We all know that inventory write-down is a common concept in accounting, but what about inventory write-up? Have you ever found yourself in a situation where the fair value of your inventory has increased and wondered if you can reflect this appreciation in your general ledger via a journal entry?
In this article, we will debrief on the concept of inventory write-up. We’ll explore whether it’s permissible under different accounting standards, specifically focusing on US GAAP and IFRS, and how such adjustments should be recorded in the general ledger.
Can You Write Up Inventory?
When it comes to adjusting inventory value in accounting, many are familiar with the concept of a write-down, which is the reduction of an inventory’s book value to align with its current market value often due to damage, obsolescence, or market changes.
However, the idea of an inventory write-up, where the market value of inventory has exceeded the book value, often prompts questions. Let’s explore whether this practice is allowed in accounting and under what circumstances.
Rules Under US GAAP
Under US Generally Accepted Accounting Principles (GAAP), the principle of conservatism plays a significant role. This principle restricts the practice of writing up inventory. US GAAP prioritizes not overestimating assets or income, which could lead to misleading financial statements.
Therefore, under US GAAP, inventory write-up is not allowed. This approach is all about making sure a company’s financial reporting is shown realistically and carefully. Otherwise, this would give businesses excessive opportunities to exaggerate and potentially mislead shareholders.
Rules Under IFRS
The International Financial Reporting Standards (IFRS) take a slightly different approach. IFRS allows for inventory write-up in certain situations, but it’s bound by specific rules. Specifically, inventory can only be written up to its original cost, which means only the reversal of a previous write-down can be recorded.
This approach under IFRS is part of its fair value principle, aiming to provide a more current and potentially accurate representation of an asset’s value. However, this also means that companies need to be careful and ensure that any write-up of inventory is justified and does not go above the original cost of its inventory.
Returning to the original question, can you simply write up an inventory because the market value exceeded the book value? The answer is generally no, but remember that IFRS allows the reversal of a previous write-down, whereas US GAAP strictly forbids any kind of write-up, including reversing a previous write-down. Understanding these differences is essential for accountants and financial professionals who are governed by specific guidance. In the next section, we will discuss the process of recording inventory write-ups (or reversal of write-downs). We will focus on IFRS guidelines, as US GAAP prohibits this practice.
Journal Entries for Inventory Write-Up
Note: The example below applies only under IFRS and not under US GAAP. Additionally, under IFRS, inventory write-up is technically permitted only as a “reversal of the previous write-down.” It’s not allowed to simply increase the value of inventory without a prior write-down.
Example: A company has previously written down its inventory value for $100 as the market value (Net realizable value) has decreased significantly. However, the market fluctuated again, and the net realizable value recovered to the inventory’s original cost. The company can now reverse the write-down or write up the $100 under IFRS.
If the inventory has been previously written down and recorded to Cost of Goods Sold (COGS), this journal entry would reverse COGS and write up the inventory value to its original cost.
This entry debits the Inventory account for $100, reflecting that the value has now recovered from the previous write-down. It also credits the Cost of Goods Sold (COGS) for $100 to reverse the effect on the income statement.
If the inventory has previously undergone a significant write-down and this was recorded as an expense under the Inventory Write-down Expense, the following journal entry would reverse that expense and restore the inventory’s value to its original cost.
In this entry, the Inventory account is debited for $100, indicating its value has rebounded from the earlier write-down. Concurrently, the Inventory Write-down Expense is credited for $100 to reverse the prior impact on the income statement.
In this topic of inventory write-up, we’ve discussed the significant differences between US GAAP and IFRS standards. Under US GAAP, inventory write-up is prohibited, reflecting a conservative approach in financial reporting. On the other hand, IFRS provides some flexibility, allowing for inventory write-up but only as a reversal of a previous write-down and not exceeding the original cost of the inventory. No guidance allows a write-up simply because the inventory’s market value has increased.
The journal entry to write up inventory is debiting Inventory and crediting either COGS or the Inventory Write-down Expense account, depending on which account was used in the previous write-down.
It’s very important to be aware of the specific accounting guidelines that apply to your business (US GAAP vs IFRS). Moreover, accountants need to follow these rules strictly, bearing in mind that writing up is generally not permitted, except in cases where it corrects a previous inventory write-down (IFRS only).