Kpmg 3 Pigs Solution
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Several factors including increased supply have caused declining prices for live hogs on the spot market. Also as shown bellow futures prices will remain below the carrying cost for live hogs until nearly the end of the fiscal year. However processed pork products such as bacon, loins, and ham remain above the current cost of production. Three Little Pigs Inc. is capable of processing hogs into these products internally at some locations. Unfortunately, not all hogs can be transported and processed at the main processing plants and must be sold as live hogs to third parties at spot market prices. There are four potential alternatives for dealing with the possible need to impair the value of Three Little Pigs Inc.s inventories.
Alternative 1: Continue to carry all inventories at cost basis.
ARB28, Par.14c “Such temporary market declines need not be recognized at the interim date since no loss is expected.”
EITF, 86-13 Discussion ” option 28 requires inventory be written to lower of cost or market unless (1) substantial evidence exists that market prices will recover before the inventory is sold…Write down is generally required unless the decline is due to seasonal pricing fluctuation.”
ARB43, Ch.4, Par.9 “Where evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss should be recognized…”
If it can be determined that the depressed prices for lean hogs are only temporary, inventories could and should be kept at cost basis. In this case, adjusting prices to match current market prices would not be necessary. Future prices indicate a recovery before the end of the fiscal year. Futures prices will surpass cost in February and remain above cost for the remainder of the fiscal year. The future prices support claims that the price fluctuations are only temporary in nature, and do not reflect a permanent downward shift in hog prices. Since inventories once impaired cannot be marked up to reflect changes in market conditions, this strategy could be beneficial to the company later on. In this case inventory would not be shown on the books at an unfairly low value.
Alternative 2: Mark down all live hog inventories
AICPA Audit Procedures for Agricultural Producers Pt.1 Ch5.02 “Growing crops and developing animals to be held for sale should be valued at the lower of cost or market.”
ARB43, Ch.4 Par.8 “A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as its cost.”
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.”
ARB43, Ch.4 Par.16 “Only in exceptional cases may inventories properly be stated above cost.”
ARB43, Par.14 “Inventory losses from market declines should not be deferred beyond the interim period in which the decline occurs.”
ARB43, Par.11 “…If there is only one end-product category the cost utility of the total stock—The inventory in its entirety—may have the greatest significance for accounting purposes.”
Current market prices reflect an inventory impairment of the live hogs held for sale. The depressed prices will likely remain through the end of the fiscal quarter based off option prices. Any later adjustment will defer losses from market declines beyond this fiscal period if prices do not recover. Adjusting inventory value during the current period is in conjuncture with the periodicity assumption as well as timeliness of information. The AICPA states clearly those inventories of crops and developing animals held for sale should be valued at the lower of cost or market. The AICPA does not provide any provisions for the anticipation of recovering prices. Marking inventories down better reflects the conservative nature within the conceptual framework.
All hogs regardless of whether they will be converted into processed products internally,