Effects of inflation adjustments on IFRS Financial Reporting in Brazil : -A comparative study of nine companies for the accounting years of 2015 and 2016

Abstract: International accounting principles are generally based on historical cost accounting which, according to Munteanu and Zuca, is the best suited accounting method due to its conforming character of clarity and reliability. Large relative price changes and high inflation makes historical cost accounting less relevant and comparable as money loses its purchasing power. The IASB have therefore established IAS 29 – Financial Reporting in Hyperinflationary Economies to tackle the accounting problems that occur during high inflation. IAS 29 states that a company’s financial statements shall be expressed in the current value unit at the end of the reporting period. Criticisms against historical cost accounting are particularly that no consideration is taken to decreased purchasing power in a country when inflation is rising and that historical cost accounting during high inflation results in companies overvaluing their net income. Thus, as a consequence, companies pay out an excessive dividend from their owners’ equity which, in turn, erodes the companies’ operative capacity. Critics mean that this is negative from a capital maintenance perspective and that dividends should only be paid out to the point the company’s purchasing power remains intact. Previous studies have been conducted in the USA, Israel and Zimbabwe in order to illustrate the problems that occur with historical cost accounting. A study made by Parker in USA 1977, shows a significant difference in the financial reporting after adjusting for inflation. This means that even an inflation rate of 11,8% must be considered when preparing the financial statements. No studies have, to the authors knowledge, been done on Brazil. A country, which during 2015 and 2016 had an inflation rate between 6,2% and 10,7% and during the years 1980-1996 had hyperinflation. The study examines how nine Brazilian companies’ respective income statements and partial balance sheets, established according to IFRS and historical cost accounting, are affected by price level accounting. The study’s results confirm, just as Parkers study, that the differences for different financial measurements and ratios are small on an aggregated level for all companies but that larger differences occur between individual companies. The large individual differences are explained by 1) inflation’s effect on revenues and costs, 2) inflation’s effect on the price level adjustment of net plant and change in depreciation and to some extent 3) inflation’s effect on the adjustment of inventories.