Commodities — Commodity loans — Agenda paper 10

Background

This was a new issue. The IC received a request to clarify the accounting for commodity loan transactions. The scenario described by the submitter is as follows:

1. Reporting Entity borrows a commodity (e.g. gold) from Lender for a fixed period of time (‘TN 1’). On physical receipt of the commodity, legal title passes to Reporting Entity. The commodity is fungible and can easily be replaced with a similar commodity.
2. There are no cash flows at inception. Instead, Reporting Entity pays a fixed fee to Lender for the duration of the contract based on (i) the value of the commodity at inception; and (ii) relevant interest rates at inception. At maturity, Reporting Entity is obliged to deliver a commodity of the same type, quantity and quality to Lender.
3. Reporting Entity then enters into a similar transaction with Borrower (‘TN 2’). In TN 2, legal title of the commodity is transferred to Borrower under the same terms and conditions as described in TN 1, but Borrower pays a higher fixed fee to Reporting Entity.

It is assumed that all parties to the transactions are unrelated to one another and that Reporting Entity negotiates TN 1 independently from TN 2.

The submitter asked whether the Reporting Entity should recognise an asset and a liability in respect of these transactions. The submitter reasoned as follows:

Argument for recognising an asset and a liability: The commodity received from Lender under TN 1 (and the commodity receivable from Borrower under TN 2) and the obligation to deliver the commodity to Lender at the end of the contract term meet the definition of an asset and a liability respectively per the Conceptual Framework.

Argument for not recognising an asset and a liability: Reporting Entity considers the commodity as being similar to financial assets that are highly liquid. Furthermore, the respective transferor in TN 1 and TN2 has not transferred the risks and rewards of ownership of the commodity to the transferee (as the transferor is subject to the full price risk of the commodity). Accordingly, TN 1 and TN 2 are regarded as lending transactions (similar to securities lending transactions described in IAS 39.AG51(b) / IFRS 9.B3.2.16(b)) as opposed to purchase & sale transactions.

The paper set out the Staff’s analysis and recommendation.

Staff analysis

The Staff conducted outreach activities which indicated that the transaction is common in several jurisdictions. All of the respondents that identified the issue as common reported diversity in practice due to the lack of guidance in IFRS on commodity transactions. In view of this, the Staff identifies various Standards that might be applicable to the transactions under consideration. However, the Staff concludes that none of the Standards identified fit the transactions squarely for the following reasons:

• IFRS 16/IAS 17: The transactions do not meet the definition of a lease because the arrangements are not dependent on the use of an identified asset (as the commodity is fungible and is readily available from the market).
• IAS 2 and IFRS 15/IAS 18: The commodities may not meet the definition of inventories. Specifically, Reporting Entity may or may not be holding them ‘for sale in the ordinary course of business’ depending on facts and circumstances. Furthermore, TN 2 does not clearly represent a sale as the significant risks and rewards of ownership of the commodity are not transferred to Borrower (IAS 18), and Reporting Entity has an obligation to repurchase an asset that is substantially the same as the original asset (IFRS 15).
• IAS 37: The obligation to deliver the commodity back to Lender at the end of TN 1 does not meet the definition of a provision. This is because the quantity and quality of the commodity to be returned is contractually agreed.
• IFRS 9/IAS 39: A commodity does not meet the definition of a financial asset. Furthermore, the Staff believes that the IFRS 9/IAS 39 scope extension to contracts to buy or sell a non-financial item is not applicable here. This is because the Staff believes that these transactions do not constitute a sale as the respective transferor in TN 1 and TN2 has not transferred the risks and rewards of ownership of the commodity to the transferee.

Given the above, the Staff considered whether the IC should add this issue to its agenda. The Staff notes that the particular issue identified by the submitter is narrow in scope and that there is a plethora of commodity transactions in practice with different fact patterns and different substance. Accordingly, the Staff believes that any conclusion reached by the IC on this particular issue would be of limited benefit, and that there would be a substantial risk of unintended consequences if any narrow-scope amendments were to be made in this regard.

Staff recommendations

The Staff recommended not adding this issue to its agenda for the reasons set out above.

Appendix A set out the proposed wording for the tentative agenda decision.

Discussion

The IC approved the Staff’s recommendation, subject to redrafting.

The IC agreed that there was a multitude of commodity transactions and acknowledged that they represented a big issue in practice and that there was diversity in accounting for them. However, the IC believed that this issue was far too broad for the IC to address. One IC member was particularly concerned that if the IC tried to address this as a narrow scope amendment, the resulting guidance would be the only guidance on commodities and that would present an even stronger reason for entities to apply that guidance by analogy to other types of commodity transactions, but perhaps inappropriately so.

On the redrafting point, the Staff agreed to redraft the agenda decision to prevent there being an unwarranted implication that entities had a free choice on how to account for commodity transactions. The revised wording would clarify that depending on the type of commodity transactions, particular Standards might be applicable and be more appropriate than others. The revised wording would also specify that appropriate disclosures should be made on these transactions.

The IC suggested that the issue be referred to the Board for consideration as a broader project. Some of the points for consideration would include a discussion on what was the unit of account for these buy-sell linked transactions, and whether the IFRS 7 disclosures should be provided if the transactions were accounted for as financial instruments.