Special Topic: Cost Included in Inventory and Inventory Write-down/up

Cost Included in Inventory

Product costs (capitalized costs) = Raw Material + Coversion Costs + Allocated Fixed Overhead (based on normal capacity level)+ Freight-in (other costs necessary to bring the inventory to its present location and condition)

Inventory Write-down/up

Original cost ................ $210
Estimated selling price $225
Estimated selling costs $22
Net realizable value .... $203
Replacement cost ........ $197
Normal profit margin $12

What are the per-unit carry value of inventory under IFRS and under U.S. GAAP?

Under IFRS, inventory is reported on the balance sheet at the lower of cost or net realizable value. Since orignial cost of $210 exceeds net realizable value ($225-$22 = $203), the inventory is written down to the net realizable value (NRV) of $203 and a $7 loss ($203 net realizable value -$210 original cost) is reported in the income statement.

Under U.S. GAAP, inventory is reported at the lower of cost or market. In this case, market is equal to replacement cost of $197, since net realizable value of $203 is greater than replaement cost, and net realizable value minus a normal profit margin (replacement cost), the inventory is written down to $197 and $13 loss ($197 replacement cost - $210 original cost) is reported in the income statement.

Assume that in the year after the writedown in the above example, next realizable value and replacement cost both increase by $10. What's the impact of the recovery under IFRS and under U.S. GAAP?

Under IFRS, the inventory should be written up to $210 ($210 original cost < $213 NRV) per unit and recognize a $7 gain in its income statement. The wrte-up (gain) is limited to the original writedown of $7. The carry value cannot exceed original cost.

Under U.S. GAAP, no write-up is allowed. The per-unit carrying value will remain at $197. it will simply recognize higher profit when the inventory si sold.