This Section, which is an integral part of the requirements of this Topic, provides general guidance to be used in accounting for
inventory. Certain assumptions have been made to simplify the computations and focus on the issue at hand in each illustration.
The following provides guidance as to whether the types of costs that are required to be allocated to inventories for tax purposes under the Uniform Capitalization Rules for Inventory under the Tax Reform Act of 1986 would be capitalizable under generally accepted accounting principles (GAAP) and, if so, whether the costing method required for tax purposes is a preferable method for purposes of justifying a change in accounting principle.
The fact that a cost is capitalizable for tax purposes does not, in itself, indicate that it is preferable, or even appropriate, to capitalize that cost for financial reporting purposes. Certain of the additional costs that are required to be capitalized for tax purposes may also be capitalizable for financial reporting purposes, depending on factors such as the nature of the entity's operation and industry practice. That determination, however, can only be made after an analysis of the individual facts and circumstances.
The service cost component of net periodic pension cost and net periodic postretirement benefit cost is the only component directly arising from employees' services provided in the current period. Therefore, when it is appropriate to capitalize employee compensation in connection with the construction or production of an asset, the service cost component applicable to the pertinent employees for the period is the relevant amount to be considered for capitalization.
Management has developed a program to provide substantial dealer incentives on purchases of the Model A, which it expects will result in the sale of this inventory in the near term. Because of the existing high profit margin on its stereo systems, Entity A would continue to earn a marginal profit on sales of the Model A under the new program. It is also reasonably possible, however, that the program will not be wholly successful, and, accordingly, a material loss could ultimately result on the disposal of the inventory.
The entity would disclose the following.
As of December 31, 19X7, some portion of $6 million of inventory of one of the entity's products is in excess of Entity A's current requirements based on the recent level of sales. Management has developed a program to reduce this inventory to desired levels over the near term and believes no loss will be incurred on its disposition. No estimate can be made of a range of amounts of loss that are reasonably possible should the program not be successful.
In this Example, Entity A discloses the existence of potentially excess quantities of inventory at the date of the financial statements and indicates that the uncertainty is expected to be resolved in the near term. The disclosure is intended to provide users with insight into management's assessment of recoverability of the cost of inventories existing at the date of the financial statements. Although disclosure of the $6 million carrying amount of the inventory of Model A is not required because, based on the facts presented, $6 million does not constitute a reasonable estimate of loss on the disposal of the inventory or the maximum amount in an estimated range of loss, disclosure of this amount is not misleading and may provide useful information.
Discussion of Entity A's provision for obsolescence for the remaining 80 percent of its inventory is not required because it is not considered reasonably possible that additional material losses on this inventory will occur.