Physical settlement of contracts to buy or sell a non-financial item (Agenda Paper 11)

Background

In November 2018, the Committee discussed a submission about how an entity applies IFRS 9 Financial Instruments to particular contracts to buy or sell a non-financial item in the future at a fixed price. The submitter asks whether, in accounting for that physical settlement, it is appropriate for an entity to record an additional journal entry to (a) reverse the accumulated gain or loss previously recognised in profit or loss on the derivative, and (b) recognise a corresponding adjustment to either revenue (in the case of a sale contract) or inventory (in the case of a purchase contract).

The Committee has published a tentative agenda decision which states that the additional journal entry on reversal of the fair value gain or loss on a derivative, which reflected the changes of mark-to-market in previous years, effectively negates the requirement in IFRS 9 to account for the contract as a derivative because it would reverse the accumulated fair value gain or loss on the derivative without any basis to do so. The additional journal entry would also result in the recognition of income or expenses that do not exist. IFRS 9 neither permits nor requires an entity to reassess or change its accounting for a derivative contract solely because that contract is ultimately physically settled.

Comment letters were received and respondents were concerned about the interaction between IFRS 9, IFRS 15 and IAS 2 and that the agenda decision does not reflect the economic substance of the transaction.

Staff analysis

Some respondents had concerns about the scoping issue. They consider that the entity should apply IFRS 15 when the non-financial item is physically settled and the amount of revenue recorded without the additional journal entry would not equate to the transaction price as required by IFRS 15. The staff analyse the scoping issue is beyond the subject matter of the question, i.e. whether the entity is permitted or required to reverse the accumulated gain or loss previously recognised in profit or loss on the derivative. Some respondents disagreed with the cost of inventory including the fair value of the derivative on the settlement date but the staff continue to hold the previous view as the cost of inventory acquired should include cash paid plus fair value of the derivative on the settlement date. Some other respondents were concerned about the disclosure and presentation regarding the gains or losses on the derivative. Therefore, the staff has proposed additional wording in the tentative agenda decision to clarify that the Committee has not considered how an entity presents gains or losses on the derivative, or how any entity presents other revenue amounts that arise from the contracts described in the submission. The staff believe that this may address some of the respondents' concerns about the usefulness of information provided to users of financial statements.

Other respondents say that the accounting outcome does not reflect the economic substance of the transaction and is different from the accounting for contracts that meet the own use exception. The staff continue to hold the previous view that IFRS Standards require a different accounting treatment for different contracts.

In addition, certain respondents commented on the impact of the subject matter in terms of the time it would take to implement the agenda decision.

Staff recommendation

The staff recommend (i) finalising the agenda decision subject to abovementioned changes; and (ii) including in IFRIC Update that the entity is entitled to sufficient time in determining the change in accounting policy as a result of the agenda decision, in order to address respondents' concern on the time it would take to implement the agenda decision.

Discussion

Most of the Committee members agreed with the staff analysis while a few Committee members were still not convinced with regard to the recognition of revenue or inventory. The Chair acknowledged that there is a diversity in views within and outside of the Committee but she believes that it is important to carefully consider the arguments for and against the staff’s conclusion. Some Committee members mentioned that the "settlement of derivative" is part of the transaction and accordingly it supports the argument for not recording the additional journal entry. Some Committee members also commented that the disclosure requirements in IAS 1 and IFRS 7 newly added in the Agenda Decision are useful.

Some Committee members expressed that they have received comments that IFRS 9 may not be prescriptive enough to support this accounting outcome. Some of them suggested to make additions to IFRS 9 to cover the specific transactions within the scope of "own use exceptions" and to address the issue in the PIR of IFRS 9.

The Committee decided, by a majority of votes, to publish the Agenda Decision with some tweaks.