This article is the seventeenth in a series of articles that takes our readers on a journey through International Financial Reporting Standards (IFRS) with a special focus on the standards’ quintessential feature: they are principles-based. In this article, we provide an overview of some of the most significant differences between IFRS and U.S. generally accepted accounting principles (GAAP) with regard to inventories. Actual differences in the accounting treatment between the two frameworks depend on specific circumstances.
The IFRS standard dealing with inventories is International Accounting Standard 2, Inventories. Under this Standard, inventories are measured at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
Under U.S. GAAP, the primary standards dealing with inventories are Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, FASB Statement No. 151, Inventory Costs - An Amendment of ARB No. 43, Chapter 4, and FASB Interpretation No. 1, Accounting Changes Related to the Cost of Inventory - an Interpretation of APB Opinion No. 20. Under these standards, inventories are measured at the lower of cost or market (current replacement cost). The upper limit on market value is net realizable value (estimated selling price minus cost of completion and disposal), and the lower limit is net realizable value minus normal profit margin.
Inventories have to be written down to net realizable value for IFRS and to market value for U.S. GAAP, preferably on an item-by-item basis. Because of the different mechanics discussed above, impairment charges might result in different amounts. However, in general, both frameworks foresee that in certain circumstances it may be appropriate to group similar or related items to calculate impairment and therefore, in such cases, differences may be virtually eliminated. Under IFRS when the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances, the amount of the write-down is reversed so that the new carrying amount is the lower of the cost and the revised net realizable value. However, the reversal is limited to the amount of the original write-down. Under U.S. GAAP, reversals are always banned.
The following table illustrates cost formulas used under the two frameworks:
|
IFRS |
U.S. GAAP |
Last-in, first-out (LIFO) |
Prohibited |
Allowed |
First-in, first-out (FIFO) |
Allowed |
Allowed |
Average cost method |
Allowed |
Allowed |
Standard cost method |
May be used for convenience if the results approximate cost |
May be used if the results reasonably approximate cost computed under one of the recognized bases |
Retail method |
May be used for convenience if the results approximate cost |
In some situations may be both practical and appropriate |
For further information, please contact Bob Dohrer (robert.dohrer@rsmi.com) or Marco Marcellan (marco.marcellan@rsmi.com) in our International Assurance Services Group.
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