Issue  |  Details  |  DisclosuresActions

What’s the issue?

As governments take action to combat climate-related risks, companies that produce or sell products that are considered to contribute to climate change may see limits or bans placed on the sale of certain products. As a result, they may see increased inventory costs due to carbon taxes, emissions schemes, changes in production processes and the need to substitute materials currently used in production for more environmentally friendly materials. To succeed, a company may need to overhaul its product range, which may also increase costs.

In addition, demand for certain products may decrease as customers shift to more climate-friendly and sustainable products, resulting in potential inventory write-downs. At its most extreme, new climate-related laws and changes in customer demand could lead to inventories becoming hard to sell or obsolete.

Companies that produce or sell products that are considered to contribute to climate change may see a fall in demand or increased costs for inventories, which may lead to inventory write-downs. Companies moving to more sustainable products and updated production processes may also see higher production costs initially.

Getting into more detail


Do inventory items need to be written down to net realisable value?

Under IAS 2 Inventories, inventory is measured at the lower of cost and net realisable value (NRV). Any write-down of inventories to NRV is recognised as an expense in the period in which the write-down occurs. [IAS 2.2.6]

NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion and sale. [IAS 2.6]

Climate-related matters could impact both the selling price and the cost of an inventory item. Therefore, management needs to consider these carefully when determining the NRV of its inventories.

What is the cost of a new item of inventory?

Companies may introduce new, more sustainable products either to meet consumer demand or to replace current products that are no longer economic to produce. Companies may also make changes to existing production processes to comply with new laws on climate-related matters.

The cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Selling and advertising costs are excluded from the cost of inventory. [IAS 2.10, 16]

When a company starts to manufacture a new product or makes significant changes to its production processes, the associated costs may be higher initially as the company builds its experience. Any abnormal additional production costs are expensed when they are incurred – e.g. excess raw material costs. In addition, fixed overheads are allocated based on normal operating capacity. This means that if a production line is operating at below its capacity, then some costs may need to be written off to profit or loss in the period when they are incurred. [IAS 2.13, 16]

In some cases, a company may incur costs as part of its learning curve in setting up a new production line. In our view, these costs should be included in the cost of inventory (subject to their recoverability) when there is clear and objective evidence that these costs are not abnormal costs. Also, if these costs are significant, then actual production costs on the earlier units produced may exceed the NRV of these units and, therefore, result in losses on initial production. [Insights 3.8.215]


Are emissions certificates an inventory item?

Certain jurisdictions operate a ‘cap and trade’ scheme. These schemes require a company to deliver emissions certificates to a third party – e.g. a regulator – to allow it to emit pollutants legally. In our view, a participant in a cap and trade scheme should choose an accounting policy for its emissions allowances based on one of the following approaches and apply it consistently.

  • As intangible assets: Under this approach, emissions allowances are considered to be identifiable non-monetary assets that have no physical substance. Therefore, they meet the definition of an intangible asset.
  • As inventories: Under this approach, emissions allowances are considered to be an input in the production process, similar to inventories. [Insights 3.8.73]

If a company receives emissions allowances from a government, then it may apply the guidance in IAS 20 Accounting for Government Grants and Disclosure of Government Assistance on initial recognition. Initially, a non-monetary government grant may be recognised either at fair value or at a nominal amount. If the company accounts for emissions allowances as inventories, then it subsequently applies the measurement requirements of IAS 2. Conversely, if it purchases emissions allowances from a third party and accounts for them as inventories, then it applies IAS 2 from initial recognition. [Insights 3.8.74–75]

In our view, emissions allowances may be classified as commodities and, therefore, may meet the broker-trader exemption included in IAS 2. If these allowances are held as a commodity for resale, then they are measured at their fair value less costs to sell. [IAS 2.3(b), Insights 3.8.75]


Are reusable and returnable packaging and parts inventory items?

As part of its strategy on climate-related matters, a company may decide to move to using reusable or returnable packaging or parts – e.g. reusable bottles or crates. Packaging or parts that are sold to a customer but will be returned to the seller for re-use are not inventory if they will be used over more than one period. Instead, these items are generally treated as property, plant and equipment. [Insights 3.8.40]  


Companies need to provide clear and meaningful disclosures about significant judgements and estimates made in recognising and measuring inventories. They are also required to disclose the amount of any write-down of inventories recognised as an expense during the period.

Actions for management to take now

  • Obtain an understanding of current and upcoming legislation that may affect the goods sold or services delivered by the company.
  • Determine whether the NRV calculation appropriately takes into account the effect of climate-related matters on the selling price and cost of inventories.
  • Assess which costs incurred in respect of new products or updated production processes can be included in the cost of inventory.

References to ‘Insights’ mean our publication Insights into IFRS

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