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Potential Accounting Impacts of Tariffs

Adam F. Hill

February 03, 2020

Recent trends of changing tariffs have become an important factor in the global economic environment. Tariffs are a form of tax or duty levied on goods imported from one country to another. A change in the taxes levied on goods imported into the United States impacts companies and the supply chain. Tariffs can also impact a company’s business and accounting. The following are potential accounting impacts companies should consider.

Inventory

The cost of inventory includes the direct costs to bring inventory to its current condition and other allocated indirect costs such as rent, utilities, and administrative expenses. Direct costs include not only the cost of the inventory and labor to manufacture the inventory, but also inbound costs such as freight, taxes, and tariffs. As tariffs increase, so does the cost of inventory. Increases in the cost of inventory can trigger the following
accounting considerations:

  • Companies that use standard costs might need to reevaluate their standards. If standards are not updated to reflect the increased cost due to additional tariffs, inventory on the balance sheet will not reflect the actual costs. If the actual cost of inventory increases and standard costs are not adjusted, cost of goods sold could be overstated while inventory, at standard, could be understated.
  • Companies will need to consider if increased tariff costs could cause inventory to become impaired. Inventory is generally measured at the lower of cost or net realizable value. Alternatively, inventory may be measured at the lower of cost or market if a company uses the last in, first out (LIFO) or retail method. No matter which method of valuing inventory is used, additional tariff costs could cause the cost of inventory to exceed the value that companies can sell to customers. When the cost exceeds the estimated net realizable value (or market), the inventory needs to be written down to the estimated net realizable value (or market) and recognized as a loss in the period in which it occurs. In light of the increased tariffs, if companies have purchase commitments for inventory that they do not expect to fully recover, the estimated loss on those purchase commitments should also be accrued and recognized in the period identified.

Costs of Goods Sold and Profit Margins

As the cost of inventory increases due to tariffs, so will the cost of goods sold as that inventory is sold. Even companies that are not direct importers could be affected by tariffs as the tariff increases are often passed
through the entire supply chain.Tariffs can change quickly and unpredictably. Profit margins can decrease if companies are unable to fully pass the cost of the new tariffs to customers just as quickly.

New Revenue Recognition Standards

As companies apply the new revenue from contracts with customers standard (Accounting Standards Codification “ASC” 606), the impact of tariffs will need to be considered. Companies will likely attempt to pass the additional tariff costs to customers through higher prices. The accounting of these higher prices will
depend on if companies have contracts with their customers that include variable pricing. ASC 606 requires companies to estimate variable pricing when determining the transaction price. If a contract allows a company to have an enforceable right to receive additional consideration to cover added costs for tariff increases, that consideration should be included in the transaction price. Recognition might also depend on how many performance obligations have been identified. In a situation where there is a long-term contract with an enforceable right to receive additional consideration for tariff increases and one performance obligation, an increase in tariffs would immediately cause an increase in both revenue (transaction price) and cost
estimates for the price increase expected over the life of the contract. In situations where there are multiple shipments and each shipment is considered a different performance obligation, then the company may be able to use the current price for each shipment rather than estimating the transaction price for all shipments.

In contracts where there is not an enforceable right to receive additional consideration to cover new tariffs, the original transaction price should be used until a contract modification is approved. If tariff increases cause existing contracts without the right to receive additional consideration to become estimated loss contracts, all losses on those existing contracts will need to be recognized in the period the loss is identified.

Long-Term Assets

Companies need to consider if long-term assets such as goodwill, property, plant and equipment, and customer lists have become impaired due to the effects of tariffs. If an increase in tariffs causes estimated cash
flows generated from the long-term asset to be less than the value of the long-term asset carrying value, the company may need to recognize an impairment loss.

Summary

It is important to be aware of the potential accounting impacts tariffs can cause. Even if you are not a direct importer you could be affected. Monitor the changing tariff situation in order to properly manage the business and to avoid big surprises when preparing financial statements.

Click here to view the article in the November/December issue of The Asset, the Official publication of the Missouri Society of Certified Public Accountants.

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