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Financial reporting in hyperinflationary economies

By Owen Mavengere

ON October 11, 2019, the accounting profession regulator in Zimbabwe, the Public Accountant and Auditors Board (PAAB) made a pronouncement that International Accounting Standard 29, Financial Reporting in Hyperinflationary Economies (IAS29), had become applicable in Zimbabwe.

This pronouncement was to apply to all entities that report based on the International Financial Reporting Standards (IFRSs).

This implied that financial statements for entities operating in Zimbabwe for the financial periods ending on or after  July 1, 2019 were to be prepared and presented using IAS 29.

The effect of preparing and presenting financial statements using IAS 29 is that current year amounts together with corresponding figures for the previous period and any information in respect of earlier periods are stated in terms of the measuring unit at the end of the reporting period.

This is achieved by restating financial statements using a general price index that reflects changes in general purchasing power.

In Zimbabwe, this is achieved by the use of the ZWL Consumer Price Index (CPI) as published by the Zimbabwe Statistical Office (Zimstat) and the Reserve Bank of Zimbabwe (RBZ).

In a non-hyperinflationary economy, assets, liabilities, income and expenditure are recorded on the dates at which they were acquired or when the respective transactions occurred.

This is the historical basis of accounting as prescribed by the International Financial Reporting Standards (IFRS).

The impact of inflation and the associated changes in inflation are ignored as they are immaterial to the financial statements as a whole and are unlikely to impact the decisions of the users of the financial statements.

The financial information produced will be useful because there is no significant change in prices in the general macro-economic environment.

Considering the prevailing hyperinflationary environment in Zimbabwe, reporting of operating results and financial position in the local currency without restatement is not useful. These financial statements will not possess the qualitative characteristics of useful financial information, that is, relevance and faithful representation.

In other words, this information will not be useful to the users of financial statements in terms of decision-making relating to the reporting entity.

The rate of loss of purchasing power in a hyperinflationary environment is such that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading.

This is regardless of whether the financial statements are based on a historical cost approach or a current cost approach. Information will therefore be useful only if it is expressed in terms of the measuring unit current at the end of the reporting period. In other words, that is, figures informed by the generally prevailing price levels or inflation at the end of the reporting period.

Financial statements prepared applying IAS 29 show a column for unadjusted financial information for the current and previous reporting period and a column for restated financial information for the current and previous reporting period.

This will enable the user of financial statements to note the effects of the restatement made to the amounts on the financial statements.

Although IAS 29 does not establish an absolute rate at which hyperinflation is deemed to arise, it gives characteristics of the economic environment of a country, which are indicative of hyperinflation.

Some of these characteristics are:

  • 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 foreign 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 the period is short and
  • The cumulative inflation rate over three years is approaching, or exceeds, 100%.

In addition to the application of procedures outlined in IAS 29 in preparation and presentation of financial statements, restatement requires a lot of judgment on the part of management.

These judgments may differ between different entities but the treatments may all be compliant with IFRS. The consistent application of these procedures and judgements from period to period is more important than the precise accuracy of the resulting amounts included in the restated financial statements.

Judgments, which were applied by the entity during the initial application of IAS 29, should continue to be used for subsequent periods so as to avoid influencing the decisions of users of financial statements through changing accounting procedures rather than the underlying information.

IAS 29 increases the relevance of financial information by enhancing its predictive value and confirmatory value.

Its predictive value is increased because it can be used as an input to processes employed by users to predict future outcomes. Although the financial information will not be a prediction or forecast, it will possess predictive value because it can be employed by users in making their own predictions.

The confirmatory value of financial information will also be enhanced by IAS 29 because it will provide feedback about (confirms or changes) previous evaluations.

Although the procedures for IAS 29 restatement of financial statements may be cumbersome and require more time than conventional financial statements, it is necessary because not restating the financial statements may lead to production of irrelevant financial statements which does not faithfully represent what it purports to represent.

The effect of the difference between the restated and the unadjusted financial information will be so material that it can reasonably be expected to influence decisions that the users of general purpose financial reports make on the basis of those reports.

  • Mavengere is the Institute of Chartered Accountants of Zimbabwe technical manager. — technical@icaz.org.zw

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