14.5.1. Inventories

SELECTED ACCOUNTING PRINCIPLES

Inventories

Inventories, including mandatory reserves comprise products, semi-finished products and work in progress, merchandise and materials.

Finished goods, semi-finished products and work in progress are measured initially at production cost. Production costs include costs of materials and costs of conversion for the production period of finished goods, semi-finished products as well as work in progress and systematic allocation of fixed and variable production overheads estimated for its normal level.

Finished goods, semi-finished products and work in progress are measured at the end of the reporting period at the lower of cost or net realizable value.

Cost flows of finished goods, semi-finished products and work in progress are determined based on the weighted average cost of production.

Merchandise and materials are measured initially at purchase price, and at the end of the reporting period at purchase price or at net realizable value, depending on which amount is lower.

Cost flows of merchandise and materials are determined based on the weighted average purchase price, except:

• coal inventories, the outflow of which is recognised as the „first in first out” (FIFO) method;
• raw materials purchased for orders – outflows according to the detailed price identification method;
• raw materials, that due to technical parameters, are released from the warehouse in the order of their receipt (e.g. ower materials/goods, printing materials) – outflow according to the FIFO method.

The initial value of inventories is adjusted for their profits or losses from settlement of cash flow hedging instruments.

ESTIMATES

Net realizable values from sale of inventories

In the event that the purchase price or production cost of inventories are not recoverable, the Group determines the amount of inventory write-offs based on estimates of their net realizable value.

Inventories which have lost their functional properties, usefulness or have dropped their selling prices are subject to revaluation to the level of net realizable sale prices.

At the end of each month, the Group compares the purchase prices of inventories (average purchase price for a given group of inventories) or inventory manufacturing costs (average production cost for a given group of inventories) with their achievable net value, which is the estimated selling price in the ordinary course of business economic activity reduced by the estimated costs of preparation of the sale and estimated costs necessary to complete the sale.

In practice, realizable values ​​are determined on the basis of the actual selling prices of inventories (both retail and wholesale) for transactions made on the last day of the month and on the first days of the month following the day on which the inventory impairment analysis is prepared, no later than, in which the books of accounts are closed and taking into account the current rotation cycle, as well as taking into account the execution prices included in the actual contracts signed as at the balance sheet date.

The value of materials intended for use in the production process is not written down below the purchase price, if it is expected that the finished products, for the production of which they will be used, will be sold for amounts higher or equal to the estimated production costs determined on the basis of historical data. However, if the cost of manufacturing products is higher than the net realizable value, the value of the materials is written down to the level of the net realizable value.

For intermediates and products in progress, verification the necessity to make a write-off takes place by comparing the cost of production with the actual prices of sale, taking into account dedicated price formulas that define the degree of their processing in relation to finished products.

Depending on the type of inventories, the Group makes individual and collective write-offs.

Individual write-offs are made when, as a result of analyses and comparisons, the net realizable value is lower than the purchase price of a given inventory component or its production cost, in the value of this difference. If there is a change in the net realizable value, then the creation or reversal of write-offs in the amount of this change is recognised.

Collective Impairment allowances apply when you group together similar or related items of inventory that originate in the same product line, have a similar purpose or end-use, produced and sold in the same facility, and that cannot be practically assessed in isolation from other items derived from the same product line and relate mainly to stocks of crude oil and petroleum products.

In the case of collective write-offs, the difference between the book value and the net realizable value calculated for individual items is netted within one group of inventories. In the event that the compensated by the above-mentioned the differences are a negative value, a write-off is made.

At the end of each month, the total value of the write-off of the inventory group is determined. The change in the value of the collective write-off at the end of the next reporting period is the amount of:

• recognition of a write-off (increase in the write-off value compared to the write-off value at the end of the previous reporting period)
• reversal of the write-off (decrease in the write-off value compared to the write-off value at the end of the previous reporting period)
• use of the write-off (reduction of the write-off due to the use, sale or liquidation of components for which the write-off was created).

The creation and reversal of write-offs updating the value of inventories, both individual and collective are recognized in the cost of sales.

The main item of inventories, which turnover period is longer than 12 months after the end of the reporting period are mandatory reserves. As at 31 December 2021 and as at 31 December 2020 the value of mandatory reserves presented in consolidated financial statements amounted to PLN 6,400 million and PLN 4,703 million, respectively. In 2021, decrease in value of inventories compared to end of 2020 is mainly due to the increase in the prices of crude oil and petroleum products.

Change in impairment allowances of inventories to net realizable value

Increases and decreases of the impairment allowances of inventories to net realizable value in 2021 were lower compared to the changes presented in the impairment allowances for the previous year, which resulted mainly from the recognition in 1^st quarter of 2020 significant impairment allowances of inventories to net realizable value due to a increase in crude oil and petroleum product prices, which were used in the subsequent periods of 2020.