Inventory accounting: IFRS® Standards vs US GAAP (2024)

From the IFRS Institute –December 3, 2021

Inventory represents a significant part of the balance sheet for many companies. In accounting for inventory determining and capturing the costs to be recognized as an asset through the inventory lifecycle is key, because it affects a company’s KPIs such as gross profit margin. Despite similar objectives, IAS 21 differs from ASC 330 in a number of areas2. Here we summarize what we see as the main differences on inventory accounting between the two standards.

What are the requirements of IAS 2?

Inventories are assets that are:

  1. held for sale in the ordinary course of business (e.g. finished goods, merchandise purchased for resale);
  2. in the process of production for such sale (i.e. work in progress); or
  3. in the form of materials or supplies to be consumed in the production process or rendering of services (e.g. raw materials, packaging).

Commercial samples, returnable packaging or equipment spare parts typically do not meet the definition of inventories, although these might be managed using the inventory system for practical reasons.

Inventories are generally measured at the lower of cost and net realizable value (NRV)3. Cost includes not only the purchase cost but also the conversion and other costs to bring the inventory to its present location and condition. If items of inventory are not interchangeable or comprise goods or services for specific projects, then cost is determined on an individual item basis. Conversely, when there are many interchangeable items, cost formulas – first-in, first-out (FIFO) or weighted-average cost – may be used. Techniques for measuring the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate cost.


What are costing techniques?


NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. It is based on the most reliable evidence available at the time the estimate is made, of the amount expected to be realizable from the inventories. When the NRV of an item of inventory falls below its cost or current carrying amount, the item is written down to its NRV and the associated loss is recognized immediately in the income statement. In our view, writedowns of inventory, as well as any reversals, should be presented in cost of sales. The amount of inventories and writedowns recognized as an expense in the period are disclosed.

How is IAS 2 different from US GAAP?

While both IAS 2 and ASC 330 share similar objectives, certain differences exist in the measurement and disclosure requirements that can affect comparability. Here we summarize what we see as the top 10 differences in measurement of inventories under IFRS Standards and US GAAP.

1. IAS 2 prohibits LIFO; US GAAP allows its use.

Unlike US GAAP, IAS 2 prohibits LIFO as a cost formula. TheInternational Accounting Standards Board (IASB® Board) eliminated the use of LIFO because of its lack of representational faithfulness of inventory flows.

US GAAP comparison

US GAAP allows the use of any of the three cost formulas referenced above. While the majority of US GAAP companies choose FIFO or weighted average for measuring their inventory, some use LIFO for tax reasons. Companies using LIFO often disclose information using another cost formula; such disclosure reflects the actual flow of goods through inventory for the benefit of investors.


2. IAS 2 generally measures inventories at the lower of cost and NRV; US GAAP does not

Unlike US GAAP, inventories are generallymeasured at the lower of cost and NRV3 under IAS 2, regardless of the costing technique or cost formula used.

US GAAP comparison

Like IAS 2, US GAAP companies using FIFO or the weighted-average cost formula measure inventories at the lower of cost and NRV. Unlike IAS 2, US GAAP companies using either LIFO or the retail method compare the items’ cost to their market value, rather than NRV.

‘Market value’ can differ from NRV. It is equal to current replacement cost (i.e. the amount that would be required currently to replace the inventory item), except that it cannot:

  • exceed NRV (ceiling); or
  • be less than NRV less a normal profit margin (floor).


3. Retail method cost is reviewed regularly under IAS 2; not under US GAAP

Under IAS 2, the cost of inventories measured using the retail method is reviewed regularly, in our view at least at each reporting date, to determine that it approximates cost in light of current conditions. The percentage of gross profit margin is revised, as necessary, to reflect markdowns of the selling price of inventory.

US GAAP comparison

Unlike IAS 2, in our experience with the retail inventory method under US GAAP, markdowns are recorded as a direct reduction of the carrying amount of inventory and are permanent. There is no requirement to periodically adjust the retail inventory carrying amount to the amount determined under a cost formula.


4. Scope of onerous contracts requirements is broader under IFRS Standards than US GAAP

IFRS Standards define an onerous contract as one in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received. Unavoidable costs are the lower of the costs of fulfilling the contract and any compensation or penalties from the failure to fulfill it. If a contract can be terminated without incurring a penalty, it is not onerous.

If a company has a contract to sell inventory for less than the direct cost to purchase or produce it, it has an onerous contract. A provision may be necessary if the write down to net realizable value is insufficient to absorb the expected loss – e.g. if inventory has not been purchased or fully produced.

US GAAP comparison

In general, US GAAP does not permit recognizing provisions for onerous contracts unless required by the specific recognition and measurement requirements of the relevant standard. However, if a company commits to purchase inventory in the ordinary course of business at a specified price and in a specified time period, any loss is recognized, just like IFRS Standards.


5. Decommissioning and restoration costs form part of inventory costs under IAS 2; not under US GAAP

A company may have a decommissioning or restoration obligation to clean up a site at a later date, which must be provided for. Under IFRS Standards, decommissioning and restoration costs (i.e. from the accrual of the corresponding liability) incurred as a consequence of the production of inventory in a particular period form part of the cost of that inventory. Accordingly, these decommissioning and restoration costs are recognized in profit or loss when items of inventory have been sold.

US GAAP comparison

Unlike IAS 2, US GAAP does not allow asset retirement obligation costs incurred as a consequence of the production of inventory in a particular period to be a part of the cost of inventory. Instead, such costs are added tothe carrying amount of the related property, plant and equipment. The subsequent depreciation of the cost is included in production overheads in future periods over the asset’s estimated remaining useful life.


6. Certain items of PP&E are reclassified as inventory under IAS 2; not under US GAAP

Items of property plant and equipment that a company holds for rental to others and then routinely sells in the ordinary course of its activities are reclassified to inventory when they cease to be rented and become held for sale.

US GAAP comparison

US GAAP does not provide specific guidance around accounting for assets that are rented out and then subsequently sold on a routine basis, and practice may vary. Proceeds from the sale would be accounted for in a manner consistent with the nature of the asset, which may be different from IFRS Standards.


7. Reversal of writedowns allowed under IAS 2; prohibited under US GAAP

In some cases, NRV of an item of inventory, which has been written down in one period, may subsequently increase. In such circ*mstances, IAS 2 requires the increase in value (i.e. the reversal), capped at the original cost, to be recognized. Reversals of writedowns are recognized in profit or loss in the period in which the reversal occurs.

US GAAP comparison

Unlike IAS 2, under US GAAP, a write down of inventory to NRV (or market) is not reversed for subsequent recoveries in value unless it relates to changes in exchange rates.


8. IAS 2 requires a consistent cost formula for similar inventory; US GAAP does not

IAS 2 requires the same cost formula to be used for all inventories with a similar nature and use to the company, even if they are held by different legal entities in a group or in different countries. In practice, for an acquired business this often requires rapid realignment to its new parent’s group methodologies and systems.

US GAAP comparison

Unlike IAS 2, US GAAP allows use of different cost formulas for inventory, despite having similar nature and use to the company. Therefore, each company in a group can categorize its inventory and use the cost formula best suited to it.


9. IAS 2 accounting for storage, shipping and handling costs may differ from US GAAP

Under IAS 2, storage costs are expensed as incurred unless:

  • storage is necessary in the production process before a further production stage;
  • inventory is produced as a discrete project; or
  • inventory requires a maturation process to bring it to a saleable condition (e.g. wines).

The costs necessary to bring the inventory to its present location–e.g. transport costs incurred between manufacturing sitesare capitalized. The accounting for the costs of transporting and distributing goods to customers depends on whether these activities represent a separate performance obligation from the sale of the goods.

US GAAP comparison

Like IAS 2, transport costs necessary to bring purchased inventory to its present location or condition form part of the cost of inventory. Unlike IAS 2, US GAAP does not contain specific guidance on storage and holding costs, which may give rise to differences from IFRS Standards in practice.

Unlike IFRS Standards, the accounting for shipping and handling activities undertaken after the customer has obtained control of the related goods is subject to a policy choice. Read KPMG article Revenue: Top 10 differences between IFRS 15 and ASC 606.


10. Intangible assets produced for re-sale may be inventory under IAS 2; not under US GAAP

Under IAS 2, inventory may include intangible assets that are produced for resale – e.g. software.

US GAAP Comparison

Unlike IAS 2, US GAAP inventory does not include intangible assets and differences from IFRS Standards may arise in practice – e.g. software inventory includes only the costs incurred for duplicating, documenting and producing materials from the product masters and for physically packaging them for sale.

The takeaway

The significance of inventory for certain industries makes accounting and valuation a pertinent focus area. The differences around costs and measurement between IFRS Standards and US GAAP can be difficult for companies to tackle as they switch between the two standards or conform acquired businesses to group costing policies. This is because changing inventory costing methodologies often requires systems and process changes. These GAAP differences can also affect the composition of costs of sales and performance measures such as gross margin.

Dual preparers should carefully assess all differences to prepare a model that is efficient to maintain, most representative of their inventory values and compliant with all applicable requirements under both GAAPs.

Inventory accounting: IFRS® Standards vs US GAAP (2024)

FAQs

What is the key difference between IFRS and US GAAP for inventory accounting? ›

Key Takeaways

GAAP permits the use of all three of the most common methods for inventory accountability; the IFRS forbids the use of the LIFO method. IFRS requires that inventory is carried at the lower of cost or net realizable value; U.S. GAAP requires that inventory is carried at the lower of cost or market value.

Is IFRS more accurate than GAAP? ›

One of the significant advantages of IFRS compared to GAAP is its focus on investors in the following ways: The first factor is that IFRS promise more accurate, timely and comprehensive financial statement information that is relevant to the national standards.

Is US GAAP more strict than IFRS? ›

GAAP is more detailed and prescriptive while IFRS is more high-level and flexible. GAAP requires more disclosures while IFRS requires fewer disclosures. GAAP is more focused on the historical cost of assets while IFRS allows for more flexibility in the valuation of assets.

Can financial statements that are prepared under IFRS and US GAAP be compared? ›

IFRS and US GAAP: Learn the differences

Therefore, it can be difficult to directly compare financial statements that have been prepared under these different standards.

Can you choose between GAAP and IFRS? ›

Which is better IFRS or GAAP? It depends on the context. Generally speaking, IFRS is more widely used globally and is better for companies that operate in multiple countries, while GAAP is more focused on the US and is better for companies that only operate in the US.

What are 2 key similarities between US GAAP and IFRS? ›

Despite several differences, there are some similarities between IFRS and GAAP. These include the use of a balance sheet, cash flow statements, and income statements. Both principles offer the same functionality to organizations dealing with cash and cash equivalent.

What is the hardest IFRS standard? ›

IFRS 9 is probably the most complicated accounting standard ever issued, written to address the accounting weaknesses claimed to have contributed to the global financial crisis and intended to be fit for purpose for the most complex banking and financial services companies.

What is the advantage of IFRS over GAAP? ›

GAAP is more conservative, while IFRS encourages reporting financial results that align with current realities. For example, GAAP requires recording fixed assets at their historical cost, then regularly depreciating the fixed assets. IFRS allows for assets to be revalued on a periodic basis to reflect their fair value.

What are the disadvantages of IFRS? ›

High adoption costs

Implementation expenses are another important disadvantage of IFRS. Each nation adopting the new standards would be required to cover the expenses of retraining and education for the accounting profession. Additionally, businesses should devote time and money to the restoration process.

Why is USA not adopting IFRS? ›

Declaring (and rightfully so) that their main goal is to protect US investors' interests, the SEC notes that IFRS lacks consistent application, allows too much leeway with judgment, and is underdeveloped in many specific areas, for which the US GAAP has detailed and accepted guidance and established practice ( ...

Is IFRS or GAAP stricter? ›

IFRS is principles-based, whereas GAAP is rules-based. Essentially, this means that GAAP is far stricter than IFRS, offering specific rules and procedures that leave little room for interpretation. By contrast, IFRS provides general guidelines that companies are encouraged to interpret to the best of their ability.

Is IFRS more flexible than GAAP? ›

The GAAP classifies interest paid, interest received and dividends received as operating activities, and dividends paid under financing activities. Following its principles-based approach, the IFRS offers practitioners more flexibility and room for interpretation.

How many pages is GAAP vs IFRS? ›

IFRS is often referred to as being principles-based, while U.S. GAAP is said to be more rules-based. Esti- mates are that, if printed, U.S. GAAP would amount to about 25,000 pages, and IFRS would take up only about 2,000 pages. With fewer pages and less specifics, IFRS often lacks the detailed guidance in U.S. GAAP.

Which accounting system most accurately reflects profitability? ›

To provide a more accurate picture of profitability, the accrual method of accounting can be used.

What is the primary difference between US GAAP and IFRS with regard to the accounting and reporting of property plant and equipment? ›

Fixed Assets: Under GAAP, fixed assets such as property, plant, and equipment (PP&E), must be recorded at historical cost (the purchase price), and depreciated accordingly. Under IFRS, fixed assets are also valued at cost, but companies are allowed to revalue fixed assets to the fair market value.

What is the IFRS for inventory? ›

Under IFRS, inventories are measured at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale.

What is the difference between IFRS and US GAAP expenses? ›

GAAP considers these expenses, while IFRS allows companies to capitalize and amortize them over multiple periods. Your accounting standard, therefore, determines where on your financial documents you must list intangible assets and affects your balance sheet's final balance.

What is the biggest difference between IFRS and US GAAP quizlet? ›

IFRS tends to be simpler in its accounting and disclosure requirements; some people say it is more "principles-based." GAAP is more detailed; some people say it is more "rules-based."

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