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Proposed Changes to Disclosure Requirements

Executive Summary

On January 10, 2017, the Financial Standards Board (FASB) issued a proposal to change the disclosure requirements under Topic 330, Inventory, for all entities. Providing information useful in assessing flow prospects and changes in inventory balances are the proposal’s objectives. The amendments would require entities to disclose inventory disaggregated by component and measurement basis and describe the types of capitalized into inventory. Requirements also include quantitative disclosure of inventory balance changes caused by circumstances, events or transactions outside the normal inventory cycle and a qualitative description of losses.

Additional disclosure requirements would apply to entities reporting some or all of their inventory using the retail inventory method (RIM) and last-in, first-out (LIFO) method. The proposal would amend segment disclosure requirements related to inventory and add an inventory disclosure requirement to the interim guidance. Disclosures related to standard costs would be removed. Although the disclosures on of sales are linked to inventory disclosures, the amendments do not extend to Topic 705, Cost of Sales and Services.

FASB requests feedback on whether the proposed disclosure requirements would impose significant incremental costs for company or auditors, among other topics. New and updated implementation guidance and illustrations are included. The proposal is objective-based, and a reporting entity would not need to provide individual disclosures if they are immaterial; additional guidance in assessing is provided.

The amendments would be applied prospectively and an effective date will be determined after FASB considers stakeholder feedback. Comments are due by March 13, 2017. The proposal would apply to all entities in all industries; however, because U.S. Securities and Exchange Commission (SEC)-registered firms are already required to comply with certain disclosures, private companies would be more affected. The amendments were developed based on disclosure objectives designed to promote the exercise of discretion and assessment of materiality. Hence, an entity is not required to provide the required disclosures if they are immaterial.

Main Provisions Applicable to All Entities

Changes in Inventory For each period presented, an entity would be required to disclose inventory balance changes during the period from transactions, circumstances or events outside the normal course of purchasing, manufacturing or selling inventory. A nonexclusive list of examples in the proposal that meet this principle includes: . Atypical losses from the subsequent measurement of inventory or shrinkage, spoilage or damage and a description of the facts and circumstances leading to the losses . reclassifications . Inventory obtained through a combination or disposed of through a divestiture . Unrealized gains and losses for recorded above cost or at selling prices

Proposed Changes to Inventory Disclosure Requirements

This requirement would replace the existing requirement to disclose substantial and unusual losses that result from the subsequent measurement of inventory. Loss estimates because of slow-moving inventory or shrinkage, which are consistent with experience in the ordinary course of business, would not need to be disclosed. Minimal information is available from current disclosure requirements to help users understand the change in inventory balance from period to period. The proposed requirements include information on specific changes that users may find useful in assessing how transactions, events and circumstances outside the normal course of business affect the inventory balance. The board was not able to justify the potential costs of requiring a full rollforward.

Composition of Inventory Entities would be required to disclose the individual inventory components, e.g., raw materials, work in process, finished goods and supplies for each period presented. When not practical to disaggregate major components of inventory using the LIFO cost flow assumption, the major components may be disclosed under cost flow assumptions other than LIFO provided the excess of such total amount over the aggregate LIFO amount is reflected as a deduction to arrive at aggregate LIFO inventory. The disclosure’s objective is to provide users with information useful in assessing how different types of inventory may affect prospects for future cash flows.

Public companies already are required to disaggregate inventory by class under Rule 5-02 of Regulation S-X of the SEC.

Capitalized Costs The proposed Accounting Standards Update (ASU) would require that entities provide a qualitative description of the types of costs capitalized in inventory. Certain FASB members expressed that this information could provide more information than currently available for users to identify changes in inventory composition across periods or companies in the same industry and would readily be available for management to provide.

Measurement Basis of Inventory Inventory Disaggregated by Measurement Basis Entities would be required to disclose the measurement basis used—LIFO, first-in, first-out (FIFO), LIFO RIM or weighted average—and the amount of inventory measured within each basis. The disclosure’s objective is to provide financial statement users with information useful in assessing how different measurement methods may affect projection information and would replace the existing disclosure of inventories stated above cost or at sales prices. Inventory Reported Within the RIM of Accounting The calculation of inventory within RIM is not directly based on inventory cost. Assumptions are used, and the methodology employed is often subjective and complex. FASB proposes to shed some light on RIM. The amendments would require an entity that records any portion of its inventory using the RIM method to disclose quantitative and qualitative information about the critical assumptions used in applying RIM at the end of each annual period presented. This would include a description of judgments and estimates that may affect the ending inventory at cost and the gross profit recognized.

2 Proposed Changes to Inventory Disclosure Requirements

The proposed ASU does not prescribe a disclosure format, but suggests entities may present the entire RIM calculation or a description of the calculation’s critical components. Within any approach, the entity should reflect specifics—or nuances—of an entity’s calculation, e.g., how the entity defines “shrinkage.” Disclosure of judgments and estimates that may affect the ending and gross profit recognized may enable users to determine the gross margin to be earned on future RIM inventory sales.

Replacement Cost for LIFO Inventory Inventory measured within the LIFO cost flow assumption often does not represent current inventory cost—often considered important for assessing a company’s prospects for cash flows. To fill this gap, FASB proposes an entity measuring all or a portion of its inventory at LIFO disclose the excess of replacement or current cost over the reported inventory amount. This amount is often represented by the “LIFO ,” which is calculated as the difference between LIFO cost and the cost determined by some other acceptable inventory costing method, e.g., FIFO or average cost. The requirements to disaggregate inventory by component and measurement basis are designed to meet the proposal’s objective of providing users with useful cash flow projection information. The proposal aligns with FASB’s March 2014, Concepts Statement, “Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements,” which states the board should consider disclosure when a line item includes components of a different nature that could affect cash flow differently or includes individual items (or groups) that are measured differently.

Inventory Measured at Standard Cost FASB proposes to remove the requirement to disclose the relationship between costs within a recognized measurement method and standard costs. For example, a description that standard costs “approximate costs determined on the first-in, first-out basis” or inventory is measured “at standard costs, approximating average costs” would not be required.

LIFO Liquidations Because of its importance, many entities already disclose a LIFO liquidation’s effect on income: the SEC requires public companies to do so and numerous non-SEC filing entities disclose this information as recommended in the November 30, 1984, AICPA-issued LIFO paper, Identification and Discussion of Certain and Reporting Issues Concerning Life Inventories. The proposed ASU would require the disclosure for all entities.

Disclosures Considered & Not Proposed Significant Estimates Estimates are inherent in many inventory balances, e.g., estimated selling prices of lower of cost and net realizable value, valuation adjustments, estimated impairment caused by deterioration or obsolescence, estimated shrinkage and markup and markdown RIM calculation estimates. Existing guidance requires the disclosure of significant estimates by reference to Topic 275, Risks and Uncertainties; FASB is not proposing any modifications. Other Disclosures FASB considered but decided not to modify disclosure requirements for inventory subject to royalty and other arrangements and inventory on consignment and pledged as collateral. 3 Proposed Changes to Inventory Disclosure Requirements

FASB agreed with certain financial statement users that disaggregating inventory by segment would help provide greater insight into gross margins and specific areas or products and in analyzing a company’s inventory like management does.

Segment Reporting Entities subject to disclosing information within Topic 280, Segment Reporting, would be required to disclose—for annual and interim periods—inventory by component for each reportable segment to the extent that information is regularly provided to the chief operating decision maker. In condensed financial statements of interim periods, public entities would disclose inventory in total and disaggregated by major component for each reportable segment. Inventory amounts not allocated to a segment or component would be classified as unallocated.

Interim Reporting Disclosure Requirements Entities would be required to apply all disclosures other than the requirement to disaggregate inventory by component and segment on an interim basis—with exception as discussed under “Segment Reporting.”

Unchanged from existing standards, the provisions for interim disclosures in Topic 270, Interim Reporting, include:

. Differences in the recognition, measurement or presentation of inventory from the most recent annual financial statements . An explanation of how the financial and results of operations relate to the entire year, e.g., seasonal inventory levels . Clarification of significant changes in financial position

Effective Date & Transition Changes to disclosure requirements would be applied prospectively beginning in the period of adoption for all entities. The board will determine the effective date and whether early adoption should be permitted after it considers stakeholder feedback on the proposal.

Next Steps FASB scheduled public roundtable meetings on its Disclosure Framework project and materiality on March 17, 2017. The meeting provides an opportunity for those who have submitted a comment letter on any of the four proposed disclosure amendments—defined benefit plans, measurement, income taxes and inventory—as well as materiality proposals—Chapters 3 and 8 of FASB’s Conceptual Framework and proposed ASU, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material. For more information on these and other topics, check out our related BKD Thoughtware®.

BKD will continue to follow developments. For more information, contact your BKD advisor.

Contributor

Connie Spinelli

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