Inventory Valuation Made Simple
Jul 25, 2014
On July 15, the Financial Accounting Standards Board proposed an Accounting Standards Update inventory valuation methods. The purpose of the update is to cut back on both the cost and complexity of accounting for inventory. This simplification can be seen as gold among the dross, as the extreme complexity of accounting standards today can be overwhelming to business owners and accountants alike.
An advantage of this proposed accounting standard is an increased consistency of inventory valuation among different companies. Consistency an important aspect to accounting standards, as their underlying purpose it to provide useful information to readers of financial statements.
The current accounting standard for inventory measurement is by using the lower of cost or market method. As it may sound harmless enough, the complexity falls within the multiple definitions of what “market” cost can be. Market can be any one of the following three options:
• Replacement cost • Net Realizable Value or • Net realizable value less normal profit margin
The proposed update will change the inventory valuation method to “lower of cost or net realizable value.” This is not a complete change from the current method, but more of a simplification. Net realizable value is defined as “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.”
By eliminating the different options to “market” valuation, there will be a more consistent application of the measure of inventory. This will also prevent companies from having to make decisions on how they will choose their method for market cost.
Another additional benefit this Proposed Accounting Standards update provides is that it is very similar to the method used in International Financial Reporting Standards. With the merging of GAAP and IFRS on the horizon, any update that would help smooth out the transition will be a benefit when that time comes.
Reminder: Proposed Accounting Standards Updates are released for public comment. The entire exposure draft can be downloaded for viewing from the Financial Standards Oversight Board website at www.FASB.org. Electronic Feedback Forms are also available via the FASB website, or responses may be emailed to email@example.com or mailed to:
Technical Director File Reference No. 2014-210 FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116
By: Anthony Mifsud, Staff Accountant