1.1 The concept of hyperinflation

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:

• historical cost figures expressed in terms of monetary units do not show the ‘value to the business’ of assets;
• holding gains on non-monetary assets that are reported as operating profits do not represent real economic gains;
• financial information presented for the current period is not comparable with that presented for the prior periods; and
• real capital can be reduced because profits reported do not take account of the higher replacement costs of resources used in the period. Therefore, if calculating a nominal return on capital based on profit, and not distinguishing this properly from a real return of capital, the erosion of capital may go unnoticed in the financial statements. This is the underlying point in the concept of capital maintenance.

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.

1.2 Relevance in the UK

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.

3.1 Terms used in Section 31

The key terms used within Section 31 have the meanings specified in the following table: [FRS 102 Appendix I]

3.2 A hyperinflationary economy

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]

1. The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain purchasing power.
2. The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency.
3. Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short.
4. Interest rates, wages and prices are linked to a price index.
5. The cumulative inflation rate over three years is approaching, or exceeds, 100 per cent.

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.

3.3 Measuring unit in the financial statements

Section 31 requires the following approach: [FRS 102.31.3]

• amounts in the financial statements of an entity whose functional currency is the currency of a hyperinflationary economy should be stated in terms of the measuring unit current at the end of the reporting period; and
• the comparative information in those financial statements for the previous period required by Section 3 – Financial Statement Presentation, paragraph 14, and any information presented in respect of earlier periods, should also be stated in terms of the measuring unit current at the reporting date.

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:

• a wide range of goods and services has been included in the price index;
• continuity and consistency of measurement techniques and underlying assumptions;
• free from bias;
• frequently updated; and
• available for a long period.

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.

3.4 Procedures for restating historical cost financial statements

3.5 Accounting for a hyperinflationary subsidiary in consolidated financial statements

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]

• all amounts (i.e. assets, liabilities, equity items, income and expenses, including comparatives) shall be translated at the closing rate at the date of the most recent statement of financial position, except that
• when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior period financial statements.

3.6 Disclosures

An entity which applies Section 31 in its own financial statements should disclose the following: [FRS 102.31.15]

1. the fact that financial statements and other prior period data have been restated for changes in the general purchasing power of the functional currency;
2. the identity and level of the price index at the reporting date and changes during the current reporting period and the previous reporting period; and
3. the amount of gain or loss on monetary items.