Page 69 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

READING 16: MULTINATIONAL OPERATIONS
LOS 16.g: Analyze how alternative translation methods for
subsidiaries operating in hyperinflationary economies affect
financial statements and ratios.
MODULE 16.7: HYPERINFLATION

Local currency rapidly depreciates relative to the parent’s presentation currency because of a deterioration of purchasing power.
In this case, using the current rate to translate all of the BS accounts will result in much lower assets and liabilities after translation. Using
the lower values, the subsidiary seems to disappear in the parent’s consolidated financial statements.

In reality, the real value of the nonmonetary assets and liabilities is not affected by hyperinflation because the local currency-
denominated values increase to offset the impact of inflation (e.g., real estate values rise with inflation).

Unfortunately, adjusting the nonmonetary asset and liabilities for inflation is not allowed under U.S. GAAP; although,
adjusting for inflation is permitted under IFRS. As a result, IFRS and U.S. GAAP differ significantly when dealing with a
subsidiary operating in a hyperinflationary environment.

According to the FASB, a hyperinflationary environment is one where cumulative inflation exceeds 100% over a 3-year period. Assuming compounding, an
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annual inflation rate of more than 26% over three years will result in cumulative inflation over 100% (1.26 − 1 = 100%). When hyperinflation is present, the
functional currency is considered to be the parent’s presentation currency; thus, the temporal method is used to remeasure the financial statements. The IASB
does not specifically define hyperinflation; however, cumulative inflation of over 100% in a 3-year period is one indication that hyperinflation exists.

Unlike U.S. GAAP, the temporal method is not used in a hyperinflationary environment under IFRS. Instead, the foreign currency financial statements
are restated for inflation and then translated using the current exchange rate. Key steps:
1. Nonmonetary assets liabilities are restated for inflation using a price index. Since most are reported at historical cost, simply multiply the original
cost by the change in the price index for the period between the acquisition date and the balance sheet date.
2. It is not necessary to restate monetary assets and monetary liabilities.
3. The components of shareholders’ equity (other than retained earnings) are restated by applying the change in the price index from the beginning of
the period or the date of contribution if later.
4. Retained earnings is the plug figure that balances the balance sheet.
5. In the statement of retained earnings, net income is the plug figure.
6. The income statement items are restated by multiplying by the change in the price index from the date the transactions occur.
7. The net purchasing power gain or loss is recognized in the IS based on the net monetary asset or liability exposure. Holding monetary assets during
inflation results in a purchasing power loss. Conversely, holding monetary liabilities during inflation results in a purchasing power gain. This figure
forces the net income to be same as the net income figure that was the plug figure in the statement of retained earnings.