The Financial Accounting Standards Board’s (FASB’s) plan to amend inventory accounting should have been a quick fix to clear up confusion about how businesses value their stockpiles of raw materials, supplies and finished goods. But the project is now on hold, because some big-box retailers fear that the changes would complicate their measurements with the retail and last-in, first-out (LIFO) inventory methods.
A plan to simplify inventory
According to Accounting Standards Codification (ASC) Topic 330, Inventory, companies measure the value of their inventory at the lower of cost or market. But the term “market” can mean different things, including:
- Cost to replace an item on the open market,
- Net value a seller will realize for the item during a normal business transaction (minus reasonably predictable costs of completion, disposal and transportation), or
- Net realizable value less an approximately normal profit margin.
Under Topic 330, the market price can be higher than the value a business might realize from a sale, but it can’t be lower than that amount. The guidance on reporting inventory hasn’t been updated since 1947.
In July 2014, FASB proposed Accounting Standards Update (ASU) No. 2014-210, Inventory (Topic 330): Simplifying the Measurement of Inventory, which would require inventory to be measured at the lower of cost or net realizable value. More than 80% of the companies, auditors and investors that weighed in last fall favored this change.
Reasons for opposition
But the remaining 20% of respondents — including some big-box retailers — raised concerns large enough to make FASB hit the pause button at a meeting last December. Specifically, Wal-Mart and Target fear that the proposal doesn’t take into account the nuances of measuring inventory under the retail inventory method (RIM) or LIFO.
In its comment letter, Wal-Mart explained that, using RIM, the company values inventory by applying a “cost complement” ratio to current retail prices. This ratio, which compares cost to selling price at a department or other level, is typically calculated before considering permanent markdowns to ensure compliance with the lower-of-cost-or-market principle. Depending on how it’s interpreted, FASB’s simplified proposal could significantly impact Wal-Mart’s current RIM practices.
Similarly, Target told FASB that the proposal could usher in significant changes for businesses that use LIFO in declining price environments, because they would be required to recognize LIFO reserves in income. This could result in false earnings boosts.
Although FASB thought its inventory accounting proposal would offer a simple and welcome change, it’s mushrooming into a huge project with many unintended consequences and some significant opposition. One solution the board considered was to proceed with the proposal but make exceptions for certain types of companies. This idea didn’t sit well with FASB members, who said it would result in even more complexity.
FASB Chairman Russell Golden suggested embarking on a much larger project to overhaul inventory accounting, an effort that would likely take at least 18 months. There was no appetite for such an endeavor, however.
Ultimately, the board agreed to keep the project narrow and conduct more research before it makes any decisions.
No simple answers
Proposed ASU 2014-210 started out as part of the broader effort to make existing accounting standards simpler with surefire fixes. But inventory reporting has proven to be an extremely complicated issue. Stay tuned for more information as FASB conducts additional research on how this proposal might affect retailers and other entities that use RIM and LIFO.
Accounting for merchandise inventory can be challenging and time-consuming, especially when a retailer carries an array of products. Physically…