Under IFRS, Inventory is reported on BS at
- Lower of cost or Net realizable value
- Net realizable value (NRV) (13)
- Expected sales price – estimated selling cost – completion cost
- Inventory is written down (14) to NRV
- NRV < cost (previously report on BS as inventory)
- Loss is recognized in IS
- Inventory is Written up (15) when NRV increase but still less than cost
- NRV < cost and NRV increased
- Gain is recognized in IS
- Gain = increase in NRV
Under U.S. GAAP, inventory is reported at
- Lower of cost or market (16)
- Market (16) = min (replacement cost, NRV) or max(replacement cost, NRV – normal profit margin)
- Usually equal to replacement cost
- Smaller than NRV
- Larger than NRV – normal profit margin
- Cost > market
- Inventory is written down to market on BS
- Decrease in value is recognized in IS by
- Increase COGS for small changes in value
- Record the loss from the inventory write-down separately
- If there is a subsequent recovery:
- No write-up allowed under US GAAP
- LIFO is less likely to recognize inventory writedown than firm using FIFO or weighted average cost
- LIFO is using most recent cost of inventory for COGS
- Writedown is recognized when original cost of inventory is higher than NVR
- NVR reflects market price of inventory in current accounting period
- For ending inventory, its original cost usually lower than NRV
- Writedown affect inventory turnover in current and future period
- Inventory turnover = sales/ average inventory
- Writedown → reduce average inventory of current period → increase inventory turnover in future period
- Under IFRS and US GAAP, reporting inventory above historical cost is permitted
- Inventory is reported at NRV
- Gains and losses from changing market prices are recognized in IS
- Writedown are usually the result of poor inventory management
- Buy too much inventory when market price is slowing down → original cost > market, NVR
Note:
Replacement cost
- Expense a business must undertake to replace an essential asset of the company at the same or equal value at the present time.
- The cash outlay that firm has to pay in order to replace an old asset at the current market price.