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The primary basis of accounting for inventories is cost, provided cost is not higher than the net amount realizable from the subsequent sale of the inventories (refer to IV 1.3.2). Cost may be determined using a variety of cost flow assumptions, such as first-in, first-out (FIFO), average cost, or last-in, first-out (LIFO). Regardless of the cost flow assumption chosen, the nature of costs includable in inventory will be consistent. Although many companies may use a standard costing approach in their operations, for financial reporting purposes, variances between actual costs and standard costs must be absorbed so as to reflect actual costs in inventory, subject to the considerations in ASC 330-10-30-3 through ASC 330-10-30-8.

1.3.1 Inventory elements of cost

The definition of cost as applied to inventories means, in principle, the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production costs, and its determination involves many considerations. Abnormal costs related to freight, handling, and wasted materials (spoilage) should be included in current period charges rather than deferred as a portion of inventory costs. In the context of freight and handling, “abnormal” generally means those costs related to activities that are duplicative or redundant—that is, not a normal element of the supply chain or production process (e.g., movement from one warehouse to another warehouse as a result of an unplanned shutdown at the primary manufacturing facility or a natural disaster). Higher than normal or higher than anticipated costs for otherwise routine activities are not “abnormal costs” in this context. In addition, the concept of wasted materials (spoilage) refers specifically to goods that are damaged or destroyed or lost (i.e., production yield) during the production process. Merely incurring higher costs when acquiring inventory from third parties is not considered “wasted materials.” Those higher costs should be capitalized, subject to lower of cost and net realizable value considerations.
Companies that hold or enter into firm commitments to purchase inventories that are commodities or to protect against fluctuations in market prices of inventories may enter into futures contracts to hedge price risk associated with such inventories or transactions. Under ASC 815, all derivative instruments must be recognized and subsequently measured on an entity’s balance sheet at fair value. The accounting for changes in fair value of a derivative instrument for a period will depend on the intended use of the derivative instrument and on whether it qualifies for hedge accounting. See PwC's Derivatives and hedging guide, for guidance on accounting for hedging activities.

1.3.2 Lower of cost and net realizable value

For inventories measured using any method other than LIFO or the retail inventory method (RIM), ASC 330-10-35 establishes the lower of cost and net realizable value rule as the guiding principle for measuring inventories. For inventories measured using RIM, refer to IV 2. For inventories measured using the LIFO cost flow assumption, refer to IV 3.8.
ASC 330 defines “net realizable value” (NRV) as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. Additionally, ASC 330-10-35-4 states that no loss should be recognized on inventories unless it is clear that a loss has been sustained.
In applying the lower of cost and NRV principle to raw materials and work-in-progress inventories, it is necessary to estimate the costs to convert those items into saleable finished goods in order to determine NRV. In determining the net amount to be realized on subsequent sales, selling costs should include only direct items, such as shipping costs and commissions on sales.
Determining NRV at the balance sheet date requires the application of professional judgment, and all available data, including changes in product prices that have occurred or are expected to occur subsequent to the balance sheet date, should be considered. For example, increases in prices subsequent to the balance sheet date but prior to issuance of the financial statements would likely demonstrate that the decline in prices at the balance sheet date was temporary, indicating that a lesser or no NRV allowance is required. However, a subsequent decrease in prices may indicate the need for an NRV adjustment at the balance sheet date. Thus, a decrease in selling price subsequent to the balance sheet date that is not the result of unusual circumstances, such as abrupt and significant but short-lived changes in supply and/or demand for the item, generally should be considered in determining NRV at the balance sheet date. See FSP 28.5.3 for additional details on recognized subsequent events for inventory.
Example IV 1-1 illustrates the impact of subsequent events on inventory valuation.
EXAMPLE IV 1-1
Assessing subsequent events for inventory valuation
During January 2020, Company A enters into a global restructuring program under which it will close certain facilities and discontinue certain product offerings. Most of the product offerings to be discontinued are currently profitable. The plan will be executed in phases beginning in October 20X0 and will continue for a period of two years. Each phase of the plan is subject to several levels of operational review and revision before ultimate approval by the CEO. Plans for product discontinuance may be revised significantly during review and may be rejected by the CEO. If products are discontinued, Company A will attempt to sell the inventory at salvage value or discard it.
The first phase is approved by the CEO in January 20X1 prior to the issuance of Company A’s calendar year-end financial statements.
Should the effect of the discontinuance be considered in the NRV assessment?
Analysis
Yes. Although the products in question are profitable at the balance sheet date, all information related to inventory valuation should be taken into account through the issuance of the financial statements. Company A had a global reorganization plan in place prior to the balance sheet date. The fact that the phase of the plan in question was not approved until after the balance sheet date would not provide a basis to defer the loss. This is in contrast to when a specific event results in the loss of value of the inventory, such as due to a post balance sheet fire. In that case, (i.e., a clear triggering event occurring after the balance sheet date), the inventory would be impaired in the same period as the specific event occurred.

1.3.2.1 Unit of account for NRV assessment

ASC 330-10-35-8 indicates that, depending on the character and composition of the inventory, the lower of cost and NRV test may be performed on an item-by-item basis, by major category of inventory, or at any other level that most clearly reflects periodic income such that losses are not inappropriately deferred. The method used should be consistently applied. Raw material inventories related to a single finished product should be grouped together for the purpose of evaluating the need for an NRV write-down. Generally, there is no need to write down individual components of a particular finished product if the net realizable value of the finished product is greater than the aggregate costs of the components, the costs of production, and direct selling expenses.
The greater the diversification of finished goods, inventories, and lines of business in which an entity operates, the greater the need for care in determining the appropriate unit of account when performing the net realizable value assessment. In general, we believe it would be inappropriate to apply a broad (e.g., entity-wide) approach to the lower of cost and NRV valuation when offsetting unrelated gains mask losses.

1.3.2.2 Adverse purchase commitments

Losses expected to arise from firm, non-cancelable and unhedged commitments for the future purchase of inventory items should be recognized unless the losses are recoverable through firm sales contracts or other means pursuant to ASC 330-10-35-17 through ASC 330-10-35-18.

1.3.2.3 Declines in NRV at interim dates

ASC 270-10-45-6 and ASC 330-10-55-2 require that inventories be written down during an interim period to the lower of cost and NRV unless it is reasonably expected that the net realizable value will recover before the earlier of the inventory being sold and the end of the fiscal year. Situations in which an interim write-down would not be necessary are generally limited to seasonal price fluctuations.
As detailed in ASC 270-10-45-6, inventory losses from NRV declines should not be deferred beyond the interim period in which the decline occurs if they are not expected to be restored prior to the inventory being sold or the end of the fiscal year. Recoveries of such losses on the same inventory in later interim periods of the same fiscal year through NRV recoveries should be recognized as gains in the later interim period. Such gains cannot exceed previously recognized losses.
As indicated in SAB Topic 5.BB, based on ASC 330-10-35-14, a write-down of inventory to the lower of cost and NRV at the close of a fiscal period creates a new cost basis that subsequently cannot be marked up based on changes in underlying circumstances after the company’s fiscal year-end. Based on this guidance, lower of cost and NRV write-downs recorded during an interim period can be reversed (partially or fully) only in subsequent interim periods of the same fiscal year if NRV recovers prior to the earlier of the inventory being sold and the end of the same fiscal year.

1.3.2.4 Mark-to-market inventories

ASC 330-10-35-15 permits the use of “mark-to-market” accounting for certain inventories.

Excerpt from ASC 330-10-35-15

Precious metals having a fixed monetary value with no substantial cost of marketing may be stated at such monetary value; any other exceptions must be justifiable by inability to determine appropriate approximate costs, immediate marketability at quoted market price, and the characteristic of unit interchangeability.

We expect the circumstances in which inventories can be carried at market to be extremely rare. In particular, ASC 932-330-35-1 provides accounting guidance for oil and gas companies and specifically prohibits measuring physical inventory at fair value, except when indicated by the authoritative literature.

ASC 932-330-35-1

Energy trading contracts that are not accounted for as derivatives in accordance with Topic 815 on derivatives and hedging shall not be measured subsequently at fair value through earnings. Entities shall not measure physical inventories at fair value, except as provided by guidance in other Topics.

Except when explicitly indicated by the authoritative literature, no basis exists to carry inventories at fair value. For example, if an entity is a broker dealer subject to the specific guidance of ASC 940, Financial Services - Brokers and Dealers, then certain of its commodity inventories may be reported at fair value. However, we believe the entity must be specifically within the scope of ASC 940 and cannot analogize to the guidance if it is outside its scope.

1.3.2.5 Other lower of cost and net realizable value matters

If there are circumstances in which sales incentives offered voluntarily by a vendor and without charge to customers may result in a loss on the sale of a product, entities should apply the guidance for consideration payable to a customer in ASC 606-10-32-25 through ASC 606-10-32-27 (as discussed in RR 4.6). Although a liability for a sales incentive offered by a vendor should be recognized according to the applicable guidance, companies should consider whether offers of sales incentives will result in a loss on the sale, which as noted in ASC 330-10-35-13, may indicate an impairment of existing inventory.
ASC 830-10-55-8 through ASC 830-10-55-9 and ASC 830-10-55-15 through ASC 830-10-55-19 describe the application of the lower of cost and NRV measurement principle for inventories held by an entity whose books and records are remeasured from local currency to the functional currency. See FX 5.4.1.2 for further discussion.
Refer to DH 3.2.4 for discussion of contracts that initially qualified for the “normal purchase normal sale” exception under ASC 815, for which physical delivery of the underlying asset is no longer probable and the contract is required to be accounted for as a derivative.
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