there appears to be a literature gap on the topic of financial reporting adjustments for inflation rates that are significant but fall below the hyperinflation threshold, such as 17.5% annually. International Accounting Standard (IAS) 29 focuses on hyperinflation (typically considered when cumulative inflation over three years exceeds 100%), but does not address moderate but persistent inflation. This gap can lead to several issues in accurately representing financial information:

Why there is no adjustment for moderate inflation

Complexity of Standardizing Adjustments: Unlike hyperinflation, where drastic adjustments are necessary to avoid distortions, moderate inflationary environments vary widely across countries, industries, and even time periods. Implementing uniform rules for moderate inflation is challenging due to these variations.

Materiality and Practicality: For moderate inflation (e.g., 17.5%), some might argue that while it erodes purchasing power, it does not result in distortions significant enough to mandate adjustments. The practicality of requiring inflation adjustments every year is a consideration, as it could impose heavy compliance burdens on companies without a clear consensus on the appropriate method to follow.

Current Mechanisms for Adjustments: Some argue that other accounting principles and disclosures, such as fair value accounting and historical cost conventions, may already provide sufficient information to stakeholders. Companies might also voluntarily disclose inflationary impacts in their notes to the financial statements, but it's not standardized.

Concerns with Not Adjusting Financial Statements

Understatement of Capital: In periods of moderate but sustained inflation, the historical cost basis of many assets and liabilities becomes outdated, leading to an understatement of capital or equity over time. For example, the real value of long-term assets purchased years ago may be eroded by cumulative inflation, even if each year’s inflation is under 20%.

Distorted Profitability: Non-adjusted financial statements in a moderate inflationary environment may misrepresent profitability. Depreciation, cost of goods sold, and other expenses are reported at historical costs, while revenues reflect current prices, creating an artificial boost in profits.

Inconsistent Comparability: Financial statements that do not adjust for inflation create comparability issues across firms, sectors, and time periods. Companies operating in different inflationary environments may report results that are not directly comparable, creating challenges for investors and analysts.

Is Capital Adequately Represented?

In the absence of adjustments for moderate inflation, it is likely that the value of capital, especially fixed assets, is not adequately represented. Historical cost accounting assumes stable currency values over time, which becomes problematic even in moderate inflation scenarios. In the long run, this could mislead stakeholders about a company’s true financial position and capacity for future growth or investment.

The Case for a Middle Ground

There is a case to be made for developing a middle-ground approach, where financial reporting standards provide guidelines or optional methodologies for companies to adjust for moderate inflation. These adjustments could help reflect the impact of inflation on the value of capital and profitability, without the need for the more drastic measures required in hyperinflationary contexts

Perhaps the reason for the insufficient professional regulations is the assumption that the concept of revaluation can be used for the subsequent measurement of fixed assets. Fixed assets represent a larger percentage value of a company's assets. Current assets, in any case, turn over within 12 months, so there cannot be a drastic deviation. However, what about companies that apply the International Financial Reporting Standards for small and medium-sized entities, and what about companies that value assets solely based on historical cost? How can the cumulative effects of inflation on financial statements be commented on?

Before Bosnia and Herzegovina adopted IFRS, the national standards prescribed the adjustment of financial statements when cumulative inflation since the last adjustment exceeds 10%. With the advent of the IFRS standard, such a reconciliation was never done again. The conditions for hyperinflation and the application of IAS 29 have never been met.

Inflation affects financial statements by eroding the real value of monetary amounts. To adjust for inflation, financial statements can be restated using methods like the constant dollar method or current cost accounting to reflect the real value of assets, liabilities, and income. This helps in providing a more accurate financial picture.

How to implement adjustment when my country recognizes only IFRS and IAS and the conditions for IAS 29 are not met? Why does the profession not give us a solution for constant moderate inflation? Opinion?

You are absolutely right. Inflation is a cumulative effect. A 5% inflation a year may not seem high but on a compounded basis it makes a big difference after 10 years. I have several papers on this subject (related with inflation accounting), showing the effect of inflation even at lower percentages.

Dear Professor Cenap Ilter , thank you for joining the discussion. Does US GAAP also lack a standard that addresses inflation conditions rather than hyperinflation? In Bosnia and Herzegovina, there is an additional problem, which is that our currency is pegged to the Euro through a currency board system. Therefore, our currency is stable, and we can never meet the condition that IAS 29 requires for the adjustment of financial statements in hyperinflationary conditions, as the value of the currency will never devalue.

I wonder how countries with, for example, a consumer price index growth rate of over 100%, yet a stable currency, apply IAS 29!? Of course, the standard provides a framework for assessing when to apply it, but one of the first conditions is a decline in the value of the currency.

Professor Cenap Ilter , do you think that this could be an appropriate area of research for a doctoral dissertation?

Yes, it may be a subject of a doctoral thesis. A few countries` inflation (and other indicators) statistics may be analyzed. The discrepancy between the inflation and devaluation rates can be analyzed. I.e. If devaluation rates lagging behind the inflation that may cause overstatement of assets or liabilities and/or equity. There will distortions of figures in financial reporting to the parent located abroad. My opinion is that 100% requirement may be loosened. As discussants say in the presence of other indicators 100% may be very hard to achieve. However, we can still use judgement even it is not at that level. It is hard to convene around a certain cumulative rate but in the presence of other factors, a country should apply inflation accounting no matter how low it is. I.e.5% a year and cumulatively it is more than 15% in three years may be good enough provided that people keep their assets in foreign currencies, collective bargaining agreements are indexed to a foreign currency or inflation indices, long term contracts are indexed to inflation indices are all indicators that that there is sustained inflation in the country and this will lead that historical cost accounting may not be valid anymore. There is a tax concern attached to this as well. I.e. if the company has CA>CL it will write monetary loss and maybe pay no taxes whereas if the monetary position is the opposite, then the company may end up with a profit and pay taxes. This will in turn put more strain on those companies who have already poor working capital or net monetary position. It is a complex subject but there is always a room to discuss the inflation and devaluation effects.

The discussion is still open and I hope to hear more opinions.