A majority of entities will soon measure inventory at the lower of cost and net realizable value. The change, part of the Financial Accounting Standards Board (FASB)'s Simplification Initiative, affects all entities that measure inventory, except those that follow last-in, first-out (LIFO) or the retail inventory method.
The FASB released Accounting Standards Update (ASU) 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory to address concerns that the accounting practices for inventory are needlessly complex. Entities currently record inventory at the lower of cost or market. Market is determined by using three different measurements of inventory: replacement cost, net realizable value and net realizable value minus a normal profit margin.
Stakeholders that use the first-in, first out (FIFO) and average cost methods for measuring inventory told the FASB having three different outcomes for market led to unnecessary complexity and reduced the comparability of financial statements. For those entities, the accounting standards update limits the choice to the lower of cost or net realizable value. The definition of net realizable value is the estimated selling price in the ordinary course of business, minus the predicted cost of transportation and disposal of the inventory. When measuring inventory that is work in process (WIP), the expected cost to complete the inventory is also used in determining net realizable value.
During the comment period on the exposure draft of Inventory (Topic 330): Simplifying the Measurement of Inventory, FASB stakeholders said that measuring inventory under the LIFO and retail inventory method would result in significant transition costs and would not improve the usefulness of the financial statements. The FASB agreed in a May 13, 2015, meeting that it would scope out the LIFO and retail inventory method from the update in order to address these concerns. Entities that use the LIFO or retail inventory method will continue to follow current practice.
All entities will continue to adjust inventory to net realizable value or market as applicable, when a product loses value due to a price level change or for other reasons such as damage, deterioration, or obsolescence.
Changes to Topic 330 also include some rewording of the guidance for inventory measurement and disclosures, but the changes are not expected to affect entities' current practices. When adopting the standard, entities are required to disclose information about the nature and reason for the change in accounting principle but are not required to provide quantitative information about the change.
The accounting standards update takes effect for public business entities in fiscal years and interim periods beginning after December 15, 2016. All other entities will implement the change for fiscal years beginning after December 15, 2016, and interim periods beginning after December 15, 2017. Early adoption is permitted starting at the beginning of an interim or annual period. No matter when entities adopt the change, the accounting update will take place on a prospective basis.
For More Information
If you have specific comments, questions or concerns about how the changes to inventory accounting will affect your operations, please share them with Mark Winiarski of the MHM Professional Standards Group. Mark can be reached at firstname.lastname@example.org or 816.945.5614.
Published on July 28, 2015