Accounting for Inventory Costs and Nonmonetary Exchanges

In late 2004, the FASB released the first two statements to result solely from efforts to converge U.S. and international standards. These statements are outcomes of a project undertaken to eliminate differences between the FASB's standards and International Financial Reporting Standards (IFRS) released by the International Accounting Standards Board (IASB).

The FASB selected inventory costs and nonmonetary exchanges for the first two convergence standards because any differences eliminated are expected to lead to narrow changes to current U.S. generally accepted accounting principles (GAAP).

The effective dates for both standards were deferred into 2005 because many large U.S. companies were nearing the ends of their long-term projects to ensure compliance with the internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act in late 2004.

A key question for many companies that have inventory costs and/or are considering nonmonetary exchanges is whether to early adopt the standards.

Should the company early adopt FASB Statement No. 151?

FASB Statement No. 151, Inventory Costs - an Amendment of ARB No. 43, Chapter 4, provides that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. It also provides that allocation of fixed production overhead to the costs of conversion should be based on the normal capacity of the production facilities.

Statement 151 applies prospectively to inventory costs incurred during periods beginning after the date of adoption. Application of the Statement is required for fiscal years beginning after June 15, 2005. Earlier adoption is permitted for inventory costs incurred during fiscal years beginning after November 24, 2004.

For many companies, Statement 151 will cause no change in accounting. However, we believe the effects of this statement will vary, and the merits of early adoption should be studied closely.

Should the company early adopt FASB Statement No. 153?

FASB Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions, addresses exceptions to the use of fair value for nonmonetary exchanges. Currently, Opinion 29 prohibits the use of the fair value for nonmonetary exchanges of similar productive assets. Statement 153 removes that exception and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.

The definitions of terms and related accounting requirements follow:

• The term similar productive assets used in Opinion 29 means assets that are (a) held for or used in the production of goods or services by an enterprise, and (b) are of the same general type, perform the same function, or are employed in the same line of business. Under Opinion 29, exchanges of these assets are valued at the recorded amount of the nonmonetary assets exchanged (after reduction for an indicated impairment of value, if appropriate).
• An exchange has commercial substance as defined in Statement 153 if (a) the configurations of future cash flows (risk, timing, and amount) of the assets differ significantly, or (b) the entity-specific value of the assets received differs significantly from the entity-specific value of the assets exchanged.

Statement 153 is effective prospectively for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after December 16, 2004.

We believe considerable judgment may be required to determine whether an exchange has commercial substance and whether the change in cash flows is significant in relation to the fair value of the assets exchanged. Because these areas may raise numerous implementation and interpretation issues, BDO USA urges clients affected by Statement 153 to consider its effect and weigh carefully the benefits and risks of early adoption.

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