On July 22, 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. The standard changes the measurement principle for inventory from the “lower of cost or market” to “lower of cost and net realizable value (NRV)”. The new principle is part of FASB’s simplification initiative and applies to entities that measure inventory using a method other than last-in, first-out (LIFO) or the retail inventory method.
Some Facts
- For entities using first-in, first-out (FIFO) or average cost, the measurement principle for their inventory changes from “the lower of cost or market” to “lower of cost and net realizable value”.
- Entities that measure inventory using LIFO or the retail inventory method are not affected.
- In addition to simplification, the standard would make United State Generally Accepted Accounting Principles (U.S. GAAP) more comparable to International Financial Reporting Standards (IFRS), under which inventory must be measured at the lower of cost or net realizable value (NRV).
- Enhanced inventory disclosures may also be considered as part of the FASB’s disclosure framework project.
Key Impacts
- Entities that do not measure inventory using LIFO or the retail inventory method, no longer will need to consider replacement cost or NRV less an approximate normal profit margin in the subsequent measurement of inventory.
- Subsequent measurement for inventory is unchanged for inventory measured using LIFO or retail inventory method.
Current U.S. GAAP requires that entities measure inventory at the lower of cost or market. The
measurement of market is commonly the current replacement cost. However, entities also need to consider NRV (ceiling) and NRV less an approximately normal profit margin (floor) in their measurement. For entities measuring inventory using a method other than LIFO or the retail inventory method, the ASU replaces market with the NRV. For entities using LIFO or the retail inventory method, there is no change to the measurement of inventory.
As per FASB Accounting Standards Codification (ASC), the NVR is defined as the: “estimated selling price in the ordinary course of business, less reasonable predictable costs of completion, disposal and transportation.” This ASU eliminates the guidance that entities consider replacement cost or NRV less approximately normal profit margin when measuring inventory when cost is determined on a FIFO or average cost basis.
The ASU does not change any other aspects of the accounting for inventory. The ASU only addresses the measurement of inventory if its value declines or is impaired. Entities would continue to apply FIFO, average cost, etc., to determine the cost of inventory and then they
would compare that to NRV to determine if an inventory write-down is necessary. Entities would recognize the difference as a loss in earnings in the period in which it occurs.
Transition and Effective Date
The ASU requires prospective adaption for inventory measurement for fiscal years beginning after December 15, 2016, and interim periods within those years for public business entities. For all other entities including not-for-profits, it is required for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. Early adaption is permitted. Entities are required to disclose the nature and reason for the change in accounting principle in the first interim and annual period of adaption.
Upon adoption, the change from the lower of cost or market to the lower of cost and NRV for inventory within the scope of the ASU, will be accounted for as a change in accounting principle. Only the nature and reason for the change in accounting principle is required to be disclosed in the first interim and annual period of adoption.
By: Lila Leno, CPA | Senior Manager
