After more than 60 years of little change in the requirements for disclosing inventory, U.S. accounting standard setters are proposing to update the standards.
Prompted by financial statement users who want more details about changes in inventory during reporting periods, the Financial Accounting Standards board in January issued a proposed accounting standards update aimed at beefing up inventory disclosures in the footnotes of financial statements. Constituents have until March 13 to comment on the proposal.
One major change would require public companies that break out the reporting of their operating segments to in certain cases disclose the inventory balances of each of those segments. (Operating segments might be the financial or manufacturing units of a corporation, for instance.)
Further, such companies would have to disclose the segments’ inventory components — for example, how much of it consists of raw materials, work-in-process, finished goods, and supplies. In fact, private companies and public ones that don’t engage in segment reporting would also have to provide component breakdowns.
Component disclosures would supply investors with crucial information about a company’s revenue and cash-flow prospects, says Georgia Tech accounting professor Charles Mulford.
For instance, even if a company reports a substantial amount of inventory, an analyst might not know the company didn’t have enough finished goods on hand to meet purchaser demand. Another previously undisclosed risk, according to Mulford: “What if I have no raw materials, and there’s a supply chain disruption?”
Another key provision in the update would require companies to disclose non-routine reasons for changes in inventory other than the routine buying, selling, and manufacturing of goods. An example of a non-routine change might be the acquisition of a company that has a large supply of inventory. Other non-routine changes might stem from writedowns of the value of goods or company divestitures.
Armed with such disclosures, investors could regard the non-routine changes as anomalies and then possibly get a truer picture of a company’s actual inventory turns. Yet another big change — at least for the many retailers that use the retail inventory method of accounting — would be for companies reporting under RIM to disclose “the critical assumptions used in the calculation of inventory,” according to the update.