IFRS Ready Inventory www.pwc.com

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IFRS Ready
Inventory
Table of Contents
Module 1 – Introduction and Overview
Module 2 – Measurement of Inventory Costs
Module 3 – Measurement of Recoverability
Module 4 – Additional Topics
Module 5 – Summary
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Module 1 – Introduction and
Overview
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Session Objectives
This session describes the accounting for inventories under
International Financial Reporting Standards (IFRS) and United States
Generally Accepted Accounting Principles (US GAAP).
By the end of this session, you will be able to:
• Identify the concept of inventory and the types of costs that should be
included in the valuation of inventory
• Apply the formulas for measuring inventories under the specific
identification, FIFO, average cost, and LIFO methods under IFRS and
US GAAP
• Describe how to address the recoverability of inventory under IFRS
and US GAAP
• Describe the key disclosure for inventories under IFRS and US GAAP
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The Concept of Inventory
IFRS and US GAAP contain similar definitions of inventory:
Assets which (1) are held for sale in the ordinary course of
business (2) are in the process of production for such sale, or (3)
in the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Inventories owned by a manufacturing company typically include:
• Raw materials (“RM”)
• Work in progress (“WIP”)
• Finished goods
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Applicable Authoritative Guidance
The primary IFRS guidance applicable to inventory accounting includes:
• IAS 2 - “Inventories”
• IAS 41 - “Agriculture”
• IFRS 6 – “Exploration for and Evaluation of Mineral Resources”
• IAS 23 (revised 2007) (“IAS 23”) – “Borrowing Costs”
The primary US GAAP and SEC guidance applicable to inventory accounting includes:
•ASC 330-10-30 “ Inventory – Initial Measurement”
•ASC 330-10-35 “ Inventory – Subsequent Measurement”
• ASC 835-20 “ Capitalization of Interest”
• EITF 86-13 – “Recognition of Inventory Market Declines at Interim Reporting Dates”
• EITF 02-16 – “Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor”
• SAB Topic 5-BB – “Inventory Valuation Allowances”
• AICPA LIFO Issues Paper, November 30, 1984
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Module 2 – Measurement of
Inventory Costs
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Inventory Costs
Under both IFRS and US GAAP, inventory cost may comprise
production and/or acquisition costs.
For example, finished goods inventory cost for manufacturers will
often include the cost of raw materials, direct labor applied to those
materials, and allocated overhead.
For distributors, inventory cost likely will be comprised of the purchase
price, as well as any transportation costs paid by the distributor to ship
the inventory from the supplier to the distributor’s place of business.
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Inventory Cost Components
An entity should include in inventory the cost of direct labor employed in
manufacturing an inventory item.
The amount of labor cost “absorbed” into inventory will be based on (a) the
number of labor hours required to produce a product (presuming normal
production rates), multiplied by (b) the hourly cost per employee involved with
production.
An entity should also include in inventory indirect costs associated with the
entity’s manufacturing operations.
• These indirect costs are referred to as overhead.
• Overhead can comprise depreciation and maintenance of factory buildings
and equipment, the cost of factory management and administration, electricity,
and other similar items.
• Overhead should be allocated to inventory based on normal production levels.
Normal production refers to a range of production levels expected to be
achieved during various cycles or seasons under ordinary circumstances.
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Example 1 – Inventory Cost Components
Assume that a manufacturer normally produces 925 to
1,000 units of a product per operating cycle. During the
current operating cycle, (a) 950 units are produced and (b)
factory costs totaled $10,000. Assume that the factory only
produces one type of product.
How much overhead should be allocated to each unit
produced?
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Capitalization of Borrowing Costs
Certain inventory products require significant manufacturing time. A
manufacturer must finance its operating costs during the construction,
production or development period. In some cases, the manufacturer
will do so by borrowing funds. In these circumstances, both IFRS (IAS
23) and US GAAP (ASC 835-20) indicate that borrowing costs may need
to be capitalized as part of the cost of inventory, if it is a qualifying
asset.
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Capitalization of Borrowing Costs – IFRS
Amendments
Under the amended IAS 23 (affective 1/1/2009), borrowing costs
associated with qualifying assets must be capitalized as part of the cost
of inventory. A company is not required to apply the standard to:
- Qualifying assets measured at fair value (e.g., investment properties,
biological assets).
- Inventories that are routinely manufactured, or otherwise produced in
large quantities on a repetitive basis.
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Capitalization of Borrowing Costs – US GAAP
Under US GAAP (ASC 835-20), capitalization of borrowing costs for
qualifying assets
(i.e., assets that require a significant period of time to get them ready
for their intended use) is mandatory.
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Inventory Cost Formulas - IFRS
Under IFRS, entities are permitted to employ one of three cost
formulas when reporting inventory expense.
These methods are:
• Specific Identification
• First-in, First-out ("FIFO")
• Weighted-Average Cost
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Inventory Cost Formulas -- US GAAP
Under US GAAP, entities are permitted to employ one of four
cost formulas when reporting inventory expense:
These methods are:
• Specific Identification
• First-in, First-out (“FIFO”)
• Weighted-Average Cost
• Last-in, First-out (“LIFO”)
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Using Inventory Formulas
Under IFRS (IAS 2.26), an entity must use the same cost formula for all
inventories having a similar nature and use to the entity. That is, a
multinational company must use a consistent inventory policy election
for each class of inventory in all of its worldwide subsidiaries.
US GAAP does not provide explicit guidance on this issue. Accordingly,
an entity is permitted to partially adopt a cost formula (e.g., LIFO for
inventories held in the United States, and FIFO elsewhere) if it has a
valid business reason for not fully adopting this policy election.
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Example 2 – Inventory Cost Formulas
To demonstrate the three inventory cost approaches permitted under
IFRS, assume that a bicycle shop purchased three identical bikes in
January (see details below). On February 1, the retailer sold Bicycle 2.
Date purchased
Cost
Bicycle 1
Jan 1
$190
Bicycle 2
Jan 15
$195
Bicycle 3
Jan 31
$215
Total
$600
• What amounts could be charged to Cost of Goods Sold when
employing IFRS?
• What other amount could be charged to Cost of Goods Sold
when employing US GAAP?
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Module 3 – Measurement of
Recoverability
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Measuring Recoverability – IFRS
Under IFRS, inventories must be measured at the lower of cost or net
realizable value (“NRV”) except for inventories in certain specialized
industries.
NRV represents the estimated selling price for an inventory item in the
ordinary course of business, less the estimated costs of completion (as
applicable) and the estimated costs necessary to make the sale.
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Measuring Recoverability – US GAAP
Under US GAAP, inventories are measured at the lower of cost or
market (replacement cost). There are limits on the range in which
market may be reported.
ceiling
Net realizable value (estimated selling
price in the ordinary course of business
less reasonably predictable costs of
completion and disposal)
Market (replacement cost)
floor
Net realizable value less
normal profit margin
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Example 3 – Measuring Recoverability
To demonstrate how to measure inventory under IFRS and US GAAP,
consider the following three scenarios. Assume in all cases that the
original cost of inventory is $130:
Scenario 1
Scenario 2
Scenario 3
NRV of $100
NRV of $90
NRV of $100
Replacement cost of $90
Replacement cost of $100
Replacement cost of $80
NRV less profit margin of
$80
NRV less profit margin of
$80
NRV less profit margin of
$90
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Measuring Recoverability -- Timing
Under IFRS, a new assessment of NRV must be made in each
subsequent period until the inventory is sold. When the circumstances
that previously caused inventories to be written down below cost no
longer exist or when there is clear evidence of an increase in NRV
because of changed economic circumstances, the amount of the writedown is reversed (the reversal is limited to the amount of the original
write-down).
Under US GAAP, inventory write-downs can never be reversed.
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Unit for Measuring Recoverability -- IFRS
Under IFRS, when an entity is determining which is lower, cost or NRV,
the unit of account
• is generally the individual inventory item
• might be a group of similar or related items if certain criteria are met
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Unit for Measuring Recoverability – US GAAP
US GAAP also suggests that the appropriate unit of account likely will
be an individual inventory item when performing this recoverability
assessment. However, US GAAP does allow for the rule of “lower of cost
or market” to be applied directly to the totals of the entire inventory,
rather than to the individual inventory items, if specific criteria are met.
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Example 4 – Recoverability
An electronics retailer holds 100 identical televisions in its inventory.
The cost of each television set was $600. Each television’s NRV is
$500 and its NRV less a normal profit margin is $400. However, due to
changes in technology, each television’s replacement cost is $350.
Assuming that the retailer operates under 1) US GAAP and 2) IFRS, at
what value should the retailer record its inventory?
a. $35,000
b. $40,000
c. $50,000
d. $60,000
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Reporting Above Cost
US GAAP
Circumstances in which an entity is permitted to report inventory above
cost are extremely limited. To account for inventory at an amount above
cost, ASC 330 requires three conditions to be met:
• The entity is unable to determine the approximate cost of the
inventory item,
• The inventory item is immediately marketable at quoted market
prices,
• The inventory item is interchangeable
IFRS
Not allowed
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Module 4 – Additional Topics
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Relieving Inventory
Under both IFRS and US GAAP, the reported value of inventories
should be relieved and charged against cost of goods sold when the
goods are sold (i.e., when the risk of ownership is transferred to the
customer).
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Example 5 – Disclosure
Which of the following disclosures is required under IFRS only?
a. If material, the amounts from the liquidation of a LIFO layer
b. The circumstances or events that led to the reversal of a write-down
of inventories
c. The accounting policies adopted in measuring inventories
d. Presentation of major categories of inventory
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Module 5 - Summary
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Summary of Key Differences
Topic
IFRS
US GAAP
Allowable cost formulas
When measuring the cost of inventory, an
entity can elect to use one of three
methods: FIFO, Weighted- Average Cost,
or Specific Identification. IFRS prohibits
the use of the LIFO approach.
Also permits the use of FIFO, Weighted-Average Cost, or Specific
Identification but also allows for the LIFO method as well.
Consistency of group
policies for cost
formulas
An entity must use the same cost formula
for all inventories having a similar nature
and use to the entity.
US GAAP does not provide explicit guidance on this issue.
Accordingly, an entity is permitted to partially adopt a cost formula
(e.g., LIFO for inventories held in the United States, and FIFO
elsewhere) if it has a
valid business reason for not fully adopting this policy election.
Measurement of
inventories
Inventories are measured at the lower of
cost or net realizable value (“NRV”).
Inventories are measured at the lower of cost or market (replacement
cost), except that market cannot (a) exceed NRV (the “ceiling”) or (b)
be less than NRV less a normal profit margin (“floor”)
Reversals of previous
inventory write-downs
Reversal of previous inventory writedowns can be required depending on
specific facts and circumstances.
Inventory write-downs can be can never be reversed.
Unit of account when
testing inventory for
recoverability
When assessing the recoverability of
inventory, an entity generally must
examine each piece of inventory
separately (i.e., each individual piece of
inventory represents the unit of account).
Also suggests that the appropriate unit of account likely will be an
individual inventory item when performing this recoverability
assessment. However, US GAAP does allow for the rule of “lower of
cost or market” to be applied directly to the totals of the entire
inventory, rather than to the individual inventory items, if specific
criteria are met. Specifically, this policy election is only permitted
when, for certain goods, no loss of income is expected to take place
as a result of a reduction of cost prices because others forming
components of the same general categories of finished products have
a market equally in excess of cost. If this approach is elected, it must
be applied consistently from year to year.
Reporting inventories at
above cost
Inventories may be reported above cost at
companies operating in certain
specialized industries (e.g., agriculture,
mining, and broker dealer)
Inventories rarely will be reported above cost (exceptions are
extremely limited)
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