kieso, weygandt ACCOUNTING IFRS EDITION Propered by: Goby Harmo! University of Califor a Sa nta Barbara 4 festmor mt Colleg WILEYInventories: CHAPTER 9 Additional Valuation Issues LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe and apply the lower- 4. Determine ending inventory of-cost-or-net realizable value by applying the retail rule. inventory method. 2. Identify other inventory 5. Explain how to report and valuation issues. analyze inventory. 3. Determine ending inventory by applying the gross profit method. 92PREVIEW OF CHAPTER 9 Lower-of-Cost- or-Net Realizable Value (LCNRV) + Net realizable value Iustration of LCNRV. Application LONRV Recording net realizable value Use of an allowance + Recovery of, inventory loss + Evaluation of rule Va) NAL VALUATION ISSUES I [ i Valuation Bases Gross Profit Retail Inventory Presentation and + Net realizable value Method Method Analysis + Relative standalone + Gross profit, + Concepts + Presentation of sales value percentage Ei conventional: inventories + Purchase + Evaluation of method + Analysis of, ‘commitments method «+ Special items inventories + Evaluation of method 93 Intermediate Accounting IFRS 3rd Edition Kieso e Weygandt « WarfieldLEARNING OBJECTIVE 1 Lower-of-Cost-or-Net Describe and apply the lower- . of-cost-or-net realizable value Realizable Value re. “{CCNRY =~ —=—CSCSCSCti‘R‘OOCS..TO.VV..VVVV 4 Acompany abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost. Net Realizable Value Estimated selling price in the normal course of business less ¢@ estimated costs to complete and ¢ estimated costs to make a sale. Lot95 Net Realizable Value Illustration: Assume that Mander AG has unfinished inventory with a cost of €950, a sales value of €1,000, estimated cost of completion of €50, and estimated selling costs of €200. Mander’s net realizable value is computed as follows. Inventory value—unfinished €1,000 Less: Estimated cost of completion € 50 Estimated cost to sell 200 250 Net realizable value € 750 ILLUSTRATION 9.1 Computation of Net Realizable Value LotNet Realizable Value ILLUSTRATION 9.1 raion 9 fab vate Inventory value—unfinished €1,000 Less: Estimated cost of completion € 50 Estimated cost to sell 200 250 Net realizable value € 750 Mander reports inventory on its balance sheet at €750. @ Inits income statement, Mander reports a Loss on Inventory Write-Down of €200 (€950 - €750). 96 LotNet Realizable Value ) | Nokia (FIN) Inventories are stated at the lower of cost or net realizable value. Cost is determined using standard cost, which approximates actual cost on a FIFO basis. Net realizable value is the amount that can be realized from the sale of the inventory in the normal course of business after allowing for the costs of realization. In addition to the cost of materials and direct labor, an appropriate proportion of production overhead is included in the inventory values. An allowance is recorded for excess inventory and obsolescence based on the lower-of-cost-or-net realizable value. Kesa Electricals (GBR) Inventories are stated at the lower-of-cost-and-net realizable value. Cost is determined using the weighted average method. Net realizable value represents the estimated selling price in the ordinary course of business, less applicable variable selling expenses. ILLUSTRATION 9.2 LENRV Disclosures: 97 LotIllustration of LCNRV Jinn-Feng Foods computes its inventory at LCNRV (amounts in thousands). ILLUSTRATION 9.3 Determining Final Inventory Value Net Final Realizable Inventory Food Cost Value Value Spinach ¥ 80,000 ¥120,000 ¥ 80,000 Carrots 100,000 410,000 100,000 Cut beans. 50,000 40,000 40,000 Peas 90,000 72,000 72,000 Mixed vegetables 95,000 92,000 92,000 ¥384,000 Final Inventory Value: Cost (¥80,000) is selected because it is lower than net realizable value. Cost (¥100,000) is selected because its lower than net realizable value, Net realizable value (¥40,000) is selected because it is lower than cost. Net realizable value (¥72,000) is selected because it is lower than cost. Net realizable value (¥92,000) is selected because it is lower than cost. Spinach Carrots Cut beans Peas Mixed vegetables 98 LotMethods of Applying LCNRV Assume that Jinn-Feng Foods separates its food products into two major groups, frozen and canned. LONRV by: Individual Major Total Cost LCNRV Items Groups Inventory Frozen Spinach ¥ 80,000 —-¥120,000 Carrots 100,000 110,000 Cut beans 50,000 Total frozen Canned Peas 90,000 Mixed vegetables 95,000 Total canned 185,000 Total ILLUSTRATION 9.4 Alternative Applications of LCNRV 99 LotMethods of Applying LCNRV ¢@ In most situations, companies price inventory on an item- by-item basis. ¢ Tax rules in some countries require that companies use an individual-item basis. Individual-item approach gives the lowest valuation for statement of financial position purposes. ¢@ Method should be applied consistently from one period to another. e410 LotRecording NRV Instead of Cost Illustration: Data for Ricardo SpA Cost of goods sold (before adj. to NRV) €108,000 Ending inventory (cost) 82,000 Ending inventory (at NRV) 70,000 Loss Loss Due to Decline to NRV 12,000 Method Inventory (€82,000 - €70,000) 12,000 coGs Cost of Goods Sold 12,000 Method Inventory 12,000 LotRecording NRV Instead of Cost Partial Statement of Financial Position Current assets: Inventory Prepaids Accounts receivable Cash Total current assets € Loss Method 70,000 20,000 350,000 100,000 540,000 coGs Method 70,000 20,000 350,000 100,000 540,000 LotRecording Net Realizable Value Income Statement Sales Cost of goods sold Gross profit Operating expenses: Selling General and administrative Total operating expenses Other income and expense: Loss due to decline of inventory to NRV Interest income Total other Income from operations Income tax expense Net income Loss Method € 200,000 108,000 92,000 45,000 20,000 65,000 12,000 5,000 (7,000) 20,000 6,000 14,000 coGcs Method € 200,000 120,000 80,000 45,000 20,000 65,000Use of an Allowance Instead of crediting the Inventory account for NRV adjustments, companies generally use an allowance account, often referred to as Allowance to Reduce Inventory to NRV. Using an allowance account under the loss method, Ricardo SpA makes the following entry to record the inventory write-down to NRV. Loss Due to Decline of Inventory to NRV 12,000 Allowance to Reduce Inventory to NRV ILLUSTRATION 9-7 Inventory (at cost) Allowance to reduce inventory to net realizable value Inventory at net realizable value 12,000 €82,000 (12,000) €70,000 LotUse of an Allowance Partial Statement of Financial Position No Allowance Allowance Current assets: Inventory € 70,000 € 82,000 Allowance to reduce inventory 12,000) Inventory at NRV 70,000 Prepaids 20,000 20,000 Accounts receivable 350,000 350,000 Cash 100,000 100,000 Total current assets 540,000 540,000 945 LotLCNRV Recovery of Inventory Loss ¢@ Amount of write-down is reversed. @ Reversal limited to amount of original write-down. Continuing the Ricardo example, assume the net realizable value increases to €74,000 (an increase of €4,000). Ricardo makes the following entry, using the loss method. Allowance to Reduce Inventory to NRV 4,000 Recovery of Inventory Loss 4,000 LotRecovery of Inventory Loss Allowance account is adjusted in subsequent periods, such that inventory is reported at the LCNRV. Illustration shows net realizable value evaluation for Vuko Company and the effect of net realizable value adjustments on income. Inventory Amount Adjustment at Net Requiredin of Allowance Effect Inventory Realizable Allowance Account on Net Date at Cost. Value Account Balance Income Dec. 31, 2019 188,000 176,000 12,000 12,000 inc. Decrease Dec. 31, 2020 194,000 187,000 7,000 5,000 dec. Increase Dec. 31, 2021 173,000 174,000 0 7,000 dec. Increase Dec. 31, 2022 182,000 180,000 2,000 2,000 inc. Decrease ILLUSTRATION 9.8 Effect on Net Income of Adusting Inventory to Net Realizable Value O47 Lotvaluation of LCM Rule LCNRV rule suffers some conceptual deficiencies: 1. Acompany recognizes decreases in the value of the asset and the charge to expense in the period in which the loss in utility occurs—not in the period of sale. 2. Application of the rule results in inconsistency because a company may value the inventory at cost in one year and at net realizable value in the next year. 3. LCNRV values the inventory in the statement of financial position conservatively, but its effect on the income statement may or may not be conservative. Net income for the year in which a company takes the loss is definitely lower. Net income of the subsequent period may be higher than normal if the expected reductions in sales price do not materialize. Lo1LCNRV P9.1: Remmers SE manufactures desks. The 2019 catalog was in effect through November 2019, and the 2020 catalog is effective as of December 1, 2019. At December 31, 2019, the following finished desks appear in the company’s inventory. Finished Desks A B Cc D 2019 Catalog selling price € 450 € 480 € 900 € 1,050 FIFO cost per inventory list 12/31/19 470 450 830 960 Estimated cost to complete and sell 50 110 260 200 2020 catalog selling price 500 540 900 1,200 Instructions: At what amount should the four desks appear in the company’s December 31, 2019, inventory, assuming that the company has adopted a lower-of-FIFO-cost-or-net realizable value approach for valuation of inventories on an individual-item basis? LotLCNRV Instru ns: At what amount should the four desks appear in the company’s December 31, 2019, inventory, assuming that the company has adopted a lower-of-FIFO-cost-or-net realizable value approach for valuation of inventories on an individual-item basis? Finished Desks A B Cc D 2019 Catalog selling price € 450 € 480 € 900 € 1,050 FIFO cost per inventory list 12/31/19 470 450 830 960 Estimated cost to complete and sell 50 110 260 200 2020 catalog selling price 500 540 900 1,200 Net Realizable Value Lower-of-Cost-or-NRV 9-20 LotLEARNING OBJECTIVE 2 Valuation Bases Identify other inventory valuation issues. Net Realizable Value Departure from LCNRV rule may be justified in situations when @ cost is difficult to determine, items are readily marketable at quoted market prices, and units of product are interchangeable. Two common situations in which NRV is the general rule: @ Agricultural assets ¢ Commodities held by broker-traders. Lo2Net Realizable Value Agricultural Inventory Biological asset (classified as a non-current asset) is a living animal or plant, such as sheep, cows, fruit trees, or cotton plants. @ Biological assets are measured on initial recognition and at the end of each reporting period at fair value less costs to sell (NRV). Companies record gain or loss due to changes in NRV of biological assets in income when it arises. 922 Lo2Net Realizable Value Agricultural Inventory Agricultural produce is the harvested product of a biological asset, such as wool from a sheep, milk from a dairy cow, picked fruit from a fruit tree, or cotton from a cotton plant. @ Agricultural produce are measured at fair value less costs to sell (NRV) at the point of harvest. @ Once harvested, the NRV becomes cost. 9:23 Lo2Agricultural Accounting at NRV Illustration: Bancroft Dairy produces milk for sale to local cheese- makers. Bancroft began operations on January 1, 2019, by purchasing 420 milking cows for €460,000. Bancroft provides the following information related to the milking cows. Milking cows Carrying value, January 1, 2019" +€460,000 Change in fair value due to growth and price changes €35,000 Decrease in fair value due to harvest (1,200) Change in carrying value 33,800 Carrying value, January 31,2019 €493,800 Milk harvested during January** “The carrying value is measured at fair value less costs to sell (net realizable value). The fair value of milking cows is deter- ‘mined based on market prices of livestock of similar age, breed, and genetic mer't. "Milk is initially measured at its fair value less costs to sell (net realizable value) at the time of milking. The fair value of milk is determined based on market prices inthe local area. ILLUSTRATION 9.9 Agricultural Assets—Bancroft Dairy 9.24 Lo2Agricultural Accounting at NRV so uustmnon os Agricultural Assets— Bancroft Dairy Milking cows Carrying value, January 1, 2019* €460,000 Change in fair value due to growth and price changes €35,000 Decrease in fair value due to harvest (1,200) Change in carrying value 33,800 Carrying value, January 31, 2019 €493,800 Milk harvested during January** Bancroft makes the following entry to record the change in carrying value of the milking cows. Biological Asset (milking cows) 33,800 Unrealized Holding Gain or Loss—Income 33,800 9:25 Lo2Agricultural Accounting at NRV Biological Asset (milking cows) 33,800 Unrealized Holding Gain or Loss—Income 33,800 Reported on the Statement of financial position as a non- current asset at fair value less costs to sell (net realizable value). Reported as “Other income and expense” on the income statement. Lo2Agricultural Accounting at NRV Illustration: Bancroft makes the following summary entry to record the milk harvested for the month of January. Inventory (milk) 36,000 Unrealized Holding Gain or Loss—Income 36,000 Assuming the milk harvested in January was sold to a local cheese-maker for €38,500, Bancroft records the sale as follows. Cash 38,500 Sales Revenue 38,500 Cost of Goods Sold 36,000 Inventory (milk) 36,000 Lo2Net Realizable Value Commodity Broker-Traders Generally measure their inventories at fair value less costs to sell (NRV), with changes in NRV recognized in income in the period of the change. @ Buy or sell commodities (such as harvested corn, wheat, precious metals, heating oil). @ Primary purpose is to > sell the commodities in the near term and >» generate a profit from fluctuations in price. 9.28 Lo2Valuation Bases Relative Standalone Sales Value Used when buying varying units in a single lump-sum purchase. Illustration: Woodland Developers purchases land for $1 million that it will subdivide into 400 lots. These lots are of different sizes and shapes but can be roughly sorted into three groups graded A, B, and C. As Woodland sells the lots, it apportions the purchase cost of $1 million among the lots sold and the lots remaining on hand. Calculate the cost of lots sold and gross profit. Lo2Relative Standalone Sales Value weston 210 Allocation of Costs, Using Relative Standalone Sales Value Number Sales Total Relative Cost Cost of Price Sales Sales Total Allocated per Lots Lots per Lot Price Price Cost to Lots Lot A 100 $10,000 $1,000,000 100/250 $1,000,000 $ 400,000 $4,000 B 100 6,000 600,000 60/250 1,000,000 240,000 2,400 c 200 4,500 900,000 90/250 1,000,000 360,000 1,800 $2,500,000 $1,000,000 ILLUSTRATION 9.11 Determination of Gross Profit, Using Relative Standalone Sales Value Numberof Cost per Cost of Lots Lots Sold Lot Lots Sold Sales Gross Profit A 7 $4,000 $308,000 $ 770,000 $ 462,000 B 80 2,400 192,000 480,000 288,000 c 100 1,800 180,000 450,000 270,000 $680,000 $1,700,000 $1,020,000 9.30 Lo2931 Valuation Bases Purchase Commitments—A Special Problem oa ° ° Generally seller retains title to the merchandise. Buyer recognizes no asset or liability. If material, the buyer should disclose contract details in note in the financial statements. If the contract price is greater than the market price, and the buyer expects that losses will occur when the purchase is effected, the buyer should recognize a liability and corresponding loss in the period during which such declines in market prices take place. Lo29.32 Purchase Commitments Illustration: Apres Paper AG signed timber-cutting contracts to be executed in 2020 at a price of €10,000,000. Assume further that the market price of the timber cutting rights on December 31, 2019, dropped to €7,000,000. Apres would make the following entry on December 31, 2019. Unrealized Holding Gain or Loss—Income 3,000,000 Purchase Commitment Liability 3,000,000 Other expenses and losses in the Income statement. Current liabilities on the balance sheet. Lo2Purchase Commitments Illustration: WhenApres cuts the timber at a cost of €10 million, it would make the following entry. Purchases (Inventory) 7,000,000 Purchase Commitment Liability 3,000,000 Cash 10,000,000 Assume Apres is permitted to reduce its contract price and therefore its commitment by €1,000,000. Purchase Commitment Liability 1,000,000 Unrealized Holding Gain or Loss—Income 1,000,000 9.33 Lo2LEARNING OBJECTIVE 3 Gross Profit Method of Determine ending inventory by applying the gross profit Estimating Inventory method Substitute Measure to Approximate Inventory Relies on three assumptions: 1. Beginning inventory plus purchases equal total goods to be accounted for. 2. Goods not sold must be on hand. 3. The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal ending inventory. 9.34 Lo3Gross Profit Method of Estimating Vi Illustration: Cetus SE has a beginning inventory of €60,000 and purchases of €200,000, both at cost. Sales at selling price amount to €280,000. The gross profit on selling price is 30 percent. Cetus applies the gross margin method as follows. Beginning inventory (at cost) Purchases (at cost) Goods available (at cost) Sales (at selling price) €280,000 Less: Gross profit (80% of €280,000) 84,000 Sales (at cost) Approximate inventory (at cost) € 60,000 200,000 260,000 196,000 € 64,000 ILLUSTRATION 9.13 Appiication of Gross Profit Method 9.35 Lo3Gross Profit Method of Estimating Severe Computation of Gross Profit Percentage Illustration: In Illustration 9.13, the gross profit was a given. But how did Cetus derive that figure? To see how to compute a gross profit percentage, assume that an article cost €15 and sells for €20, a gross profit of €5. Markup _ £5 _ 9509 at tail Marke _ 25 = = = 334% on cost Retail €20 Cost €15 iis ILLUSTRATION 9.14 Computation of Gross Profit Percentage 9:36 Lo3Gross Profit Method ILLUSTRATION 0.15 Formulas Relating to Gross Profit Percentage Markup on Cost 1. Gross Profit on Selling Price = 100% + Percentage Markup on Cost Gross Profit on Selling P: 2. Percentage Markup on Cost = 100% — Gross Profit on Selling Price Gross Profit on Selling Price Percentage Markup on Cost on 20 ILLUSTRATION 9.16 Given: 20% = ———> 20 _— - 25% Appcaton of ross 00 — Pratt Formos me 5 2 Given: 25% sag = 810% 25 5 gn . ODERIO5a | men ccna 50 —_ 33109 <————_a@iven: 50% 1.00+.50° ~~" Wven: 9.37Gross Profit Method of Estimating Vi E9.14: Astaire ASA uses the gross profit method to estimate inventory for monthly reporting purposes. Presented below is information for the month of May. Inventory, May1 € 160,000 Sales € 1,000,000 Purchases (gross) 640,000 Sales returns 70,000 Freight-in 30,000 Purchases discounts 12,000 Instructions: (a) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of sales. (b) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of cost. 9.38 Lo3Gross Profit Method of Estimating Inventory (a) Compute fhe estimated inventory at May 31, assuming that the 9.39 gross profit is 25% of sales. Inventory, May 1 (at cost) Purchases (gross) (at cost) Purchase discounts Freight-in Goods available (at cost) Sales (at selling price) Sales returns (at selling price) Net sales (at selling price) Less: Gross profit (25% of €930,000) Sales (at cost) Approximate inventory, May 31 (at cost) € 1,000,000 (70,000) 930,000 232,500 € 160,000 640,000 (12,000) 30,000 818,000 697,500 120,500 Lo3Gross Profit Method of Estimating Inventory (b) Compute fhe estimated inventory at May 31, assuming that the 940 gross profit is 25% of cost. Inventory, May 1 (at cost) Purchases (gross) (at cost) Purchase discounts Freight-in Goods available (at cost) Sales (at selling price) Sales returns (at selling price) Net sales (at selling price) Less: Gross profit (20% of €930,000) Sales (at cost) Approximate inventory, May 31 (at cost) € 1,000,000 (70,000) 930,000 186,000 160,000 640,000 (12,000) 30,000 818,000 Lo3Gross Profit Method of Estimating Severe Evaluation of Gross Profit Method Disadvantages 1) Provides an estimate of ending inventory. 2) Uses past percentages in calculation. 3) Ablanket gross profit rate may not be representative. 4) Normally unacceptable for financial reporting purposes because it provides only an estimate. IFRS requires a physical inventory as additional verification of the inventory indicated in the records. ot Lo3LEARNING OBJECTIVE 4 Retail Inventory Method Determine ending inventory by 942 applying the retail inventory method Method used by retailers to compile inventories at retail prices. Retailer can use a formula to convert retail prices to cost. Requires retailers to keep a record of: 1) Total cost and retail value of goods purchased. 2) Total cost and retail value of the goods available for sale. 3) Sales for the period. Methods @ Conventional Method (or LCNRV) Cost Method Lo4Retail Inventory Method Illustration: The following data pertain to a single department for the month of October for Fuque Ltd. Prepare a schedule computing retail inventory using the Conventional and Cost methods. COST RETAIL Beg. inventory, Oct. 1 £ 52,000 £ 78,000 Purchases 272,000 423,000 Freight in 16,600 Purchase returns 5,600 8,000 Additional markups 9,000 Markup cancellations 2,000 Markdowns (net) 3,600 Normal spoilage and breakage 10,000 Sales 390,000 943 Lo4Retail Inventory Method CONVENTIONAL Method: Beginning inventory Purchases Purchase returns Freight in Markups, net Current year additions Goods available for sale Markdowns, net Normal spoilage and breakage Sales Ending inventory at retail Ending inventory at Cost: £ 96,400 x 67.0% = £ £64,588 cost 52,000 272,000 (5,600) 16,600 283,000 335,000 Cost to RETAIL Retail % £ 78,000 423,000 (8,000) 7,000 422,000 500,000 (3,600) (10,000) (390,000) £96,400 67.0% Lo4Reta Inventory Method COST Method: Cost to cost RETAIL Retail % Beginning inventory £ 52,000 £ 78,000 Purchases 272,000 423,000 Purchase returns (5,600) (8,000) Freight in 16,600 Markdowns, net (3,600) Markups, net Current year additions 283,000 Goods available for sale 335,000 67.49% Normal spoilage and breakage Sales Ending inventory at retail £ Ending inventory at Cost: £ 96,400 x 67.49% = £ 65,060 945 Lo4946 Retail Inventory Method Special Items Relating to Retail Method o¢-¢ ¢ 6 Oo @ Freight costs Purchase returns Purchase discounts and allowances Transfers-in When sales are recorded gross, companies do not Abnormal shortages recognize sales discounts. Normal shortages Employee discounts Lo4EXTREME SPORT APPAREL Cost Retail Beginning inventory € 4,000 € 1,800 Purchases 30,000 60,000 Freight-in 600 = Purchase returns (1,500) (3,000) Totals 30,100 58,800 Net markups 9,000 Abnormal shortage (1,200) (2,000) Totals €28,900 <—_______> 65,800 Deduct: Net markdowns 1,400 Sales €36,000 Sales returns (900) 35,100 Employee discounts 800 Normal shortage 1,300 Ending inventory, at retail €27,200 ILLUSTRATION 9.22 €28,900 ‘Conventional Retail Cost-to-retail ratio = "= 43.9% Inventory Method— €65,800 Special items Inchided Ending inventory at LCNRV (43.9% x €27,200) = 47Retail Inventory Method Evaluation of Retail Inventory Method Used for the following reasons: 1) To permit the computation of net income without a physical count of inventory. 2) Control measure in determining inventory shortages. 3) Regulating quantities of merchandise on hand. 4) Insurance information. Some companies refine the retail method by computing inventory separately by departments or class of merchandise with similar gross profits. 948 Lo4. . LEARNING OBJECTIVE 5 Presentation and Analysis @%ir tow to report and analyze inventory. Presentation of Inventories Accounting standards require disclosure of: 1) Accounting policies adopted in measuring inventories, including the cost formula used (weighted-average, FIFO). 2) Total carrying amount of inventories and the carrying amount in classifications (merchandise, production supplies, raw materials, work in progress, and finished goods). 3) Carrying amount of inventories carried at fair value less costs to sell. 4) Amount of inventories recognized as an expense during the period. 249 LosPresentation and Analysis Presentation of Inventories Accounting standards require disclosure of: 5) Amount of any write-down of inventories recognized as an expense in the period and the amount of any reversal of write-downs recognized as a reduction of expense in the period. 6) Circumstances or events that led to the reversal of a write-down of inventories. 7) Carrying amount of inventories pledged as security for liabilities, if any. 9-50 LosPresentation and Analysis Analysis of Inventories Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell the inventory. ost LosAnalysis of Inventories Inventory Turnover Measures the number of times on average a company sells the inventory during the period. Illustration: In its 2015 annual report Tate & Lyle plc (GBR) reported a beginning inventory of £372 million, an ending inventory of £263 million, and cost of goods sold of £1,319 million for the year. Cost of Goods Sold £1,319 =~ > = 3.59 times Average Inventory (£372 + £363)/2 Inventory Turnover = ILLUSTRATION 9.25 982 LosAnalysis of Inventories Average Days to Sell Inventory Measure represents the average number of days’ sales for which a company has inventory on hand. ILLUSTRATION 9.25 Inventory Turnover = Cost of Goods Sold £1,319 Fe = 3.59 times Average Inventory (£372 + £363)/2 953 Average Days to Sell \ 365 days / 3.59 times = every 101.7 days LosD ' GLOBAL ACCOUNTING INSIGHTS LEARNING OBJECTIVE 6 Compare the accounting for inventories under IFRS and U.S. GAAP. Inventories In most cases, IFRS and U.S. GAAP related to inventory are the same. The major differences are that IFRS prohibits the use of the LIFO cost flow assumption and records market in the LCNRV differently. 9-54 Lo6D ‘ GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S. GAAP and IFRS related to inventories. Similarities + U.S. GAAP and IFRS account for inventory acquisitions at historical cost and evaluate inventory for lower-of-cost-or-net realizable value (market) subsequent to acquisition. + Who owns the goods—goods in transit, consigned goods, special sales agreements—as well as the costs to include in inventory are essentially accounted for the same under U.S. GAAP and IFRS 9-55, Lo6D ‘ GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences + U.S. GAAP provides more detailed guidelines in inventory accounting. The requirements for accounting for and reporting inventories are more principles-based under IFRS. + Amajor difference between U.S. GAAP and IFRS relates to the LIFO cost flow assumption. U.S. GAAP permits the use of LIFO for inventory valuation. IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS. Both sets of standards permit specific identification where appropriate. 9-56 Lo6S GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences + In the lower-of-cost-or-market test for inventory valuation, U.S. GAAP defines market as replacement cost subject to the constraints of net realizable value (the ceiling) and net realizable value less a normal markup (the floor). IFRS defines market as net realizable value and does not use a ceiling or a floor to determine market. + Under U.S. GAAP, if inventory is written down under the lower-of-cost-or- market valuation, the new basis is now considered its cost. As a result, the inventory may not be written up back to its original cost in a subsequent period. Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the previous write-down. Both the write-down and any subsequent reversal should be reported on the income statement. 957 Lo6D ' GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences + IFRS requires both biological assets and agricultural produce at the point of harvest to be reported at net realizable value. U.S. GAAP does not require companies to account for all biological assets in the same way. Furthermore, these assets generally are not reported at net realizable value. Disclosure requirements also differ between the two sets of standards. 9-58, Lo6D ' GLOBAL ACCOUNTING INSIGHTS On the Horizon One convergence issue that will be difficult to resolve relates to the use of the LIFO cost flow assumption. As indicated, IFRS specifically prohibits its use. Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages. In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and therefore enables companies to compute a more realistic income. 9-59 Lo69-60 Copyright Copyright © 2018 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.