Background Relating to Key IssueBackground Relating to Key Issue

Background Relating to Key Issue

BC5 A number of constituents raised issues with the Board relating to the conceptual soundness of applying the lower of cost and current replacement cost treatment to inventories held for distribution as well as the practicality of its application to certain types of inventories held for distribution.

BC6 The Board considered the view that writing down inventory held for distribution when its current replacement cost falls below cost may result in the recognition of impairments when the service potential to the entity of those inventories remains unchanged. In addition, the Board noted that the service potential to the entity of inventories held for distribution may fall, but that current replacement cost to the entity may remain higher than the original cost. The Board concluded that this is in part because the lower of cost and current replacement cost requirement focuses on financial values, whereas the service potential of inventories held for distribution by many not-for-profit entities is considered in physical terms.

BC7 The Board also considered the practical problem that current replacement costs are sometimes not readily available for many of the inventories held for distribution that have long lives because they have not been replenished for long periods. In some cases, such inventories may have maintained their service potential, but may no longer be available in the form held by the entity.

BC8 The Board noted that a for-profit entity will readily know its costs and its net realisable values, because most businesses buy and sell inventories regularly. In a not-for-profit entity that holds inventories for distribution and buys and distributes them regularly, the lower of cost and current replacement cost requirement has been viewed as the nearest available equivalent requirement.

BC9 The Board noted that the practical problems emerge when the inventories held for distribution are retained over the long term and replacement costs are not readily available. A major part of the burden is the possible need to maintain records of three prices for each type of inventory: (1) the cost; (2) the up-to-date replacement cost in case there is a need for write down; and (3) in the event that the replacement cost has previously fallen below cost, that replacement cost [carrying amount]. The Board also noted that the records of the three prices might also need to be maintained to facilitate the reversal of write downs in the event that the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in current replacement cost because of changed economic circumstances.