Memorandum

To: Farmer Joe, CEO, Three Little Pigs Inc.

From: Dillon Schmidt, Jason Doddridge, Rui Liu, Accounting Advisors

Subject: Impairment for Hog Inventory

Date: November 12, 2014

Farmer Joe,

Thank you for giving our team the chance to perform research on your question regarding inventory impairment related to your inventory of live hogs, developing animals, and processed pork products. The situation that has been presented to us is interesting and combines a number of industry specific issues as well as a question involving inventory valuation and how to test for the impairment of inventory. After much research it is our opinion that hogs be evaluated for impairment monthly, or when there is an event which would suggest that there could be impairment. Given that the Big Bad Wolf was captured this quarter, it is critical that PIGS tests for impairment on September 30, 2002 because of the negative impact this event will have on the futures price for lean hogs.

Research Questions: There are three key questions to consider when testing whether or not impairment has occurred.
1) Are there any specific rules in place related to an inventory consisting of developing and held for sale animals?
2) Does the change in futures prices qualify as a seasonal price fluctuation or a permanent change in the market?
3) How do we define and test for impairment?

1. Are there any specific rules related to an inventory consisting of developing and held for sale animals?
Within the Accounting Standards Codification (ASC), there are many sections that are industry specific and provide guidance related to issues that may be distinct between different types of businesses. Agriculture is one such industry, and the ASC provides us with information regarding how production animals like lean hogs, both developing and held for sale shall be valued.
ASC 905-330-35-2 states that “developing animals to be held for sale shall be valued at the lower of cost or market.” As for the live hogs held for sale, ASC 905-330-35-3 states that “animals held for sale shall be valued at either of the following:
a. The lower of cost or market; or
b. At sales price less estimated costs of disposal, if all the following conditions exist:
1. The product has a reliable, readily determinable, and realizable market price.
2. The product has relatively insignificant and predictable costs of disposal.
3. The product is available for immediate delivery.”
Given the lack of evidence showing that the criteria are met to allow the inventory to be valued at sales price less costs of disposal, we assume that developing animals as well as live hogs ready for sale shall be valued at the lower of cost or market.

2. Does the change in futures prices qualify as a seasonal price fluctuation or a permanent change in the market?
One of the issues that is presented in the information provided to us is the idea that the futures prices for hogs may have been permanently changed by the capture of the Big Bad Wolf this quarter. ASC 330-10-55-2 provides us guidance on this topic, suggesting that “...A write-down is generally required unless the decline is due to seasonal price fluctuations.”. However, given the unique nature of the capture of the Big Bad Wolf, it is reasonable to assume that this is not simply seasonal price fluctuations and that the change in prices is permanent.
Fortunately for PIGS, the market price is still expected to recover to above the carrying cost of its’ hogs before the end of the fiscal year, but the market price will never return to the level it would have been had the Big Bad Wolf not been captured. 3. How do we define and test for impairment?
In this situation, there has been a decline in market prices related to inventory of live hogs and developing animals held for sale to third parties. According to ASC 330-10-35-2, “a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in