Companies must measure inventory at the lower of cost or market value under existing U.S. Generally Accepted Accounting Principles (GAAP). But what exactly is “market” value? It can mean the cost to replace an item on the open market, the net value a seller will realize for the item during a normal business transaction minus selling costs, or the net realizable value less an estimate of the normal profit margin.

To help simplify matters and reduce compliance costs, the Financial Accounting Standards Board (FASB) recently approved new guidance that will require certain companies to value inventory using the lower of cost or net realizable value (NRV). Accounting Standards Update (ASU) No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, clarifies that NRV is the estimated selling price in the normal course of business, minus the cost of completion, disposal and transportation.

Exceptions Add Complexity

Concerns from large retailers prompted the FASB to provide exceptions to the new inventory rules for companies that use the last-in, first-out (LIFO) or retail inventory methods to report inventory. For these companies, the existing lower of cost or “market” guidance will continue to apply. Several FASB members dissented on the new standard, arguing that these exceptions perpetuate complexity and make it harder to compare financial results from companies that use different inventory methods.

For public companies that use the first-in, first-out (FIFO) or average cost methods, the changes go into effect prospectively for fiscal years that begin after December 15, 2016. Affected private companies will apply the changes a year later. Early implementation is permitted.

Watch for More Simplification Efforts

ASU 2015-11 is part of a larger “simplification” initiative that the FASB has undertaken. The goal is to minimize complexity, compliance costs and disclosure overload — without depriving investors and creditors of high quality financial data and disclosures.

To date, the FASB’s simplification efforts have targeted narrow problem areas and offered quick solutions. For example, the FASB has already eliminated the concept of “extraordinary items,” removed its incremental financial reporting requirements for development stage entities, and streamlined its guidance on consolidation and debt issuance costs.

Simplification projects currently on the FASB’s agenda include proposals to simplify the rules for:

• Hedge accounting,
• Debt classification,
• Share-based payments,
• Employee benefit plans,
• Income taxes related to intra-asset transfers and deferred taxes,
• Financial instruments with characteristics of both debt and equity, and
• Investments reported under the equity method.

We’re keeping our eyes on all of these proposals and others that may emerge as the FASB continues to clean up U.S. GAAP, attempting to make the standards easier to apply and more closely aligned with global financial reporting standards.

For more information on FASB’s Proposed Changes to Not-for-Profit Reporting, download our eBook.

Questions? Contact us.