Titan Union
Accountants
Titan Union
Accountants

Memorandum

To: Farmer Joe, CEO, Three Little Pigs, Inc. (PIGS)
From: Accounting Consultant
Subject: Assessment of Impairment
Date: January 1, 2003

I. Facts

During this fiscal year, with the capture of the Big Bad Wolf, there is an increase of supply of pork and the market price of pork is on the decline. Although the market price for hogs is forecasted to stabilize within the year, Three Little Pigs, Inc. (PIGS) is dealt with the dilemma of whether they should impair their inventory of hogs, effective September 30, 2002. With three categories of hog inventory (live hogs for sale, developing animals, and processed pork products), PIGS is only considering to impair their inventories of live hogs and developing animals to be sold to third parties at market prices. Concerning processed pork prices, they are believed to be sufficient to cover production costs.

II. Issues

Management refuses to write off their inventory as they believe future stabilized prices will cover the losses from the previous quarters. However, specific scenarios must be evaluated to decide what the best solution is for PIGS to efficiently report their inventory. The issue is whether impairment should exist at September 30, 2002. If impairment shall exist, the question remains whether the impairment would be evaluated under the lower cost or market method on a total inventory basis, category basis, end product basis, or on an individual basis. If deemed necessary to impair, PIGS will need to determine whether impairment should be recognized in an interim period where prices are expected to recover.

III. Conclusion

On behalf of Titan Union Accountants, I believe the best way to represent fair income is to evaluate impairment under the lower cost or market method on an end product category basis. This assessment would separate live hogs and developing animals to be processed into pork goods in one group and live hogs and developing animals sold to third parties in another group. Because PIGS is undergoing a loss with excess supply of hogs with a decline in price, stating inventory at an end product category basis is the most effective way to report income. Accordingly, if impairment is necessary, we insist that PIGS do not recommend impairment in an interim period if prices are expected to stabilize.

IV. Research and Analysis

To justify our stance behind evaluating impairment under lower cost or market method on end product category basis, we reference to FASB, ASC 330-10-35-8. It 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”. Since the processed pork products do not have a lower cost or market issue, it is best to separate the inventories and have the other two assessed for impairment. Similarly, FASB, ASC 330-10-35-10 also supports this claim; it states, when “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 determining whether live hogs should be evaluated for impairment, FASB, ASC 905-330-35-3 claims that unless all conditions are met, animals held for sale can be valued at the lower cost or market. In this case, all conditions do not meet because it is not stated that the hogs are “available for immediate delivery”. Thus, live hogs can be valued at lower cost or market. In the case of developing animals, FASB, ASC 905-330-35-2 states that developing animals can also be valued at lower cost or market. Therefore, because inventory is applicable to be valued at lower cost or market, inventory should be evaluated under end product category basis to receive the most efficient report of income.

If impairment is indeed necessary, impairment should not be recognized in an interim period if prices are expected to recover as stated in FASB, ASC 270-10-45-6c:

“Inventory losses from market declines shall not be deferred beyond the interim period in which the decline occurs. Recoveries of such losses on the same inventory in later interim periods of the same fiscal year through market price recoveries shall be recognized as gains in the later interim period. Such gains shall not exceed previously recognized losses. Some market declines at interim dates, however, can reasonably be expected to be restored in the fiscal year. Such temporary market declines need not be recognized at the interim date since no loss is expected to be incurred in the fiscal year”.

Even though there is a loss reported initially, PIGS should anticipate prices to recover and losses to diminish as the fiscal year comes to an end.

V. Summary and Recommendations

PIGS is dealt with complications with excess supply and declining market prices, facing the tough task of deciding whether to impose impairment on inventories of hog. To assess the dilemma, PIGS must decide whether to evaluate inventory as a whole or in individual categories.

Titan Union Accountants recommends that the inventories of hog be evaluated in separate end product categories – live hogs and developing animals to be processed in one group and live hogs and developing animals to be sold in another group. Consequently, if impairment is deemed necessary, impairment should not be reported in an interim period.

Titan Union Accountants hope that Three Little Pigs, Inc. is able to receive ample guidance with this assessment of impairment. We are glad to discuss this recommendation with you and provide feedback on any conclusions you decide upon.