HOW HYPERINFLATIONARY AFFECTS FINANCIAL REPORTING | Daily News

HOW HYPERINFLATIONARY AFFECTS FINANCIAL REPORTING

Central Bank of Sri Lanka
Central Bank of Sri Lanka

Inflation is one of the major economic problems experienced by both developing and developed economies. These problems are embodied in the high level of prices as a result of various reasons such as the increased quantity of money supply, prices rising due to increases in production costs, (raw materials and wages), currency depreciation etc. The Sri Lankan economy is highly dependent on imports. For instance, as per the Central Bank report, import expenditure in 2020 was 16,055 million United States (US) dollars and in 2021 it shows 20,637.4 million US Dollars. Import expenditure in Sri Lanka has been increased by 28.54% in 2021 when compared to 2020. As per the Central Bank report 2022, highest import expenditure incurred on intermediate goods. Intermediate goods consists of Fuel, Textiles and Textile Articles, Chemical Products, Base metals, Plastics and articles thereof, Paper and paperboard and articles thereof, Wheat and maize, and Other Intermediate Goods.

As per the IMF Executive Board Sri Lanka Article IV, executive summary shows, “COVID-19 severely hit the economy, causing a loss of tourism receipts and necessitating several strict lockdowns. Pre-pandemic tax cuts and the impact of COVID-19 led to fiscal deficits larger than 10 percent of GDP in 2020 and 2021 and a rapid increase in public debt to 119 percent of GDP in 2021. Sri Lanka’s access to international capital markets was lost in 2020, prompting a decline of international reserves to critically low levels and large-scale direct lending to the government by the Central Bank of Sri Lanka (CBSL). External debt repayments and a widening current account deficit have led to foreign exchange (FX) shortages, while the official exchange rate has been de facto fixed since April 2021. Inflation is on the rise, reaching double digits in December 2021, reflecting imported inflation, supply shocks, and a pickup in domestic demand amid loose monetary policy”.

Due to depreciation of Sri Lankan rupee against the US dollars, there are bad consequences on Sri Lankan Economy. For example, it leads to high inflation as Sri Lanka is highly dependent on imports. The Central Bank of Sri Lanka allowed to float the currencies. As a result, Sri Lankan rupee was depreciated drastically with effects from March 8, 2022. Preceding to this date, exchange rate was constant in the range of LKR 190 to LKR 200 to 1 US dollar. However, with the floating decision by the Central Bank of Sri Lanka, the exchange rate was dropped to LKR 370 to LKR 380 during last couple of months. (March to May 2022).

Increase price in goods and services

As there is a high depreciation in LKR against US Dollars, fuel prices were drastically increased a couple of times in the short term. As a result, the price levels of almost all goods and services are drastically increased in Sri Lanka. As there is a significant inflation in the country, there is a high impact on financial reporting (Konchitchki, 2011; Kramarova, 2021).

As per the conceptual framework for financial reporting, investors, potential investors, lenders and other creditors are the interested parties for financial reporting. These parties may take inappropriate decisions if financial statements are not adjusted against inflation. In addition, there is an adverse effect on “comparability”, one of enhancing qualitative characteristics of useful financial information. Thus, International Accounting Standards Board (IASB) has issued an Accounting Standard to address the above issue in July 1989, under the name of Financial Reporting in Hyperinflationary Economies (IAS 29) (As per Sri Lanka Accounting Standards, LKAS 29).

Application of LKAS 29

LKAS 29 Financial Reporting in Hyperinflationary Economies applies where an entity's functional currency is that of a hyperinflationary economy. Functional currency means the currency of the primary economic environment in which the entity operates. In Sri Lankan context functional currency is Sri Lankan Rupees which has been highly inflated during the last couple of months. LKAS29 doesn’t prescribe when hyperinflation arises. However, it requires the financial statements (and corresponding figures for previous periods) of an entity with a functional currency that is hyperinflationary to be restated for the changes in the general pricing power of the functional currency.

Which jurisdictions are hyperinflationary? LKAS 29 defines and provides general guidance for assessing whether a particular jurisdiction's economy is hyperinflationary. But the IASB does not identify specific jurisdictions. However, there are two reliable sources to see hyperinflationary information. One is the International Monetary Fund (IMF) publishes inflation forecasts and the second one is the International Practices Task Force (IPTF). As per the International Monetary Fund (IMF) inflation forecasts, the following economies have been considered as hyperinflationary economies for the purposes of applying LKAS 29 for the year ending December 31, 2021: Argentina, Islamic Republic of Iran, Lebanon, South Sudan, Sudan, Suriname, Syrian Arab Republic, Venezuela, Yemen, Zimbabwe. In addition, following countries have been listed as per IPTF report issued on November 6, 2021 as hyperinflationary economies. Argentina, Iran, Lebanon, South Sudan, Sudan, Venezuela, Zimbabwe, Suriname, Yemen, Angola and Haiti.

Luckily, Sri Lanka has not been listed as a hyperinflationary economy as per above reports. However, there is a high chance, Sri Lanka to be listed as one of hyperinflationary economies in the forthcoming reports. Therefore, it is crucial to investigate the application of LKAS 29 to Sri Lankan companies. The objective of LKAS 29 is to establish specific standards for entities reporting in the currency of a hyperinflationary economy, so that the financial information provided is meaningful. In Sri Lankan context, this standard was not used frequently in history but, these days many people are talking about the application of this standard to Sri Lankan companies. The basic principle in LKAS 29 is that the financial statements of an entity that reports in the currency of a hyperinflationary economy should be stated in terms of the current measuring unit at the reporting date. Comparative figures for prior period(s) should be restated into the same current measuring unit.

Restatements are made by applying a general price index. Items such as monetary items that are already stated at the measuring unit at the financial position date are not restated. Other items are restated based on the change in the general price index between the date those items were acquired or incurred and the reporting date. For instance, trade receivable, trade payables, cash and cash equivalents are some examples for monetary items whereas property plant and equipment and inventories are some examples for non-monetary items. Monetary items are not restated whereas non-monetary items are restated from the general price index.

When an economy ceases to be hyperinflationary, and an entity discontinues the preparation and presentation of financial statements in accordance with LKAS 29. As per LKAS 29, following information should be disclosed. The fact that financial statements and other prior period data have been restated for changes in the general purchasing power of the reporting currency, whether the financial statements are based on an historical cost or current cost approach and identity and level of the price index at the reporting date and moves during the current and previous reporting period.

(The writer has PhD in Accounting, B.Sc. in Accounting, FCA)


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