A recent Accounting Standards Update (ASU) issued by the Financial Accounting Standards Board (FASB) aims to simplify accounting for inventory. FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory as part of its Simplification Initiative, launched in 2014, which seeks to improve accounting principles generally accepted in the United States of America (U. S. GAAP) by reducing the costs and complexity of financial reporting while improving and maintaining the usefulness and value of financial statement information provided to statement users. The level of analysis required under current standards is considered unnecessarily complex and will be significantly reduced for all entities affected by the ASU.
Under the existing standards, entities are required to measure inventory at the lower of cost or market value. Market value could be the inventory’s replacement cost, net realizable value, or net realizable value less a normal profit margin. Net realizable value is defined by FASB as the estimated selling price of the inventory less the costs of completion, disposal, and transportation. The current replacement cost is used as market value when it is less than net realizable value of inventory (the “ceiling”) but greater than the net realizable value less a normal profit margin (the “floor”).
The new ASU requires inventory measurement at the lower of cost or net realizable value. The calculation of the floor and ceiling under current standards is no longer required. In addition to simplifying financial reporting, the amendments in the ASU also more closely align inventory measurement in U. S. GAAP with inventory measurement in International Financial Reporting Standards (IFRS).
The ASU does not apply to inventory measured using the last-in, first-out (LIFO) or the retail inventory methods. Inventory measured using LIFO or retail inventory methods may continue to be measured at the lower of cost or market. The ASU applies to all other methods of inventory measurement.
The ASU is effective for public business entities for fiscal years beginning after December 15, 2016, as well as interim periods within those years. The ASU is effective for all other entities for fiscal years beginning after December 15, 2016, and for interim periods beginning after December 15, 2017. The amendments in the ASU should be applied prospectively, and early application is permitted.
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