Download The Effects of Hyperinflationary Environments on

The Effects of Hyperinflationary Environments on Multination Corporations
by Stephen L. Larson
February 8, 2014
Introduction
The General Electric Company (GE) is a multi-billion
dollar multinational company providing products and
services for such industries as power and water, oil and
gas, energy, aviation, healthcare, transportation, home,
and business (GE Annual Report, 2012). It is a global
company with operations located throughout the world.
Total assets and revenues of the company, as reported in
the company’s 2012 annual report, are distributed as
follows:
Forty-nine percent of the company’s assets and fifty-two percent of the
company’s revenues are located or generated outside of the United States. This creates
significant exposure to foreign exchange (FX) volatility. Exposures to short-term and
long-term FX exchange risk, impact on cost of raw materials and products, foreign
interest rate exposures, and credit risk are significant. The company manages these risks
through various tools including natural hedges, derivatives and hedging strategies (GE
Annual Report, 2012). It is the company’s policy to minimize exposure to interest rate
changes and currency fluctuations. Consequently, the company assesses its exposure
periodically and establishes the necessary offsets in either natural hedges or derivatives
so that parity within a 10% deviation in exchange rates can be maintained (GE Annual
Report, 2012).
Hyperinflationary Environments
Hyperinflation was defined by Phillip Cagan in 1956 (Hyperinflation, 2012) as an
average monthly increase of 50% in prices. On an annualized basis this would result in
an inflation rate of 12,875 percent. Statement of Financial Accounting Standard (SFAS)
No. 52 defines hyperinflation as 100% or more over a three year period (FASB 52
Summary, 1981) and International Accounting Standard (IAS) No. 29 defines
hyperinflation as the cumulative inflation rate over a three year period that approaches or
exceeds 100% (IAS 29 Summary, 2012). Though the SFAS and the IAS levels of
inflation that trigger hyperinflation differ significantly from that proposed by Cagen in
1952, the disruption to a country’s economy is devastating leading to devaluation of a
country’s currency, rampant price increase, economic decline, decline in savings, high
unemployment, and political instability.
The Effects of Hyperinflationary Environments on Multination Corporations
by Stephen L. Larson
February 8, 2014
Risks of Operating in a Hyperinflationary Environment
In the 1980’s Argentina and Brazil experienced 20 to 25 percent monthly inflation
(800 to 1,400 percent annualized, respectively) and Bolivia saw, at its peak in 1985, an
annualized inflation rate of 50,000 percent (the highest inflation rate in world history for
a peacetime economy) (Swanson, 2003). The primary cause of the high inflation rates
was deficit spending. The three governments paid off debt by increasing the money
supply without increasing production, which lead to higher prices (Swanson, 2003).
In a hyperinflationary economy, a company operates in an unstable environment.
The cost of doing business is constantly changing. Salaries are continually increasing,
prices for raw materials escalate, and supplies disappear immediately. Management must
maintain a policy of flexibility and be able to make decisions immediately for waiting a
day may result in a significant increase in costs. The real value of money is eroding
continually. As such, hyperinflationary thinking requires immediate use of the money.
For example, at a 20% monthly inflation rate, a delay of 30 days in collections can
eliminate a 20% profit margin on a sale. On the other side, a delay in the acquisition of
goods results in higher costs. Consequently, hyperinflationary environments require
stockpiling of excess inventories or arrangements of fixed prepaid purchased agreements.
Available credit shrinks and is generally limited to short-term relationships at high
interest rates. Leverage declines and funding sources are expanded with focus on owner
infusions. Capital expenditures are minimized so that cash is freed up to support daily
operations.
Differences Between U.S. GAAP and IAS in Accounting for Hyperinflation
U.S. GAAP is limited on its guidance as hyperinflation has not been a factor in
the U.S. (Kampanje, 2012). U.S. GAAP addresses hyperinflation in Accounting
Standards Codification (ASC) Topic 830, Foreign Currency Matters. In International
Financial Reporting Standards (IFRS), hyperinflation is addressed in IAS 29, Financial
Reporting in Hyperinflationary Economies. Each standard requires the determination of
a functional currency to report results and the time periods for comparison purposes.
However, as McGladrey (2012) notes, when hyperinflation exists, U.S. GAAP requires
the financial statements to be re-measured in the functional currency of the parent
company with any exchange differences reported in the income statement as gains or
losses. But, IAS 29 allows for continuance of the current currency, however, requiring
indexing using a general price level index and then translated into the reporting currency
at the current rate. In IFRS, financial statements are to be restated using the general price
index reflecting the change in purchasing power. When the period of hyperinflation is
over, the amounts reported at the end of the previous period become the basis for
subsequent financial statements (IAS 29 Summary, 2012). Consequently, companies not
following IFRS will have significantly different numbers than those companies following
IAS 29. Comparability between such companies will not exist.
The Effects of Hyperinflationary Environments on Multination Corporations
by Stephen L. Larson
February 8, 2014
References
Anonymous (2012). Hyperinflation. (2012, Sep 26, 2012). Mint, pp. n/a.
FASB 52 Summary (1981). Statement of Financial Accounting Standards No. 52:
Foreign Currency Translation. Financial Accounting Standards Board. December,
1981. http://www.fasb.org/summary/stsum52.shtml. (accessed February 6, 2014).
GE Annual Report (2012). General Electric Company Annual Report for 2012.
http://www.ge.com/ar2012/pdf/GE_AR12.pdf. (accessed February 6, 2014).
IAS 29 Summary (2012). International Accounting Standards No. 29: Financial
Reporting in Hyperinflationary Economies. International Accounting Standards
Board. January, 2012. http://www.ifrs.org/Documents/IAS29.pdf. (accessed
February 6, 2014).
Kampanje, B. (2012). Multinational banks operating in hyperinflationary economies.
Available at SSRN 2099831.
McGladrey. (2012). US GAAP vs IFRS Hyperinflation. IFRS Resource Center.
http://mcgladrey.com/content/dam/mcgladrey/pdf/ifrs_foreign_currency_translation.
pdf. (accessed February 6, 2014).
Swanson, G. (2003). The hyperinflation survival guide: Strategies for american
businesses Eric Englud.