Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling, according to Investopedia. In the United States, the current 12-month inflation rate is just over 2%. Some inflation is good for an economy, but what if it gets out of control? For example, consumer prices in Venezuela jumped a whopping 800% year-on-year in 2016, according to Trading Economics. Obviously, this is not good for an economy, but what is the effect on financial reporting? Luckily, the IASB has issued IAS 29 Financial Reporting in Hyperinflationary Economies to provide guidance on the identification of and accounting for hyperinflationary economies. U.S. GAAP contains similar guidance on highly inflationary economies within ASC 830 Foreign Currency Matters, specifically ASC 830-10-45-11 through 45-17.

Identification of hyperinflationary economies

According to IAS 29.3, hyperinflation is indicated by characteristics of the economic environment of a country which include, but are not limited to, the following:

• 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.
• The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable currency. Prices may be quoted in that currency.
• Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if that period is short.
• Interest rates, wages, and prices are linked to a price index.
• The cumulative inflation rate over three years is approaching, or exceeds, 100%.

IAS 29 clearly states that the Standard does not establish an absolute rate at which hyperinflation is deemed to arise and that the ultimate determination of whether an economy is hyperinflationary is a matter of judgment.

Under U.S. GAAP, the determination is similar. ASC 830-10-45-12 clearly states that a three-year cumulative inflation rate over 100% “shall be considered highly inflationary in all instances.” However, if the cumulative three-year rate is under 100%, historical inflation rate trends (increasing or decreasing) and other pertinent economic factors should be considered before a final determination is made.

This is a clear of example of how differences could arise because of the principles of IFRS conflicting with the “bright lines” under U.S. GAAP. However, one wouldn’t expect many differences in this area. But, as I learned by writing this post, differences could arise based on interpretation of the rules by regulators!

These flags represent the highly-inflationary economies of the world at the end of 2016 according to the Center for Audit Quality’s ( CAQ’s) International Practices Task Force (IPTF). They are ( beginning in upper right hand corner, going clockwise):

• Venezuela
• Sudan
• Malawi
• South Sudan
• Ukraine

The IPTF meets periodically with the staff of the SEC to discuss emerging financial reporting issues related to SEC rules and regulations. According to their November 2016 IPTF Joint Meeting Highlights, the following countries had three-year cumulative inflation rates exceeding 100% (with projected 3-year cumulative inflation rates at the end of 2016):

• Venezuela (3,782%)
• South Sudan (1,477%)
• Ukraine (102%)
• Sudan (65%)

Why is Sudan on the list?

The IPTF notes that the three-year cumulative inflation rate at the end of 2015 was 101% and is projected to be 65% by the end of 2016. However, they said, “based on these inflation rates, it would appear that registrants should continue to treat the economy of Sudan as highly-inflationary.” The IPTF noted that registrants should have appropriate controls in place to monitor Sudan’s reported inflation data and consider other pertinent economic indicators to determine when it is appropriate to cease treating Sudan’s economy as highly-inflationary.

Where the heck is Malawi and why isn’t it on the list since you had their flag?

Malawi is a landlocked country in southeastern Africa bordered by Mozambique, Zambia and Tanzania. According to the IPTF, the three-year cumulative inflation rate for Malawi was 91% for 2015 and is projected to be 79% by the end of 2016. In other words, it’s three-year cumulative inflation rate is less than 100%. However, the IPTF stated, “based on the fact that the three-year cumulative inflation rates had exceeded 100% in recent years, combined with the actual inflation rates for the most recent year, it would appear that registrants should continue to treat the economy of Malawi as highly-inflationary.”

See where I’m going with this!

Clearly, the economies of Venezuela and South Sudan would be considered highly inflationary under both IFRS and U.S. GAAP. That’s a no-brainer. But what about the others? Are there any differences between IFRS and U.S. GAAP?

Ukraine

The three-year cumulative inflation rate (102%) is clearly over the 100% “bright-line” threshold set by U.S. GAAP and, just to be sure there is no confusion among registrants, the guidance put out by the IPTF says it should be considered highly-inflationary. ASC 830-10-45-12 clearly states “projections cannot be used to overcome the presumption that an economy is highly inflationary if the three-year cumulative rate exceeds 100 percent.”

However, under IFRS, the three-year cumulative inflation rate is just one of five indicators set out in IAS 29.3. The IPTF noted that the three-year cumulative inflation rate was primarily influenced by a spike in inflation in 2015. Furthermore, using inflation data published by the National Bank of Ukraine, the three-year cumulative inflation rate is projected to be below 100% by June 30, 2017. Could you make an argument that Ukraine is not a hyperinflationary economy under IAS 29? Perhaps.

Sudan

As previously stated, Sudan’s three-year cumulative inflation rate (65%) is projected to be below the threshold by the end of 2016. ASC 830-10-45-12 requires you to look at “historical inflation rate trends (increasing or decreasing) and other pertinent economic factors” to determine whether classification as highly inflationary is appropriate, when the cumulative three-year rate is under 100%. ASC 830-10-45-13 clearly states “the definition of a highly inflationary economy shall be applied with judgment.”

That said, the IPTF in their joint meeting with the SEC has taken judgment out of the equation by stating “based on these inflation rates, it would appear that registrants should continue to treat the economy of Sudan as highly-inflationary.” Yeah, let me be the guy that applies my judgment that contradicts the judgment of the SEC. No thanks! It’s highly-inflationary. Period!

However, under IFRS, I think you could make the argument that with a three-year cumulative rate of only 65%, the economy of Sudan is not hyperinflationary (and there’s no SEC equivalent to stop me!).

Malawi

Again, why is the economy of Malawi considered highly-inflationary under U.S. GAAP? In a nutshell, because the IPTF after meeting with the SEC says so! I’m sorry, that sounds like my dad when I was a kid. I didn’t like that answer then and I don’t like it now!

Obviously, under IFRS judgment is required, but I doubt many companies applying IFRS would classify the economy of Malawi as hyperinflationary.

Final Thoughts

I started this post wanting to talk about GAAP differences related to accounting for hyperinflationary economies. That’s going to have to wait for a subsequent post because, after digging into IAS 29, ASC 830, and the IPTF Highlights, I realized that there could be differences in the identification of hyperinflationary economies under IFRS and U.S. GAAP. Did you realize this difference existed? I did not. But then again, I didn’t know where Malawi was either!

Disclaimer
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