IMA RESEARCH

Inventory Valuation
Under
IFRS
and
GAAP
This article is based on a study supported by the IMA® Research Foundation.

By Sudha Krishnan and Ping Lin, CMA

The Securities & Exchange Commission (SEC) is in the process of deciding whether U.S. companies can issue
financial statements using International Financial Reporting Standards (IFRS). For management accountants,
inventory valuation is of special concern. Though IFRS and U.S. Generally Accepted Accounting Principles
(U.S.GAAP) have commonalities in inventory valuation requirements, they differ in initial measurement,
subsequent measurement, disclosure requirements, and tax impact. Switching to IFRS wouldn’t only require
coordinating many regulatory authorities, such as the Public Company Accounting Oversight Board
(PCAOB), the Internal Revenue Service (IRS), and the SEC, but it would also put pressure on changes to
company information systems, internal controls, and tax planning.

March 2012 I S T R AT E G I C F I N A N C E 51
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We’ll review the major milestones on the road to possi- James Kroeker indicated that they “are in the final stages
ble convergence, summarize the differences in inventory of completion of the majority of the field work related to
valuation between IFRS and GAAP, and identify major the Work Plan (2010).” He also said the SEC does need
issues that companies switching to IFRS have to contend more time and that they are many months away from
with. finalizing any decision related to IFRS (www.sec.gov/news/
According to the 2008 IFRS roadmap, the SEC was speech/2011/spch120511jlk.htm).
supposed to decide in 2011 whether U.S. companies can But the move to converge to IFRS has tentatively been
issue financial statements using IFRS from 2015 onward. set. Accounting practitioners and educators need to pre-
In September 2009, the leaders of the G20 nations pare for the transition now and learn the differences
requested that the international accounting bodies create between these two sets of standards. Management
a single set of global accounting standards by June 2011. accountants in particular need to educate themselves
In November 2009, the International Accounting Stan- about inventory valuation. In manufacturing and mer-
dards Board (IASB) and the Financial Accounting Stan- chandising industries with significant inventories, differ-
dards Board (FASB) reaffirmed that they would continue ent valuation methods not only affect assets on a balance
to harmonize their respective standards and try to meet sheet, but they also result in different cost of goods sold
(COGS) reported and have implications for tax planning.
For example, Exxon Mobil Corp. reported that its
replacement cost of inventories at 2010 and 2009 year-
ends exceeded its last-in, first-out (LIFO) inventories by
$21.3 billion and $17.1 billion, respectively. Because IFRS
doesn’t allow for the LIFO inventory valuation method,
companies like Exxon Mobil, which adopts LIFO under
GAAP, would face tremendous difficulty in the transition.

GAAP—Initial Measurement
GAAP primarily values inventory just like other assets—
the 2011 deadline. In February 2010, the SEC issued a at cost of acquisition or production (Accounting Stan-
“Statement in Support of Convergence and Global Stan- dards Codification® paragraph 330-10-30). Valuation for
dards” and issued a Work Plan highlighting six areas of cost of acquisition includes all the costs incurred to bring
concern commentators raised. inventory to a saleable condition and location, and pro-
Although the SEC didn’t decide by June 30, 2011, they duction includes all variable overheads and allocation of
sponsored a roundtable on July 7, 2011, to further ana- fixed overheads. Interest can’t be allocated to the cost of
lyze issues related to investor analysis and knowledge of inventory during routine production. If the inventory
IFRS, as well as the impact of IFRS on smaller public items are specific and separately identifiable, the costs can
companies and the regulatory environment. In addition, be uniquely allotted, but if the inventory items are identi-
the Office of the Chief Accountant at the SEC issued cal and interchangeable, then an assumption of the flow
working papers in May and November 2011 on imple- of costs can be made—first-in, first-out (FIFO), average
mentation issues, differences in GAAP vs. IFRS, and costs, or LIFO. The method chosen should be the one
analysis of foreign issuers already using IFRS. In Novem- that best reflects income. Standard costs are also accepted
ber 2011, the Division of Corporate Finance at the SEC provided the company adjusts them to reflect current
also issued an analysis of IFRS in practice. conditions. GAAP also requires the company to value
Currently, most U.S. companies aren’t expected to be inventory using the same procedure year after year (Codi-
filing with IFRS for the next five years. Yet the SEC fication paragraph 330-10-15).
requires three years of comparative statements, which
implies that if IFRS becomes applicable by 2015 (as per GAAP—Subsequent Measurements
the SEC statement above), some companies may need to If there’s evidence that disposing of inventory in the nor-
adopt the new standards in 2012. In a speech to the mal course of business will be at lower than cost, then the
American Institute of Certified Public Accountants difference between cost and expected disposal price will
(AICPA) on December 5, 2011, SEC Chief Accountant be recognized as a loss in the current period (Codifica-
52 S T R AT E G I C F I N A N C E I March 2012
 Table 1: Differences in GAAP and IFRS Regarding Inventory Valuation

ITEM GAAP IFRS

Applicable regulations ARB 43, SFAS 34, SFAS 151, SEC Staff Accounting IAS 2, IAS 23
Bulletin 5-BB, and SEC Regulation S-X all summarized
in Codification paragraph 330.
Initial measurement Cost—specific cost, LIFO, average cost, Cost—specific cost, average cost, FIFO.
FIFO.
Expense allotted Variable costs, allotted fixed costs. Interest costs not to Interest to be capitalized if production takes sub-
be capitalized if inventory manufactured routinely. stantial time or financing element in purchase
agreement. Foreign exchange differences not to
be capitalized.
Consistency of measurement All inventories having similar nature and use must No explicit guidance, so companies can use LIFO
be measured using same method. for U.S. inventory and FIFO for international
inventory.
Subsequent measurement Lower of cost or market where market is replacement Lower of cost and net realizable value.
cost not exceeding net realizable value and not less than
net realizable value minus normal profit.
Assessment of inventory Expense in the year market is lower than cost, resulting Net realizable value assessed every time period.
in new cost for subsequent period. No reversals allowed. Write-downs in year when net realizable value is
less than cost. Reversal allowed when circum-
stances change. Reversal limited to original
write-down—reduction in expense.
Intragroup sales of inventory No deferred taxes can be recognized as the seller can’t Deferred taxes can be recognized at buyer’s tax
recognize profits until inventory sold to outsiders. rate.
Disclosure requirements Required by the SEC, not the accounting standard. IAS 2 requires specific detailed disclosure.
If LIFO used, LIFO reserve disclosure required.
Tax implications If LIFO is used for U.S. income tax reporting, Firms with LIFO valuation need to switch to either
LIFO must be used for financial reporting. FIFO or average cost valuation, resulting in an
increase in current and deferred taxes.

tion paragraph 330-10-35). To do so, a company values applies to firm purchase commitments the company can’t
inventory at market value (lower than cost), which is cancel. Also, the SEC Staff Accounting Bulletin (para-
called the lower-of-cost-or-market rule. The market value graph 330-10-S99-2) has interpreted that once the inven-
is the current replacement cost subject to the following tory has been written down below cost to a new value, it
conditions: can’t be written back up again to historical costs if facts
◆ It doesn’t exceed net realizable value (selling price in and circumstances change.
normal business minus reasonable costs of completion GAAP considers income to have accrued at the time of
and disposal), and sale, so profits can’t be anticipated by valuing inventory at
◆ It isn’t less than net realizable value minus a normal the current selling price (paragraph 330-10-35-15). But
profit margin. there are exceptions. When the selling price is controlled
One exception to the lower-of-cost-or-market rule is and costs aren’t easily obtained, such as in agricultural
that if there’s any evidence that sales would occur at a products, metals, or minerals, a company can value such
fixed price, even if current replacement cost is lower than inventory at market price minus disposal costs.
actual cost, then such a loss won’t be recognized. If a
company used fair value hedges to fix inventory costs, it GAAP—Disclosure Requirements
should adjust the cost of inventory. If inventory has been Regulation S-X rule 5 provides the disclosure require-
written down under the lower-of-cost-or-market rule, ments for balance sheet items (paragraph 210-10-S99-1).
then the new value would be the cost of inventory in the Inventories are disclosed under current assets. The classes
subsequent period. The lower-of-cost-or-market rule also of inventory and the basis of valuation are stated sepa-
March 2012 I S T R AT E G I C F I N A N C E 53
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Table 2: Sample Disclosures

PANEL A: MANUFACTURING SECTOR—OIL AND GAS INDUSTRY

GAAP Exxon Mobil Corporation

Footnote 1 Summary of Accounting Policies
Inventories. Crude oil, products, and merchandise inventories are carried at the lower of current
market value or cost (generally determined under the last-in, first-out method—LIFO). Inventory costs
include expenditures and other charges (including depreciation) directly and indirectly incurred in bring-
ing the inventory to its existing condition and location. Selling expenses and general and administrative
expenses are reported as period costs and excluded from inventory cost. Inventories of materials and
supplies are valued at cost or less.

Footnote 3 Miscellaneous Financial Information

In 2010, 2009, and 2008, net income included gains of $317 million, $207 million, and $341 million,
respectively, attributable to the combined effects of LIFO inventory accumulations and draw-downs.
The aggregate replacement cost of inventories was estimated to exceed their LIFO carrying values by
$21.3 billion and $17.1 billion on December 31, 2010, and 2009, respectively.
Crude oil, products, and merchandise as of year-end 2010 and 2009 consist of the following:

2010 2009
(billions of dollars)
Petroleum products $3.5 $3.2
Crude oil 3.8 3.2
Chemical products 2.1 2.0
Gas/other 0.5 0.3

Total $9.9 $8.7

IFRS Royal Dutch Shell plc

Footnote 2 Accounting Policies
Inventories are stated at cost to Shell or net realizable value, whichever is lower. Cost comprises direct
purchase costs (including transportation), cost of production, and manufacturing and taxes, and is
determined using the first-in, first-out (FIFO) method for oil and chemicals and by the weighted-
average-cost method for materials.

Footnote 13 Inventories

$millions
Dec 31, 2010 Dec 31, 2009
Oil and chemicals 27,742 25,946
Materials 1,606 1,464
Total 29,348 27,410

The cost of inventories recognized in income includes net write-downs and reversals of write-downs,
which are driven primarily by fluctuations in oil prices. In 2010, net reversals were $184 million
(2009: $1,535 million net reversals; 2008: $1,770 million net write-downs).

54 S T R AT E G I C F I N A N C E I March 2012
 Table 2: Sample Disclosures
PANEL B: MANUFACTURING SECTOR—PHARMACEUTICAL INDUSTRY

GAAP Pfizer Inc.

Footnote 1 I
Cost of sales and inventories: We value inventories at lower of cost or market. The cost of finished
goods, work in process, and raw materials is determined using average actual cost.

Footnote 10
The components of inventories as of December 31 follow:
(millions of dollars) 2010 2009
Finished goods $3,760 $5,249
Work-in-process 3,733 5,776
Raw materials and supplies 912 1,378
Total inventories(a)(b) $8,405 $12,403

(a) The decrease in total inventories is primarily due to the inventory sold during 2010 that was acquired from Wyeth and had been
recorded at fair value, as well as operational reductions and the impact of foreign exchange. Also, in the third quarter of 2010, we
recorded, in cost of sales, a write-off of inventory of $212 million (which includes a purchase accounting fair value adjustment of
$104 million) primarily related to biopharmaceutical inventory acquired as part of our acquisition of Wyeth that became unusable
after the acquisition date.
(b) Certain amounts of inventories are in excess of one year’s supply. These excess amounts are primarily attributable to biologics
inventory acquired from Wyeth at fair value and the quantities are generally consistent with the normal operating cycle of such
inventory. There are no recoverability issues associated with these quantities.

IFRS GlaxoSmithKline plc

Footnote 2
Inventories are included in the financial statements at the lower of cost (including raw materials, direct
labor, other direct costs, and related production overheads) and net realizable value. Cost is generally
determined on a first-in, first-out basis. Prelaunch inventory is held as an asset when there is a high
probability of regulatory approval for the product. Before that point a provision is made against the
carrying value to its recoverable amount; the provision is then reversed at the point when a high prob-
ability of regulatory approval is determined.

Footnote 9 Inventories
The following expenses were included in operating profit:
2010 2009 2008 (£m)
Cost of inventories included in cost of sales 7,014 6,743 5,734
Write-down of inventories 305 276 298
Reversal of prior year write-down of inventories (66) (116) (118)
The reversals of prior year write-downs of inventories principally arise from the reassessment of usage
or demand expectations prior to inventory expiration.

Footnote 14
The group is required under IFRS to create a deferred tax asset in respect of unrealized intercompany
profit arising on inventory held by the group at the yearend by applying the tax rate of the country in
which the inventory is held (rather than the tax rate of the country where the profit was originally
made and the tax paid, which is the practice under U.K. and U.S. GAAP). As a result of this difference
in accounting treatment, the group tax rate under IFRS increased by 1.7% in 2010 (2009—0.5%
increase, 2008—2.1% increase) arising from changes in work-in-progress and finished goods.

Footnote 23
2010 2009 (£m)
Raw materials and consumables 1,466 1,153
Work-in-progress 751 1,437
Finished goods 1,620 1,474
3,837 4,064

March 2012 I S T R AT E G I C F I N A N C E 55
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Table 2: Sample Disclosures

PANEL C: MERCHANDISE SECTOR—CONSUMER GOODS RETAILING

GAAP Safeway Inc.

Footnote A Merchandise Inventories
Merchandise inventory of $1,685 million at yearend 2010 and $1,629 million at yearend
2009 is valued at the lower of cost on a last-in, first-out (LIFO) basis or market value. Such LIFO inven-
tory had a replacement or current cost of $1,720 million at yearend 2010 and $1,692 million at
yearend 2009. Liquidations of LIFO layers during the three years reported did not have a material effect
on the results of operations. All remaining inventory is valued at the lower of cost on a first-in, first-out
(FIFO) basis or market value. The FIFO cost of inventory approximates replacement or current cost. The
company performs physical counts of perishable inventory in stores every four weeks and nonperish-
able inventory in stores and all distribution centers twice a year. The company uses a combination of
the retail inventory method and cost method to determine the cost of its inventory before any LIFO
reserve is applied. The company records an inventory shrink adjustment upon physical counts and also
provides for estimated inventory shrink adjustments for the period between the last physical inventory
and each balance sheet date.

Footnote J Taxes on Income

2010 2009
Deferred tax liabilities:
Property $(649.5) $(626.3)
Inventory (306.5) (286.9)
Investments in foreign operations (60.2) (54.5)
(1,016.2) (967.7)

IFRS TESCO plc

Note 1 Accounting policies
Inventories
Inventories comprise goods held for resale and properties held for, or in the course of, development
and are valued at the lower of cost and fair value less costs to sell using the weighted average cost
basis.

Note 15 Inventories
2/26/2011 2/27/2010
£m £m
Goods held for resale 3,142 2,726
Development properties 20 3
3,162 2,729

56 S T R AT E G I C F I N A N C E I March 2012
rately. If any costs are allotted to inventory, they have to
be disclosed separately, and if a company uses the LIFO
method, then it has to disclose the difference between the
stated and current value, which is the LIFO reserve.

GAAP—Tax Impact of
Inventory Valuation
The IRS tax conformity rule IRC §472(c) requires that
companies using LIFO for tax purposes have to use LIFO
for income measurement in financial accounting, too.
Typically, companies using LIFO tend to have lower tax
expenses, but they also have lower financial income. A
change in inventory methods can affect the company’s be made of either FIFO or average costs. Unlike with
taxable income. If the change results in lower taxes, then GAAP, LIFO isn’t an acceptable method of inventory val-
the company can deduct the entire change in the year of uation. In Panel A of Table 2, we present the inventory
the change, but if the change results in the company valuation disclosure of Exxon Mobil Corp. and Royal
owing taxes, then the IRS allows the company to defer the Dutch Shell plc. Exxon files under GAAP with LIFO cost-
taxes for three years (IRC §481). Also, a gain on sale of flow assumption and reports $9.8 billion inventory as of
inventory and any tax effects on such a gain between 2010 year-end. Shell follows IFRS with FIFO assumption
related companies can’t be recognized until the inventory and reports $29.34 billion inventory. We can compare the
is sold to an outside party. inventory of the two top oil and gas competitors if we
add the LIFO reserve of $21.3 billion to Exxon’s 2010
Switch to IFRS year-end inventory of $9.8 billion. Similarly, a compari-
IFRS adopted International Accounting Standard (IAS) 2, son of inventory valuation between two merchandising
Inventories, which provides guidance on inventory valua- firms, Safeway Inc. under GAAP and TESCO plc under
tion and applies to companies beginning January 1, 2005. IFRS, is provided in Panel C of Table 2.
Although the standard is similar to GAAP, the differences If the company adjusts standard and retail costs to
can result in substantially different inventory values. reflect current conditions, IFRS accepts them. There are
Table 1 summarizes the main differences in inventory exceptions to IAS 2. IFRS doesn’t apply IAS 2 to agricul-
valuation between GAAP and IFRS. tural produce, minerals, and mineral products and to
brokers and dealers whose inventory is always valued at
IFRS—Initial Measurement selling price minus costs of selling.
Similar to GAAP, IFRS values inventory at the cost of
acquisition or production. Cost of acquisition includes all IFRS—Subsequent Measurement
costs incurred to bring inventory to a saleable condition IFRS requires a company to value inventory at the lower
and location, and production includes all variable over- of cost or net realizable value (or fair value). Net realiz-
head and allocation of fixed overhead. Paragraphs 16 to able value is the estimated selling price minus the esti-
18 in IAS 2, identify certain costs, such as storage and mated costs necessary to make the sale. In the three
selling costs, that a company can’t add to the inventory panels of Table 2, companies under GAAP report inven-
cost. When it takes the company substantial time to get tories valued at the lower-of-cost-or-market rule, and
the inventory ready for sale, IAS 23, Borrowing Costs, companies under IFRS report inventories valued at the
allows interest to be allocated to cost of inventory. Fur- lower of cost and net realizable value.
thermore, IAS 2 specifies that when a company purchases If the market price is lower than cost, IFRS also recog-
inventory with deferred settlement terms, the difference nizes an expense in that period. But unlike GAAP, IFRS
between the amount actually paid and purchase price is allows companies to reverse the expense in the period
considered interest, so the company can add it to the cost when the market price goes back to above cost. Table 2
of inventory. features an example of such reversals in Panel A (Royal
IFRS mandates that if inventory items are identical and Dutch Shell plc footnote 16) and Panel B (GlaxoSmith-
interchangeable, an assumption of the flow of costs can Kline plc’s footnote 9).
March 2012 I S T R AT E G I C F I N A N C E 57
 IMA RESEARCH

IFRS—Disclosure Requirements Jan/DeathOfLIFO.htm).

IAS 2 paragraph 36 requires detailed disclosures of inven- Implementing IFRS in the United States also requires
tory classification; the accounting policy; cost formula coordinating many regulatory authorities. The PCAOB
used; fair value less costs to sell; inventory expense for the has to educate its employees so they can answer audit
period; write-downs and reversals of write-downs, if any; questions; the IRS, as mentioned earlier, should remove
reasons for reversals; and value of any inventory used as the conformity rule; and the SEC will have to educate
collateral. As IFRS doesn’t allow LIFO, there’s no need for employees on how to investigate companies that report
any LIFO disclosures. using IFRS.
Although IFRS has far more disclosure requirements In the 2008 IFRS roadmap, the SEC allowed an option
than GAAP, companies following GAAP have disclosures of early adoption of IFRS by the largest companies in the
on inventory classification, accounting policy, cost basis, U.S. under certain conditions. In order to do so, the com-
and LIFO disclosure, if necessary. They also provide vol- panies had to get a “no-objection” letter from the Division
untary disclosures on write-downs if they are material of Corporate Finance at the SEC. The letter would be
and inventory expenses for the period in the form of cost valid for three years, and companies had to provide an
of goods sold in the income statement. IFRS-to-GAAP reconciliation. The earliest companies
could do so was as of December 31, 2009. The rest of the
IFRS—Tax Impact of companies would adopt IFRS by 2015, provided the SEC
Inventory Valuation approved such an action in 2011. As we mentioned before,
Unlike GAAP, gain on sale of inventory between related the chief accountant of the SEC stated that they need
companies requires that the seller recognizes deferred more time to analyze as to when to adopt IFRS. One note:
taxes at the buyer’s tax rate. Consider GlaxoSmithKline Some commentators about the SEC roadmap objected to
plc. Its 2010 year-end statement footnote 14 illustrates the early adoption by large companies on the grounds that
the tax impact of switching from GAAP to IFRS (see a dual system would make it difficult to compare compa-
Panel B of Table 2). nies and, further, some companies may opportunistically
decide which accounting system to adopt.
Implications of Switching to In addition to complying with the potential rule
IFRS Inventory Valuation change to IFRS for reporting, companies must update
The switch to IFRS will most impact companies using information systems for new reporting structures and
LIFO to value inventory. According to the “Incorporating recheck internal controls. There are also implications in
IFRS into Intermediate Accounting” presentation at the tax planning and changes to any contractual agreements,
2008 American Accounting Association (AAA) annual such as loan covenants. Since the Sarbanes-Oxley Act
meeting, the IRS estimates that removing LIFO will result requires the CEO and CFO to sign a certificate taking
in more than $10 billion in increased tax revenues. LIFO responsibility for the financial statements, these execu-
requires companies to include current inventory costs in tives have to understand the impact of the change. Tran-
income calculation. With a mild increase in inventory sitioning to IFRS involves getting auditors, corporate
costs, LIFO methodology can result in lower taxable accountants, corporate executives, and accounting stu-
income and lower taxes—the higher the cost increase, the dents educated about the differences between IFRS and
bigger the tax advantages. For the year 2010, Exxon Mobil GAAP. SF
had a LIFO reserve of $21.3 billion. Given the effective
tax rate of 45% in footnote 18, if Exxon were to switch to Sudha Krishnan, Ph.D., is a professor of accountancy in the
IFRS reporting and use FIFO, its taxes would increase by College of Business Administration at California State Uni-
$9.6 billion. Therefore, it would be all the more necessary versity in Long Beach. You can reach Sudha at (562) 985-
for the IRS to remove the conformity rule and allow 5757 or sudha.krishnan@csulb.edu.
companies to report taxable income using LIFO and
financial reporting with either FIFO or average costs. Ping Lin, CMA, Ph.D., is an associate professor of accoun-
Robert Bloom and William Cenker suggested another tancy in the College of Business Administration at Califor-
option, which would be to encourage companies to reduce nia State University in Long Beach and a member of IMA’s
inventory reserves over the next few years while IFRS gets San Antonio Chapter. You can reach Ping at (562) 985-
phased in (www.journalofaccountancy.com/Issues/2009/ 4560 or ping.lin@csulb.edu.
58 S T R AT E G I C F I N A N C E I March 2012