Key Differences between U.S. GAAP and IFRS for Consumer Products Companies
IFRS guidance is currently comprised of 38 standards and 26 interpretations. Some of the more significant differences between U.S. GAAP and IFRS of particular interest to consumer product companies are discussed below, along with their associated impact on tax, processes and systems.
Inventories: International Accounting Standard 2 (IAS 2) Accounting Methods
The cost of inventory under both U.S. GAAP and IFRS generally includes direct expenditures of getting inventories ready for sale, including overhead and other costs attributable to the purchase or production of inventory. IAS 2 specifically requires use of either the first-in, first- out (FIFO) or the weighted-average cost method, but allows the standard cost method or the retail method for convenience if the results approximate cost. Further, IFRS requires that the same costing formula be used for all inventories with a similar nature and use to the entity.
The Tax Dilemma
Under U.S. GAAP, during periods of rising prices, the LIFO costing method leads to higher recognized costs of sales, and thus reduces taxable income. Under Internal Revenue Service (IRS) rules, consumer product companies using the LIFO method must conform their financial reporting method to LIFO. But under IFRS, use of the LIFO costing method is explicitly not permitted. The adoption of IFRS for financial reporting purposes could result in significant tax consequences, as its stated preclusion of LIFO for financial reporting would violate current IRS conformity requirements for those using LIFO for tax purposes.
Some business observers speculate that the U.S. Congress and the IRS will be compelled to address this issue should IFRS be mandated, perhaps by offering a one-time conversion opportunity that limits the tax liability. Companies should closely monitor developments in this area and may want to begin the analysis to estimate the dollar cost of converting from LIFO under the current IRS conversion rules.
Under U.S. GAAP, inventories are required to be stated at the lower of cost or market (“LCM”), with market defined as current replacement cost. Market should not exceed net realizable value (defined as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal) or be less than NRV reduced by an allowance for a normal profit margin. For U.S. GAAP purposes, application of the LCM approach leads to an acceptable range of practice among consumer product companies, given the floor and ceiling concept in the definition of market.
Under IFRS, inventories are stated at the lower of cost or net realizable value (defined as the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost necessary to make the sale). Under IFRS, there is no concept of reducing NRV to allow for a normal profit margin. While the definitions of carrying value under U.S. GAAP and IFRS appear to be only slightly different, the outcome may be significantly different depending on a company’s current practice for determining LCM.
Reversal of Write-Downs
A new assessment is made of net realizable value in each subsequent period. Under IFRS, unlike U.S. GAAP, when the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances, the amount of the write-down is reversed (i.e., the reversal is limited to the amount of the original write-down) so that the new carrying amount is the lower of the cost or the revised net realizable value. This occurs, for example, when an item of inventory that is carried at net realizable value because its selling price had declined, is still on hand in a subsequent period and its selling price has increased. Any impairment or reversal is recorded to cost of sales in the period in which it occurs.
Summary of Impact on Inventories
Key Accounting Differences
Measure at cost or NRV
Use same valuation
Reversal of impairment
Valuation of inventory
Potential Implications Process/Systems
Inventory system changes
Processes around reversal of
Potential significant cost if LIFO change
Impact from change in valuation