International Accounting Standards Financial Reporting in Hyperinflationary Economies Understanding IAS 29
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Preface International Accounting Standards (IAS) are increasingly popular with enterprises raising international capital through debt or equity. This includes many enterprises in emerging markets and fast developing economies which may be hyperinflationary environments. IAS 29 Financial Reporting in Hyperinflationary Economies is an integral and mandatory part of the IAS body of standards. It requires the IAS financial statements of any enterprise reporting in the currency of a hyperinflationary economy to take full account of the effects of inflation using a current purchasing power approach. The requirements of IAS 29 also need to be considered by any enterprise located outside the hyperinflationary environment preparing IAS consolidated financial statements that include a foreign entity (such as a subsidiary, associate, joint venture or branch) which reports in the currency of a hyperinflationary economy. Preparation of financial statements using a current purchasing power approach requires both an understanding of the underlying economic concepts and a complex series of procedures and reconciliations to ensure accurate results. This guide has been prepared to serve as a practical aid for those enterprises applying IAS 29. PricewaterhouseCoopers has helped many enterprises to apply this difficult standard. Our experience and our proven methodology, described in this guide, will make applying IAS 29 less burdensome for your company. Other publications on IAS The following publications on International Accounting Standards have been published by PricewaterhouseCoopers and are available from your nearest PricewaterhouseCoopers office: International Accounting Standards A Pocket Guide 2001 International Accounting Standards Disclosure Checklist 2001 International Accounting Standards Illustrative Corporate Financial Statements 2001 International Accounting Standards Illustrative Bank Financial Statements 2001 International Accounting Standards Illustrative Fund Financial Statements 2001 International Accounting Standards Understanding IAS 39 International Accounting - Similarities & Differences IAS, US GAAP and UK GAAP and on wider aspects of international reporting: Audit Committees Good Practices for Meeting Market Expectations Reporting Progress Good Practices for Meeting Market Expectations You can find latest news, discussions and publications on our website at http://www.pwcglobal.com/extweb/corprep.nsf/docid/ PricewaterhouseCoopers 1
Contents Chapter 1 Introduction 5 Why is this guide needed? 5 Inflation or changes in the general purchasing power of money 5 Characteristics of hyperinflation 5 Benefits of purchasing power adjusted financial statements 6 Objectives of IAS 29 6 Who must apply IAS 29 6 Reporting in a stable currency 6 Intra-group reporting 7 Chapter 2 Applying the standard 9 Overview 9 Selection of the price index 9 Segregation of monetary and non-monetary items 10 Restatement of non-monetary items 11 Income statement 11 The calculation of monetary gain or loss 12 Cash flow statement 12 Restatement of corresponding figures 12 Disclosures 13 Economies ceasing to be hyperinflationary 13 Chapter 3 Restatement procedures for non-monetary balance sheet items 15 Introduction 15 Non-monetary items at fair value or NRV 15 Prepaid expenses 15 Advances paid on purchases 16 Inventories 16 Investments in associates 16 Property, plant and equipment and accumulated depreciation 17 Intangible assets 18 Advances received 18 Deferred income (for instance grants) 19 Deferred tax assets and liabilities 19 Restatement of shareholders equity 19 20 2 PricewaterhouseCoopers
Contents Chapter 4 Restatement of the income statement 21 Revenue 21 Cost of goods sold 21 Depreciation, amortisation of intangible assets and realisation of prepaid expenses and deferred income (grant) 22 Other items included in the income statement 22 Adjustments and/or reclassifications made to statutory financial statements in order to arrive at IAS historic financial statements 22 Taxation on income 22 Monetary gain/loss 23 Chapter 5 Monetary gain or loss 25 Proof average monetary position method 25 Proof statement of sources and application of net monetary assets and liabilities method 25 27 Chapter 6 Cash flows 29 30 Chapter 7 Practical example of IAS 31 PricewaterhouseCoopers 3
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Chapter 1 Introduction Why is this guide needed? IAS 29 is based on current purchasing power principles and requires that financial statements prepared in the currency of a hyperinflationary economy be stated in terms of the value of money at the reporting balance sheet date. This straightforward requirement needs an understanding of complex economic concepts, a thorough knowledge of the enterprise s financial and operating patterns and a detailed series of procedures to implement. It represents a real challenge for enterprises and auditors. The guide provides an overview of the concepts in the standard, descriptions of the necessary procedures and a detailed worked example. This chapter of the implementation guide covers the economic concepts, the objectives of the standard and who must apply it. Inflation or changes in the general purchasing power of money The purchasing power of money declines as the general level of prices of goods and services rises. In an inflationary environment, the general purchasing power of money and the general price level are interdependent. Financial statements unadjusted for inflation in most countries are prepared on the basis of historic cost without regard to changes in the general level of prices. Consequently, the individual assets, liabilities, shareholders equity, revenue, expenses and gains and losses are stated at cost at the time these items originated. The impact of inflation is thus ignored. This produces a meaningful result provided that there are not dramatic changes in the purchasing power of money. Significant changes in the purchasing power of money mean that financial statements unadjusted for inflation are likely to be misleading. Amounts are not comparable between periods and the gain or loss in general purchasing power that arises in the reporting period is not recorded. Financial statements unadjusted for inflation do not reflect an accurate position of the company at the balance sheet date or the results of its operations or cash flows. Inflation adjusted financial statements are an extension to and not a departure from historic cost accounting. IAS 29 seeks to overcome the limitations of historic cost financial reporting in hyperinflationary conditions. Characteristics of hyperinflation IAS 29 does not provide an absolute definition of hyperinflation. The general characteristics identified in IAS 29 are the following: people accumulate wealth in non-monetary assets or in a stable foreign currency; monetary amounts are expressed in terms of a relatively stable foreign currency. Prices (for example, rent, wages and capital goods) may be quoted in that currency; PricewaterhouseCoopers 5
Chapter 1 Introduction prices for credit sales and purchases are calculated to compensate for the expected loss of purchasing power during the credit period, even for short term credit; interest rates, wages and prices are linked to a price index; and the cumulative inflation rate over three years is approaching, or exceeds, 100%. Other characteristics not mentioned in the standard, but which can be useful in determining the presence of hyperinflation, include: severe exchange controls to protect the local currency; and frequent Central Bank intervention in the currency. Frequently asked questions If the cumulative inflation in an economy deemed to be hyperinflationary drops below 100% in a three-year period, has hyperinflation ceased? Probably, the economy has ceased to be hyperinflationary. However, this quantitative measure needs to be evaluated in the context of overall economic developments and trend. Although judgement is involved in determining when an economy is no longer hyperinflationary, all entities should cease to apply IAS 29 from the same date to ensure financial statements are comparable from entity to entity. Benefits of purchasing power adjusted financial statements Financial statements that are expressed in a measuring unit current at the balance sheet date under IAS 29 provide several intrinsic benefits: they give comparable information from period to period to management, shareholders and other users as to the underlying results of operations, capital maintenance and trends in performance; they enable management to make more reliable decisions on capital investment plans as the financial statements are more relevant; and the financial statements become more useful to international investors and other users of accounts in that they are comparable with other companies the same industry. Objectives of IAS 29 The IAS 29 approach is to restate all balances recorded in the financial statements (including comparative numbers) to the year-end general purchasing power of the reporting currency. The effects of the IAS 29 restatement on the financial statements will depend on the magnitude of inflation and the composition of the assets and liabilities of the company. The remeasurement process requires the application of judgement as well as certain required procedures. The standard explicitly states: The consistent application of these procedures and judgements from one period to another is more important than the precise accuracy of the resulting amounts included in the restated financial statements. Who must apply IAS 29 Compliance with IAS 29 is mandatory for any company presenting IAS financial statements in the currency of a hyperinflationary economy, and notably in connection with any application by such a company for listing on an international stock exchange. The standard applies to the financial statements of any enterprise from the beginning of the reporting period in which it identifies the existence of hyperinflation in the country of its reporting currency. Reporting in a stable currency The restatement process outlined in IAS 29 specifically applies to those situations where a company prepares its IAS financial statements in the currency of a hyperinflationary economy. IAS 29 does not address the situation where a company operating in a hyperinflationary economy prepares its IAS financial statements in a stable currency (for example the US dollar). When an enterprise reports in a stable currency, it should ensure that the financial statements have 6 PricewaterhouseCoopers
Chapter 1 Introduction appropriately dealt with the impact of hyperinflation. Enterprises should restate the local currency IAS financial statements in accordance with IAS 29. The year-end exchange rate is used to translate the financial statements into the stable currency for all periods presented. Intra-group reporting A foreign entity operating in a hyperinflationary economy may be required for group purposes to report to its overseas parent in a stable currency, usually the parent s reporting currency. IAS 21 states that the foreign entity must restate its local currency IAS financial statements in accordance with IAS 29 before translation into the parent s reporting currency. A foreign operation s activities may be an integral part of those of the reporting enterprise, where substantially all its transactions are in the currency of its parent. An integral foreign operation located in a hyperinflationary economy reporting to its parent in a stable currency, treats all local currency transactions as if they are foreign currency transactions in accordance with IAS 21 p9. PricewaterhouseCoopers 7
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Chapter 2 Applying the Standard Overview Application of IAS 29 requires the restatement of the financial statements, including the cash flow statements, into current purchasing power at the balance sheet date. This requires a number of procedural steps plus the application of judgement. Consistent application of procedures is more important than the precise accuracy of the results. In outline form, the restatement procedures consist of the following: selection of a general price index, segregation of monetary and non-monetary items, restatement of non-monetary items, restatement of the income statement, calculation and proof of the monetary gain or loss, preparation of the cash flow statement with recognition of inflationary effects, and restatement of corresponding figures This chapter gives an overview of the restatement process. Further chapters provide detailed guidance on complex areas. An extensive worked example is shown in the second half of this publication. Selection of the price index IAS 29 requires the use of a general price index to reflect changes in purchasing power. Most governments issue several periodic price indices that vary in their scope. The standard does not indicate which index to use. It is preferable that all enterprises that report in the currency of the same economy use the same index. The most reliable indicators of changes in general price levels are the consumer price index and the wholesale price index. In some countries, because of differences in the scope and the weighting of items included, the two indices may indicate slightly different rates of inflation in the short-term. Over the long-term, however, the two indices should show approximately the same rate of inflation. The most important attributes for a reliable general price index are: wide range of reference, such as inclusion of most of the goods and services produced in the economy, in order to reflect varying price fluctuations; accurate reflection of price changes; availability of prior year indices as well as those of the current year; regular, preferably monthly, updating; and consistency, uniformity and continuity. PricewaterhouseCoopers 9
Chapter 2 Applying the Standard Once the index has been selected, conversion factors need to be calculated based on the increase in the general price index in order to restate historic cost amounts to current purchasing power. Example: A fixed asset was purchased in December 20X0 at a price of 200 million Currency Units. The restated fixed asset cost at 31 December 20X2, determined using the conversion factors below, is 200 x 4.114 = 822.8 million Currency Units, current at 31 December 20X2. General Price Index Conversion factor 31 December 20X0: 54.224 4.114 (223.100/54.224) 31 December 20X2: 223.100 1.000 (223.100/223.100) Segregation of monetary and non-monetary items The standard requires restatement of all balance sheet amounts that are not expressed in terms of the measuring unit current at the balance sheet date. Monetary items do not need to be restated as they represent money held, to be received or to be paid. Thus, monetary items are already in current purchasing power. To apply the standard, all balance sheet items must be segregated into monetary and non-monetary items. Most balance sheet items are obviously monetary or non-monetary. In less straightforward cases, the determination as to whether a component is monetary is dependent on its underlying characteristics. For example, the provision for doubtful accounts is considered monetary because receivables are monetary. However, the provision for inventory obsolescence is non-monetary because inventory is non-monetary. Examples of monetary assets and liabilities are: Assets Cash and due from banks Marketable debt securities Trade receivables Notes receivable Other receivables Liabilities Trade payables Accrued expenses and other payables Taxes and withholding taxes payable Borrowings Notes payable 10 PricewaterhouseCoopers
Chapter 2 Applying the Standard Assets and liabilities other than monetary items are called non-monetary items. Once paid in or accumulated, all elements of shareholders equity are non-monetary. Examples of non-monetary items are: Assets Prepaid expenses * Advances paid on purchases Inventories Marketable equity investments Investments in associates Property, plant and equipment Intangible assets Deferred tax assets Liabilities *Advances received on sales Deferred income (for example, grants) Deferred tax liabilities Shareholders equity * Advances paid or received are considered non-monetary if they are linked to specific purchases or sales, otherwise they should be considered monetary. Restatement of non-monetary items Non-monetary assets and liabilities are restated in terms of the measuring unit current at the balance sheet date, using the increase in the general price index from the transaction date, when they arose, to the balance sheet date. Specific issues arise when restatement increases the carrying amount of assets beyond the net realisable value or if non-monetary assets are carried at fair value. Detailed guidance on these issues and on the restatement of non-monetary items is included in the balance sheet found in Chapter 3. Income statement The historic cost income statement generally reports revenues and costs that were current whenever the underlying transaction or event occurred. IAS 29 requires that all items in the income statement be expressed in terms of the measuring unit current at the balance sheet reporting date. Therefore, all amounts need to be restated by applying the change in the general price index for the dates when the items of income and expenses originated. Income statements are normally restated on a monthly basis. Income statement items, such as interest income and expense, and foreign exchange differences related to invested or borrowed funds are also associated with the net monetary position. These items are adjusted for inflation and, along with the monetary gain or loss, presented as separate lines under the non-operating items caption in the income statement. These items may be subtotalled within the non-operating caption as financing income or expenses. Detailed guidance on restatement of the income statement is found in Chapter 4. PricewaterhouseCoopers 11
Chapter 2 Applying the Standard The calculation of monetary gain or loss One of the two main objectives of IAS 29 is to account for the financial gain or loss which arises from holding monetary assets or liabilities during a reporting period (the monetary gain or loss). The monetary gain or loss is calculated based on the enterprise s monetary position. The monetary position can be derived from the basic equation: Assets monetary non-monetary Liabilities = monetary + non-monetary Shareholders Equity Therefore Monetary Assets Monetary Non-monetary Non-monetary = + Liabilities Liabilities Assets Shareholders Equity Monetary position Non-monetary All monetary assets and liabilities (net monetary position) held during the year are represented in the financial statements either by non-monetary assets and liabilities recorded on the balance sheet, or by transactions recorded in the profit and loss account if they have been realised. The monetary gain or loss may be calculated by restating non-monetary items (including the profit and loss account that is a part of shareholders equity) to year-end purchasing power and comparing the restated values to the historic cost amounts or, where balances existed at the beginning of the year, to the historic amounts restated to the beginning of the year purchasing power. It is also theoretically possible to calculate the gain or loss on the company s daily net monetary position. The costs of such a calculation, however, would be onerous. An approximation of the monetary gain or loss can be calculated using average monetary positions during the period as a reasonableness test of the monetary gain or loss derived by restating the non-monetary assets and liabilities. Additional detail on calculation of the monetary gain or loss, and proof of the amount, is found in Chapter 5. Cash flow statement IAS 29 requires that all items in the cash flow statement be expressed in a measuring unit current at the balance sheet date. Therefore, all items in the cash flow statement are restated by applying the relevant conversion factors from the date the transaction originated. IAS 29 does not provide detailed guidance on this complex area. However, looking at the objectives of both IAS 29 and IAS 7 it is possible to arrive at an appropriate presentation. This includes separate disclosure of the effects of inflation on operating, investing and financing activity and on cash and cash equivalents itself. Detailed guidance on preparation of the cash flow statement is included in Chapter 6. Restatement of corresponding figures The prior year comparatives are restated in terms of the measuring unit current at the end of the latest reporting period. If prior year financial statements have already been prepared to conform with IAS 29, the current year conversion factor is applied to the prior year financial statements. 12 PricewaterhouseCoopers
Chapter 2 Applying the Standard Disclosures Enterprises should describe in their accounting policy note the methodology used in applying IAS 29. The following specific information should be disclosed in accordance with IAS 29: the fact that the financial statements and the corresponding figures for previous periods have been restated for the changes in the general purchasing power of the reporting currency and, as a result, are stated in terms of the measuring unit current at the balance sheet date; the identity and level of the price index at the balance sheet date and the movement in the index during the current and the previous reporting period; and whilst not required by the standard it is useful to disclose the three-year cumulative inflation rate at the balance sheet date for each period presented in the financial statements. Economies ceasing to be hyperinflationary When an economy ceases to be hyperinflationary and a company discontinues the preparation and presentation of financial statements in accordance with IAS 29, it should treat the amounts expressed in the measuring unit current at the end of the previous reporting period as the basis for the carrying amounts in its subsequent financial statements. Practically speaking, an enterprise will continue to use the restated amounts as the cost basis of the non-monetary items in the balance sheet. Enterprises preparing IAS accounts for the first time in economies which have ceased to be hyperinflationary will need to make a cumulative adjustment to the non-monetary items in the balance sheet. All adjustments to non-monetary items will be charged or credited to retained earnings. Although IAS 29 is no longer applicable in this situation, an enterprise may, if it wishes, provide supplementary information reflecting the effects of changing prices using the guidance in IAS 15. PricewaterhouseCoopers 13
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Chapter 3 Restatement procedures for non-monetary balance sheet items Introduction All non-monetary components of the balance sheet, excluding retained earnings, are restated by applying a general price index from the dates on which the items arose at the first application of IAS 29. Restated retained earnings, excluding current year earnings, are the balancing figure derived from all the other amounts in the opening restated balance sheet. This chapter describes the detailed procedures for restating non-monetary assets and liabilities. Non-monetary items at fair value or net realisable value Some non-monetary assets may be carried at fair value at the balance sheet date such as fixed assets revalued by an independent appraiser as allowed under IAS 16, marketable equity securities fair valued under IAS 39 and investment properties carried at fair value under fair value model of IAS 40. The historic cost amounts should be restated in order to obtain the appropriate monetary gain or loss. The restated carrying amount should then be compared to the current values and the difference, if any, charged or credited to the income statement or shareholders equity in accordance with the appropriate IAS. The net realisable value of an asset may be less than its restated amount. Application of the normal lower of cost and market value rule would therefore result in a write-down to net realisable value in the restated financial statements, even if no write-down of the asset was required in the historic cost financial statements. Prepaid expenses Obtain the ageing of prepaid expenses. Restate prepaid expenses from the date of the payments to the balance sheet date. Frequently asked questions Marketable Securities Should equity securities that are carried at fair value be restated? Equity securities classified as either held for trading assets or available-for-sale assets are carried at fair value on the balance sheet under IAS 39. Fair value gains and losses on held for trading assets are recognised immediately in the income statement where fair value gains and losses on available-forsale assets are recognised, under a one-time policy choice, either in equity or in the income statement. Fair value gains and losses deferred in equity are recycled to the income statement on disposal or impairment. The treatment for IAS 29 requires the historic cost of the equity securities be restated. The difference between the fair value of the equity securities and the restated historic cost of the equity securities is the fair value gain or loss. PricewaterhouseCoopers 15
Chapter 3 Restatement procedures for non-monetary balance sheet items Advances paid on purchases Obtain a breakdown of advances paid ensuring that where appropriate, the relevant specific advances have already been netted off against accounts payable. For advances paid in respect of purchases of future inventories or fixed assets, obtain the ageing of advances, including the amounts and payment dates. Restate advances according to the ageing schedule from the payment dates to the balance sheet date. When the inventory or fixed asset is received the restated carrying value of the advance should be added to the restated cost base of the asset. Inventories Raw materials Obtain the historic cost prices and acquisition dates of raw materials. If a detailed ageing of inventory cannot be obtained, the average ageing of items could (subject to materiality considerations) be estimated using inventory turnover. If the FIFO or moving average method is used, restate raw materials inventories based on the ageing of the related items using the increase in the general price index for the period from the purchase dates to the balance sheet date. If a yearly average is used, restate raw materials using the yearly average increase in the general price index. Semi-finished/finished goods Obtain the ageing of semi-finished and finished goods. Deduct the historic depreciation expense of property, plant and equipment that is included in cost of semi-finished goods as this will be replaced with the restated depreciation expense. If the FIFO or moving average method is used, restate the balance of semi-finished goods, based on the ageing of the composition of cost elements included in inventories. If yearly average costing is used, restate using the yearly average increase in the general price index. After completion of the restatement as mentioned above, add back to inventory the attributable depreciation calculated by reference to the restated property, plant and equipment balances. After the inventory has been restated, review the restated balances to determine the need for any net realisable value provisioning. Frequently asked questions Inventory Will the costing method of inventory (for example FIFO, LIFO, or weighted average) have an impact on the IAS 29 restatement? The costing method should have no impact on the final restated value of the inventory if there are no price changes in real terms. For example under both the FIFO and LIFO inventory costing methods, the historic cost of the inventory would be restated to year-end purchasing power. In practice, there is likely to be slightly different results as the changes in the cost of inventory may not be exactly equal to the change in the general price index. How are inventory and the related provision for impairment treated when the inventory is subsequently sold or disposed of? Inventory, and any provision against the carrying value, is a non-monetary item. As such, the carrying value of both the inventory and the provision should be inflated up to the date of the sale or disposal. Investments in associates Obtain the historic cost prices and acquisition dates of investments according to the purchase date and cost of purchase. Restate the balance of investments, using the increase in the general price index from the purchase date to the balance sheet date. Compare the restated investment balance with the market value, and adjust the investment balance, if necessary, based on the lower of restated cost and market value. 16 PricewaterhouseCoopers
Chapter 3 Restatement procedures for non-monetary balance sheet items Frequently asked questions Subsidiaries and associates What exchange rates should be used when consolidating a foreign subsidiary of an entity reporting in a hyperinflationary economy? If the foreign subsidiary is operating in an economy that is not experiencing hyperinflation the income statement should be translated using the historic exchange rates (in practice average exchange rates may be used). The income statement items should then be restated in accordance with IAS 29 from the date of the transaction (which would be the same date used to translate the foreign currency into the local hyperinflationary currency). This will facilitate the elimination of any inter-company transactions as the transactions will be on the same basis of accounting and thus be comparable. The balance sheet should be translated into the hyperinflationary currency using the closing rate method. The investor s share of net assets in the subsidiary at the beginning of the year (as calculated by the equity method of accounting) should be adjusted for current year inflation. The difference between the parent s share of the closing net assets and the opening balance and earnings for the period both adjusted for inflation as described above should be charged to equity as a translation adjustment. What exchange rates should be used when equity accounting for a foreign associate of an entity reporting in a hyperinflationary economy? The investor s share of the results of operations would be translated into the reporting entities currency at the dates the earnings accrued. The earnings would then be restated to year-end purchasing power in accordance with IAS 29 in the consolidated accounts from the date of translation. The opening investment balance accounted for using the equity method at opening exchange rates should be adjusted for inflation to year-end purchasing power. To calculate the net investment in the associate, the investee s balance sheet should be translated into the reporting currency at year end rates, which forms the basis for carrying value of the investment. The difference between the carrying value and the opening balance plus earnings for the period, both adjusted for inflation, should be charged to equity as a translation adjustment. Property, plant and equipment and accumulated depreciation Obtain the original historic cost prices and acquisition dates of property, plant and equipment. The restatement should be based on the original purchase date of the asset, not the capitalisation date. If existing, eliminate from the IAS historic financial statements any revaluation of construction in progress, property, plant and equipment and the associated accumulated depreciation that does not meet the conditions of IAS 16. Restate the original purchase cost of property, plant and equipment from the date of the purchase of each item to the balance sheet date, using the general price index. Calculate the depreciation charge for the period on the basis of the restated property, plant and equipment. Opening accumulated depreciation is also calculated on the basis of restated property, plant and equipment. For disposals determine the original date of purchase and the historic cost. Calculate and then deduct the restated property, plant and equipment balance that has been disposed of and its accumulated depreciation. Historic depreciation charges included in general administrative expenses, idle time expenses, cost of goods sold and inventory balances should be replaced with the depreciation expense calculated on the basis of the restated property, plant and equipment balances. PricewaterhouseCoopers 17
Chapter 3 Restatement procedures for non-monetary balance sheet items Obtain the historic cost prices and acquisition dates of the construction in progress balance and restate the balances by applying indices according to transaction date. When the construction in progress is subsequently transferred to fixed assets the related inflation adjustment should be transferred and applied to the asset. If the company capitalises interest in accordance with IAS 23, the part of the capitalised borrowing cost that compensates for the inflation during the same period should be recognised as an expense in the period in which those costs were incurred. If the company capitalises exchange losses in accordance with the allowed alternative treatment in IAS 21, such exchange losses should (for the purpose of IAS 29) be recognised as an expense in the period in which they arise. For the initial year of adopting the IAS 16 alternative treatment for measurement, the historic cost of the fixed asset would be restated in accordance with IAS 29 in order to obtain the correct monetary gain or loss in the income statement. The carrying value would then be replaced with the appraised value, the difference should be treated in accordance with IAS 16.39 or 16.40. Assess for impairment in accordance with IAS 36. Frequently asked questions Property, plant, and equipment What indices are used to restate construction in progress (CIP)? How does the restatement of CIP affect the future value of fixed assets? CIP should be restated from the date the payment was made. An asset or project within CIP should be restated within CIP. When capitalised, the related inflation adjustment should be transferred to fixed assets and added to the cost base of the item being transferred. When an entity is initially adopting IAS 29 where the economy of the reporting entity has been experiencing hyperinflation in previous years, it is important to consider the inflation effect on fixed assets which were previously held in CIP How are assets that have been remeasured by an independent appraiser in accordance with IAS 16 treated when restating the fixed assets in accordance with IAS 29? If assets are revalued during a year of restatement the historic cost should be restated in order to arrive at the correct monetary gain or loss. The restated cost would then be compared to the appraised amount, the difference would be treated as noted in IAS 16. In subsequent years the appraised carrying amount and the revaluation reserve (unless it is first year of IAS 29 application when eliminated) would be restated. Intangible assets Intangible assets, including goodwill, are inflated in the same manner as property, plant, and equipment. Advances received Obtain a breakdown of advances received ensuring that, where appropriate, the relevant specific advances have been netted off against the relevant accounts receivable. Obtain the ageing of advances received. Restate advances according to the ageing and increase in the general price level from the date of receipt to the balance sheet date. When the sale is realised the restated advances received should be added to the sales value. Deferred income (for instance grants) Obtain the ageing of deferred income according to the date of receipt. Restate the original amount of deferred income received from the transaction date to the balance sheet date. Calculate accumulated amortisation and current period amortisation on the basis of the restated deferred income balance. Replace historic amortisation credited to the income statement with the amortisation calculated on the basis of the restated deferred income. 18 PricewaterhouseCoopers
Chapter 3 Restatement procedures for non-monetary balance sheet items Frequently asked questions Provisions for liabilities and charges Are provisions for liabilities and charges monetary or non-monetary items, for example should we recognise a gain as a result of holding provision or not? Provisions for liabilities and charges could be monetary, monetary but inflation linked, or non-monetary. Their classification depends on the nature of liability exposed. If warranty obligations are limited to a defined original amount, the warranty provision is monetary. If the enterprise s liability is specified as a repair or exchange of the item under warranty, the liability is non-monetary. Deferred tax assets and liabilities See Taxation on income on page 22. Restatement of shareholders equity At the beginning of the first period of application of IAS 29, the components of shareholders equity in the opening balance sheet, excluding retained earnings, are restated by applying a general price index from the dates on which the items arose. Any revaluation surplus that arose in previous periods is eliminated. Restated retained earnings is the balancing figure derived from all the other restated amounts in the restated opening balance sheet. At the end of the first period and in subsequent periods, all components of shareholders equity are restated by applying a general price index from the beginning of the period, or the dates on which the items arose if later. This restatement forms part of the monetary gain or loss calculation. Any statutory revaluation surplus (that is not in accordance with IAS 16) arising in subsequent periods is eliminated against the related assets revalued. Current year restated net income is added to the balance of the restated opening retained earnings. For the purpose of the statement of changes in shareholders equity, dividends paid during a period should be restated by applying a general price index from the date when the shareholders right to receive payment is established to the balance sheet date. Frequently asked questions Equity What are the components of shareholders equity that need to be restated? Which dates should be used for the restatement? All components of shareholders equity should be restated, with certain exceptions for revaluation reserves. Legal and extraordinary reserves are generally become a part of retained earnings in IAS accounts. These reserves are not considered for restatement purposes. It may be beneficial to disclose the historic statutory reserves in the footnotes to the financial statements. Capital increases should be restated from the date the consideration was received. If consideration was received in the form of a non-monetary contribution (such as fixed assets contributed), the fair value of the asset should be used as the historic cost. How is the revaluation reserve in equity treated? Very often statutory regulations for countries operating in a hyperinflationary economy allow companies to increase the carrying value of fixed assets based on prescribed rules, with a corresponding increase to the equity usually called the revaluation reserve. Generally, these statutory revaluation adjustments are not in accordance with IAS 16, Property Plant, and Equipment, and, should be eliminated from the IAS accounts. If a revaluation has been performed at year-end in accordance with IAS 16, the revaluation reserve would be the difference between the historic values restated in accordance with IAS 29 and the revalued amounts per IAS 16. There would be no need to inflate the revaluation reserve, as it would be current at year-end. In subsequent years the revaluation reserve would be inflated. PricewaterhouseCoopers 19
Chapter 3 Restatement procedures for non-monetary balance sheet items Equity continued How should a share capital increase by way of a transfer from the statutory revaluation surplus be treated? As noted above, the statutory revaluation surplus is eliminated from the IAS restated financial statements. Thus, a share capital increase by way of a transfer from the statutory revaluation surplus is not considered in calculating the restated paid-in capital. The increase of the share capital will be offset by a reduction of retained earnings. The amount of the increase to be disclosed is the restated amount of statutory increase inflated as from the date of increase authorisation. How are dividends payable treated? A dividend payable is a monetary liability that will result in a monetary gain for the company. Therefore, the dividend amount should be excluded from retained earnings at the date the dividend becomes payable. Should unpaid capital that the shareholders have committed to pay be inflated? The treatment of the unpaid share capital depends on whether the shareholder is legally bound to pay-up the capital or whether the commitment is nothing more than an unbinding promise to pay. If the shareholder has no legal obligation to pay this capital there would be no receivable recorded in the company s books. The unpaid capital and commitment would be disclosed in the footnotes at the historic amounts which is the consideration expected to be received by the company. There is no effect on monetary gain or loss, as the company does not have an enforceable receivable. However, if the capital increase is legally binding, and approved by the general assembly, the company would show a receivable from shareholders with a corresponding increase in share capital (the fact that the share capital has not been paid-up would be disclosed in the footnotes). The share capital would be restated to account for any subsequent changes in inflation that creates a monetary loss in the income statement from holding the receivable. 20 PricewaterhouseCoopers
Chapter 4 Restatement of the Income Statement All items in the income statement should be restated by applying the change in the general price index from the dates when the items of income and expense were originally recorded. Provided inflation is occurring at a relatively stable rate during the year, most enterprises will restate activity on a monthly average basis, with all transactions presumed to occur evenly throughout the relevant period. This chapter describes the detailed procedures for restating the income statement. Revenue Obtain a monthly break down of revenue. Restate each period using the appropriate indices to year-end. Frequently asked questions Selection of the index What is the correct index to be used to restate the income statement? The items within the income statement should be restated from the date of the transaction. Having said this, it is generally not practical to restate the items from the date of the transaction, therefore, average indices may be used as approximations. The average indices to use would depend on the frequency of the transaction (in other words sales earned evenly throughout the period) and whether inflation was relatively constant throughout the period. If the income statement transactions occurred evenly throughout the year, without seasonal fluctuations, and inflation was relatively constant during the year, the yearly average index may be used for the restatement. In practical terms, this is never the case and use of monthly indices is more appropriate. Cost of goods sold Obtain the monthly breakdown of the items included in production costs. Restate all components of production costs, except depreciation and raw materials, from the month when the costs were incurred to the year-end. Calculate raw material used in the production process through the reconciliation of restated opening raw materials and closing raw materials balances. Calculate depreciation related to production costs on the basis of the restated property, plant and equipment, as explained on balance sheet section, and replace the historic depreciation with this restated depreciation. Restate opening and closing historic finished and semi-finished goods as explained on balance sheet section. The restated cost of goods sold figure is obtained by adding to purchases and other production costs restated from the date when the cost was PricewaterhouseCoopers 21
Chapter 4 Restatement of the Income Statement incurred the restated opening finished and semi-finished goods and deducting the restated closing finished and semi-finished goods. The restated opening finished goods and semi-finished goods is derived by: Restating amounts to the prior balance sheet date purchasing power, and Inflating the restated cost of opening amounts as calculated above by the conversion factor for the entire year. Depreciation, amortisation of intangible assets and realisation of prepaid expenses and deferred income (grant) Depreciation of property, plant and equipment, amortisation of intangible assets and realisation of prepaid expenses and deferred income is calculated on the basis of the restated asset and/or liability balance. Other items included in the income statement Obtain the monthly breakdown of all items. Restate all items for each month using the increase in the general price index from the related month or quarter until the year-end. Certain non-monetary items being included in the opening balance sheet could be realised through the income statement for the period, for example inventory and disposed property, plant and equipment. In that case the restatement should be applied with taking into account the restatement surplus accumulated whilst the item was recognised on the balance sheet. Frequently asked questions Foreign exchange Should interest income or expense and foreign exchange gains or losses be restated? IAS 29.26 states that all items in the income statement should be restated. There are no exceptions to this rule. Frequently asked questions Bad debts If the bad debt expense is inflated the movement schedule of the provision does not reconcile. How then does the opening and closing balance reconcile? At the time the debt is considered bad it is provided against. The provision is a monetary item as the underlying asset it relates to is monetary. Therefore a monetary gain will result from carrying this provision (which actually offsets the monetary loss being incurred as a result of holding the receivable). The bad debt expense is inflated from the date the provision was made. To ensure the reconciliation of the provision account, all items must be in terms of the measuring unit current at the balance sheet date. The difference between the restated opening balance, restated current period expense (net of any restated provision reversals) and the closing balance is a monetary gain. Adjustments and/or reclassifications made to statutory financial statements in order to arrive at IAS historic financial statements If the adjustment and/or reclassification made in accordance with IAS is related to a specific period or specific date, the adjustment and/or reclassification calculated in historic terms should be restated for the related time period, using the increase in the general price index from the specific date to the balance sheet date. Taxation on income Current taxation Obtain details of monthly or quarterly taxation calculated on the basis of the monthly or quarterly taxable income of the company. Restate monthly or quarterly tax expenses for each month or quarter in terms of balance sheet date purchasing power, using the increase in the general price index from the related month or quarter until the reporting date. 22 PricewaterhouseCoopers
Chapter 4 Restatement of the Income Statement Deferred taxation Calculate deferred tax expense/income and deferred tax liability/asset with reference to historic adjustments made (if any) in moving from the tax accounts to the IAS historic financial statements. Calculate deferred tax in relation to temporary differences arising from the restatement of nonmonetary assets and liabilities. According to IAS 12 (revised) deferred tax is calculated in full on the temporary differences arising from the restatement of non-monetary assets and liabilities. As the closing deferred tax position is calculated as the difference between the tax base and the IAS 29 adjusted financial statements (that is to say measuring unit current at the balance sheet date) there is no need to adjust the closing deferred tax balance for inflation. The difference between the opening deferred tax balance, adjusted to yearend purchasing power, and the closing deferred tax balance is the deferred tax expense or credit for the period. Monetary gain/loss The gain or loss on the net monetary position arises from holding monetary assets and liabilities, and is reported as a separate item in the restated income statement (see Chapter 5 for additional detail on the monetary gain or loss). The monetary gain or loss is derived from restating the closing balance sheet (less the inflation adjustments to the opening balance sheet in prior year-end purchasing power) and the items in the income statement. The derived amount may need additional netting off with the indexation differences occurred in the income statement on those monetary items that are linked to inflation index and as such, being not subject to inflationary risks or holding benefits, such as monetary gains or losses. PricewaterhouseCoopers 23
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Chapter 5 Monetary gain or loss Calculation and proof of the monetary gain or loss is an important element of applying IAS 29. This chapter contains several methods to prove the accuracy of the monetary gain or loss arising from restatement. The monetary gain or loss may be estimated by applying the change in a general price index to the weighted average difference between monetary assets and monetary liabilities. The weighted average of the opening monetary position and the monetary position at year-end may be used for the purpose of this calculation. It is possible, however, that a large difference may arise between the monetary gain or loss in the income statement and the estimate as calculated by the proof if the monetary position has not been relatively constant throughout the year. Proof statement of sources and application of net monetary assets and liabilities method In addition, a statement of source and application of net monetary assets or liabilities is often prepared as alternative proof of the net monetary gain or loss (see below). The items which cause changes in the monetary assets/liabilities are analysed, and the net balance of the monetary assets/liabilities is determined as if there were no changes first, and then you should adjust for current year movements. Restatements are performed and the comparison with the actual net balance and movements of monetary assets or liabilities enables the monetary gain or loss to be approximated. Therefore, if the monetary position is changing significantly a more accurate proof of the monetary gain or loss would be obtained by using the quarterly or monthly weighted average monetary position in the proof calculation. Proof average monetary position method A simple example with a constant monetary position is set forth below. In this example it would be appropriate to use the weighted average of the opening and closing monetary position. PricewaterhouseCoopers 25
Chapter 5 Monetary gain or loss Conversion factor 1.649 for the year Closing position Currency Units Opening position Inflation current at the Currency Units adjustment balance sheet date Balance sheet Cash 10,000 10,000 Share capital 10,000 6,490 16,490 Retained earnings (6,490) (6,490) Income statement Monetary loss (6,490) (6,490) Monetary loss proof: Average monetary position for the year (10,000+10,000)/2) 10,000 Change in inflation factor (1.649 1.000) 0.649 Monetary loss estimated for the year 6,490 Monetary loss per income statement (6,490) Procedures for preparation of a statement of source and application of net monetary assets and liabilities are as follows: Historic column: 1. Calculate the net monetary position at the beginning of the period under restatement. 2. Identify all items that caused changes in the monetary position during the period. These should be the actual or uninflated changes in the monetary position. These items can be obtained from the historic cost income statement and/or cash flow statement. 3. Arrive at the monetary position at the end of the period by adding or subtracting the changes as identified. Check that monetary position as calculated is equal to the actual monetary position at the end of the period. Restated column: 4. Calculate the net monetary position at the beginning of the period as in step 1 above, but restate it for inflation for the entire period. The inflation adjustment restates the opening monetary position as if there were no monetary gain or loss, in other words by adjusting the opening monetary position as if the opening monetary assets and liabilities were not eroded as a result of inflation. 5. Inflate the changes in the monetary position (step 2 above) but restate as if there were no monetary gain or loss, for example adjusting the changes in monetary position for inflation restates the monetary changes as if the monetary assets and liabilities obtained or disposed of during the period were not eroded as a result of inflation. These items may be obtained from the inflation adjusted income statement and/or cash flow statement. 6. Determine the net monetary position restated at period end as if inflation had not effected the monetary assets and liabilities. Note that the real monetary position does not change as a result of the inflation adjustment. Proof: 7. Compare the actual net monetary position at the end of the period included in the historic column with the restated net monetary position at the end of the period in the restated column. The difference between the actual position and the restated monetary position is the estimate of the monetary gain or loss. This estimate should be compared to the actual gain or loss in the income statement. A simple example is set out on the next page to demonstrate such statement preparation. For the purposes of this example, the inflation factor was 1.650 and there were only two types of transactions that happened evenly throughout the period. 26 PricewaterhouseCoopers
Chapter 5 Monetary gain or loss Closing position at period end Opening Closing Inflation purchasing position position adjustments power Balance sheet Cash 100 100 100 Trade receivables 200 200 100 300 Trade payables 100 100 Share capital 100 100 65 165 Current profit 100 (65) 35 100 300 Income statement Credit sales 200 60 260 Cost of sales (100) (30) (130) Monetary loss * (95) (95) Profit 100 (65) 35 * Monetary loss is calculated as follows: Monetary loss from sales (60) Monetary gain from cost of sales 30 Restatement of share capital (65) (95) Monetary loss proof statement of sources and application of net monetary assets and liabilities Historic Restated Net monetary asset at the beginning of the period 100 165 Add movement in receivables 200 260 Deduct movement in payables (100) (130) (A) 200 (B) 295 Monetary loss ((A)-(B)) (95) PricewaterhouseCoopers 27
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Chapter 6 Cash flows Preparation of a cash flow statement under IAS 29 presents some unique challenges. All activity needs to be presented in current purchasing power, but readers of the financial statements must also be able to follow cash flows between the restated balance sheets and income statements. Most enterprises use the indirect method although both methods are presented in the detailed example in Practical example of IAS 29. There are three unique elements in the hyperinflationary cash flow statement: net income before tax is adjusted for the monetary gain or loss for the period; the effect of inflation on operating, financing and investing activity is disclosed separately; and the monetary loss on cash and cash equivalents is presented separately. The example below shows how the monetary gain element impacts financing activity. Example: Below are the historic and price level adjusted movements on a loan account. Inflation in the year is 100%, average inflation for the year is 41%; assume movements occur rateably over the year. Balance Draw down Repaid Monetary Balance 20X7 gain 20X8 Historic movements 1,000 500 (700) 800 Conversion factor 2.0 1.41 1.41 1.0 Price level adjusted 2,000 705 (987) (918) 800 A B C PricewaterhouseCoopers 29
Chapter 6 Cash flows How should the monetary gain of 918 be recorded in a statement of cash flows? There is no authoritative guidance, but it seems most appropriate to show this movement as financing activity with separate disclosure of the components of the movement. This can be illustrated as follows: Proceeds Reduction of loan balances Inflationary effect on financing activities A B+C (C) Net cash flow from financing activities A+B This has the following advantages: Changes in the loan balance can be reconciled to movements in the restated balance sheets; and Total gains from financing activity can be seen. 30 PricewaterhouseCoopers
Chapter 7 Practical example of IAS 29 This section of the guide provides a detailed practical example of the application of IAS 29. The term restated is used to describe financial statements after the application of IAS 29. The term historic is used to describe financial statements before restatement to current purchasing power. This example is prepared for illustrative purposes only, income statement, statement of changes in shareholders equity and statement of cash flows are presented for one year. Under IAS 1 comparative figures of these statements are required to be disclosed by the reporting enterprise. This example does not cover all possible circumstances, nor does it take account of any specific legal framework. Depending on the circumstances, further specific information may be required in order to ensure fair presentation under International Accounting Standards. The example is arranged as follows Page A B Historical Financial Statements (without notes) A.I Historical Balance Sheets as at 31 December 2003 and 2002 34 A.II Historical Income Statement for the year ended 31 December 2003 35 A.III Historical Statement of Cash Flows for the year ended 31 December 2003 36 37 A.IV Historical Statement of Changes in Equity for the year ended 31 December 2003 38 Additional Historical Information Required for IAS 29 Restatement B.I Property, Plant and Equipment 39 B.II Investments B.II.1 Investment in associated undertaking 40 B.II.2 Other long-term investments 40 B.II.3 Trading investments 40 B.III Inventories and Production Expenditures Incurred B.III.1 Inventory movements for the year 41 B.III.2 Analysis of production costs incurred within the period 41 B.III.3 Holding period of inventory 41 B.IV Equity B.IV.1 Share capital 42 B.IV.2 Dividends 42 PricewaterhouseCoopers 31