Deloitte Three Little Pigs

The main goal of evaluating impairment of inventory is to provide users of financial statements an accurate assessment of how the company stands. PIGS has three categories of inventory – live hogs ready for sale, developing animals, and processed pork products.

Within these categories, PIGS has inventory of live hogs and developing animals which are to be internally processed into pork products, and also live hogs and developing animals which are held for sale to third parties. The issue of holding inventory at lower of cost of market is with the hogs sold to third parties (PIGS feels that the internally processed products cover costs sufficiently and will not have a LCM issue).

However, with the Big Bad Wolf being captured, market prices for lean pork have decreased due to the increased supply of pork.

The carrying cost of the live and developing hogs is now (and for the next few months) more expensive than the market value. However, the CEO believes that this is just a seasonal fluctuation.

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I feel that the way to best represent periodic income is to evaluate for impairment of each end product category. Since the internally processed hogs do not have a LCM issue, the live hogs and developing hogs for sale to outside parties should be tested for impairment.

This is supported by the FASB codification in section 330-10-35-8 as well as 330-10-35-10. 35-8 states: Depending on the character and composition of the inventory, the rule of lower of cost or market may properly be applied either directly to each item or to the total of the inventory (or, in some cases, to the total of the components of each major category).

The method shall be that which most clearly reflects periodic income. I would classify the inventory into two categories, outside parties and internally processed.

Section 330-10-35-10 states: Similarly, where more than one major product or operational category exists, the application of the lower of cost or market rule to the total of the items included in such major categories may result in the most useful determination of income. When no loss of income is expected to take place as a result of a reduction of cost prices of certain goods because others forming components of the same general categories of finished products have a market equally in excess of cost, such components need not be adjusted to market to the extent that they are in balanced quantities.

Thus, in such cases, the rule of lower of cost or market, may be applied directly to the totals of the entire inventory, rather than to the individual inventory items, if they enter into the same category of finished product and if they are in balanced quantities, provided the procedure is applied consistently from year to year. By using these two operational categories, it seems that applying lower of cost or market will give the best valuation of income. 2)If the company determines that an impairment of inventory is necessary, should the impairment be recognized in an interim period if prices are expected to recover before the year end?

Section 330-10-55-2 in the codification states the following: If near-term price recovery is uncertain, a decline in the market price of inventory below cost during an interim period shall be accounted for as follows. Paragraph 270-10-45-6 requires that the inventory be written down to the lower of cost or market unless either of the following conditions is met: a. Substantial evidence exists that market prices will recover before the inventory is sold.  In the case of last-in, first-out (LIFO) inventory, substantial evidence exists that inventory amounts will be restored by year-end.

A write-down is generally required unless the decline is due to seasonal price fluctuations. When looking at the information provided, two things in particular catch my attention. The CEO says that total revenues for pork products and total revenues for sales to outside parties, based on current prices, will exceed the cost to complete the sales. Also, when looking at the futures prices (and considering Farmer Joe already stated that it was a seasonal fluctuation) it appears that the price drop is temporary. According to 330-10-55-2, a write down is required unless the decline is due to seasonal price fluctuations.