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How high inflation impacts financial reporting according to HGB and IFRS

In 2022, inflation accelerated markedly around the world. In view of the large number of significant consequences for businesses and consumers, the potential impact on the financial reporting by businesses also needs to be discussed. Taking high inflation rates into account can be challenging, in particular, in the context of the preparation and audit of consolidated financial statements in accordance with the German Commercial Code (Handelsgesetzbuch, HGB) and International Financial Reporting Standards (IFRS).

Specific accounting standards for factoring in high inflation

In high inflation countries loss of purchasing power can be so severe that a comparison over time of amounts in the nominal local currency is difficult or provides little meaningful information. The aim of the standard setters consists in defining specific guidelines for companies that report in the currency of a high inflation country in order to ensure that their financial information is and remains sufficiently meaningful. 

  • In financial reporting according to IFRS, the IASB has regulated how to deal with above-average high inflation in IAS 29. 
  • The Accounting Standards Committee of Germany (ASCG) has detailed how to deal with high inflation under commercial law in its German Accounting Standard (GAS) 25. 

These guidelines should be used respectively when subsidiary companies from high inflation countries have to be included in consolidated financial statements. 

Definition of the concept of high inflation

The IASB and also the ASCG have not established an absolute rate at which high inflation is deemed to arise. Instead, discretionary leeway is allowed and indicators within the economic environment have been defined that could point to the existence of high inflation. Such indicators are that, in particular,

  • amounts of local currency held are immediately invested (to maintain purchasing power),
  • interest rates, wages and prices are linked to a price index, or
  • the cumulative inflation rate over three years approaches, or exceeds, 100%.

Interim conclusion: Taking into account the above-mentioned indicators and with a view to applying GAS 25 or IAS 29, as at 31.12.2022, the following economies have to be considered highly inflationary: Argentina, Ethiopia, Iran, Lebanon, South Sudan, Sudan, Suriname, Syria, Turkey, Venezuela, Yemen and Zimbabwe. 

Application of IAS 29 in IFRS single entity financial statements

Where an entity’s functional currency is that of a highly inflationary economy, IAS 29 requires the financial statements of that entity to be stated consistently in terms of the measuring unit current at the balance sheet date. To this end, balance sheet as well as profit and loss items will potentially need to be restated with the aid of a general price index. Comparative figures for prior periods should also be restated.

Here, IAS 29 requires a restatement for non-monetary assets and liabilities, equity capital as well as all items in the statement of comprehensive income. Monetary items are not restated because they are already or should be expressed in terms of the measuring unit current at the balance sheet date. Non-monetary items are restated on the basis of changes in a general price index from the dates that the items were purchased or acquired and up to the balance sheet date. This will result in a significant increase in the carrying amounts of non-monetary assets. Examples that could be mentioned here

… of monetary items: cash and cash equivalents, trade receivables, trade payables, income tax;
… of non-monetary items: accrued/prepaid expenses, inventories, equity interests held in associates, property, plant and equipment, intangible assets, equity capital, deferred income.

Non-monetary assets that have been restated in terms of the measuring unit current at the reporting date, in accordance with IAS 29, would still have to be subjected to an impairment test. If the recoverable amount for an asset is below that of its restated amount then the asset is written down even if on the basis of historical acquisition or production costs it would not have been necessary to report an impairment of the asset in the financial statements. Any impairment loss is recognised as an expense. 

Please note: Companies that have tested assets for impairment in earlier reporting periods will have to analyse whether or not the inflation-related restatement of the carrying amounts of the assets affects the result of the impairment test.

Special rules in consolidated financial statements ...

… according to IFRS 

When IFRS consolidated financial statements are being drawn up it is necessary to take into account IAS 21.43; this requires that where the functional currency of a subsidiary company is that of a highly inflationary economy then the financial statements have to be restated in accordance with IAS 29 before the subsidiary is included in the consolidated financial statements. IAS 29 is applied to all of the subsidiary company’s assets and liabilities before the translation into another currency. In this respect, it should be noted that fair value adjustments as well as any goodwill from the acquisition of the subsidiary company would likewise have to be restated in accordance with IAS 29. All the amounts in the subsidiary company’s financial statements are subsequently translated into another currency at the closing rate on the reporting date. 

Comparative amounts that were previously expressed in a stable currency are not restated. 

Furthermore, there are additional requirements with respect to disclosures in the notes to the consolidated financial statements that have to be complied with. These includes, for example, 

  • information about the gain or loss on the net position of the monetary items, 
  • the type and level of the price index at the reporting date, 
  • changes in the index during the current and the previous periods as well as 
  • a description of the method used for adjusting inflation.

… according to HGB

In HGB consolidated financial statements, as under IFRS, indexation can be done to adjust for high inflation at the subsidiary companies concerned. Alternatively, adjustments can be made to take account of inflation by drawing up financial statements in a hard currency. The guidelines on disclosures in the notes to the financial statements similarly apply.

When preparing financial statements where the items are stated in a hard currency, the non-monetary assets are translated at historical rates of exchange and carried forward in accordance with general principles (Section 253(3) – (5) HGB). Lower fair values (Section 253(3) sentence 5 and (4) sentence 1 HGB) and monetary items have to be translated at the closing rate. The equity items are not translated at historical rates of exchange. Instead, equity arises as the residual amount in the financial statements expressed in hard currency.

P&L items – with the exception of depreciation and material costs that are translated at historical rates of exchange – are translated at actual rates of exchange.

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