Hyperinflation accounting to trigger market-wide losses

After enjoying rare inflated topline growth in the first six months of 2019 and the immediate past financial year, Zimbabwe companies are set to report a sharp contraction in earnings for the full year period to December 2019.

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The projection of a worse off outcome is premised on a pronouncement by the Public Accountant and Auditors Board (PAAB), a statutory board created by an Act of Parliament and mandated with regulatory oversight of the accounting and auditing profession in Zimbabwe, that companies preparing financial statements for the period July 1 onwards, are urged to adopt IAS 29. This follows a broad consultation with market players including accounting and auditing professionals which established that there was a consensus on hyperinflation in Zimbabwe.

IAS 29 Financial Reporting in hyperinflationary economies applies where an entity’s functional currency is that of a hyperinflationary economy. The standard does not prescribe when hyperinflation arises but 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.

Zimbabwe is a classified hyperinflation economy from an accounting perspective which, however, is at variance to the economic classification.

Economists typically classify an economy as under hyperinflation if month-on-month inflation remains above 50% over three consecutive months. Zimbabwe’s monthly inflation for September was last recorded at 17,5% having been slightly up a month earlier. Annual inflation for the respective month, however, came in at 353%.

From an accounting perspective, the view is that an economy satisfies hyperinflation if certain conditions are met and does not necessarily prescribe a particular rate of inflation. According to the standard characteristics of the economic environment of a country which indicate the existence of hyperinflation include the general population preferring to keep its wealth in non-monetary assets or in a relatively stable foreign currency; amounts of local currency held are immediately invested to maintain purchasing power; the general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency; sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short; interest rates, wages, and prices are linked to a price index; and the cumulative inflation rate over three years approaches, or exceeds 100%.

Zimbabwe perfectly satisfies all the conditions set above in the IAS 29 standard which qualifies an economy as being under hyperinflation. The pronouncement by PAAB, therefore, follows the necessary evaluation and now companies will have to adopt the standard in the current period and the impact on earnings will be fundamental.

In the half year period to June, all listed companies reported surging earnings, driven by upward price reviews, and other once off gains such as revaluations and foreign currency exchange gains, which are all related to the economic environment. A change in reporting currency from US dollar to Zim dollar resulted in fair value gains and exchange gains which significantly drove net earnings upwards. Prices have soared by 350% year on year as September and this shows how companies benefited from price increases to boost income.

Although the quality of earnings and sustainability of earnings in this regard was questionable, at least there was no standard at present compelling companies to adjust their earnings for a more factual presentation of their earnings. With the coming in of IAS 29, companies will have to use a price index to discount their earnings, such that if the rate of price growth (inflation) is ahead of earnings growth, then a company’s results based on hyperinflation accounting will be in losses.

Old Mutual, which is the only company to have applied hyperinflation accounting on its first half earnings, reported that profit for the period under hyperinflation accounting was -$210,47 million against a profit position under historical cost accounting of $509,15 million which was a gain of 671% on the prior year. This is how exposing hyperinflation accounting is.

Old Mutual, however, stated that the magnitude of loss was exacerbated by the fact that the bulk of the group’s net assets comprised monetary assets carried at fair value and these have not increased at the same level as CPI.

This means for companies with less exposure to monetary assets such as manufacturers, the gravity of loss emanating from this specific adjustment may be less severe. Broadly this would mean to preserve value companies have to increase stock levels and contain costs, maximise production efficiency and adopt a flexible pricing mechanism which closely track CPI.

Although government has stopped the publication of annual CPI data, companies will have to continue referring to the same data, which is readily available at research houses, to inform their pricing. To investors, valuations will have to be adjusted accordingly taking note of the effect of inflation on the adjusted earnings based on hyperinflation accounting.

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