In July 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (ASU 2015-11). ASU 2015-11 is part of FASB’s simplification initiative that is intended to improve U.S. GAAP by reducing costs and complexity while maintaining or enhancing the usefulness of the related financial statement information. Also, this pronouncement more closely aligns the measurement of inventory under U.S. GAAP with the measurement of inventory under International Financial Reporting Standards (IFRS), and some may argue that was the real driver behind the issuance of the new guidance.
The accounting guidance only changes the measurement of inventory from current U.S. GAAP in situations which the value of the inventory declines or is impaired. The pronouncement amends U.S. GAAP by requiring inventory to be reported at the lower of cost and net realizable value. The ASU defines net reasonable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.”
You may be thinking: “Doesn’t current U.S. GAAP require that inventory be reported at lower of cost or market? What’s the difference between ‘lower of cost or net realizable value’ versus ‘lower of cost or market’ and what’s the significance of the change?”
Although current U.S. GAAP requires inventory to be carried at the lower of cost or market, depending on the specific details of the inventory, this may require the reporting of inventory at either cost, net realizable value, replacement cost or net realizable value less a normal profit margin. For those entities that have write-downs on their inventory, ASU 2015-11 does simplify U.S. GAAP because “replacement cost” and “net realizable value less a normal profit margin” are no longer considered when determining the proper carrying value of inventory.
For public business entities, the amendments of ASU 2015-11 are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments of this new guidance are effective for fiscal years beginning after December 15, 2016 and interim periods within fiscal years beginning after December 15, 2017.
Our firm is actively involved in auditing and consulting with our clients on inventory issues in the manufacturing and wholesale distribution industries. If you have any questions regarding our services please contact your LSL Advisor at 714.569.1000.
By: Rex A. Vollmer, CPA
