A manufacturer's normal operating cycle, from raw-material purchase through to cash collection on the resulting sale, is clearly identifiable as 18 months, longer than a standard 12-month period. At the reporting date, the manufacturer holds work-in-progress inventory that will not be sold and converted to cash until 16 months after the reporting date. Under IAS 1, how should this inventory be classified?
- As non-current, because settlement will not occur within twelve months of the reporting date
- As non-current, unless the entity elects to use a twelve-month period regardless of its actual operating cycle
- Split between current and non-current in proportion to the number of months beyond twelve
- As current, because it will be realised as part of the normal operating cycle even though that cycle exceeds twelve months
Why D? And why not the others?
Correct answer: D. As current, because it will be realised as part of the normal operating cycle even though that cycle exceeds twelve months
IAS 1 classifies assets such as inventories as current when they are expected to be realised, or are held for sale or consumption, in the entity's normal operating cycle — and this applies even when that cycle is not expected to complete within twelve months of the reporting date. The twelve-month period is only used as a default assumption when the entity's normal operating cycle is not clearly identifiable; here the 18-month cycle is clearly identifiable, so it governs instead. The option classifying the inventory as non-current purely because settlement exceeds twelve months applies the default assumption in a case where the standard says the actual operating cycle should be used instead. The option describing an election to use twelve months regardless of the actual cycle invents a free choice that the standard does not offer; the operating cycle is a factual characteristic of the business, not an accounting policy an entity can elect to override. The option proposing a proportional split between current and non-current based on months beyond twelve has no basis in IAS 1, which classifies an asset as current or non-current in full, not by prorating a single balance.
Source: IAS 1 Presentation of Financial Statements, paragraphs 66–68 (classification of assets as current, including the operating cycle exception)