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Interpretations Committee discusses whether interest should be accreted in supply contracts with long-term prepayments

 11 December 2014

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 is whether the purchaser should accrete interest on long-term prepayments by recognising interest income, resulting in an increase in the costs of inventories and, ultimately, the cost of sales.

In May 2014 the IASB issued IFRS 15 Revenue from Contracts with Customers, which includes guidance on reflecting the time value of money when accounting for sales to customers. At this meeting the Interpretations Committee discussed how the guidance in that Standard could inform its discussion on this issue. It also considered the guidance on accounting for the time value of money in other Standards such as IAS 2, IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets.

The Interpretations Committee noted that IFRS 15 requires that the effect of a significant financing component should be reported separately as interest income or expense if a contract contains such a component. The Interpretations Committee also noted that a purchaser may prepay for goods and services for reasons other than as part of a financing arrangement, such as security of supply. In its discussions, the Interpretations Committee acknowledged the practical difficulties that would be encountered in separating these elements but thought that any difference between the amount payable in accordance with the arrangement and the cash selling price at the delivery date would be significant in making that determination.

The Interpretations Committee asked the staff to conduct outreach to collect evidence about the nature of, and reasons for, the prepayments made by purchasers in long-term supply contracts, and to identify whether the arrangements included a financing component or whether the purchaser made the prepayment for other reasons.

The staff will present an analysis of the evidence about the nature of prepayments in long-term supply contracts at a future meeting.

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