Inventory. Academic Resource Center Inventory Page 2 Typical coverage of US GAAP ► Definition and...

Inventory

Academic Resource Center

Inventory

Typical coverage of US GAAP

► Definition and scope

► Perpetual vs. periodic systems

► Physical goods and costs included in inventory

► Effects of inventory errors

► Cost flow assumptions► Specific identification

► Average cost methods

► First-in, first-out method (FIFO)

► Last-in, first-out method (LIFO) (including dollar-value LIFO)

► Retail inventory method (RIM)

► Lower of cost or market

► Disclosures


Inventory

Executive summary

► IFRS does not permit the LIFO method of costing inventory, unlike US GAAP.

► IFRS reports inventory at the lower of cost or net realizable value (LCNRV). US GAAP reports inventory at the lower of cost or market (LCM), where market is defined as a replacement cost with a floor (NRV less normal profit margin) and a ceiling (NRV).

► IFRS allows reversals of prior inventory write-downs to be made and recognized in income, unlike US GAAP.


Inventory

Primary pronouncements

US GAAP

► ASC 330, Inventory

IFRS

► IAS 2, Inventories


Inventory

Progress on convergence

► On July 15, 2014, the FASB issued an ED Inventory (Topic 330): Simplifying the Measurement of Inventory.

► Comments are due September 30, 2014.► Inventory would be reported at LCNRV, the

same as the IFRS approach. ► The proposed effective date is for annual

periods beginning after December 15, 2015, with early adoption permitted.


Inventory

Definition and scope

Inventory includes finished goods, work-in-progress and raw materials.

Inventory is recognized when the risk and rewards pass to entity.

Similar

Similar

IFRSUS GAAP


Inventory

Definition and scope

US GAAP

► Intangible assets produced for resale (e.g., software) are not included in inventory.

► ASC 908, Agriculture, is used to scope out agricultural products and commodities.

IFRS

► Intangible assets produced for resale are included in inventory.

► IAS 41, Agriculture, is used to scope out agricultural products and commodities.


Inventory

Perpetual vs. periodic systems

Both systems are allowed. Similar

IFRSUS GAAP


Inventory

Physical goods and costs included in inventory

Costs include productions costs, conversion costs and purchase costs.

Cost includes freight-in.

Similar

Similar

Interest must generally be capitalized. Similar, although certain conditions must be met.

IFRSUS GAAP


Inventory

Physical goods and costs included in inventory

US GAAP

► No guidance is provided on storage costs.

IFRS

► Storage costs are usually expensed.


Inventory

Cost flow assumptions

Specific identification, average cost, FIFO and RIM are allowed.

Similar

IFRSUS GAAP


Inventory


IFRS

► The same cost flow assumptions must be used for inventory with a similar nature and use even if inventory is held in different geographic locations and/or by different entities.

► LIFO method is not allowed:

► This is significant to some companies because of taxation implications. If IFRS is adopted with no changes made in the current standards and the current tax laws, then companies will have to pull the LIFO reserve back into their taxable income over a four-year period.

US GAAP

► Different cost flow assumptions may be used for inventory with a similar nature and use.

► LIFO method is allowed:

► The IRS has a conformity rule that requires LIFO to be used for book purposes if it is used for tax purposes.


Inventory


Analysis of companies as of 2011:

Variable Mean Median

Reserve balance (in millions) $363$45

Net income (in millions) $893$109

LIFO reserve/operating income 50%17%

LIFO reserve/net income 60%27%

LIFO reserve/assets 4%

2%

LIFO reserve/inventory* 17%14%

*Inventory is the LIFO inventory with the reserve added back.

Analysis of companies as of 2011 using Compustat: 6,432 companies in the sample of which 4,384 companies had inventory of which 291 companies had a LIFO reserve.

► Exxon had a reserve of $25.6 billion in 2011 and $21.3 billion in 2010. In 2011, this was 47% of Exxon’s operating income, 62% of its net income and 8% of its assets.

► Central Steel & Wire Co. had a reserve balance that was 11 times its operating income and 16 times its net income in 2011.


Inventory

Lower of cost or market

Write-downs of inventories are required in certain circumstances.

Similar, but specifics vary.

IFRSUS GAAP


Inventory


US GAAP

► Reports at the LCM:► Market is defined as replacement cost with

a floor (NRV less normal profit margin) and a ceiling (NRV).

► NRV is defined as the estimated selling price less the estimated costs of completion and sale.

► Reversals of prior write-downs are not allowed.

IFRS

► Reports at the lower of cost or net realizable value (LCNRV):► NRV is defined as the estimated selling

price less the estimated costs of completion and sale.

► Since replacement cost would typically be less than NRV, IFRS will generally result in lower write-downs than US GAAP.

► Reversals of prior write-downs can be made and recognized in income.


Inventory


US GAAP

► Write-down can be done using an item-by-item, group-by-group or on a total inventory basis.

IFRS

► Write-downs are typically done on an item-by-item basis:

► Group-by-group basis is allowed under certain circumstances.

► Since most companies in the US use an item-by-item basis, significant differences are not expected.


Inventory


US GAAP

► Write-downs must be included as expense:► ASC 420-10-S99-3, Exit or Disposal Cost

Obligations – Overall – SEC Materials, states that inventory write-downs should be included in cost of goods sold even when related to an exit or restructuring cost.

► ASC 330-10-50-2, Inventory – Overall – Disclosure, states that if “substantial and unusual losses” result from the LCM rule then the loss amount should not be included in cost of goods sold on the income statement.

IFRS

► Write downs and reversals of write-downs must be included as expense, but a particular expense account is not specified.


Inventory

Example 1 – inventory write-down

Part 1:On December 31, 2012, Jets International had an inventory of five different types of airplane parts. Given the current fuel costs, airplane parts are not as valuable as they once were. The chart on the next slide provides the cost basis, net realizable value, replacement cost and net realizable value less normal profit margin as of December 31, 2012.

Inventory write-down example

► What is the amount of write-down (if any) required using US GAAP on both a total and item-by-item basis? Please provide the necessary journal entry.

► What is the amount of write-down (if any) required using IFRS on both a total and item-by-item basis? Please provide the necessary journal entries.


Inventory

Cost NRV RC NRV-NPM

Part 1 $ 10,000 $ 20,000 $ 15,000 $ 12,000

Part 2 $ 20,000 $ 19,000 $ 18,000 $ 17,000

Part 3 $ 5,000 $ 3,000 $ 4,000 $ 2,000

Part 4 $ 8,000 $ 15,000 $ 12,000 $ 11,000

Part 5 $ 15,000 $ 12,000 $ 9,000 $ 11,000


Part 1 (continued):


Inventory

Original cost NRV RC

NRV-NPM

US GAAPmarket

US GAAPLCM

IFRS LCNRV

Part 1 $10,000 $20,000 $15,000 $12,000 $15,000 $10,000 $10,000

Part 2 20,000 19,000 18,000 17,000 18,000 18,000 19,000

Part 3 5,000 3,000 4,000 2,000 3,000 3,000 3,000

Part 4 8,000 15,000 12,000 11,000 12,000 8,000 8,000

Part 5 15,000 12,000 9,000 11,000 11,000 11,000 12,000

Item-by-item basis $58,000 $50,000 $52,000

Total basis $58,000 $69,000 $58,000 $53,000 $58,000 $58,000

Example 1: Part 1 solution:


Total basis for US GAAP: If the inventory write-down is calculated for the total inventory, there is no write-down under US GAAP as the LCM value is $58,000 the same as the original cost.


Inventory

Part 1 solution (continued):Item-by-item basis:US GAAP: IFRS:

Original cost $ 58,000 Original cost $ 58,000LCM 50,000 LCNRV 52,000Write-down $ 8,000 Write-down $ 6,000

US GAAP journal entry: IFRS journal entry:

CGS $8,000 Inventory write-down expense $6,000Inventory $8,000 Inventory valuation allowance $6,000

The amount of inventory write down in this example is $8,000 using US GAAP because the LCM is less than the original cost. The amount is to be recorded in the income statement to CGS and directly to inventory because a future reversal of write-downs is not permitted. Using IFRS, the write-down is $6,000 because the LCNRV is less than the original cost. The write-down is not required to be recorded in a specific income statement account. A valuation allowance is used because future reversals of write-downs are permitted.



Inventory

Inventory write-down reversal example

Example 1 – write-down reversal

Part 2:The airline industry’s business was so terrible during 2013 that Jets International still had the same five parts in its inventory as of December 31, 2013. However, fuel prices have decreased, so the outlook is more optimistic. As of the end of the year, Jets International’s original cost basis, net realizable value, replacement cost and net realizable value less the normal profit are as shown on the next slide.

► What is the amount of write-down reversal (if any) required using US GAAP? Please provide the necessary journal entry.

► What is the amount of write-down reversal (if any) required using IFRS? Please provide the necessary journal entry.


Inventory


Original Cost NRV RC NRV-NPM

Part 1 $ 10,000 $ 21,000 $ 16,000 $ 13,000

Part 2 $ 20,000 $ 20,000 $ 19,000 $ 18,000

Part 3 $ 5,000 $ 4,000 $ 9,000 $ 3,000

Part 4 $ 8,000 $ 16,000 $ 11,000 $ 12,000

Part 5 $ 15,000 $ 14,000 $ 10,000 $ 12,000

Part 2 (continued):


Inventory

Example 1:

Part 2 solution:


Original CostIFRS LCNRV

December 31, 2012 NRVIFRS LCNRV

December 31, 2013

Part 1 $ 10,000 $10,000 $21,000 $10,000

Part 2 20,000 19,000 20,000 20,000

Part 3 5,000 3,000 4,000 4,000

Part 4 8,000 8,000 16,000 8,000

Part 5 15,000 12,000 14,000 14,000

Total $ 58,000 $ 52,000 $56,000


Inventory


Part 2 solution (continued):No reversal of a write-down is permitted using US GAAP.

IFRS:

December 31, 2013 LCNRV $ 56,000December 31, 2012 LCNRV 52,000Write-down $ 4,000

Journal entry:

Inventory valuation allowance $4,000Inventory write-down expense $4,000

Since the LCNRV at December 31, 2013 exceeds the LCNRV at December 31, 2012 by $4,000, this amount is recorded as a reversal to the previous write-down.


Inventory

Disclosures

Basis upon which amounts are stated (e.g., LCM) and costing method

Carrying amounts by classification

Similar

Similar

Inventory financing arrangements Similar

IFRSUS GAAP


Inventory

Disclosures

US GAAP

► Requires disclosure of the amount of write-downs recognized as expense.

► Various required disclosures when a firm uses the LIFO costing method (e.g., the LIFO reserve or replacement cost must be disclosed).

IFRS

► Requires disclosure of both the amount of write-downs recognized as expense and any reversal of write-downs.

► No required disclosures related to LIFO method since LIFO is not allowed.

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Inventory. Academic Resource Center Inventory Page 2 Typical coverage of US GAAP ► Definition and...

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