A comparison among Chinese GAAP, US GAAP and IFRS -- Inventory

With Appendix 1: Chines Tax Adjustments

1.Relevant Financial Accounting Standards

1)CHN: Enterprise Accounting Standard No.1 Inventory

2)CHN: Enterprise Accounting Standard Application Guidance No.1 Inventory

3)US GAAP: ARB No.43 Chapter 4, Inventory Pricing Statement

4)US GAAP: FAS No.151 Inventory Cost

5)IFRS: IAS No.2 Inventories

2.Introduction

All the three GAAPs adopt essentially the same definition of Inventory and are based on the same principle that the primary basis of accounting for inventory is cost. They also share the same rules on what to include in and exclude from cost of inventory.

In other aspects Inventory accounting, CHN GAAP generally complies with IFRS with minor deviations, while significant differences exist between US GAAP and IFRS.

Differences between US GAAP and IFRS will be discussed first, then the minor difference between CHN GAAP and IFRS. Adjustments to comply with CHN tax law can be found in Appendix 1. More discussions on GAAP of other Asia countries will be added later on(if I get around to it).

3.Differences between US GAAP and IFRS

There are three major differences between US GAAP and IFRS.

1)Inventory Measurement

IFRS measures inventories at the lower of Cost and Net Realisable Value. Net Realisable Value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. It’s an entity-specific value, instead of a market value.

US GAAP measures inventory at the lower of Cost and Market, where Market means current Replacement Cost with Net Realisable Value as the upper limit and Net Realizable Value reduced by an allowance for normal profit margin as the lower limit.

2)Reversal of Inventory Write-down

IFRS requires write-downs to be reversed (ie the reversal is limited to the amount of the original write-down), when the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances. The reversal shall be recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs.

U.S. GAAP does not allow the reversal of previous write down. If inventory value is written down to lower amount, the reduced amount becomes new cost for subsequent periods. Inventories may be stated above cost only in exceptional cases (e.g. precious metals).

3)Inventory Cost Formula

Under IFRS, only FIFO and Weighted Average are permitted besides specific identification. At the same time, IFRS requires that all inventories having a similar nature or use, the same cost formula should be used.

USGAAP permits LIFO and does not have explicit requirement for consistent application of cost formula for similar inventories. (With all the fuss made on “LIFO technicalities” during US accounting education, I’m really interested to see what will happen to LIFO during US conversion to IFRS.)

4.Differences between CHN GAAP and IFRS

1)Allocation of fixed production overheads to costs of conversion

Both IFRS and US GAAP require that allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facility. In periods of abnormally low production or idle plant, the amount of fixed production overheads allocated to each unit of production is not increased, with the unallocated overheads recognized as an expense in the period in which they are incurred. However, in periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost.

CHN GAAP has no such requirement.

2)Reversal of Inventory Write-down

IFRS requires write-downs to be reversed (ie the reversal is limited to the amount of the original write-down), when the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances.

CHN GAAP only permits reversal when the circumstances that previously caused inventories to be written down below cost no longer exist.

IFRS requires the reversal to be recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs. (Note 1)

CHN GAAP requires the reversal to be recognized under asset impairment loss.

3)Additional disclosure requirements from IFRS, compared to CHN GAAP：

The amount of inventories recognized as an expense during the period （Note 1）.

Note 1: In IFRS, the amount of inventories recognized as an expense during the period, which is often referred to as cost of sales, consists of those costs previously included in the measurement of inventory that has now been sold and unallocated production overheads and abnormal amounts of production costs of inventories. The circumstances may also warrant the inclusion of other amounts, such as distribution costs.

Appendix 1: CHN Tax Adjustments

1.Inventory write-down and reversal

1)Accounting Standard: Inventories shall be measured at the lower of cost and net realizable value, with the amount of write-down recognized as an expense in the period the write-down.

2)Income Tax Law: Asset impairment loss shall and shall only be recognized when actual and permanent loss happens. Evidence of impairment loss need to be provided to tax authority and approval is required.