P C Finance Research Clarifying Complexities

Registration Number: 1985/000022/23 Members: P E Hattingh and C P Hattingh

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IFRS Buzz 049

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Try this one for difficulty (10 out of 10)!

Facts

A local company (C) buys fruit from local farmers (F) and exports the fruit on behalf of the farmers. The fruit is delivered CIF. C is only informed of the dollar price it is to receive when the fruit is sold by the importer (I). The price received from I in rands less all the costs incurred by C and C’s “commission” is paid to the farmer sometime after the farmer has delivered the fruit. C takes the credit risk, i.e. if I does not pay, C takes the loss, but does not take any forex risk, i.e. any foreign exchange gains and losses are passed onto F.

Problems

  1. When does C recognise the obligation to pay F and the related inventory?
  2. When does C recognise the revenue and how does C measure the revenue?
  3. How does C account for any foreign exchange differences?

Interpretation

General

Because C takes credit risk, it is not acting as an agent but as a principle so C will have to recognise the inventory, payables, revenue and receivables.

Recognition of Inventory and Accounts Payable

For some inexplicable reason, IAS 2 gives no guidance on when to recognise inventories. In such a case one refers to IAS 8 which gives a hierarchy of steps to take in obtaining guidance. One could refer to IAS 16 or to IAS 18 for such guidance. IAS 16 states that property, plant and equipment is recognised when it is probable that future economic benefits associated with the item will flow to the entity and when the costs of the item can be measured reliably. IAS 18 states that revenue is only recognised when, among other things, costs can be measured reliably.

The Framework, paragraph 86, states that in many cases costs may have to be estimated and goes on to state that estimates are an essential part of the preparation of financial statements.

The question to ask is: “Is the estimation of the cost of inventory so unreliable in this situation as to preclude recognition?” This is a judgement call.

IAS 39 AG35(b) states that liabilities are generally not recognised until at least one of the parties has performed under the agreement. Accounts payable should, therefore, be recognised when the farmer delivers the goods, unless reliable measurement is not possible.

Recognition of Revenue and Receivable

IAS 18.14 sets out the conditions for recognising revenue. Para (c) requires that the amount of revenue must be able to be reliably measured and para (e) requires that the costs incurred or to be incurred in respect of the transaction must be able to be reliably measured. The other three requirements for recognition would have been met.

The last three paragraphs under the previous heading are also applicable to revenue and C will have to apply judgement to determine whether or not measurement is sufficiently unreliable as to preclude recognition.

Foreign Exchange Differences

When C is able to recognise revenue because the uncertainties have been resolved, it should recognise revenue and the receivable at the spot rate at that date. On the same date it will recognise cost of sales and the accounts payable. Any changes in the exchange rate between the recognition date and the date of receipt will be recognised in C’s profit or loss. The adjustment to the payable in respect of this gain or loss will be made between cost of sales and accounts payable.

Note

For internal control purposes, the company’s system may be different to the above. IFRS does not require the books of account to comply with the standards. Any difference between the books and IFRS at the year-end should be journalised to convert the books of account to IFRS compliant financial statements.

Business Model Accounting

IFRS 9’s requirement that an entity’s business model should determine whether it should use fair value or amortised cost has possibly opened a big can of worms. Should the way you account for something reflect your business model? I believe the answer is “yes”. For example, if it is your business model to operate in other entities’ fixed property, your financial statements should not reflect this fixed property on your “balance sheet”! Watch this space for more. I like Brian Singleton-Green’s point that if it is your business model to realise profits through sales to customers, one should not realise the profits until the goods are sold. This has been my point all along on taking profits on agricultural biological assets before selling the sheep, cows or maize. (Accountancy)

Kind regards,

Charles Hattingh

December 2011

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