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IAS 2 — Should interest be accreted on prepayments in long-term supply contracts?

Date recorded:

Agenda paper 3 — IAS 2 — Should interest be accreted on prepayments in long-term supply contracts?

The Project manager introduced the agenda paper. She said that the IFRS Interpretations Committee (the ‘Interpretations Committee’) received a request to clarify the accounting for long-term supply contracts of raw materials when the purchaser of the raw materials agrees to make significant prepayments to the supplier. The question considered was 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.

At its meeting in November 2014 the Interpretations Committee discussed this issue and how the guidance in IFRS 15 Revenue from Contracts with Customers, issued in May 2014, could inform that discussion. That Standard requires that if a contract contains a significant financing component, it should be reported separately as interest income or expense. At the November 2014 meeting the Interpretations Committee asked the staff to conduct outreach to collect evidence about the nature of, and the reasons for, the prepayments made by purchasers in long-term supply contracts and to identify whether those supply contracts included a financing component or whether the purchaser made the prepayment for other reasons.

The project manager said that the purpose of this paper was to present those findings. She said that the staff had conducted recent outreach activities and there was only one respondent (a European company) that indicated that since they concluded there was no significant financing component, they did not accrete interest on prepayments. They had also conducted outreach with the Global Preparers Forum who indicated that they believed this transaction was unusual. Finally, she said that the staff concluded that the issue was not widespread and they were unable to conclude whether there was diversity in practice; consequently, the staff was recommending not adding the issue to its agenda and indicated that the tentative agenda decision was included in Appendix A of the agenda paper.

There was general agreement within the Interpretation Committee members to not add the issue to its agenda; however, there were concerns mentioned in relation to making a reference to IFRS 15 in the tentative agenda decision. The concerns related to: (i) IFRS 15 applying to the seller instead of the buyer and the difficulty in automatically concluding that the seller and the buyer would have the same view of the transaction; and (ii) IFRS 15 is not yet effective.  One observing IASB Board member indicated that she would suggest caution in using the concept of a ‘significant financing component’ because it was a specific term introduced by IFRS 15.

There was general agreement that if an entity identified a situation in which there was a significant financing component, then an entity should recognise the financing component separately and several Interpretation Committee members indicated that this view should be included in the tentative agenda decision. There was also general agreement that judgement would need to be made in order to conclude that there was a financing component.

There was also general agreement that the agenda decision should refer to IAS 2, IAS 16 and other standards that already mention the requirement to separate financing components. In that regard, some Interpretation Committee members indicated that, for example, IAS 2 mentions deferred payments and associated interest expenses which seems relatively intuitive but the idea of interest income on prepayments is less intuitive. Another concern mentioned by some Interpretation Committee members was that there could be different reasons for an entity making a prepayment (i.e. it could be to secure a price, but also to secure procurement, to make an investment or other market reasons)

One Interpretation Committee member suggested making the wording of the tentative agenda decision more flexible so that entities could continue with their existing accounting policies. However, there was no support for his view.

The Chairman pointed out that the topic was raised in the latest Emerging Economies Group. He said that it was noted that it was very common among them to have prepayments. He also said that based on concerns raised by the  Interpretation Committee members the reference to IFRS 15 would not be necessary but it should be clarified that other standards (such as IAS 2 or IAS 16) make references to separate interest expenses when there are financing elements.  

The Chairman called a vote and the majority of Interpretation Committee members accepted the staff recommendation on the understanding that references to IFRS 15 would be omitted; (8 votes in favour).

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