The way companies report inventory on financial statements is more straightforward now thanks to the Financial Accounting Standards Board’s (FASB) Accounting Standards Update 2015-11, Inventory (Topic 330).
These amendments, which are effective for fiscal years beginning after December 15, 2016, require companies to report inventory at the lower of cost or net realizable value. Net realizable value can be defined as the estimated selling price in the ordinary course of business, minus reasonably predictable costs of completion, disposal (such as commission or brokerage costs), and transportation.
Who Is Affected?
This amendment impacts all companies that carry inventory using methods other than last-in, first-out (LIFO) or the retail inventory method (RIM). Most affected, however, will be companies that are subject to declining sales prices of their inventory, discontinued product lines, short product life cycles, and inventory subject to deterioration in quality or that can be easily damaged.
Generally, we see companies with highly perishable products, commodity-based inventory, new technology products, or products with thin gross margins to be most at risk for impairment adjustments. This could include—but isn’t exclusive to—the seafood, dairy, and other agricultural sectors as well as technology-driven products.
This change simplifies a method that was determined to be overly complex and resulted in inconsistent application.
Previously, companies were required to report inventory at the lower of cost or market. While the inventory’s market price was initially considered to be its replacement cost, such amount was required to not exceed a “ceiling” (the net realizable value) or fall below a “floor” (net realizable value less a normal profit margin).
These rules resulted in a company having to calculate three different amounts to determine the proper adjustment to reach market value for subsequent measurement of inventory. Once a company adopts the new guidance, it will have to calculate only the net realizable value.
In addition to being more straightforward, the new accounting guidance also will align US GAAP more closely with International Financial Reporting Standards.
Companies that measure inventory using LIFO or RIM, which are both already more complicated methods, will continue to use the prior guidance when evaluating inventory for impairment and subsequent measurement.
Effective Dates and Transition
Companies have time to evaluate the effects of this change.
For public business entities, the new guidance is effective in years beginning after December 15, 2016, including interim periods within those years. For all other entities, the new guidance is effective for years beginning after December 15, 2016, and interim periods within the following year. Early adoption is permitted for all entities as of the beginning of an interim or annual reporting period, and once adopted, the change is applied prospectively with no change to any previously recorded inventory write-downs.
Consistent with most other accounting changes, companies must disclose the adoption of the new standard in the footnotes to their financial statements in the initial interim and annual period of adoption.
We're Here to Help
To learn more about this accounting standards update and how it might affect your business, or for guidance on correctly implementing this change, please contact your Moss Adams professional.