Inventory BROOKS REYNOLDS RUSSELL ENGLAND WAFA HINDIYEH

GAAP  Codification Topic 330  Tangible personal property of the following:  1. held for sale  merchandise, finished goods  2. in the course of production  work in process  3. to be consumed in the production  raw materials

GAAP  Initial measurement  Inventories are measured at cost when first recognized  Job Order Costing—accumulates and allocates overhead costs separately for each order  Process Costing—accumulates and allocates overhead separately for each stage

GAAP  Cost flow assumptions  One of the following assumptions is made to determine the cost of inventory:  1. First-in First-out (FIFO):  2. Last-in First-out (LIFO):  3. Average method: Weighted average  4. Retail inventory method  5. Specific identification

GAAP  Subsequent measurement  If the market is lower than the cost  -- inventory is measured at the market  -- "Lower of Cost or Market" (LCM)  New GAAP rules for methods other than LIFO and Retail Method:  An entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation

GAAP  Market under original rules:  1. The market refers to current replacement cost  2. If net realizable value (NRV) is lower than current replacement cost   NRV is the market (net realizable value)  3. If current replacement cost is lower than (1)   (1) is the market  (1) net realizable value - normal profit margin  Reporting under new rules:  Net Realizable Value (NRV)  Lower of cost or NRV

GAAP

 Write-downs  Item by item  Group by group  Total inventory  ASC 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 , 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 – IAS 2  Cost included in Inventory Cost  Inventory Cost includes Production Costs, Conversion Costs, and Purchase Costs.  Cost of Freight-In is to be included in Inventory Cost.  Interest on Inventory must generally be capitalized, although certain conditions must be met.

IFRS – IAS 2  Allowed Inventory Costing Method:  Company has ability to choose between FIFO and Average Costing Methods.  LIFO Method is not allowed under 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.

IFRS – IAS 2  Reports at the lower of cost or net realizable value (LCNRV): ► Net Realizable Value (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.

IFRS – IAS 2  Inventory Write-downs:  Write-downs are typically done on an Item-by-Item basis  Group-by-Group basis is allowed under certain circumstances.  Write-downs and reversals of write-downs must be included as expenses.

IFRS – IAS 2  Disclosures:  Requires disclosures on the basis upon which amounts are stated (LCNRV) and costing method.  Requires disclosures on Inventory Financing Arrangements.  Requires disclosures of both the amount of write-downs recognized as expense and any reversal of write-downs.

Comparison to US GAAP 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. US GAAP ► Different cost flow assumptions (FIFO, LIFO, weighted average) may be used for inventory with a similar nature and use. ► LIFO method is allowed.

Lower of Cost or Market US GAAP  For LIFO & Retail inventory method  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.  New rules for all other methods:  Reports at the lower of cost and NRV  Net realizable value is the estimated selling prices, less reasonably predictable costs of completion, disposal, and transportation  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 Write-down Example  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, Jets International prepares its inventory valuation comparisons on an item-by-item basis.  What is the amount of write-down (if any) required using US GAAP? Please provide the necessary journal entry.  What is the amount of write-down (if any) required using IFRS? Please provide the necessary journal entry.

CostNRVRCNRV-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 Inventory Write-down Example Part 1 (continued):

Original costNRVRC NRV- NPM US GAAP market US GAAP LCM IFRS and GAAP LCNRV Part 1$10,000$20,000$15,000$12,000$15,000$10,000 Part 220,00019,00018,00017,00018,000 19,000 Part 35,0003,0004,0002,0003,000 Part 48,00015,00012,00011,00012,0008,000 Part 515,00012,0009,00011,000 12,000 Total$58,000$50,000$52,000 Example 1: Part 1 solution: Inventory Write-down Example

Part 1 solution (continued): US GAAP:IFRS and new US GAAP: Original cost58,000Original cost $58,000 LCM50,000LCNRV 52,000 Write-down $8,000Write-down $6,000 US GAAP journal entry:IFRS journal entry: COGS$8,000 Inventory write-down expense $6,000 Inventory$8,000 Inventory valuation allowance$6,000 GAAP Journal entry: Loss on Write-down $6,000 Inventory$6,000 New GAAP: When evidence exists that the net realizable value of inventory is lower than its cost, the difference shall be recognized as a loss in earnings in the period in which it occurs. 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 COGS 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 Write-down Example

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, 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 Write-down Reversal Example Original CostNRVRCNRV-NPM Part 1$10,000$21,000$16,000$13,000 Part 2$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):

Example 1: Part 2 solution: Inventory Write-down Reversal Example Original Cost IFRS LCNRV December 31, 2012NRV IFRS LCNRV December 31, 2013 Part 1$10,000 $21,000$10,000 Part 2 20,00019,00020,000 Part 3 5,0003,0004,000 Part 4 8,000 16,0008,000 Part 5 15,00012,00014,000 Total$58,000$52,000$56,000

Inventory Write-down Reversal Example Part 2 solution (continued): No reversal of a write-down is permitted using US GAAP. IFRS: December 31, 2013 LCNRV$56,000 December 31, 2012 LCNRV52,000 Write-down $4,000 Journal entry: Inventory valuation allowance$4,000 Inventory 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. The reversal cannot be more than the original write-down.

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