Inventory valuation methodologies differ in the United States and Canada and this can have a noticeable impact on balance sheets. Read on to learn about key differences between both sets of methods.
U.S. GAAP and IFRS Accounting Standards
Accounting methodology in the United States is dictated by U.S. Generally Accepted Accounting Principles, or U.S. GAAP, which were adopted by the U.S. Securities and Exchange Commission. In Canada, the International Financial Reporting Standards have been the standard since 2009. While progress has been slow, the SEC intends to move from GAAP to IFRS. Both sets of principles define inventory the same way, but there are significant differences between them.
Difference #1: Measurement of Carrying Value
The carrying value of inventory is the original cost of the asset less any accumulated depreciation, amortization, or impairments. GAAP dictates that this value be equal to the lower of either cost or market value. IFRS states that it should be the lower of either cost or net realizable value. In the United States, market value typically means the item’s replacement cost. Assume an inventory item has an original carry value of $100. Its current replacement cost is $85, and its net realizable value is $95. In the United States, the carry value would be adjusted to $85, while in Canada, it would be adjusted to $95.
Difference #2: Costing Formula
With GAAP, the same formula used to determine the cost of inventory does not need to be used across all inventories that have the same nature and use to the business. In Canada, this is the opposite. All inventories that have the same nature and use to the business must have the same costing formula.
Difference #3: Asset Retirement Obligations
If an ARO is created during the production of inventory, GAAP states that it is added to the carrying amount of property, plant, and equipment used to produce the inventory. Under IFRS, this amount is accounted for as a cost of the inventory. It may be added to the carrying amount of the inventory.
Difference #4: Accounting Methods
Under GAAP, first in, first out, or FIFO; last in, first out, or LIFO; weighted average; and specific identification are all acceptable methods of cost determination for inventory. Under IFRS, LIFO is not permitted, and specific identification is required for certain types of inventory and in certain cases.
Difference #5: Reversal of Write-Downs
Under GAAP, write-downs taken to reduce inventories to the lower of their cost or market value cannot be reversed to increase valuations later. Under IFRS, these write-downs are reversible.
Is GAAP or IFRS Better?
There is no one-size-fits-all answer. Each set of standards has its strengths and weaknesses. Depending on the type of company and types of inventories involved, GAAP or IFRS can be more advantageous to the company by causing its balance sheet to increase. Since companies in each country must use their respective standards, there isn’t much that can be done. The only extreme case would be to relocate the entire company to the other country if the inventory valuations would drastically improve by switching reporting standards.