Inflation and Financial Reporting: Nigeria’s Ascent to Hyperinflationary Economy

An essential qualitative characteristic of financial statements is comparability. This quality is crucial for decision-making by users, enabling them to see how a company has grown over the years in terms of financial performance and financial position. Investors are particularly interested in how a company has expanded its asset size and improved its profit trend. However, it is important to remember that the true value of comparability in financial figures diminishes when inflation rates are high. Accounting standards typically assume that the value of money remains constant over time. This assumption underpins the meaningfulness of comparability. But what happens when an economy faces significant inflation? Recently, the National Bureau of Statistics (NBS) reported an inflation rate of 34.19%. In such a scenario, how can we determine if a company's profit growth is due to genuine economic activity or merely inflationary effects?

Consider a company that reports a 15% increase in profit for the FY 2023, while the inflation rate stood at 29%. Can we confidently say the company’s management has performed well? The answer isn't straightforward. In high inflation environments, distinguishing between real growth and inflationary gains becomes challenging, if not impossible. It is for this reason that the IASB has a special standard that addresses how to deal with financial reporting for entities in hyperinflationary economies. The standard basically provides that entities in such environments should restate the financial statements (and corresponding figures for previous periods) for the changes in the general pricing power of the functional currency. Now, it is important to understand that deciding to follow the provisions of this standard is not merely an entity-specific decision. Managements would be generally forced to comply once their economy has been tagged “hyperinflationary”. It is for this reason that this article is written – considering our current elevated and rising inflation rate, are we on the brink of being classified as a hyperinflationary economy?

It may interest you to know that Ghana was classified as a hyperinflationary economy in 2023 and thus most entities, if not all had to restate their financials to account for this. A cursory look at the audit report of Access Bank Corp. will show that a key audit matter was the inclusion of its Access Bank Ghana subsidiary which was remeasured because of its operations in a hyperinflationary economy. So, back to our question - considering our current elevated and rising inflation rate, are we on the brink of being classified as a hyperinflationary economy? The sad answer is Yes.

While the IASB standard does not specify an absolute inflation rate at which hyperinflation is deemed to arise, it provides guidance to determine this. One key indicator is that the cumulative inflation rate over three years approaches or exceeds 100%. An objective approach in determining this has been the use of the IMF World Economic Outlook (WEO) publication. This publication includes a three-year cumulative rate of inflation for each economy, and on that basis, countries are classified as hyperinflationary or added to watchlists if they are approaching hyperinflation.

A publication by EY in October 2023 tracked this and classified Nigeria as a non-hyperinflationary economy subject to monitoring. In the same report, Ghana was classified as a hyperinflationary economy, having a three-year cumulative rate of inflation of 92% as of December 2022, with forecasted three-year cumulative rates of 128% and 133% for 2023 and 2024, respectively. Similarly, the IMF WEO reported that Nigeria had a three-year cumulative inflation rate of 62% as of December 2022, with a forecasted rate of 83% for both 2023 and 2024 – figures that clearly approach the 100% threshold indicated by the standard.

While we hope that we do not eventually get classified as a hyperinflationary economy due to its implications on financial reporting, it is important to understand the current impacts on the status quo. Comparatives may present a seemingly better performance and position than merely high figures in current reporting periods, as the value of comparison has been lost due to the significant changes in the value of money over the periods considered. This distortion challenges the true assessment of a company's financial health and performance, underscoring the need for careful analysis and adjustments in high-inflation environments, of which Nigeria is at the moment.

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