Board Meeting Handout Disclosure Framework Disclosure Review, Inventory September 19, 2016

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1 Board Meeting Handout Disclosure Framework Disclosure Review, Inventory September 19, 2016 PURPOSE OF THIS MEETING 1. This is a decision-making Board meeting for discussion of potential inventory disclosure requirements for Topic 330, Inventory, on the basis of the staff s evaluation of the decision questions in the 2014 proposed FASB Concepts Statement, Conceptual Framework for Financial Reporting Chapter 8: Notes to Financial Statements (proposed Concepts Statement). 2. This handout is organized as follows: 1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) Issue 1: Disclosure Objectives Issue 2: Disaggregation of Inventory Issue 3: Changes in Inventory Issue 4: Alternative Inventory Measurement Methods Issue 5: Existing GAAP Disclosures Issue 6: Other Recommended Disclosures Issue 7: Other Disclosures Considered but Not Recommended Issue 8: Non-Public Business Entity (Non-PBE) Considerations Issue 9: Retail Inventory Method (RIM) Issue 10: Interim Disclosure Considerations Transition 1 Note to the Board: Question numbers have been changed from Board memo 105 to be sequential. The order of the questions has not changed. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 13

2 (l) Cost and Complexity (m) Next Steps. ISSUE 1: DISCLOSURE OBJECTIVES 3. In the other disclosure framework projects, the Board decided that, in general, the objectives for disclosures within each Topic would be developed using the decision questions from the proposed concepts that are used to identify relevant disclosure requirements. 4. Section , Inventory Overall Disclosure, currently outlines a prescriptive list of information that entities shall disclose with no overall objectives for disclosures. (1) Does the Board think that an overall objective for disclosures about inventory should be included in Section ? ISSUE 2: DISAGGREGATION OF INVENTORY 5. Decision Question L4 of the proposed Concepts Statement asks: Does the line item include components of different natures that could affect prospects for net cash flows differently? 6. Decision Question L9 of the proposed Concepts Statement asks: Does the line item include individual items (or groups) that are measured differently? 7. The following disaggregations of inventory could be required by the Board: (a) (b) (c) Disaggregation by segment Disaggregation by component Disaggregation by geographic location Page 2 of 13

3 (d) (e) Disaggregation by age Disaggregation by measurement bases. 8. To facilitate the vote on the disaggregation of inventory, the staff developed packages of different disaggregations for the Board s consideration as follows: (a) Option 1: (i) The chief operating decision maker (CODM) approach to inventory disaggregation disclosure requirements. (ii) Public business entities (PBEs) would be required to disclose inventory by segment, by segment further disaggregated by component, by age, and by geography if the entity s decision makers use inventory information disaggregated in those ways to make decisions about the entity s operating matters. If an entity s decision makers do not use inventory disaggregated by segment and by component to make decisions about the entity s operating matters, the entity would still be required to disclose inventory by component in total. (iii) Non-PBEs would only be required to disclose inventory by component in total. (b) Option 1A: On the basis of the Board s feedback at the July 27 Board meeting, the staff also developed this option as follows: (i) PBEs would be required to disclose inventory by segment and by segment further disaggregated by component, if the entity s decision makers use inventory information disaggregated in those ways to make decisions about the entity s operating matters. If an entity s decision makers do not use inventory disaggregated by segment and by component to make decisions about the entity s operating matters, the entity would still be required to disclose inventory by component in total. (ii) Non-PBEs would only be required to disclose inventory by component in total. Page 3 of 13

4 (c) Option 2: (i) PBEs would be required to disaggregate inventory by reportable segment, further disaggregated by component, without consideration of the information that the CODM reviews because these metrics were considered by users to be broadly relevant across industries and entities. (ii) PBEs would not be required to disaggregate inventory by age or geographic location because the relevance of inventory age and geography varies significantly for different industries and entities. (iii) Non-PBEs would only be required to disaggregate inventory by component and geographic location. (d) Option 3: (i) Hybrid approach proposing that PBEs be required to disaggregate inventory by segment, further disaggregated by component, regardless of whether this information is provided to the CODM. (ii) PBEs would be required to disaggregate inventory by age and geographic location only if the entity s decision makers use inventory information disaggregated in those ways to make decisions about the entity s operating matters. (iii) Non-PBEs would only be required to disaggregate inventory by component in total. Page 4 of 13

5 Questions for the Board (2) Should reporting entities be required to disclose inventory disaggregated as described in paragraph 8 above: a. Package 1 (CODM approach) b. Package 1A (CODM approach for only segment/component) c. Package 2 (Mandated by segment and component) d. Package 3 (Hybrid approach)? ISSUE 3: CHANGES IN INVENTORY 9. Decision Question L7 asks: Are the causes of the changes in an entity s line item of an asset, liability, or equity instrument not easily understood? This question led the staff to consider whether disclosure of certain changes in inventory should be disclosed, potentially in the form of a rollforward of the beginning inventory balance to the ending inventory balance. Such a disclosure would help the user to understand the cause of changes in the balance from the prior period. The staff has identified the following disclosures that would be indicated by this decision question and feedback received: (e) (f) (g) Rollforward of inventory balance Noncash changes to inventory Qualitative disclosure of internal costs capitalized into inventory. 10. To facilitate the vote on changes in inventory, the staff developed packages of different requirements for the Board s consideration as follows: (a) Option 1 would not require a full rollforward of inventory but would require disclosure of changes to inventory balance that are not specifically related to the purchase, manufacture, or sale of inventory, as well as a qualitative Page 5 of 13

6 disclosure of costs capitalized into inventory. This would be required for all entities. (b) Option 2 would require a rollforward of inventory balance from the beginning of the period to the end of the period. Because a full rollforward would be required and would include quantitative disclosure of costs capitalized into inventory to the extent material, there would be no separate requirement for qualitative descriptions of those costs. If selected, this would be required for PBEs, but non-pbes would only be required to disclose the requirements in Option 1. (c) Option 3 would require a rollforward of inventory balance from the beginning of the period to the end of the period only if any indicators that inventory is significant to an entity exist. If there is no indication that inventory is significant to an entity, that entity should disclose changes in the inventory balance other than those from the purchase, manufacture, or sale of inventory as described in Option 1. These indicators could include: (i) A review of inventory by the CODM, either by segment or in total (ii) The fact that inventory is a significant portion of total assets (iii) The fact that revenues earned or costs incurred from the sale of inventory are significant to the entity s operations. Page 6 of 13

7 Questions for the Board (3) Should a reporting entity disclose changes in inventory under: a. Option 1 (specific changes and qualitative description of capitalized costs) b. Option 2 (rollforward of the inventory balance from the beginning of the period to the end of the period) c. Option 3 (rollforward of inventory for entities for which it is significant; specific changes for other entities)? (4) Should the following additional modifications be included in the disclosure requirements: a. Removal of the substantial and unusual threshold associated with losses from the subsequent measurement of inventory b. Inclusion of a description of the facts and circumstances leading to impairment losses c. Removal of the separate income statement presentation of losses on firm purchase commitments? Other Issues Losses from the Subsequent Measurement of Inventory 10. Paragraph , as amended by FASB Accounting Standards Update No , Inventory (Topic 330): Simplifying the Measurement of Inventory, states that substantial and unusual losses resulting from the subsequent write-down of inventory should be disclosed. 11. Inventories are generally measured at cost, adjusted for losses resulting from application of the rule of lower of cost or market (or, in the future, lower of cost and net realizable value for certain inventories under the amendments in Update ). Under the guidance on the subsequent measurement of inventory, inventories Page 7 of 13

8 are written down whenever there is evidence that the utility of the goods is no longer as great as their cost. 12. Decision Question L8 of the proposed Concepts Statement asks: Could the quality or utility of a nonfinancial asset have changed? This led the staff to consider a disclosure of lower of cost or market or lower of cost and net realizable value (NRV) charges and to describe the facts and circumstances leading to those write-downs. Losses on Firm Purchase Commitments 13. Topic 330 requires recognition of impairment losses on firm, uncancelable, and unhedged purchase commitments as a separate line item in the income statement, which is a presentation issue and not a disclosure issue. However, because it is outlined in the Disclosure Section of Topic 330, the Board may want to address it in conjunction with this project. ISSUE 4: ALTERNATIVE INVENTORY MEASUREMENT METHODS 14. Decision Question L15 of the proposed Concepts Statement asks Is there an alternative measure or way of applying a measurement that clearly would be useful in assessing prospects for future cash flows? The range of methods available for measuring inventory under GAAP relies primarily on cost, and Decision Question L15 indicates a potential disclosure of inventory measured using other methods such as fair value, NRV, or market value. 15. There are no disclosure requirements in GAAP on alternative inventory measurement methods. 16. Inventories are generally measured at cost, adjusted for losses resulting from application of the rule of lower of cost or market or lower of cost and NRV. Losses resulting from the subsequent measurement of inventory signal a decline in utility of the inventory. This results in measuring inventory at NRV, replacement cost, or NRV Page 8 of 13

9 less a normal profit margin but only if the metrics are below cost. Inventory is not measured at fair value (unless it is acquired in a business combination), and subsequent increases in the fair value of inventory are generally not recognized The staff has identified the following disclosures related to the value of the inventory that were indicated by Decision Question L15 and the feedback received: (a) (b) (c) Fair value of inventory Fair value is based on the concepts in Topic 820, Fair Value Measurement, and is defined as the price that would be received to sell an asset in an orderly transaction between market participants. NRV of inventory NRV of inventory is defined in Topic 330 as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. Market value of inventory Market value of inventory generally means current replacement cost, although it cannot exceed NRV or NRV less an approximately normal profit margin. (5) Should entities be required to disclose the fair value, NRV, and/or market value of inventory? ISSUE 5: EXISTING GAAP DISCLOSURES 18. Very few disclosure requirements exist in Topic 330. Many of the requirements included in the Topic are redundant with other Topics or are incorporated into the disclosures described in Issues 2 and 3 above. 2 In practice, entities using last-in, first-out (LIFO) may reverse valuation reserves established in a prior period. Page 9 of 13

10 Questions for the Board (6) Should the following existing disclosure requirements be removed: a. The measurement basis of stating inventories b. Consistent application of the measurement basis c. Changes in the measurement basis d. Inventories stated above cost or at selling prices e. Standard costs? (7) Should the disclosure requirement on significant estimates be retained? ISSUE 6: OTHER RECOMMENDED DISCLOSURES 19. Examining the existing inventory disclosure requirements in the context of the proposed Concepts Statement s decision questions yielded many indicated additional disclosures. (8) Should the following disclosure requirements be added: a. Last-in, first-out (LIFO) liquidations b. Inventory under the care, custody, or charge of an unconsolidated party c. Royalty and other arrangements d. Replacement cost for LIFO inventory? Page 10 of 13

11 ISSUE 7: OTHER DISCLOSURES CONSIDERED BUT NOT RECOMMENDED (9) Should the following disclosure requirements be added: a. LIFO method and computation techniques b. Changes in market factors or sales prices c. Internal and external factors affecting inventory d. Inventory pledged as collateral (see also question 11 under Issue 8 below) e. Terms of firm purchase commitments? ISSUE 8: NON-PUBLIC BUSINESS ENTITY (NON-PBE) CONSIDERATIONS 20. Alternative disclosure requirements for non-pbes are included in Issues 2 and 3 above because they relate to the disaggregation of inventory by measurement basis and by segment and component (Issue 2) and changes in inventory (Issue 3). Questions for the Board (10) Should non-pbes be granted any additional disclosure alternatives other than those discussed in Issues 2 and 3? (11) Should non-pbes be required to disclose arrangements whereby inventory has been pledged as collateral for a liability? ISSUE 9: RETAIL INVENTORY METHOD (RIM) 21. The staff notes that Topic 330 allows RIM to be used in certain situations. RIM is a reverse mark-up method whereby the retail value of inventory is adjusted for any markdowns (for example, promotional pricing, special sales, or damaged goods). RIM can be done on a first-in, first-out (FIFO) basis or a LIFO basis. There are no specific inventory disclosure requirements associated with the retail industry. Page 11 of 13

12 (12) Should entities using RIM be required to disclose additional qualitative details on their inventory accounting policies? ISSUE 10: INTERIM DISCLOSURE CONSIDERATIONS (13) Should inventory disclosures in interim financial statements follow the principles in Topic 270, Interim Reporting, and Topic 280, Segment Reporting, for all applicable disclosures, or should disclosure of segment and component information be disclosed on an interim basis regardless of how significantly the balance has changed? TRANSITION 22. The staff identified two transition alternatives for all inventory disclosures: (d) Alternative A Require retrospective transition for all inventory disclosures. (e) Alternative B Require prospective transition for all inventory disclosures. (14) Should inventory disclosures be applied using a retrospective transition method or a prospective transition method? COST AND COMPLEXITY (15) Subject to what we learn through comment letters and stakeholder outreach, would the expected benefits of the changes justify the perceived costs? Page 12 of 13

13 NEXT STEPS Permission to Draft for Vote by Ballot Questions for the Board (16) Does the Board direct the staff to draft a proposed Accounting Standards Update for vote by written ballot? (17) What comment period does the Board select for the proposed Accounting Standards Update? Page 13 of 13