Web-based presentation — Inventories, Section 3031 Exposure Draft, “Inventories, Section 3031” SLIDE 1 Exposure Draft, “Inventories, Section 3031” This presentation provides an overview of the requirements of the Accounting Standards Board’s Exposure Draft on Inventories, Section 3031. It also highlights some of the expected changes in Canadian practice as a result of the proposals. The Exposure Draft is the official version of the Board’s proposals. Nothing in this presentation overrides the Exposure Draft, which contains details not covered in this presentation. An important part of the Board’s process is the exposure of proposed standards for public comment, and consideration of the input received. Viewers of this presentation are encouraged to provide their comments on the specific questions set out in the Exposure Draft. Comments on the Exposure Draft proposals are requested by September 15, 2006. NEXT SLIDE: [Background] SLIDE 2 Background The Board developed the proposals as a result of its longstanding goal of significantly enhancing Canadian generally accepted accounting principles (GAAP). Specifically, the proposals will replace Section 3030, Inventories, which is one of the oldest standards in the Handbook. The Board considered International Financial Reporting Standards 1 of 12
Web-based presentation — Inventories, Section 3031 (IFRSs) and US GAAP, both of which provide more extensive guidance on accounting for inventories than current Section 3030 and have been recently updated. The proposals are based on the International Financial Reporting Standard No. 2, Inventories, so as to avoid a second round of changes in the proposed transition to IFRSs as a result of the Board’s recently adopted Strategic Plan. (For more information on the Board’s Strategic Plan, please visit our web site at www.acsbcanada.org.) NEXT SLIDE: [Benefits] SLIDE 3 Benefits The proposals represent an improvement to Canadian GAAP, as they: • Require inventory to be valued at the lower of cost and net realizable value, with certain exceptions; • Provide more extensive guidance on the determination of cost, including allocation of overhead • Narrow the permitted cost formulas • Require impairment testing; and • Expand the disclosure requirements to increase transparency. I will address each of these points in more detail throughout the presentation. NEXT SLIDE: [Applicability] 2 of 12
Web-based presentation — Inventories, Section 3031 SLIDE 4 Applicability The proposals would apply to all inventories of all entities, including not-for-profit organizations, except: • Work in progress arising under construction contracts • Financial instruments • Contributed items and services not recognized by not-for-profit organizations in accordance with contributions — revenue recognition, paragraph 4410.16. This paragraph permits a not-for-profit organization to not recognize certain contributions of materials and services. The proposals scope out contributions not recognized to be consistent with this choice. [NEXT SLIDE: Measurement] SLIDE 5 Measurement The proposals require inventories to be measured at the lower of cost and net realizable value. However, there are a small number of exceptions. Not-for-profit organizations may hold inventories that are not expected to generate a cash flow, for example, inventories such as informational brochures that will be given away as part of the organization’s programs. Specific provisions for not-for-profit organizations are discussed later in the presentation. The proposals provide a scope exemption from the measurement requirements for agricultural inventories up to and including the point at which they are harvested. This 3 of 12
Web-based presentation — Inventories, Section 3031 measurement scope exemption also applies to inventories held by producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products provided that these inventories are measured at net realizable value in accordance with well-established practices in those industries. Commodity broker-traders may measure their inventories at fair value less costs to sell. In each of these cases the scope exemption is only from the measurement requirements and the other requirements of the proposals, including disclosures, apply. The proposals provide that inventories comprising agricultural produce that an entity has harvested from its biological assets are measured on initial recognition at their carrying amount at the point of harvest. For example, this carrying amount may be fair value, which becomes the cost of inventories at the point of harvest for application of the proposals. [NEXT SLIDE: Cost of inventories] SLIDE 6 Cost of inventories The proposals provide more extensive guidance than current Canadian GAAP on the determination of cost, including guidance on the allocation of overheads. Some Canadian entities will encounter significant changes in the determination of the cost of their inventories as a result of adopting the proposals. The proposals require that the cost of inventories comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The costs of purchase include the purchase price, transport and handling costs, taxes that are not recoverable and other costs directly attributable to the purchase. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase. 4 of 12
Web-based presentation — Inventories, Section 3031 Emerging Issues Committee Abstracts of Issues Discussed No. 144, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor , provides additional guidance on accounting for cash received from the seller. The proposals provide detailed guidance on the costs of conversion which include direct costs such as labour, material and direct overheads, and an allocation of fixed and variable production overheads. The proposals also provide guidance on joint products and by-products as the production process may result in more than one output being produced simultaneously. If the cost relating to the individual products cannot be identified, total production costs are allocated between the products on a rational and consistent basis. One possible method is to allocate the total production costs based on relative selling prices. If a production process results in products that are incidental to the primary products, the cost allocated to these by-products may be based on their net realizable value. Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. These may include non-production overheads or the costs of designing products for specific customers. The proposals also provide examples of costs excluded from the cost of inventories and recognized as expenses in the period in which they are incurred such as abnormal amounts of wasted materials, labour and other production costs, and selling costs. Unlike Section 3030 which focuses on a manufacturing concern, the proposals are broader as they address the cost of inventories of a service provider. Specifically, these costs consist primarily of the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads. NEXT SLIDE: [Formulas and techniques to measure cost] 5 of 12
Web-based presentation — Inventories, Section 3031 SLIDE 7 Formulas and techniques to measure cost Where possible, cost is determined on an individual item basis. This determination is appropriate for unique items such as custom-built furnishings, property developments and antiques. For many types of inventories it is not possible to identify the costs of a specific unit of inventory, because there are large numbers of inventory items that are interchangeable. Here the proposals require the use of either the first-in, first-out (FIFO) or weighted average cost formula. The use of the last-in, first-out (LIFO) basis of cost determination will no longer be acceptable under Canadian GAAP. This elimination of LIFO may create a US-Canadian GAAP difference for entities using LIFO for US GAAP. In addition, the proposals require an entity to use the same cost formula for all inventories having a similar nature or use to the entity. For inventories with a different nature or use, different cost formulas may be justified. The proposals also address the techniques for the measurement of the cost of inventories. Specifically, the proposals suggest that the standard cost method or the retail method be used for convenience, but only if the results approximate cost. Standard costs must be reviewed regularly and adjusted to take into account changes in circumstances. Some applications of the retail method currently may not approximate cost and this could result in a significant change. NEXT SLIDE: [Impairment] 6 of 12
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