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IAS 2 — Long-term prepayments for inventory supply contracts

Date recorded:

The Committee received a request to clarify whether interest should be accreted on long-term prepayments. The staff performed outreach with the national standard setters and noted that there appeared to be diversity in practice from one jurisdiction to another and also within each jurisdiction. A majority of respondents noted that the prevalent practice was that entities do not accrete interest on long-term payments because the prepayments were not financial instruments. Accreting interest on non financial assets and liabilities would not be appropriate in the existing IFRS literature and the amount received or paid is the appropriate amount that should be accounted for as revenue or inventory. The majority of the respondents also noted that prepayment arrangements are generally entered into for operational reasons, e.g. to secure the supply of materials in the future or to fix the purchase price of the materials over a future period, rather than for financing reasons.

The staff recommended that the Committee take the item on to its agenda noting that a consensus on the issue could be reached on a timely basis and within the confines of existing IFRSs and improve financial reporting through the elimination of diverse methods. The staff supported the view that when a seller receives a prepayment, the seller should account for an interest expense so that the revenue is measured at fair value when the sale of goods is recognised (under IAS 18). The staff also noted that accounting for tangible assets at cost or for inventories at cost does not preclude an entity from recognising the financing component if goods or services are prepaid. As such, when a purchaser makes a prepayment, the purchaser should account for interest income so that inventory is measured at cost (cash price equivalent) when the inventory is recognised. The financing component of a transaction is in line with the concept of time value of money which is applied throughout the IFRSs. The staff noted that it would be preferable if the accounting for the financing component was consistent between the financial statements of the supplier and the financial statements of the purchaser (the purchaser should account for interest income resulting in an increase of the cost of inventories and the supplier should account for interest expense resulting in an increase in revenues). Long-term prepaid supply contracts could include a financing component whether an interest rate is explicitly identified or not. This financing component might be significant if the contract is longer than one year (i.e., if the period between payment of the raw materials and delivery of the raw materials is longer than one year). The staff noted that it is reasonable to presume that the purchaser and the seller considered this financing component in setting the prices. In addition, the staff noted that the revised revenue ED proposes that when determining the transaction price, the entity should consider the effect of the time value of money (whether there is a prepayment or a deferred payment) when the period between payment by the customer and the transfer of goods or services is greater than one year. While several Committee members agreed with the staff's recommendations, some Committee members did not agree with accreting for interest in long-term prepayments. They noted that prepayments are not financial instruments and therefore accreting interests on non-financial assets and liabilities would not be appropriate. They also noted that at the date the prepayments are made, they are measured at cost and reflect the amount that is paid or received. As such, there is no basis for recognising any interest income or payment. These Committee members also noted that the prepayments may have been entered into to secure the supply of materials in the future and therefore should not include a financing component.

In particular, the Committee concluded that there may be subsets of possible transactions within the scope of prepayments and that it would be important to look at the various facts and circumstances. The Committee also noted that it was important to consider the time value of money provisions of the revised revenue exposure draft to determine if there were any conflicting issues. The Committee ultimately decided not to take the item on to its agenda at this point but rather asked the staff to consider the feedback provided by the Committee and to bring back a proposal to the Committee during a future meeting.

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