Hyperinflationary economies (2024)

IFRS Perspectives: Foreign operations in hyperinflationary economies

The accounting applied to a foreign operation changes fundamentally when the economy in which it operates is determined to be hyperinflationary (highly inflationary).1This, coupled with accounting differences between IFRS and US GAAP, means that identifying hyperinflationary economies is an essential step in the financial reporting process of a multinational dual reporter.

Accounting for foreign operations is often complex. It first requires companies to establish and maintain processes and controls to ensure the consistent application of accounting policies and the correct treatment of intercompany transactions on consolidation.

International groups then have the additional task of translating the balances, results and cash flows of foreign operations into the presentation currency. This is particularly challenging when the foreign operation is in a (potentially) hyperinflationary economy, for two main reasons.

• The assessment of whether or not the economy is hyperinflationary requires significant judgment, and it is often difficult to obtain stable and reliable inflation data from stressed economies to perform the analysis.
• The accounting for operations in hyperinflationary economies is inherently complicated, as companies with operations in Venezuela (a hyperinflationary economy) can attest.

Dual reporters with foreign operations in a hyperinflationary economy face further complexity. IFRS and US GAAP have different accounting models for hyperinflationary economies that create GAAP differences in the numbers reported.

Identifying hyperinflationary economies

Both IFRS and US GAAP explicitly recognize that identifying hyperinflation requires judgment. But while the assessment methodologies are not aligned, in our experience, conclusions about the hyperinflationary status generally do not diverge.

IAS 29 lists five indicators of hyperinflation to be considered, along with any other relevant factors, when analyzing the economic environment of a country. One of these indicators is a cumulative inflation rate over three years approaching or exceeding 100 percent. However, this is not determinative and should not be considered in isolation.

US GAAP is sequenced in its approach; the assessment of a hyperinflationary economy follows a two-step methodology.

• Step 1.Perform a quantitative analysis of the cumulative inflation rate – any economy that has a cumulative inflation rate for the three years preceding the beginning of the reporting period in excess of 100 percent is considered to be hyperinflationary.
• Step 2.If Step 1 results in the cumulative rate being less than 100 percent, judgment is applied in an analysis of historical inflation rate trends and other pertinent economic factors.

When dealing with countries in economic stress, even Step 1 can require judgment because there may not be a single, reliable general inflation index available for the full three-year period.
The IPTF2has developed a process to identify and monitor country inflation statistics. Our experience is that historically, US GAAP and dual reporters often use the IPTF’s analysis as a significant reference point in their documentation.

However, this does not relieve management of its responsibility to perform its own robust assessment of potentially hyperinflationary economies under both GAAPs. Companies should also have appropriate controls in place to monitor such economies. As already mentioned, there are some differences in the IFRS and US GAAP approaches. Therefore, while the underlying data on the economy should be consistently used in both assessments, a dual reporter will need to demonstrate that its assessment complies with both approaches.