary items and of certain items of the statement of comprehensive income (e.g. sales revenue). The account balance is the gain or loss on the net monetary position that becomes part of the statement of comprehensive income and therefore also of the statement of financial position. The balance of the purchasing power account should equal approximately the gain or loss on the net monetary position calculated by dividing the change in the net monetary position during the period by two.

Step 6: Determining the comparative figures

When the results and financial position of an entity whose functional currency is hyperinflationary are translated into a non-hyperinflationary presentation currency, comparative amounts are those that were presented as current year amounts in the relevant prior year financial statements (i.e. not adjusted for subsequent changes in exchange rates or subsequent changes in the price level) (IAS 29.34 and IAS 21.42–21.43).

Step 7: Translation into the presentation currency

After inflation adjustment, translation into the presentation currency of the group is effected according to the normal rules for foreign currency translation (IAS 29.35).

3 REPORTING PERIOD IN WHICH AN ENTITY IDENTIFIES HYPERINFLATION WHEN THE CURRENCY WAS NOT HYPERINFLATIONARY IN THE PRIOR PERIOD

In the reporting period during which an entity identifies the existence of hyperinflation in the country of its functional currency that was not hyperinflationary in the prior period, IAS 29 is applied as if the economy had always been hyperinflationary. Therefore, in relation to non-monetary items measured on the basis of historical cost, the opening statement of financial position at the beginning of the earliest period presented is restated to reflect the effect of inflation from the date the assets were acquired and the liabilities were incurred or assumed until the end of the reporting period (IFRIC 7.3).

4 EXAMPLE WITH SOLUTION2

Example

Illustration of steps 3–5

E prepares its consolidated financial statements as at Dec 31, 02. This requires, among others, adjusting the financial statements of the hyperinflationary subsidiary H (balance sheet date: Dec 31, 02) for changes in purchasing power.

In 01, an appropriate index adjustment has been made, which resulted in the following statement of financial position as at Dec 31, 01:

In 02, the inflation rate is 100%. Among others, the following business activities take place in 02:

• The old building (remaining useful life: three years) is depreciated by the amount of CU 2 (on the basis of the amount indexed as at Dec 31, 01).3
• A new building (useful life: 20 years) is acquired on Jul 01, 02 for CU 80. Depreciation of CU 2 is recognized for that building.
• All of the old merchandise is sold in 02.
• On Jul 01, 02, new merchandise is acquired for CU 80. Half of the new merchandise is sold in 02.

An assumed profit for the year 02 of CU 20 and the business activities described above result in the statement of financial position as at Dec 31, 02 presented below. The old building, share capital, and retained earnings (excluding profit for 02) are included in that statement on the basis of values indexed as at Jan 01, 02.

The separate income statement for 02 has not yet been indexed:

Separate income statement for 02
Sales revenue	110
Old merchandise sold	–30
New merchandise sold	–40
Depreciation expense (old building)	–2
Depreciation expense (new building)	–2
Other expenses	–16
Profit for 02	20

In 02, sales revenue and other expenses occur on a regular basis and the inflation rate also develops consistently.

Posting status:

There have not yet been any entries with respect to the inflation adjustment for 02. All other entries have already been made.

Required

Perform steps 3–5 of the 7-step-approach. Prepare any necessary entries relating to inflation adjustments.

Hints for solution

In particular Section 2.

Solution

The statement of financial position as at Dec 31, 02 has to be adjusted for inflation as follows:

• The monetary items (i.e. H's trade receivables, H's cash, and H's loan payable) are not adjusted.
• The share capital and the retained earnings as at Dec 31, 01 are multiplied by 2.
• The adjustment of the merchandise and of the buildings is explained below.

Adjustment of the merchandise for inflation

By Dec 31, 02, all of the old inventories have been sold, whereas half of the new inventories have not yet been sold. Thus, the costs of purchase of the new inventories that have not yet been sold are CU 40 (= CU 80 : 2). Since the new inventories were acquired in the middle of the year (on Jul 01, 02) they are indexed with half of the inflation rate (i.e. with 50%, instead of 100%). The indexed carrying amount as at Dec 31, 02, is therefore CU 60 (= 40 · 150%).

For determining the cost of the merchandise sold in 02, the carrying amount of the old merchandise as at Dec 31, 01 is indexed with 100% and the new merchandise acquired in the middle of 02 (on Jul 01, 02) is indexed with 50%:

	Historical values/old index	Index as at Dec 31, 02
Balance as at Jan 01, 02	30	60
+ Acquisition on Jul 01, 02	80	120
– Balance as at Dec 31, 02	40	60
= Cost of the merchandise sold in 02	70	120

The account “merchandise” is presented below (with historical values and values based on the old index on the left and values after inflation adjustment on the right):4

The increase in the cost of the merchandise sold of CU 50 (see above) is caused by the old merchandise in the amount of CU 30 (= CU 30 · 100%) and by the new merchandise in the amount of CU 20 (= CU 40 · 50%). According to the posting status, the cost of the merchandise sold has already been recognized in the amount of CU 70. However, the corresponding inflation adjustment has not yet been recognized.

Adjustment of the buildings for inflation

The old building and corresponding depreciation are indexed at 100%, whereas the new building (which was acquired on Jul 01, 02) and corresponding depreciation are indexed at half of the inflation rate (50%). The account “buildings” is shown below (with historical values and values based on the old index on the left and values after inflation adjustment on the right). The carrying amount of the buildings as at Dec 31, 02, is the remainder.

According to the posting status, the depreciation for the old building of CU 2 has already been recognized. However, the corresponding inflation adjustment has not yet been recognized.

Further inflation adjustments

Share capital and retained earnings as at Dec 31, 01 are adjusted by 100%:

In this example it is assumed that sales revenue and other expenses occur on a regular basis in 02. Hence, they are adjusted by half of the inflation rate (i.e. 50%):

Determining the gain on the net monetary position

The gain on the net monetary position is the balance of the purchasing power account:

The net monetary position (which represents a liability, in this example) is calculated by deducting the trade receivables and cash from the loan payable. Thus, the net monetary position is CU 6 (= CU 26 – CU 20) as at Jan 01, 02 and CU 72 (= CU 76 – CU 4) as at Dec 31, 02. This means that there is a change of CU 66 in 02. The average of the change for the year 02 is CU 33 (= CU 66 : 2). The balance of the purchasing power account (CU 39) equals approximately the gain on the net monetary position calculated by dividing the change in the net monetary position during the period by two (CU 33).

Preparation of the inflation-adjusted statement of financial position and separate income statement

The gain on the net monetary position is inserted in the separate income statement. The profit for 02 is the balance.5

These amounts (expressed in units of the hyperinflationary currency) are translated into the presentation currency of the group according to the normal rules for foreign currency translation.

---

1 See Lüdenbach/Hoffmann, IFRS Commentary, 9th edition, 2011, Section 27, Chapter 4 with regard to the explanations and the example in this chapter of the book. The commentary cited is published in the German language.

2 In this example, the presentation specifications of IAS 1 are ignored.

3 In this example, the term CU is used to denote the currency units of the hyperinflationary currency.

4 CU 70 = CU 30 (balance as at Jan 01, 02) + CU 40 (acquisition on Jul 01, 02).

5 The unadjusted values are shown on the left.