Inventory is a mandatory component of current assets. Their accounting, at first glance, seems simple. But such simplicity is deceptive. In particular, many issues arise in the event of inventory depreciation. Let's take a closer look at this issue.
Accounting approaches to inventory depreciation
In the practice of inventory accounting, an entity may apply two accounting approaches to inventory depreciation – the direct write-down of the cost reduction amount and the write-down of the cost reduction amount through the formation of a reserve for the depreciation of inventories.
Direct write-off of the cost reduction amount
The standards do not contain any reservations or restrictions regarding charge of amount of inventory depreciation as the cost. Therefore, according to accounting rules, the amount of the depreciation of inventories is directly charged as the expenses of the period in which the depreciation is made and, accordingly, reduces the financial result before tax.
The amount of inventory depreciation under this approach is recorded in the enterprise's accounting in accordance with its work plan of accounts directly as a part of the expenses by the following account:
Dt 94 “Other operating expenses” – Cr 281 “Goods in stock”.
Tax implications
Corporate income tax
The amount of the depreciation is included in the object of income taxation under accounting rules and is subject to adjustment.
VAT
The fact of the depreciation does not have the value added tax consequence (hereinafter - VAT), since the transfer of ownership of the depreciated inventory is not conducted, and therefore there are no grounds for determining the object of taxation.
However, this approach is often unacceptable to businesses that are VAT payers. The fact is that according to paragraph 188.1 of Art. 188 of the Tax Code of Ukraine (hereinafter – TCU), the tax base of transactions for the supply of goods/services may not be lower than the price of their purchase. Therefore, keeping a record of VAT, the entity must constantly compare the selling price with the purchase price of such goods during the sale of goods and, in the case of sales below the value of the purchase tax, deduct VAT from the purchase value (the so-called “15” feature).
The mentioned monitoring cannot be carried out by the enterprise concerning the depreciated goods to net value of the sale, since after the depreciation in accounting the information on their historical cost of purchase disappears.
In order to retain historical information about the cost of inventories, businesses often take a second approach to depreciation accounting – through the formation of a depreciation reserve.
Writing-off of amount of depreciation through formation of depreciation inventory reserve
The depreciation reserve is created for the amount of inventory depreciation determined by the results of inventory testing procedures to ensure that their book value complies with the expected selling price.
The depreciation reserve is created in excess of the book value of inventories (taking into account the previously created reserve for individual items and lots of inventories) over their estimated value of sale.
A separate contractual subaccount, for example, 2811 “Inventory reserve”, is proposed to be created for accounting of the depreciation reserve. According to the characteristics the subaccount is passive, with analytics on nomenclature and batches of depreciated inventory. The subaccount credit reflects the creation of the depreciation reserve and the debit – write-off of a previously created reserve in connection with the disposal of the reserves for which the reserve was created.
In the balance sheet, the inventories are measured at net selling value as follows:
Inventory value shown in the balance sheet = Inventory book value – Depreciated inventory reserve.
Such approach allows to keep in the account the historical cost of inventory purchases and to continue to track the sale of goods below the cost of purchase to tax the excess amount.
Accounting procedures and reflection in the accounting records of the depreciation reserve
1. According to the results of testing of inventories regarding depreciation and in case of need the depreciation of individual inventory, the amount of reserve is determined, and the accounting record is formed:
Dt 94 “Other operating expenses” – Ct 2811 “Reserves of inventory depreciation”.
The depreciation amount is reflected in accounting as other operating expenses during the depreciation period.
Analytical accounting of the depreciation is carried out by nomenclature positions and lots.
2. In the case of further testing procedures, the expected selling price is compared to the book value of the individual inventory items deducting the previously created reserve.
3. The disposal of inventories that previously created the reserve of inventory depreciation is reflected in the following accounting records:
- at the time of sale:
Dt 902 “Cost of sales“ – Сt 281 “Goods in stock“ (in the amount of book value);
- on the last day of the quarter for inventories sold during the quarter that created the reserve:
Dt 2811 “Reserves of inventory depreciation“ – Ct 902 “Cost of sales“;
- VAT liabilities are charged to the amount exceeding the purchase price over the sale price of inventories:
Dt 94 “Other operating expenses“ – Ct 6432 “Tax liabilities not confirmed”.
Tax implications
Corporate income tax
The following differences apply when defining a corporate income tax of the entity for the transactions described above:
- in the case of the creation of reserve of inventories depreciation, the financial result before tax is increased by the amount of the reserve created;
- in the case of the write-down of the reserve in the amount of the depreciation of inventories disposed during the reporting quarter, the financial result before taxation is reduced by the amount of the reserve created in respect of the corresponding nomenclature items that have been disposed for the period.
VAT
There are no additional risks and features regarding VAT in the process of creating a reserve of inventory depreciation. At the same time, it should be remembered that if the entity – VAT payer sells the inventory below the purchase, it must charge additional tax liabilities to the excess amount.
Adjustment of object subject to corporate income tax on the amount of creation and use of the reserve of inventory depreciation
According to Art. 139 TCU the creation (use) of reserves (assurances) leads to the obligation of the payer of income tax to adjust the financial result before taxation for their amount (in case of creation – increase, in case of use – decrease). The differences arising in the formation of reserves (assurances) regarding the refund for subsequent (future) expenses are defined in i. 139.1 of the TCU.
The financial result before taxation increases (subitem 139.1.1 of the TCU) by the amount of expenses on creation of assurances (reserves) for refund for the subsequent (future) expenses (except for assurances (reserve) of expenses for payment of employees' leave, other payments related to wages, and the cost of a single social contribution charged to such payments) in accordance with the NAS or IFRS.
The necessity to adjust the financial result before taxation in case of creation/use of the reserve of inventory depreciation is confirmed by the position of tax authorities in the letter No. 4730/6/99-99-15-02-02-15/ІПК of November 8, 2018, stating: “if the enterprise has made a decision to provide depreciation through the creation of the assurances (reserve) for the inventories depreciation in accordance with the NAS or IFRS, the above differences arise“.
As we can see, the creation of the depreciation reserve is not required by standards, so it can only be made upon the decision of the enterprise. Therefore, in the case of the first approach to accounting for inventory impairment, the issue of adjusting the financial result before income taxation for the amount of the reserve does not arise. However, this approach does not allow the historical information on the cost of the purchase of depreciated inventories to be accounted for, that in turn makes it difficult to track the sale of goods below the cost of the purchase in order to calculate VAT liabilities for excess amount.
If the entity chooses to create the depreciation reserve, it entails the obligation to adjust (increase) the financial result before taxation for the amount of the reserve created.
