Can someone give me an example of what these two costs could be please?
You have a sweet 1968 427 CSX Cobra that you plan on unloading at the next Barrett-Jackson auction when you realize that the hood badge is missing. (Your brother-in-law is the prime suspect.)
Before you can sell it, you have to get a new hood badge and install it: completion cost.
When you sell it, Barrett-Jackson will take a commission on the selling price: selling cost.
Ahh great example!!!
I’ve been bashing my head against the wall how an inventory ‘write down’ or ‘write up’ occurs…and it’s pretty sore at the moment and I wonder if you can help soothe the pain please!?
If we take your example above and assume we are adhering to IFRS and that we are a vintage car dealer.
NRV = selling price - selling costs - completion costs
We have just bought a 1968 427 CSX Cobra for $5.5m and intend to sell it for the right price in the near future. Suddenly, for what ever reason, there is a global economic recession which means people are only prepared to pay $4.5m. Would we now recognise a loss on the income statement of $1m in the form of an increase COGS?
If thats correct, it’s understandable how ‘selling price’ changes lead to ‘write downs’ or ‘write ups’.
But when we get to selling costs and completion costs, this is where I get majorly confused!!
If the new hood badge for the Cobra has been bought and installed - how can this capitalised cost increase or decrease in value when it has already been installed onto the vehicle?
Likewise with selling costs (which are period costs, expensed in the period incurred). How can they affect NRV which in turn affects the carrying value of the inventory when itself isn’t capitalised, i.e. how can selling costs go up or down affecting NRV which in turn may lead to a ‘write down’ or ‘write up’ when you haven’t sold the car yet!
Or is it the estimation of what you think selling costs will be which affects the write down/write up?
Its the estimation (or a reasonable assumption). Your salesman asks for a raise or he will cross the street and sell Kia’s instead of your Hyundias. You give in. Now it costs you 5% to sell a car, rather than 4%. Selling costs went up. Alternatively there is a recall on your crappy Hyundias and the dealer needs to pay a mechanic $100 out of pocket before the car is ready for sale. Your completion costs went up. That said, most inventory write downs are driven by changes in expected selling price, not selling or completion costs. Things like obsolescence can destroy the value of inventory.
Maybe. (This is probably best answered by the practicing accountants, but I’ll give it a shot, fully prepared to be corrected by those with more knowledge than I.) I suspect that if you believe that the drop in market price is temporary, then you wouldn’t write down the Cobra, but if you believe that it is permanent (or, at least, long-lived), you would.
In any case, if you write it down, you would include that in COGS if the amount isn’t material, but would show it separately on the income statement if it is material. If your annual COGS is $100,000,000, just throw it into COGS and be done with it; if your annual COGS is $10,000,000, you’d better show it separately.
Thanks geo / s2000magician! very helpful 
Isn’t there double counting here?
If you have to pay your salesman a higher salary, your selling costs increase - and therefore you immediately recognise an expense in the the I/S (as selling costs are a period cost).
When you sell the vehicle, your COGS will increase by the combined amount of selling costs + completion costs.
However, the NRV contains selling costs which have already been expensed earlier. Therefore are you not recognising selling costs twice in the I/S? First when you ‘write down’ the inventory and second when you sell the inventory?
E.g. NRV = Selling Price - Selling Costs - Completion Costs
NRV= $10 - $4 - $1 = $5
If selling costs increase by $1 you ‘write down’ the inventory by $1 by recognising an expense in the I/S = $1:
Subsequently, NRV= $10 - $5 - $1 = $4
Now you sell the vehicle:
$10 = revenue in the I/S
$6 = COGS in the I/S
Am I getting confused here?
You’re welcome.
I’m trying to figure out where you think you’re counting something a second time. No luck so far.
And you would normally expect to show a profit after you recognize that expense. The point of including selling costs in NRV is that unless the book value of your inventory is less than your selling price less your completion costs and selling costs, you won’t show a profit when you sell it.
Selling costs aren’t part of COGS; they’re part of SG&A (the S part).
I’m not following your example. Let’s try another:
- Current inventory cost = $10
- Selling price = $12
- Completion cost = $1
- Selling cost = $3
If we don’t write down the inventory, then when we sell it, we show:
- Revenue = $12
- Expenses = $10 + $1 + $3 = $14
- Operating profit = -$2
If we write down the inventory to NRV (= $12 – $1 – $3 = $8), then we show a loss of $2. When we sell it, we show:
- Revenue = $12
- Expenses = $8 + $1 + $3 = $12
- Operating profit = $0
As best I can tell, both ways result in showing a loss of $2.
I guess what I’m getting at is why we capitalise selling costs when they are a period cost?
As selling costs should be expensed in the period incurred, what happens if we don’t sell the product until the next period.
*You expense selling costs $3 on the I/S in the first year.
*In the second year, when you sell the product:
- Revenue: $12
- COGS: $8
- SG&A expenses: $4 ( $3 +$1)
- Gross Profit: $0
You are expensing the selling costs for the 2nd time?
Ohh but the selling costs are only incurred when you actually sell the product, so you would always expense the selling costs in the same period the product is sold!?
Even if selling costs increase a year before selling the product, you would just write down the inventory and recognise a loss on the I/S. Then in the second year when you actually sell the product, then you would recognise the selling costs as an expense?
so in the example above, first year, you wouldn’t expense anything.
Second year you sell the product you would show:
- Revenue: $12
- COGS: $8
- SG&A expenses: $4
- Gross Profit: $0
I erred in writing “gross profit”; it should have been “operating profit”; I fixed that.
When we write the inventory down we effectively expense the selling costs; you’re correct. When we later sell the inventory, we _ un _expense the selling costs in the gross profit ($12 – $8 – $1 = $3 gross profit), then _ re _expense them in SG&A to arrive at operating profit ($3 – $3 = $0 operating profit). So we’re not, net, double counting either completion costs or selling costs; the net is (– + –) = –, subtracting them once.
If your selling costs go up, your COGS don’t change based on that selling cost amount. The impairment of inventory, if any, reduces future COGS, it doesn’t increase them.
Thanks for being so patient with me S2000magician!!
I was completely wrong there geo, thanks!
Por nada.