Accounting for Inventories: US GAAP Vs IFRS

U.S. GAAP are the generally accepted accounting principles accepted in the United States. U.S GAAP was published by the Financial Accounting Standards Board, FASB, and adopted by the U.S. Securities and Exchange Commission, SEC. IFRS are international reporting standards issued by the International Accounting Standards Board, IASB. IFRS is used in over 100 countries, which is a main reason the SEC intends to switch from U.S GAAP to IFRS, but the progress has been slow. There are similarities between the frameworks, but also some substantial differences exist between the two accounting standards.

Specifically comparing standards of accounting for inventory, U.S. GAAP and IFRS are based off of similar principles. For both, inventories are defined as assets that are held for sale in the ordinary course of business, used in the process of production for sale, or materials or supplies to be consumed in the production of inventory or in the rendering of services. Similarly, they both rely on cost as the main basis in accounting for inventory.

The first difference is the inventory costing methods used and applied. U.S. GAAP permits the use of last-in first-out (LIFO) costing method. Last-in first-out assumes that assets produced or acquired first are the assets used, sold, or disposed of first. Meaning, the newest inventory goes out first. The LIFO inventory costing method is prohibited by IFRS. U.S. GAAP and IFRS use first-in first-out (FIFO) and weighted-average cost. FIFO is another asset-management and valuation method used nationally and internationally. The assets produced or acquired first are sold, used or disposed of first. Assuming the assets left in inventory at the end of the accounting period correspond to the assets that are produced or purchased most recently. The weighted-average costing method uses the average of the costs of the goods, which is achieved by taking the total cost of items in inventory and dividing that number by the total number of units available for sale. The weighted-average method produces a cost for inventory that is between the costs determined by LIFO and FIFO. With regard to application of the different costing methods, U.S. GAAP does not require the same method to be used in determining the cost of for all inventories with similar nature and use to the entity. Inversely, IFRS requires the same method used to determine cost of inventory to be applied to all inventories with similar nature and use to the entity. The additional accounting method for determining cost of inventory, LIFO, and the ability to apply different costing methods to different inventories are the first differences between U.S. and international standards when accounting for inventory.

The second difference is how each framework measures carrying value. U.S. GAAP uses the lower-of-cost-or-market method, and IFRS uses the lower-of-cost-or-net-realizable-value method. The lower-of-cost-or-market means that at the end of the accounting period the amount reported of inventory is either the cost or value of inventory in the market, whichever is the lower amount. The lower-of-cost-or-net-realizable-value method takes the lower number between the cost or the net realizable value, amount a company expects to receive from the sale of inventory. The net present value is calculated by taking the estimated selling price and subtracting out the estimated costs to complete and estimated costs to make a sale.

The third difference is the reversal of write-downs. The reversals of write-downs are prohibited by U.S. GAAP, but are required for subsequent recoveries under IFRS. A write-down is the reducing of the book value of inventory because it is overvalued compared to the market. This would occur if the carrying value of inventory subsequently could not be justified as fair value, and is unlikely that the inventory could be sold at cost or book value. For U.S. GAAP a write-down taken to reduce the book value of inventory to the lower of cost or market, cannot be reversed for subsequent increases in value. On the other hand, IFRS requires the reversal of write-downs taken to reduce the book value of inventory to the lower of cost or net present value, in the event of subsequent increases in value of inventory. IFRS limits the reversal to the amount of the original write down.

Costing methods and application, measurement of carrying value, and reversal of write downs, are the three significant differences with respect to accounting for inventory between U.S. GAAP and IFRS. If planning to grow internationally, an entity should be educated in all the differences in accounting standards between both U.S. GAAP and IFRS to be in compliance.

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