IntroductionThe FASB often issues accounting standard updates (ASU) with an aim of improving best practices in accounting. Among the most recent update that has been released by the FASB, is ASU 2015-11. This update simplifies previously issued guidance through which an entity was required to measure inventory at the market or lower cost. In the context of the previously mentioned views, an elaborate review of ASU 2015-11 will provide insight on the main provisions of the update, reasons for the update, and why LIFO and retail inventory techniques were excluded.
Main provisions of ASU 2015-11
Deloite (2016) indicates that ASU 2015-11requires organizations to liken the cost of inventory to their net realizable value. This has facilitated the elimination of the need to determine replacement costs, and evaluate whether replacement costs are above the ceiling or net realizable value (NRV) or below the floor, which is the NRV less a normal profit margin. In addition, this provision is used when costs are determined on a first-in, first-out (FIFO) or average cost basis (Financial Accounting Standards Board, 2016). In the context of the previously mentioned views, ASU 2015-11 applies for organizations that recognize inventory as per the scope of ASC330, while excluding inventory under the LIFO basis or the RIM approach due to complexities associated with applying the NRV and lower cost approaches to the methods (FASB, 2016).
In addition, Deloite (2016) points out those provisions of ASU 2015-11 are only effective in public entities, whose fiscal years begin after December 15, 2016 and the periods therein. In contrast, for all other non-public entities, the provisions of ASU 2015-11 will be effective for annual periods that begin after December 15, 2016, and interim periods thereafter (Deloite, 2016). Organizations that transition to the new accounting system will be required to disclose the type of and reason behind the accounting change.
Reason behind ASU 2015-11
The introduction of ASU 2015-11 was aimed at simplifying subsequent measurements of inventory (Deloite, 2016).The process of simplifying inventory-related accounting was aimed at improving U.S.GAAP through the reduction of costs and complexities, while maintaining the usefulness of financial statements associated with inventories(FASB,2016).
Difference between ASU 2015-11 and Other Standards
Update ASU 2015-11 differs from other updates in a variety of ways. First, update ASU 2015-11 differs from other standards since the updates reduced costs within the inventory. Precisely, the updates reduce costs and increase comparability of inventories measured using average cost or FIFO (FASB, 2016). Second, the updates target a narrow scope of the inventories as compared to other standards, which introduce general changes in accounting. To illustrate, ASU 2015-11 seek to simplify accounting processes and reduce costs associated with inventories determined on a first-in, first-out (FIFO) or average cost basis, while excluding inventory under the LIFO basis (Deloite, 2016).
ASU 2015-11 Benefits to Accountants
In addition, ASU 2015-11 introduced the benefit of simplifying the process of computing inventories under FIFO basis. More elaborately, Deloite (2016) indicates that the accounting update facilitated the elimination of the need to determine replacement costs, and evaluate whether replacement costs were above the net realizable value (NRV) or below the NRV less a normal profit margin. Subsequently, this update introduced the benefit of simplifying accounting activities for statement preparers.
Exclusion of LIFO and Retail inventory
Entities using LIFO and Retail inventory method were excluded from the update; since, the process off accounting inventories under these methods involves considerable complexities. To illustrate, the use of LIFO basis and RIM approach faces complexities associated with the application of NRV and lower cost approaches (FASB, 2016).
Earnings quality
Earnings quality refers to the capability of reported earnings to envisage an entity’s future earnings. Further, update ASU 2015-11 will have considerable effects on the quality of income from net income and continuing operations. More elaborately, update ASU 2015-11 has simplified the accounting process created considerable differences between organizations that account for inventory using the LIFO and FIFO basis. As a consequence, earning comparisons across firms will be more misleading since accounting data from inventories using FIFO and LIFO will less comparable and inconsistent due to changes introduced by the updates.
Moreover, the simplification of inventory accounting for companies using FIFO basis will lead to significant variations in earning trends reported using LIFO basis (Carmichael et al., 2012). For instance, the liquidation of LIFO layers will lead to increases in reported income and current taxes, and the impact on the net income will be disclosed in the footnotes. Given the differences between LIFO and FIFO, update ASU 2015-11 may lead to measurement biases and inconsistencies, thus adversely affecting the quality of earnings.
- Carmichael, D.R., Whittington, O. Ray., & Graham, Lynford. (2012). Accountants’ Handbook, Financial Accounting and General Topics. John Wiley & Sons Inc.
- Deloite, (2016). FASB Issues ASU on Simplifying the Measurement of Inventory. Deloite, 22(26), 1-3. Retrieved from https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/ASC/HU/2015/us-aers-headsup-fasb-issues-asu-on-simplifying-the-measurement-of-inventory-072315.pdf
- Financial Accounting Standards Board (FASB), (2016). Update 2015-11—Inventory (Topic 330). Fasb.org. Retrieved 14 November 2016, from http://fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176166207669&acceptedDisclaimer=true
