Topic 204 - Inventories

IAS 2 Inventories

IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine

• 204.1.1.1

• IFRIC Agenda Decision – Accounting for core inventories

• 204.1.1.2

• IFRIC Agenda Decision - Commodity loans

• 204.1.1.3

• IFRIC Agenda Decision - Holdings of Cryptocurrencies

• 204.2.1.1

• IFRIC Agenda Decision - Inventories—cash discounts

• 204.2.1.2

• IFRIC Agenda Decision - Discounts and rebates

• 204.2.1.3

• IFRIC Agenda Decision - Prepayments in long-term supply contract

• 204.3.1.1

• IFRIC Agenda Decision - Consumption of inventories by a service organisation

• 204.3.1.2

• IFRIC Agenda Decision - Costs Necessary to Sell Inventories

204.1.1.1

IFRIC Agenda Decision – Accounting for core inventories

November 2014 - The Interpretations Committee received a request to clarify the accounting for ‘core inventories’. The submitter defined core inventories as a minimum amount of material that:

The issue is whether core inventories should be accounted for under IAS 16 or IAS 2.

The Interpretations Committee discussed the issue at its March 2014 meeting and tentatively decided to develop an Interpretation. The Interpretations Committee further directed the staff to define the scope of what is considered to be core inventories and to analyse the applicability of the concept to a range of industries.

At its July 2014 meeting the Interpretations Committee discussed the feedback received from informal consultations with IASB members, the proposed scope of core inventories and the staff analysis of the applicability of the issue to a range of industries.

The Interpretations Committee observed that what might constitute core inventories, and how they are accounted for, can vary between industries. The Interpretations Committee noted that significant judgement might be needed in determining the appropriate accounting. Disclosure about such judgements might therefore be needed in accordance with paragraph 122 of IAS 1 Presentation of Financial Statements.

The Interpretations Committee noted that it did not have clear evidence that the differences in accounting were caused by differences in how IAS 2 and IAS 16 were being applied. In the absence of such evidence, the Interpretations Committee decided to remove this item from its agenda.

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204.1.1.2

IFRIC Agenda Decision - Commodity loans

March 2017 - The Committee received a request on how to account for a commodity loan transaction. Specifically, the transaction is one in which a bank borrows gold from a third party (Contract 1) and then lends that gold to a different third party for the same term and for a higher fee (Contract 2). The bank enters into the two contracts in contemplation of each other, but the contracts are not linked—ie the bank negotiates the contracts independently of each other. In each contract, the borrower obtains legal title to the gold at inception and has an obligation to return, at the end of the contract, gold of the same quality and quantity as that received. In exchange for the loan of gold, each borrower pays a fee to the respective lender over the term of the contract but there are no cash flows at inception of the contract.

The Committee was asked whether, for the term of the two contracts, the bank that borrows and then lends the gold recognises:

The Committee observed that the particular transaction in the submission might not be clearly captured within the scope of any IFRS Standard. [The Committee observed, however, that particular IFRS Standards would apply to other transactions involving commodities (for example, the purchase of commodities for use in an entity’s production process, or the sale of commodities to customers).] In the absence of a Standard that specifically applies to a transaction, an entity applies paragraphs 10 and 11 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors in developing and applying an accounting policy to the transaction. In doing so, paragraph 11 of IAS 8 requires an entity to consider:

The Committee noted that, applying paragraph 10 of IAS 8, the accounting policy developed must result in information that is (i) relevant to the economic decision-making needs of users of financial statements; and (ii) reliable—ie represents faithfully the financial position, financial performance and cash flows of the entity; reflects the economic substance; and is neutral, prudent and complete in all material respects. The Committee observed that, in considering the requirements that deal with similar and related issues, an entity considers all the requirements dealing with those similar and related issues, including relevant disclosure requirements.

The Committee also observed that the requirements in paragraph 112(c) of IAS 1 Presentation of Financial Statements are relevant if an entity develops an accounting policy applying paragraphs 10 and 11 of IAS 8 for a commodity loan transaction such as that described in the submission. In applying these requirements, an entity considers whether additional disclosures are needed to provide information relevant to an understanding of the accounting for, and risks associated with, such commodity loan transactions.

The Committee concluded that it would be unable to resolve the question asked efficiently within the confines of existing IFRS Standards. The wide range of transactions involving commodities means that any narrow-scope standard-setting activity would be of limited benefit to entities and would have a high risk of unintended consequences. Consequently, the Committee decided not to add this matter to its standard-setting agenda.

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204.1.1.3

IFRIC Agenda Decision - Holdings of Cryptocurrencies

June 2019 - The Committee discussed how IFRS Standards apply to holdings of cryptocurrencies.

The Committee noted that a range of cryptoassets exist. For the purposes of its discussion, the Committee considered a subset of cryptoassets with all the following characteristics that this agenda decision refers to as a ‘cryptocurrency’:

Nature of a cryptocurrency

Paragraph 8 of IAS 38 Intangible Assets defines an intangible asset as ‘an identifiable non-monetary asset without physical substance’.

Paragraph 12 of IAS 38 states that an asset is identifiable if it is separable or arises from contractual or other legal rights. An asset is separable if it ‘is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability’.

Paragraph 16 of IAS 21 The Effects of Changes in Foreign Exchange Rates states that ‘the essential feature of a non-monetary item is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency’.

The Committee observed that a holding of cryptocurrency meets the definition of an intangible asset in IAS 38 on the grounds that (a) it is capable of being separated from the holder and sold or transferred individually; and (b) it does not give the holder a right to receive a fixed or determinable number of units of currency.

Which IFRS Standard applies to holdings of cryptocurrencies?

The Committee concluded that IAS 2 Inventories applies to cryptocurrencies when they are held for sale in the ordinary course of business. If IAS 2 is not applicable, an entity applies IAS 38 to holdings of cryptocurrencies. The Committee considered the following in reaching its conclusion.

Intangible Asset

IAS 38 applies in accounting for all intangible assets except:

Accordingly, the Committee considered whether a holding of cryptocurrency meets the definition of a financial asset in IAS 32 or is within the scope of another Standard.

Financial asset

Paragraph 11 of IAS 32 defines a financial asset. In summary, a financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right to receive cash or another financial asset from another entity; (d) a contractual right to exchange financial assets or financial liabilities with another entity under particular conditions; or (e) a particular contract that will or may be settled in the entity’s own equity instruments.

The Committee concluded that a holding of cryptocurrency is not a financial asset. This is because a cryptocurrency is not cash (see below). Nor is it an equity instrument of another entity. It does not give rise to a contractual right for the holder and it is not a contract that will or may be settled in the holder’s own equity instruments.

Cash

Paragraph AG3 of IAS 32 states that ‘currency (cash) is a financial asset because it represents the medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements. A deposit of cash with a bank or similar financial institution is a financial asset because it represents the contractual right of the depositor to obtain cash from the institution or to draw a cheque or similar instrument against the balance in favour of a creditor in payment of a financial liability’. 

The Committee observed that the description of cash in paragraph AG3 of IAS 32 implies that cash is expected to be used as a medium of exchange (ie used in exchange for goods or services) and as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognised in financial statements. 

Some cryptocurrencies can be used in exchange for particular good or services. However, the Committee noted that it is not aware of any cryptocurrency that is used as a medium of exchange and as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognised in financial statements. Consequently, the Committee concluded that a holding of cryptocurrency is not cash because cryptocurrencies do not currently have the characteristics of cash.

Inventory

IAS 2 applies to inventories of intangible assets. Paragraph 6 of that Standard defines inventories as assets:

The Committee observed that an entity may hold cryptocurrencies for sale in the ordinary course of business. In that circumstance, a holding of cryptocurrency is inventory for the entity and, accordingly, IAS 2 applies to that holding.

The Committee also observed that an entity may act as a broker-trader of cryptocurrencies. In that circumstance, the entity considers the requirements in paragraph 3(b) of IAS 2 for commodity broker-traders who measure their inventories at fair value less costs to sell. Paragraph 5 of IAS 2 states that broker-traders are those who buy or sell commodities for others or on their own account. The inventories referred to in paragraph 3(b) are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.

Disclosure

In addition to disclosures otherwise required by IFRS Standards, an entity is required to disclose any additional information that is relevant to an understanding of its financial statements (paragraph 112 of IAS 1 Presentation of Financial Statements). In particular, the Committee noted the following disclosure requirements in the context of holdings of cryptocurrencies:

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204.2.1.1

IFRIC Agenda Decision - Inventories—cash discounts

August 2002 - This issue considers how a purchaser of goods should account for cash discounts received.

The IFRIC agreed not to require publication of an Interpretation on this issue because IAS 2 Inventories paragraph 8 provides adequate guidance. Cash discounts received should be deducted from the cost of the goods purchased. [Paragraph 8 was renumbered paragraph 11 of IAS 2 as a result of the Improvements project.

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204.2.1.2

IFRIC Agenda Decision - Discounts and rebates

November 2004 - The IFRIC considered three related questions on the application of IAS 2 Inventories that had been referred to it by the Urgent Issues Group (UIG) of the Australian Accounting Standards Board:

On (a), the IFRIC tentatively agreed that settlement discounts should be deducted from the cost of inventories. Because the requirements under IFRSs were sufficiently clear, the IFRIC tentatively agreed that the matter should not be added to the agenda.

On (b), the IFRIC tentatively agreed that IAS 2 requires only those rebates and discounts that have been received as a reduction in the purchase price of inventories to be taken into consideration in the measurement of the cost of the inventories. Rebates that specifically and genuinely refund selling expenses would not be deducted from the costs of inventories. Because the requirements under IFRSs were sufficiently clear, the IFRIC tentatively agreed that the matter should not be added to the agenda.

On (c), the IFRIC tentatively agreed that there was insufficient evidence of diversity in practice to warrant the matter being added to the agenda.

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204.2.1.3

IFRIC Agenda Decision - Prepayments in long-term supply contract

November 2015 - The Interpretations Committee received a request seeking clarification on the accounting for long-term supply contracts for inventories when the purchaser agrees to make significant prepayments to the supplier. The question considered is whether the purchaser should accrete interest on long-term prepayments by recognising interest income, resulting in an increase in the cost of inventories and, ultimately, the cost of sales.

The Interpretations Committee discussed this issue and noted that paragraph 18 of IAS 2 Inventories requires that when an entity purchases inventories on deferred settlement terms, and the arrangement contains a financing element, the difference between the purchase price on normal credit terms and the amount paid is recognised separately as interest expense over the period of the financing. It also noted that IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets include similar requirements when payment for an asset is deferred. IFRS 15 Revenue from Contracts with Customers, issued in May 2014, additionally includes the requirement that the financing component of a transaction should be recognised separately in circumstances of both prepayment and deferral of payment.

The Interpretations Committee conducted outreach on this issue, but the outreach returned very limited results. In the absence of evidence about this issue, and of a broader range of information about the facts and circumstances relating to these transactions, the Interpretations Committee thought it would be difficult for it to address this topic efficiently and effectively. The Interpretations Committee observed, however, that when a financing component is identified in a long-term supply contract, that financing component should be accounted for separately. The Interpretations Committee acknowledged that judgement is required to identify when individual arrangements contain a financing component.

The Interpretations Committee concluded that this issue did not meet its agenda criteria and therefore it decided to remove this issue from its agenda.

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204.3.1.1

IFRIC Agenda Decision - Consumption of inventories by a service organisation

March 2004 - The issue related to the consumption of inventories by a service entity, in particular the assessment of net realisable value when the inventory is consumed as part of the service rendered.

The IFRIC noted that the same issues existed for commercial entities. The IFRIC concluded that this matter was one of assessing the recoverability of an asset without a direct cash flow.

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204.3.1.2

IFRIC Agenda Decision - Costs Necessary to Sell Inventories

June 2021 - The Committee received a request about the costs an entity includes as the ‘estimated costs necessary to make the sale’ when determining the net realisable value of inventories. In particular, the request asked whether an entity includes all costs necessary to make the sale or only those that are incremental to the sale.

Paragraph 6 of IAS 2 defines net realisable value as ‘the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale’. Paragraphs 28–33 of IAS 2 include further requirements about how an entity estimates the net realisable value of inventories. Those paragraphs do not identify which specific costs are ‘necessary to make the sale’ of inventories. However, paragraph 28 of IAS 2 describes the objective of writing inventories down to their net realisable value—that objective is to avoid inventories being carried ‘in excess of amounts expected to be realised from their sale’.

The Committee observed that, when determining the net realisable value of inventories, IAS 2 requires an entity to estimate the costs necessary to make the sale. This requirement does not allow an entity to limit such costs to only those that are incremental, thereby potentially excluding costs the entity must incur to sell its inventories but that are not incremental to a particular sale. Including only incremental costs could fail to achieve the objective set out in paragraph 28 of IAS 2.

The Committee concluded that, when determining the net realisable value of inventories, an entity estimates the costs necessary to make the sale in the ordinary course of business. An entity uses its judgement to determine which costs are necessary to make the sale considering its specific facts and circumstances, including the nature of the inventories.

The Committee concluded that the principles and requirements in IFRS Standards provide an adequate basis for an entity to determine whether the estimated costs necessary to make the sale are limited to incremental costs when determining the net realisable value of inventories. Consequently, the Committee decided not to add a standard-setting project to the work plan.

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