MHM Messenger: Proposal to Simplify Inventory Accounting
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our roots run deep TM MAYER HOFFMAN MCCANN P.C. – AN INDEPENDENT CPA FIRM A publication of the Professional Standards Group MHMMessenger © 2014 MAYER HOFFMAN MCCANN P.C. 877-887-1090 • www.mhmcpa.com • All rights reserved. TM The Financial Accounting Standards Board (FASB) has been working on a Simplification Initiative. The goal of this initiative is to identify areas of US Generally Accepted Accounting Principles (GAAP) where cost and complexity can be reduced while maintaining or improving the usefulness of information provided in the financial statements. As part of the Simplification Initiative the FASB has proposed a change to the accounting for inventory. Lower of Cost or Market Existing GAAP requires that inventory be measured at the lower of cost or market. The measurement of market begins with the cost to replace the inventory. However, in order to use replacement cost as the market measurement of inventory the replacement cost must be between two constraining variables. Replacement cost must not be greater than the estimated selling price in the ordinary course of business, less the reasonably predictable costs of completion, disposal and transportation, known as net realizable value (NRV). In addition, the replacement cost must not be less than NRV less a normal profit. August 2014 Proposal to Simplify Inventory Accounting Example A distributor of home appliances purchases 100 ovens for $2,000 per unit in November 2014. All 100 units are held in inventory at December 31, 2014. Prior to year-end, the manufacturer issues a permanent price reduction to $1,750 per unit. Originally, the ovens were listed by the distributor at a selling price of $2,500, but when the price was reduced by the manufacturer the distributors selling price had to be reduced to $2,200 to match competitors’ pricing. For simplicity, there is no cost of completion, disposal or transportation. To determine the value of inventory at December 31, 2014, the distributor evaluates the ovens under lower of cost or market using the following steps: Step 1: Determine cost: The original cost to purchase the inventory was $2,000. Step 2: Determine market: • Step 2a: Determine the upper limit (NRV): The expected selling price of $2,200 • Step 2b: Determine the replacement cost: The new permanent cost to purchase the inventory $1,750 • Step 2c: Determine the lower limit (NRV less normal profit: $2,200-($2,500-$2,000) = $1,700 Since the replacement cost of $1,750 is between the upper limit of $2,200 and the lower limit of $1,700 it is used as the market value of the inventory. A lower of cost or market adjustment of $250 per unit is recorded.
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The Financial Accounting Standards Board (FASB) has been working on a Simplification Initiative. The goal of this initiative is to identify areas of US Generally Accepted Accounting Principles (GAAP) where cost and complexity can be reduced while maintaining or improving the usefulness of information provided in the financial statements. As part of the Simplification Initiative the FASB has proposed a change to the accounting for inventory.
Transcript of MHM Messenger: Proposal to Simplify Inventory Accounting
our roots run deepTM
Mayer HoffMan Mccann P.c. – an IndePendenT cPa fIrM
a publication of the Professional Standards Group
MHMMessenger
© 2 0 1 4 M ay e r H o f f M a n M c c a n n P. c . 877-887-1090 • www.mhmcpa.com • All rights reserved.
TM
The financial accounting Standards Board (faSB) has been working on a Simplification Initiative. The goal of this initiative is to identify areas of US Generally Accepted Accounting Principles (GAAP) where cost and complexity can be reduced while maintaining or improving the usefulness of information provided in the financial statements. As part of the Simplification Initiative the FASB has proposed a change to the accounting for inventory.
Lower of Cost or Market
Existing GAAP requires that inventory be measured at the lower of cost or market. The measurement of market begins with the cost to replace the inventory. However, in order to use replacement cost as the market measurement of inventory the replacement cost must be between two constraining variables. Replacement cost must not be greater than the estimated selling price in the ordinary course of business, less the reasonably predictable costs of completion, disposal and transportation, known as net realizable value (NRV). In addition, the replacement cost must not be less than NRV less a normal profit.
august 2014
Proposal to Simplify Inventory Accounting
ExampleA distributor of home appliances purchases 100 ovens for $2,000 per unit in November 2014. All 100 units are held in inventory at December 31, 2014. Prior to year-end, the manufacturer issues a permanent price reduction to $1,750 per unit. Originally, the ovens were listed by the distributor at a selling price of $2,500, but when the price was reduced by the manufacturer the distributors selling price had to be reduced to $2,200 to match competitors’ pricing. For simplicity, there is no cost of completion, disposal or transportation.
To determine the value of inventory at December 31, 2014, the distributor evaluates the ovens under lower of cost or market using the following steps:
Step 1: Determine cost: The original cost to purchase the inventory was $2,000.
Step 2: Determine market:
• Step2a: Determine the upper limit (NRV): The expected selling price of $2,200
• Step2b:Determine the replacement cost: The new permanent cost to purchase the inventory $1,750
• Step 2c:Determine the lower limit (NRV less normal profit: $2,200-($2,500-$2,000) = $1,700
Since the replacement cost of $1,750 is between the upper limit of $2,200 and the lower limit of $1,700 it is used as the market value of the inventory. A lower of cost or market adjustment of $250 per unit is recorded.
© 2 0 1 4 M ay e r H o f f M a n M c c a n n P. c . 877-887-1090 • www.mhmcpa.com • All rights reserved.
MHMMessenger
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TheinformationinthisMHMMessengerisabriefsummaryandmaynotincludeallthedetailsrelevanttoyoursituation.PleasecontactyourMHMauditortofurtherdiscusstheimpactonyourauditorauditreport.
Lower of Cost or Net Realizable Value
Under the proposed guidance lower of cost or market is simplified by replacing market with NRV. This simplification will reduce the complexity by removing several variables in the evaluation.
Other Information
The proposed change does not impact other areas of inventory accounting such as the use of first-in, first-out (FIFO), last-in, first-out (LIFO), average cost or the retail inventory method. In addition, the application of lower of cost or NRV is still required to be applied by the method that most accurately reflects periodic income, either by item, aggregate category of inventory or total inventory.
What Happens Next?
The FASB is accepting comment letters on the proposal through September 30, 2014. If adopted as proposed, the standard will be effective for periods beginning after December 15, 2015 (calendar year ending December 31, 2016) for all entities. Early adoption would be permitted.
For More Information
If you have any specific questions, comments or concerns, please share them with Ernie Baugh or James Comito of MHM’s Professional Standards Group or your MHM service professional. You can reach Ernie at [email protected] or 423.870.0511 and James at [email protected] or 858.795.2029.
ExampleUsing the example on the previous page, the measurement of inventory would be done as follows:
Step 1: Determine cost: The original cost to purchase the inventory was $2,000.
Step 2: Determine NRV: The new permanent selling price is $2,200.
Inventory will be valued at $2,000, which is the lower of cost or NRV and no adjustment is recorded to the inventory.
