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Inventory Project Moves Forward, LIFO Left Intact

A FASB proposal to simplify the ways businesses calculate the value of their inventory is moving forward, but a divided board agreed to carve out the last-in, first out (LIFO) and retail inventory methods (RIM). The carve-out will mostly apply to large retailers, which said the carve-out was needed to avoid creating complications for the way they measure inventory.

The FASB’s inventory accounting project began as a short-term effort to simplify the multiple, complex ways businesses calculate the value of their raw materials, supplies, and finished goods.

Wal-Mart Stores Inc. and Target Corp., two of the largest retailers in the U.S., however, told the FASB that Proposed Accounting Standard Update (ASU) No. 2014-210, Inventory (Topic 330): Simplifying the Measurement of Inventory , issued in July 2014, would have the opposite effect.

To address these concerns, a majority of the FASB on May 13, 2015, agreed to proceed with the project but exclude from it last-in-first-out (LIFO) accounting and the retail inventory method (RIM) for measuring inventory.

The proposal requires inventory to be calculated using the lower of cost or net realizable value. The net realizable value is the estimated selling price in the normal course of business, minus the cost of completion, disposal, and transportation. Businesses would no longer consider replacement cost or net realizable value less a normal profit margin when measuring inventory.

The vote to allow an exception for LIFO and RIM means the inventory accounting methods used by some large retailers will remain intact.

Several FASB members expressed reservations about starting a project to simplify accounting but ending up with a solution that involved exceptions and carve-outs.

“I don’t know how we do a simplification project that adds complexity,” said FASB member Thomas Linsmeier. “I don’t understand the whole purpose.”

FASB Vice Chairman James Kroeker, who ultimately voted with the board’s majority, said labeling a project as a “simplification” to U.S. GAAP did not mean that it would not result in changes or additional costs for some businesses. His first preference was to require the change for all businesses.

“We’re not making a change that doesn’t have an impact,” Kroeker said.

He said of the more than two dozen comment letters the FASB received on the proposal, “three or four” said there would be a significant impact on their business practice.

“Generally, those entities have selected exceedingly complex inventory to start with; they’re the ones that include different inventory calculations for tax versus book. And then there are complaints about how this could further disassociate their inventory policy with current costs,” Kroeker said. “I don’t even understand that policy.”

FASB member Harold Schroeder also said his first choice was to require a change for all.

“This is a simplification, not just for preparers, but for users as well,” Schroeder said.

FASB member Marc Siegel voted to scrap the project entirely.

“I don’t see this as really simplifying anything,” Siegel said. “I think it reduces costs for some people.”

A first vote resulted in deadlock. When FASB Chairman Russell Golden called for members’ second preferences, a majority agreed that the proposal, carve-outs included, would still be an improvement over current accounting practices. Linsmeier and Siegel dissented.

“What we should be focused on is looking at reducing complexity, promoting simplification, and promoting consistency for inventory models,” Golden said. “I’m not sure it’s feasible to have one inventory model in U.S. GAAP, but I do think it’s feasible to have fewer inventory models than we have today.”

Under Topic 330, Inventory , companies measure the value of their inventory at the lower of cost or market, or LOCOM. But “market” can mean different things. It can be the cost to replace an item on the open market, the net value a seller will realize for the item during a normal business transaction, minus costs, or the net realizable value less an approximately normal profit margin.

The FASB issued the July 2014 proposal to reduce the number of ways to measure the goods companies have in their inventories.

Most of the audit firms, professional groups, and companies that responded to the standard-setter’s proposal said they favored this clarification. Google Inc., for example, said the value of its technology products typically lose value over time, and the existing requirement to perform an analysis with respect to historical cost, current replacement cost, net realizable value, and net realizable value minus a normal margin on a regular basis requires a lot of work to produce a subjective figure.

Target, Wal-mart, and a retail trade group, however, said the plan didn’t take into account the nuances of calculating inventory at LIFO or RIM.

Businesses using LIFO generally recognize a lower of cost or market (LOCOM) adjustment when LIFO inventory cost exceeds the market value. In a “declining price environment,” inventory is carried at replacement cost on the balance sheet.

RIM approximates inventory cost by using current retail prices and applying a ratio of cost to selling price at a department or other level. Retailers believe RIM is a practical measure, Wal-Mart wrote to the FASB in a September 30 comment letter.

If the retailers were forced to follow the FASB’s proposed change, they would have to increase their inventory balances, FASB Project Manager Jennifer Hillenmeyer told the board.

After the FASB agreed to proceed with the proposal for most businesses, the board agreed that it would delay the implementation date by one year, to fiscal years and the interim periods within the fiscal years beginning after December 15, 2016.

The FASB’s research staff said the final standard would be published by the end of 2015.

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