Big Things Come in Small Packages
- A J Mohammed Rayaan 1910852
- Oct 10, 2020
- 3 min read
Updated: Oct 14, 2020
The story of a nation’s economy being saved by a simple hyper-inflationary accounting rule!
Inflation Accounting as a practice, is influential in building the economic infrastructure of nations. Inflation essentially means the fall in purchasing power of a currency within the country. Developing nations and other backward third world countries tend to see a very dynamic flow of purchasing power. This rise and fall is attributed heavily to factors such as rapid economic growth at unstable rates, foreign investments and the growth of businesses. Here, accounting plays a major role as it provides a medium of tracking the growth of individuals, companies, conglomerates and nations as a whole. Hence, putting these two aspects together we get a simple practice of “taking into account, the inflation”. Now when inflation in itself affects the accounting process, hyperinflation has a much heavier impact. This impact is felt especially when there is grey area in the rules of accounting for inflation.
Fun Fact
The case in point, is Argentina and its hyperinflation over the years. In
the year 2018, the country recorded a CPI of 47.6%. In simple terms, the importance of inflation accounting is as follows: firms that
do not make the required adjustments for falling purchasing power tend to have
inflated values in their financial statements.
This means that the financial statements will represent the external number and not the internal value of the particulars they are assigned to. So, in the special case of hyperinflation in Argentina, where the accumulated inflation rate was over 100% in 3 years in 2019 the problem was at a greater scale. This meant, that not accounting for the inflation would have led financial statements to convey the message that every value was now double of what it was 3 years ago, which is a situation that business entities can only dream of.
So, what did Argentina do to resolve this problem?
On 01st July 2018, Argentina brought into picture the bold move of IAS 29. Here we will try to understand what IAS 29 means and the effect that it had on various companies in Argentine.
IAS 29 acts as a special provision or rule that deems all business entities and large companies that function with the currency of the home country, to start reporting the financial activities with the necessary adjustments for hyperinflation. It is used in countries where hyperinflation has the potential to ruin the credibility of a country’s economy. Other than Argentina it has also been used in countries like Zimbabwe which faced very similar problems in recent times.
In the case of Argentina, it was able to apply this rule for all companies that deal with foreign exchange in the US as well because the US GAAP says that any economy with a “cumulative three year inflation approaching or exceeding 100%” will be considered a hyperinflationary economy. So these companies had pressure to change their accounting techniques from both sides. Argentina was also able to use it for home companies as they follow the IFRS which made it much simpler.
However, it was not a simple change.
When Argentine banks announced the policy changes there were four major financial firms that were “deemed delinquent by the U.S. Securities and Exchange Commission”. These companies were held accountable because they issue American depository receipts. They delayed in their filings and blamed the adoption of the new IFRS system.
These major financial firms are as follows: Grupo Financiero Galicia SA, Banco Marco SA, BBVA Banco Frances SA, and Group Supervielle SA.
Let us put into perspective just how much impact the IAS 29 had on just 3 of these 4 firms cumulatively. Before it was introduced, the 1st, 2nd, and 4th banks reported a cumulative profit of 11.58 billion pesos in 2017. Once the IAS 29 was introduced, these figures drastically nosedived to a cumulative loss of 8.46 billion pesos in 2018. This means that these companies saw a disparity of over 20 billion pesos in just a year. In 2017, the GDP of Argentina
was 720 billion pesos. This means that these 3 companies alone had overvalued the Argentine economy by 2.78%. The scale of gross misrepresentation all over the country would have been colossal. Completely independent of this, the
third financial firm BBVA Banco Frances SA, was further investigated by an independent audit committee and was alleged to have violated certain anti-money laundering and terrorist financing regulations. This gives us a different narrative of the importance of auditing and accounting principles which is not quantitative in nature.
The aim of this case was to highlight the gross disparity that is allowed to flow through the books of a country at large when essential accounting practices are not mandated. And if the concept of IAS 29 was never applied to the Argentine economy the country would still have been “progressing” on paper, while reality would have been very different.
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