Peeling away financial reporting issues one layer at a time

Trying My Best to Save LOCOM for Inventory

In my previous post, I expressed my opposition to the FASB’s proposal for replacing the LOCOM rule for inventory with “lower of cost or net realizable value.”

I stated that the extant U.S. GAAP on LOCOM embodied a principle of measuring the economic utility of an asset that exists nowhere else.  It is worth preserving, if for no other reason, than to show students of accounting and business that bridges between financial reporting and economics can indeed be construct. As the last one is being blasted to smithereens, it’s legitimate to ask why there aren’t more such bridges.

But, I was surprised when my post led to this comment by a former FASB member, whom I respect greatly and choose not to name:

“Unlike Tom who believes this is an assault on users’ information needs, I think this is a ho hum matter. The answers are not likely to differ greatly in most cases and it’s quite possible that most companies will find that they just keep doing what they were already doing. I don’t think an extensive basis for conclusions is needed when the Board just wants to simplify what is essentially a mechanical process.”

I took these comments to heart in the comment letter I just submitted to the FASB.  I hope expressed clearly, these three points:

First, if you believe in the same economic principles that the members of the Committee on Accounting Procedure believed in back in 1947, then logic dictates that the proposal violates the FASB’s pledge to not promulgate “simplifications” that reduce the usefulness of the information provided to users of financial statements.

Second, as the former FASB member said, it’s quite possible that most users will continue to do what they have been doing, so there won’t be an appreciable savings of time and effort.  Instead of eliminating LOCOM, the Board could have issued a set of indicators to clarify when the “floor” and “ceiling” tests would not be needed.

Third, the ED is a seriously flawed document, that sends an implicit message that comments on the key issues are not welcome.  I’ll quote from my comment letter:

The Board’s simplification initiative seems to have a single objective and a single constraint. This makes it self-evident that the most important questions the FASB should have for stakeholders are: (1) whether the simplification objective is met; and (2) whether the information usefulness constraint is violated. Both of these questions are arguably subsumed in “Question 1,” but I suggest that in future proposals they should be separated and explicitly addressed.

Moreover, the ED does not disclose how the Board has concluded that its information usefulness constraint is not violated. In my opinion, this is an unconscionable omission. [emphasis supplied]

* * * * * * *

As I stated in my post, but did not state in my comment letter, I smell a rat.  I believe that there is more at stake than “simplifying” the accounting for inventory.  For one thing, LOCOM is just the tip of the iceberg of a very complex topic (e.g., LIFO), for another the FASB’s proposal assures that there will be fewer write downs; and when they occur, many will be for less than under the current rules.

Last week, the FASB issued — after a protracted period of deliberations, and over the dissents of two members — an Accounting Standards Update to require disclosures of going concern uncertainties.  If the FASB were truly concerned about simplifying financial reporting, it would have scrapped that project years ago.

More on going concern disclosures in my next post.


1 Comment

  1. Reply Amy-Jean October 13, 2014

    As a first year accounting student, the line in the second paragraph” It is worth preserving, if for no other reason, than to show students of accounting and business that bridges between financial reporting and economics can indeed be construct.” caught my attention. It is very interesting to see what you have to say about the LOCOM. As a first year we only recently learned about the concept of LOCOM and do agree that it does indeed show us that bridges between financial reporting and economics can be construct. Although I have so long to go before I actually become a qualified CA, and I understand that the accounting standards need to change to keep up with the times. If something like LOCOM was taken away, I feel as though a lot of my time learning about it would have just been a waste.

    The main thing we are taught is to ensure that Financial statements are presented with as much usefulness and reliability of the information as possible. With my limited knowledge of accounting, I agree that taking away the LOCOM rule would indeed decrease the usefulness of the information provided.

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