Translation When a Foreign Subsidiary Operates in a Hyperinflationary Economy
Hyperinflationary environments can occur at a moment's notice and last for increasingly longer periods of time. Not only are consumers hit with sky-high prices, but companies are also forced to adjust quickly. Just ask Coca-Cola or British Petroleum (BP), two companies operating in Zimbabwe, where at one point inflation caused the issuance of a ZWD 100,000,000,000,000 bill.
Scenarios just like this are the reason that US GAAP (Coca-Cola) and IFRS (BP) have specific rules regarding how to account for foreign companies in hyperinflationary environments. Not surprisingly, though, both US GAAP and IFRS differ in their approaches.
Not quite.
The currency has depreciated, not appreciated.
You got it!
BP will experience a net purchasing power _gain_. And if BP holds a greater amount of monetary assets during a highly inflationary period, it will experience a net purchasing power _loss_.
For Coca-Cola, it's really straightforward. Per US GAAP rules, Coke's foreign currency financial statements are translated using the temporal method. No remeasurement (referring specifically to hyperinflation) of the financial statements is allowed. Why do you think that's the case?
You can probably tell at this point that the IFRS method is pretty similar to the temporal method when it's all said and done. But by not restating monetary assets and liabilities, IFRS has exposed BP's monetary assets and liabilities to purchasing power risk, meaning that assets and liabilities are held in the depreciating currency.
If BP holds a greater amount of monetary liabilities during a highly inflationary period, what do you think happens to the liability amount?
Well, no.
Inflation will have an impact on assets and liabilities.
For IFRS restatement, BP's income statement items are restated using the change in the general price index from the dates when the items were originally recorded on the balance sheet date.
So this means that net income is also impacted. Why?
The balance sheet remeasurement follows specific guidelines. First, monetary assets and liabilities aren't restated.
What do you think the reasoning for this is?
Now, for comparison purposes, that monetary asset and liability exposure typically leads to companies having different results under US GAAP and IFRS. But in rare cases, the amount of the US GAAP temporal method and the IFRS remeasurement and restatement can lead to the exact same results. This will occur when the change in exchange rates (temporal method) is equal to the change in the general price index. A very rare case indeed.
In sum:
[[summary]]
Coke would use the temporal method because it naturally uses historical rates for historical balance sheet items, which prevents a depreciating currency from wiping away an asset's value.
So that's pretty easy: US GAAP requires the temporal method in hyperinflationary environments.
Yes!
All assets and liabilities being translated at current exchange rates applies to the current exchange rate method, not the temporal method.
No.
That applies to the current exchange rate method, not the temporal method.
But things get trickier for BP. That's because with IFRS, the financial statements are first restated for inflation, and then the inflation-adjusted financial statements are translated using the current exchange rate method.
That's it!
Monetary assets and liabilities already reflect the change in purchasing power, so there's no need to restate these amounts.
But there is a need for BP to restate non-monetary assets and liabilities, which are restated for the change in the general purchasing power of the currency. Since most non-monetary items are carried on the balance sheet at a historical value, the change in the general price index is measured from the valuation date to the balance sheet date. For example, property plant and equipment is restated from the last date of revaluation.
All components of stockholders' equity are restated using the change in the general price index over the reporting period or from the date of contribution to the balance sheet.
No.
Inflation definitely impacts monetary items.
Incorrect.
Monetary assets and liabilities are translated, so that's not the reason.
If all income items are restated, then the purchasing power impact is also included in net income, so the net income amount _is_ impacted.
Not so.
Exactly!
Because all assets and liabilities are translated at current exchange rates
Because historical amounts held on the balance sheet are translated at historical rates
It increases
It decreases
It remains the same
Because the net gain or loss from purchasing power is included
Because the net gain or loss from purchasing power is removed
Inflation doesn't impact monetary items
Monetary assets are already in current units
Monetary assets and liabilities are not translated
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