After getting some feedback from stakeholders, the Financial Accounting Standards Board (FASB) is going to make an effort to try and reduce the complex nature of financial statements.
As part of this effort, the first project will be to simply the way inventory is measured at lower of cost and net realizable value. As the accounting guidelines are now, a company should consider “net realizable value, replacement cost, and net realizable value less a normal profit margin when measuring inventory.”
The second project will be to eliminate the extraordinary items from the income statement. The current accounting guidelines state that “organizations to evaluate whether an event or transaction is an extraordinary item; and if it is an extraordinary item – to separately present and disclose the item.”
I can definitely understand the need to simply the inventory valuation. Inventory is often one of the largest, if not the largest, accounts on the balance sheet. Giving a company to much leeway in determining the value of their inventory could lead to some manipulation. However, sometimes there is not a surefire way to determine the value of an item. For example, an antique dealer may have paid a certain amount for an item, but the realizable value of that item is partially subjective. That’s a very specific example, but that does not take away from the fact that most companies have to use their own judgment in determining the value of their inventory. This move to narrow the inventory valuation methods down to two will ultimately benefit the investors by removing an additional element, normal profit margin, that is essentially just an estimate.
The second project is a little more cloudy. Accountants spend a considerable amount of time trying to determine if an event is considered extraordinary in nature. FASB statement No. 145 offers guidance as to what should be considered an extraordinary item. The problem that I think the FASB is trying address is the difficulty accountants have in distinguishing between nonrecurring items and extraordinary items. Most of the accounting literature tends to lump the one-time items into a category and attempts to determine which one of those items is likely to occur again down the road. To distinguish between those two categories is important because one group can be listed above the bottom line (extraordinary items) and the other group can be listed below the bottom line, usually after taxes (nonrecurring items). While I’ve described to the accounting treatment of the above items, I haven’t given any clear examples of either, and that’s the point. Some accountants may consider an event as extraordinary and others might consider it nonrecurring. It seems as though the IFRS does not recognize the concept of extraordinary items for this very reason.