Case

PlasTech International, Inc. is a privately held (not listed)international chemical companybased in the U.S. It prepares its consolidated financial statements in accordance with U.S. GAAP,and has a German subsidiary, PlasTech Germany AG. The subsidiary is a privatelyheld (not listed)stock company locatedin Munich and specializes in the production of different kinds of plasticmaterial for which petroleum is an importantingredient. It must prepare financial statements according to German GAAP to meet local legal and tax requirements, and must also prepare a U.S.GAAP reporting package[1]so that its results can be consolidated with those of PlasTech International, Inc.

Kurt Mueller recentlygraduated from a Master of Accounting programand accepted a position as an inventoryaccounting specialist with PlasTech Germany AG. He reports directly to the head of accounting, Rosalyn Robinson, and is responsible for all accounting issues associated with inventory. As part of the preparation of the financialstatements, Kurt is responsible for determining PlasTech Germany AGs cost of goods sold (reflected on the income statement), and the cost of raw materials, work-in-process, and finished goodsinventory on hand at the end of the year (reported on the balancesheet). In addition, Kurt must determine whether the companyshould recognize any impairments associated with inventory (reflected as an impairment loss on the income statement,and as a reduction in the inventorybalance on the balance sheet).He must determine these amounts in accordance with both German and U.S. GAAP, so that the subsidiarys financialstatements can be prepared in accordance with German GAAP, and the U.S. GAAP reportingpackage can be completed and sent to the parent company to assist in the preparation of the consolidated financial statements.

One of PlasTech Germany AGs critical raw materialsis petroleum. The company typically purchasespetroleum once per quarterand stores it in a large tank. The tank is connected to the production facilities by a small pipeline,and petroleum is automatically pumped to the production facility in accordancewith the companysproduction needs. The company defines a standard cost of petroleum for cost accounting purposes. For financial accounting purposes, the company uses a periodic inventory system, takes a physicalinventory at year-end, and then recognizes the appropriate expenserelated to the amount of petroleum that was used duringthe year. The company typicallymaintains a substantial amount of petroleum in the tank at all times to ensure that productioncan take place around the clock.

TABLE 1

Historical Market Price for Petroleum Large QuantityPurchases

U.S. Presentation		German Presentation
Date	Market Price of Petroleum	Date	Market Price of Petroleum
03/31/X1	$65/barrel	31.03.20X1	65 USD/barrel
06/30/X1	$63/barrel	30.06.20X1	63 USD/barrel
09/30/X1	$59/barrel	30.09.20X1	59 USD/barrel
12/31/X1	$60/barrel	31.12.20X1	60 USD/barrel
01/31/X2	$58/barrel	31.01.20X2	58 USD/barrel

The market price of petroleum decreasedover the past year, and the company continued purchasingon a quarterly basis according to its regular pattern. Table 1 shows the historical quarterly market price of petroleum in both the Germanand U.S. presentation formats.[2]Because the companydoes not purchase sufficiently large quantities, it typically pays a markup of 15 percent of the market price. The companyspurchases are shown in Table 2.

TABLE 2

Purchase Prices & Quantities of Petroleum

U.S. Presentation			German Presentation
Date	Purchase Price	Quantity	Date	Purchase Price	Quantity
01/19/X1	$75/barrel	1,250barrel	19.01.20X1	75 USD/barrel	1,250barrel
05/23/X1	$71/barrel	1,500barrel	23.05.20X1	71 USD/barrel	1,500barrel
09/26/X1	$66/barrel	1,200barrel	26.09.20X1	66 USD/barrel	1,200barrel
11/10/X1	$68/barrel	1,600barrel	10.11.20X1	68 USD/barrel	1,600barrel

At the beginningof the business year, 1,300 barrels of petroleum were in the tank and measured at $77/barrel.The physical inventory (stocktaking) at year-endshows that thereare 1,200 (1.200)barrels on hand (in stock) on 12/31/ X1 (31.12.20X1). This is Kurts first year with the company, and management has instructed him to learn about the financial reporting requirements associated with inventoryfor both U.S. and German GAAP.

Q1: What cost flow assumption options exist for measuring cost of goods sold and ending inventory under U.S. GAAP? Provide a reference to the appropriate Accounting Standards Codification (ASC), a short description of each method as would be applied to this case, and whether there is enough information to use the method.

Q2: Assume the U.S. parent company uses LIFO for the consolidated financial statements. What will the ending inventory values be according to U.S. GAAP (before any potential impairments)? Explain your calculations.

As they observedthe price decreasesfor petroleum duringthe year, some of PlasTechs larger customers began to demand price concessions during quarterly price negotiation meetings.In addition, throughout the year there was a general decrease in demand for plastic materials,resulting in fierce competition within the chemical industry. Therefore,the sales department felt they had no choicebut to lower prices. By year-end, the companys sales prices for their most important products had decreased by 15 percent.All of the companysproducts remain profitable; however, the companysprofit margins are much reduced.

On January 18, Kurt met with Rosalynabout the preparation of thefinancial statements, which had begun on January 11.

Rosalyn: Hi Kurt. The CFO of PlasTech International, Inc. wants to know as soon as possibleif we will have any unexpected expenses or losses. As we start to pull together the financial statements, I would like to get a feel for where we are with respect to impairments. Does it look like we will have any issues?I am particularly concerned about our inventory, given the implications arising from the decline in petroleum prices.

Kurt: Hello Rosalyn.I had thought about that issue but I have not had a chance to get my handsaround that yet. I will sit down this afternoonand take a hard look at it. I should be able to give you a general idea of what to expect by tomorrow morning.Anything I need to know to completethis task? Do you think we are facing any overstocking or spoilage issues with respect to the petroleuminventories?

Rosalyn: Great questionsKurt. To your first question, we apply the lower of cost or market rule at the item level (i.e., to each item in inventory) and costs of completion and disposal are negligible and assumed to be $0 while required transportation costs are $2/barrel, Furthermore, if we were to sell the petroleum in the market, we would sell to other small purchasers who would pay us a 15 percentpremium above the market price.Last, our normal profit margin is 17 percent. With respect to your second question,we should be able to consume all of the petroleum on hand within a normal quartersworth of production, and petroleumis not perishableat least, not over our relevant time horizon;therefore, I do not believe that we currently have any overstocking or spoilage issues.

Kurt: Okay,thanks! Ill move this project to the top of my To Do list.

Kurt immediately went back to his officeto evaluate whetherinventories were impaired,and if so, how much impairment loss the company would have to recognize.

Q3: Is an inventory impairment necessary according to U.S. GAAP? If so, how much impairment loss should PlasTech Germany AG recognize? Are there any indications that additional impairments may be necessary? Explain your reasoning and your calculations.

Q4: Using U.S. GAAP, what journal entries would PlasTech make to record an impairment using the direct method? The allowance method? How does an impairment affect current year net income? How does an impairment affect net income in the future? Can an impairment be reversed under U.S. GAAP?

Q5: If PlasTech International, Inc. changed its inventory cost methodology to FIFO, is an impairment necessary? If so, how much impairment should PlasTech Germany AG recognize according to U.S. GAAP? What journal entries would PlasTech make to record an impairment using the direct method? The allowance method? Explain your reasoning and your calculations.