Accounting for Subsidiaries in Hyperinflationary Economies

Hyperinflation is a situation in which the inflation in an economy is chronic and high, which is generally reflected in very high general prices in the economy. Hyperinflation is often caused by the governments printing more money than their economy can support. The government may issue more money to sustain government expenditures, which diminishes the value of the money. This reduces the purchasing power parity of individuals, since they can buy less for more money.

GAAP and Hyperinflation

Under U.S. GAAP, a hyperinflationary economy is defined as one whose cumulative three-year inflation rate exceeds 100%.

A parent company that has a subsidiary operating out of a hyperinflationary economy, will see a diminishing in value of the subsidiary’s assets and liabilities due to the reduced value of the currency. The real value of the non-monetary assets and liabilities continue to be the same.

Under US GAAP, when this threshold is broken (cumulative three-year inflation rate exceeds 100%), the parent company must use the temporal method for translation. The temporal method is the historical method of translation in which the currency of the subsidiary is converted into the currency of the parent company. The use of the temporal method under a hyperinflationary scenario will maintain the value of fixed assets at historical cost.

IFRS and Hyperinflation

IFRS does not use a numerical threshold, like GAAP. However, GAAP’s test threshold is still a legitimate test to determine if an economy is hyperinflationary.

In a hyperinflationary environment, IFRS mandates that using rules in IAS 29 foreign financial statements have to be restated for foreign inflation. Then using the current rate method the financial statements are translated into the parent company’s currency.

Let us look at the key points of IAS 29:

Financial statements, including comparative information, are to be expressed in units of the functional currency that is current at the end of the reporting period. The restatement to current units of currency is made using the change in a general price index.

The Consumer Price Index (CPI) can be used for this purpose since it represents a basket of goods. In the absence of a reliable general price index, we can use the exchange rate or any other equivalent. Local sources could include the Ministry of Finance, the Govts. statistics department, Central Bank or any other reliable research publication. External sources could include the IMF, World Bank and the Economic Intelligence Unit.

The gain or loss on the net monetary position must be included in profit or loss for the period. This must be separately disclosed.

Then we restate the financial position. We do so by first categorizing items on the financial statement as monetary and non-monetary. Cash and the equivalents of cash like receivables, payables, and loans are considered monetary assets and liabilities. These items are not restated, as they reflect the purchasing power at the end of the period, since the absolute value stays the same.

Index linked assets and liabilities have to only be adjusted in accordance to contractual terms and not the General Price Index.

Non-monetary assets and liabilities at current cost are also not restated. Non-monetary assets and liabilities at historical costs are restated.

Restated NBV=Historical CostGPI at reporting dateGPI at acquisition date\text{Restated NBV} = \text{Historical Cost} * \frac{\text{GPI at reporting date}}{\text{GPI at acquisition date}}

  • NBV = Net Book Value at the end of the period
  • GPI = General Price Index
  • Historical cost = Price paid for the asset when it was bought

When equity items first apply IAS29, any revaluation surplus must be removed. Retained earnings being subject to the laws of different countries can be used to balance the financial statements. Other components like stock holdings should be restated by the general grice index from the date of contribution.

In restating the statement of Profit and Loss and Other Income, the IAS29 states that all amounts are to be restated using the general price index from the transaction date.

Restated Amount=Transaction amount prior to restatementGPI at end of reporting periodGPI at the transaction date\text{Restated Amount} = \text{Transaction amount prior to restatement} * \frac{\text{GPI at end of reporting period}}{\text{GPI at the transaction date}}

Gain or loss on monetary positions is considered the opposite of gain or loss of non-monetary items.

Income and expenses are restated by applying the change in the GPI from the date when the items were initially recorded and to the end of the reporting period.

In case of taxes, the difference in assets and liabilities due to restatement is tax deductible or payable in the next period.

The disclosures that need to be included are that the financial figures of the entity in hyperinflation have been restated as per IAS29. It should also disclose if the financial statements are based on historical cost approach or current cost approach. The identification of the price index and its movement must also be disclosed. The period in which the subsidiary existed in a hyperinflationary situation must also be stated.

Once the economy is no longer hyperinflationary then hyperinflationary reporting of the subsidiary must be discontinued.