GAAP vs IFRS Inventory Methods

"As the globalization wave continues to rise, GAAP's days appear to be numbered, along with those of its generator, the Financial Accounting Standards Board ("FASB"). The Securities and Exchange Commission ("SEC"), long the backer and protector of GAAP and the FASB, lately changed course to defect against them in favor of IFRS and its generator, the International Accounting Standards Board ("IASB"). The road to defection began when the SEC eliminated the requirement that foreign issuers registered in the United States and reporting under IRFS restate their financials to GAAP." (Bratton and Cunningham) With this being said, there are many different issues that come to order, one being inventory methods. Inventory is a major component of businesses around the world, many relying on inventory sales to produce income. Globalized companies now have to interpret which accounting system is at use depending on the area. Conducting this form of analysis is costly and time consuming for a business. Even with the same inventory counts, sales, and costs, both systems will produce different outcomes with different calculations. RELATED ARTICLES INVENTORY MANAGEMENT 73 Ideas To Reduce Costs And Build Profits In Ware-Housing, Distribution Centres And Inventory Management Current assets – different dimensions Globalization of Accounting Standards When looking at inventory, IFRS and GAAP differ in many ways, but there are some similarities. "Both GAAP and IFRS define inventory as assets held for sale in the ordinary course of business, in the process of production for such sale or to be consumed in the product of goods or services." (Ernest & Young) Both of these accounting principles understand until inventory is sold to a direct consumer or retailer, it is considered to be a cost. The cost of the inventory is determined the same with both systems allocating overhead, materials, and labor into the finished product, excluding selling cost from the cost of inventory. (E & Y) Both of these systems recognize inventory as the same, but understanding the calculation of inventory, well that's a different story. GAAP and IFRS differ when marking inventory in many different ways. "GAAP is famous for rules while IFRS is known for principles." (B & C) One reason why IFRS is considered known for its principles is because of the marking of intangible assets. Under GAAP, "intangible assets are recognized at fair value, as for IFRS, goods are only recognized if they will have a future economic benefit." (Nguyen) GAAP considers the cost of intangible assets, creating a different net income then a company using IFRS. The SEC is trying to eliminate these types of errors by making IFRS a global system. One of the biggest differences between GAAP and IFRS is how they determine costing methods. When using GAAP, it is acceptable to use Last in First out (LIFO) and First in First out (FIFO). "FIFO more closely reflects economic reality on the balance sheet, listing inventories close to current values, while LIFO better reflects prevailing economics on the income statement with a figure for cost of goods sold reflecting current prices." (B & C) GAAP allows companies to use either of these costing methods, as both can be reflected on different journals or ledgers. Turning to IFRS, it is not acceptable to choose which method a company would like to use. "IFRS requires the same costing method to be applied to all inventories, this method being FIFO."(E & Y) Globalized companies are starting become more popular as time goes on. With the SEC not requiring foreign companies to switch accounting information to GAAP, it is becoming costly and time consuming for companies to compare inventory counts. "The move to a single method of inventory costing could lead to enhanced comparability between countries, and remove the need for analysts to adjust LIFO inventories in their comparison analysis." (Nguyen) Another major difference between GAAP and IFRS is the procedure of recording write-downs. Write downs occur when assets are not seen as book value and are ultimately overpriced. This may occur when inventory is damaged in some way or another. Companies never want to see this happen, but when it does, companies will write off these assets, ultimately lowering a company's net income. Companies recording write-downs using the GAAP approach cannot be reversed. Instead of reversing inventory write downs, companies will designate a different account for these losses. When international companies experience this type of problem using IFRS, they have the ability to reverse the inventory losses. "Recognized impairment losses are reversed up to the amount of the original impairment loss when the reasons for the impairment no longer exist." (E & Y) Another noticeable difference between both accounting systems is the process of markdowns of permanent inventory using the retail inventory method (RIM). If a company is using GAAP, "permanent markdowns do not affect the gross margins used in applying the RIM. Rather, such markdowns reduce the carrying cost of inventory to net realizable value, less an allowance for an approximately normal profit margin, which may be less than both original cost and net realizable value." (E & Y) IFRS is completely different when using RIM. Here, "permanent markdowns affect the average gross margin used in applying the RIM. Reduction of the carrying cost of inventory to below the lower of cost or net realizable value is not allowed." (E & Y) Ultimately, GAAP will record inventory costs lower then original costs as IFRS will not allow this type of recording occur. An international company could have the same inventory counts for a specified branch, but using different approaches could lead to different calculations of gross margins. These accounting systems differ in many other ways then just inventory counts. Businesses all across America are starting to become global and having to calculate different records in different areas is redundant. Companies would find having one international accounting system be a benefit, rather then a cost.