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Wednesday, 27 April 2011

Historical Cost Accounting should be banned during hyperinflation

Historical Cost Accounting should be banned during hyperinflation

Valuation in units of constant purchasing power is required for all non-monetary items (variable and constant real value non-monetary items) in IFRS during hyperinflation as per the Constant Purchasing Power Accounting (CPPA) inflation accounting model defined in IAS 29 Financial Reporting in Hyperinflationary Economies. The only way a hyperinflationary country can maintain its non-monetary or real economy relatively stable (at a rate of real value erosion by the stable measuring unit assumption in constant real value non-monetary items never maintained constant limited to a rate equal to the annual rate of inflation of the hard currency used for determining the parallel rate – normally the US Dollar) during hyperinflation is by continuously measuring all non-monetary items (variable and constant real value non-monetary items) in units of constant purchasing power.  However, not by restating HC and Current Cost financial statements at the end of the reporting period in terms of the period-end CPI to make them more useful as required by IAS 29, but, by applying the daily parallel US Dollar exchange rate,  or -  as was done in Brazil during the 30 years from 1964 to 1994 - with daily indexation which is, in principle, the better than measurement in units of constant purchasing power by applying the daily US Dollar parallel rate since Brazilian-style indexation, theoretically, keeps the constant item economy perfectly stable: the erosion of the real value of constant items never maintained caused by the stable measuring unit assumption as applied to the US Dollar is eliminated in the formulation of the index value.

Zimbabwe

The implementation of IAS 29 Financial Reporting in Hyperinflationary Economies by Zimbabwean listed companies as required by the Zimbabwean Stock Exchange made no difference to the Zimbabwean economy during the final stages of the hyperinflationary erosion of the real value of the monetary unit in Zimbabwe, i.e. the Zimbabwe Dollar. The IASB has agreed that it was not possible to implement IAS 29 during severe hyperinflation at the end of the hyperinflationary period in Zimbabwe since there was no CPI available. The daily Old Mutual Implied Rate (OMIR) was, however, available till 20th November, 2008, the day Gideon Gono, the governor of the Reserve Bank of Zimbabwe issued regulations that closed down the Zimbabwe Stock Exchange and effectively led to the end of the Zimbabwe Dollar.

         Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency. The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR).

“The ratio of the Old Mutual share price in Harare to that in London equals the

Zimbabwe dollar/sterling exchange rate." P 8  ¹

Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist.

“Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” P 9-10 ²

¹,² Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation,

Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-64 Available at


There was severe hyperinflation in Zimbabwe while there was exchangeability with at least one relatively stable foreign currency – the British Pound in this case as made possible via the OMIR. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and hyperinflation stopped: no exchangeability means no hyperinflation.

Valuing all non-monetary items as required by the IAS 29 CPPA inflation accounting model in terms of the period-end Consumer Price Index which was published a month or more after the month to which it related when the real value of the Zimbabwe Dollar halved every day, obviously, had no effect at all.

“The Zimbabwe government last published an official Zimbabwe dollar inflation index in July 2008. This, combined with the complexities of not having a stable currency due to the phenomenon described above, meant that there were severe limitations to accurate financial reporting in the period from August 2008 to when the Zimbabwe dollar was abandoned in early 2009. During this period the Institute of Chartered Accountants in Zimbabwe set up a technical subcommittee to address these challenges, as it was impossible to apply IAS 29 “Financial Reporting in Hyperinflationary Economies” without a general price index, or IAS 21 “Exchange Rates” without a single spot rate.”  Inflation Gone Wild, Gordon Whiley, Accountancy SA, March 2010.


The stable measuring unit assumption as it forms part of the Historical Cost Accounting model - as accepted by the IASB and PricewaterhouseCoopers (amongst others) as an appropriate accounting model to be restated during hyperinflation - unnecessarily, unknowingly and unintentionally eroded Zimbabwe´s real economy by implementing HCA during the financial year, as required by the IASB in IAS 29, and then restated their year-end HC financial statements of their very much hyper-eroded companies in terms of the year-end CPI (while the CPI was made available in Zimbabwe) to make them more useful for comparison purposes. That did not stop them from unknowingly eroding their real or non-monetary economy with HCA - as supported by the IASB and PricewaterhouseCoopers - during the course of the financial year during hyperinflation.

PricewaterhouseCoopers state the following regarding the use of the HCA model during hyperinflation:

"Inflation-adjusted financial statements are an extension to, not a departure from, historic cost accounting."

Financial Reporting in Hyperinflationary Economies – Understanding IAS 29, PricewaterhouseCoopers, May 2006, p 5.

           IAS 29 states: The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach shall be stated in terms of the measuring unit current at the end of the reporting period. IAS 29, Par 8.

How anyone can use or recommend the use of the HCA model during hyperinflation is completely incomprehensible. The use of the HCA model during hyperinflation should specifically be banned by law.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.