Three Pigs Corporation Essay Example for Free

Three Pigs Corporation Essay * Relevant Facts 1. There are essentially three major categories of hog inventory—live hogs ready for sale, developing animals, and processed pork products. 2. Not all live hogs in other locations that cannot be easily transported and processed at the Company’s main processing plants. As a result, these live hogs must be sold to third parties at spot market prices. 3. There are several factors, including increased supply of pork due to the capture of the Big Bad Wolf, have lead to the declining prices for their live hog on the spot market. * Solution Analysis Complying with the periodicity assumption and the conservative principle, marking inventories down will better reflect the value of the inventory. There are several parts mentioned the inventory impairment in ARB43, Ch.4 Par.9: The rule of cost or market whichever is lower is intended to provide a means of measuring the remaining usefulness of an inventory expenditure. Inventory losses from market declines should not be deferred beyond the interim period in which the decline occurs. There are four alternatives to deal with this inventory case of the Company. i) Under the lower of cost or market method on a total inventory basis GAAP requires that the inventory be written down to the lower of cost or market when substantial evidence exists that market prices will recover before the inventory is sold. A write-down is generally required unless the decline is due to seasonal price fluctuations (FASB Cod. # 270-10-45-6). In this case, if it can be determined that the future prices for lean hogs decline only for a temporary period and will recover before the end of the fiscal year, the inventory could be record on a total inventory basis. However, IRS regulations say the types of items to be included in the same pool should be â€Å"substantially similar.† It seems that the three major categories of hog inventory are quite different products. It is not appropriate enough to put all of them into a single pool. ii) Under the lower of cost or market method based on end product category The method that marking down only live hogs that cannot be processed into pork products seems to be reasonable to some extents. The live hogs processing at the Company’s main processing plants do not need to make cost adjustment because the spot market does not affect their price while the other hogs that cannot be processed have to be marked down to reflect the value. ARB43, Ch.4 Par.11 â€Å"If there is only one end-product category the cost utility of the total stockThe inventory in its entiretymay have the greatest significance for accounting purposes.† However, there are three categories in this case. And the developing animals and live hogs to be processed internally and to be sold to third parties are not different in nature. Even though they will be with different price because of the different processed method, it is not appropriate to evaluate them separately. iii) Under the lower of cost or market method on an individual basis to the extent possible Although there are some advantages to evaluate at the individual level, such as accuracy, it is not a practical way. Firstly, the specific identification method may be practical only in a few situations in which units are costly and can be easily distinguished. The cost of each individual is not identifiable in this kind of complex manufacturing and retailing situation. Secondly, the method may become too expensive to use as the increase of the volume and the cost of record keeping. Thirdly, the amount of profit varies even though the units of inventory are identical. The ability of earnings management is not allowed under GAAP. iv) Under the lower of cost or market method by inventory category To evaluate the impairment of inventory under the lower of cost or market method by inventory category seems to be the most practical and reasonable method in this case. The lower of cost or market method is accurate only if the goods in the inventory are perfectly homogeneous. The Company’s inventory of three categories meets this criterion here. Markups and markdowns do not exist at the same time and all the marked-down items will be sold by the end of this fiscal year. * Conclusion My recommendation is that all hogs are impaired and can be marked down to reflect the value using the LCM by inventory category. Based on the analysis above, this seems to be the most appropriate method that would most accurately reflect the intent of US GAAP. * Interim reporting Interim financial information is essential to provide investors and others with timely information as to the progress of the entity. However, GAAP states clearly that temporary market declines need not be recognized at the interim date since no loss is expected to incur in the fiscal year. If the company recognizes a decline and then reverses it in a later interim period, it should recognize a loss recovery and increase the inventory value by the amount of the recovery, but only up to the original cost (FASB Cod. #270-10-45). In this case, the inventory price is expected to be recovered by the end of this fiscal year and should be sufficient to recover the cost of the Company’s inventory. Such temporary declines do not need to report in the interim report.