How do firms account for inventories?
INVENTORIES
Firms initially record inventories at acquisition cost. Acquisition cost for a merchandising
firm includes the costs incurred to purchase and transport the inventory prior to sale. Acquisition cost for a manufacturing firm includes the direct material, direct labor, and manufacturing overhead cost to produce the inventory.
If the market values of inventory items decline below acquisition cost prior to sale, firms
must reduce their balance sheet carrying values using the lower of cost or market method. U.S. GAAP uses a combination of replacement cost and net realizable values to measure market value. IFRS defines market as net realizable value, the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs to make the sale. Neither U.S. GAAP nor IFRS permits firms to remeasure inventories upward when market value exceeds acquisition cost. However, if the market values of inventories increase during a period, IFRS permits firms to recognize the unrealized gain to the extent that the firm had previously recognized an unrealized loss on those inventory items. U.S. GAAP does not permit recognition of such reversals of previously recognized unrealized losses.
Firms measure the cost of goods sold and the amount of ending inventories for a period
either using specific identification or making a cost-flow assumption. U.S. GAAP permits
firms to use a first-in, first-out (FIFO), weighted-average, and last-in, first-out (LIFO) cost-
flow assumption. IFRS does not permit the use of LIFO.
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