Enquiry:

Can foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency be capitalized in cost of inventory?

Opinion:

The Board notes that guidance should be obtained from IAS 2 ‘Inventories’ and IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’.

The cost of inventories should be determined in accordance with IAS 2 and the accounting of inventory whose costs of purchase is denominated or requires settlement in a foreign currency should be done in accordance with IAS 21.

IAS 2 requires that inventories should be measured at lower of cost or net realizable value. The cost comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of purchase include purchase price, import duties, handling and transportation costs. However, as explained previously in introduction paragraph IN 10 of IAS 2, the exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency are not permitted to be included in the cost of purchase of inventories.

In addition to IAS 2, the principles outlined in IAS 21 for the recognition and measurement of foreign currency transactions can also be considered in respect of the inventory (whose purchase price is denominated or requires settlement in a foreign currency).

In accordance with paragraphs 21 and 22 of IAS 21, a foreign currency transaction is initially recorded at the spot exchange rate between the functional currency and the foreign currency, prevalent at the date of the transaction. The date of a transaction is the date on which the transaction first qualifies for recognition in accordance with IFRS.  The date of transaction for the inventories is generally the date on which risks and rewards of ownership are transferred to the buyer.

Further, in accordance with the paragraph 23 of IAS 21, re-translation is not required at the subsequent reporting date/s for the foreign currency based non-monetary assets that are measured at historical cost. Accordingly, inventory is not required to be re-translated as it is a non-monetary asset measured at historical cost.

In context of the enquiry, it is relevant to mention that the term “recent acquisition” was used in SIC 11 ‘Foreign Exchange-Capitalisation of Losses from Severe Currency Devaluations’ (which has been superseded by IAS 21). Further, in SIC 11 the term “recent acquisition” referred to the acquisitions within twelve months prior to the severe devaluation or depreciation of the reporting currency.

Based on the above discussion, the Board is of the view that inventory whose cost is denominated or requires settlement in a foreign currency should be:

• Initially recognised using the foreign currency exchange rate at the date of transaction i.e. the date of transfer of risks and rewards of ownership of inventory;
• The exchange differences arising directly on the ‘recent acquisition’ of inventories invoiced in a foreign currency should not to be included in the cost of purchase of inventories; and
• The inventory measured at cost should not be subsequently re-measured for changes in exchange rate. Resultantly the subsequent changes in the exchange rate would not be capitalised in the cost of inventory.

(April 20, 2018)