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.

Inventories of high-methane gas in storage are measured jointly for all storage units, at the average weighted cost.

Changes in the inventories of gas fuel stored in the Underground Gas Storage Facilities for sale and own consumption, as well as balance-sheet differences, are measured at the average weighted cost, which includes in particular: costs of purchase of gas from all sources together with an appropriate portion of costs of system and transaction charges, actual costs of its production from domestic sources, costs of nitrogen removal and regasification.

LNG inventories are measured at actual production cost or purchase price, depending on the source. The purchase price is increased by acquisition costs, including costs of transporting the gas to the storage site (including towing and mooring services, port fees, etc.). LNG inventories are measured using the weighted average method. Changes in LNG inventories (sale and consumption, including regasification) are measured at the average actual unit cost in a given reporting period for a given location.

In accordance with the provisions of the Energy Law, the Group companies acting as producers of electricity from renewable sources receive free of charge certificates of origin for electricity. Such property rights, in the part in which they are intended for sale, are recognised as goods at fair value determined as at the date of their registration.

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.

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).

Recognition and reversal of impairment allowances on both individual and collective inventories are recognised in cost of sales.

With regard to gas inventories held for sale, the book value of gas inventories is compared to the realizable value from their sale using data from concluded gas sales contracts, forecasted sales volumes and forecasted sales prices on the Polish Power Exchange (TGE in Polish) (prices of monthly forward contracts in the following 12 months). On the basis of contracts and forecasts for a period of a year in monthly granulation, the average selling price is calculated, weighted by the volume of planned and contracted sales in particular months. If the value of the forecasted revenues determined in this way is lower than the book value of gas stocks in the warehouse intended for sale as at the balance sheet date, an inventory impairment allowances is created in the amount of the difference between these values, which is charged to 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 2022 and as at 31 December 2021 the value of mandatory reserves presented in consolidated financial statements amounted to PLN 12,213 million and PLN 6,400 million, respectively. In 2022, increase in value of inventories compared to end of 2021 is mainly due to the increase in the prices in crude oil and petroleum product prices and the recognition of the former LOTOS Group and former PGNiG Group inventories in consolidation.

Change in impairment allowances of inventories to net realizable value

Increase in impairment losses of inventories to net realizable value in 2022 was higher than in the corresponding period of the previous year, mainly due to the merger with the PGNiG Group and the recognition of a gas allowance due to a decrease in gas prices on stock exchanges in December 2022 and the related reduction of price forecasts for the next 12 months.