The Ripple Effect of Tariffs: Inventory, Pricing and Financial Statements

These days, nothing is more fluid in the United States than the term “tariffs.” While debate can be had on the macroeconomics and impacts of tariff policy on the U.S. economy, the tariff discussion appears to be ongoing for the foreseeable future. Because of this, business owners and managers will need to contemplate the impacts of tariffs on their financial reporting process.   

For importers of raw materials or finished goods, Accounting Standards Codification (“ASC”) 330: Inventory requires that all costs necessary to bring a product to its saleable state should be classified as inventory. The aggregate of such costs becomes a component of a company’s finished goods available for sale. Tariffs become additive in this context, similar to freight costs or customs duties.

For example, a U.S.-based distributor purchases finished goods from a manufacturer in Japan. The Japanese manufacturer sources components from a Canadian-based customer for its products, where in Canada the components underwent a substantial transformation. When these goods reach the US, an appropriate tariff is calculated on the components originating from Canada. The resulting tariff is an inventoriable cost to the U.S. distributor and will ultimately become part of cost of goods sold.

Manufacturing businesses that utilize standard costing for their inventory also need to consider the impact of tariff costs on their costing process. If standards are not adjusted to account for increased material costs resulting from tariffs, there can be considerable effects – primarily an understatement of ending inventory and overstatement of cost of goods sold. Manufacturers should closely monitor standard to actual cost variances to implement timely adjustments to their process.

Additionally, if tariff costs are significant and are not expected to be fully recovered from customers, there may be inventory write-down considerations. ASC 330 requires that companies analyze their inventory to ensure it is stated at the lower of cost or net realizable value, defined as the estimated selling price in the ordinary course of business, less the cost of transportation. While this issue may not be at the forefront, businesses should be considering their lower-margin items impacted by tariffs.

A common discussion among businesses facing tariff hikes surrounds the best way to pass along the cost to their customers. Most distributors of finished goods will avoid increasing the price precisely by the tariff charge, lest savvy customers gain negotiating leverage in future contract discussions by backing into their vendor’s margins. While manufacturers have a less direct path between tariff impact and ending price to customers, they too are concerned about this issue. One popular solution is a surcharge applied on each order, similar to the approach businesses took with the freight surcharges popular from 2021-2023. Under ASC 606-10, a company would likely be a principal (not an agent) with regard to tariff charges. As such, tariff charges are reflected gross as revenue and expense as opposed to net (a reduction of a transaction price).

Multinational companies with purchases or sales through non-U.S. affiliates typically have transfer pricing arrangements, whether documented using experts, or more formally with governmental agencies (e.g. Advance Pricing Agreements or “APA”). Such documents serve to establish and support arm’s length prices between related parties – or, in the case of an APA, establish margin corridors to satisfy respective taxing authorities.

With the imposition of new tariffs, multinational businesses may naturally react by wanting to lower the import price to minimize the impact of the tariff, but need to carefully consider transfer pricing parameters and tax implications. Further, with related party purchases of tariff-imposed goods, the import transaction price may be adjusted at a later date through the effects of transfer pricing adjustments. These adjustments, which could significantly alter the total transaction price, may result in the need to accrue for additional customs and tariff liabilities relevant to inventory transactions during a reporting period.

In preparing financial statements, companies need to consider whether or not to disclose enacted or speculative trade policy changes that could significantly impact the business. Factors that would give rise to disclosure include:

Ultimately, assessing the significance of such factors will be a critical component of determining the level of disclosure.   

With tariffs remaining a moving target, businesses need to stay on top of how these costs impact their financials. Whether it’s properly accounting for tariffs in inventory, adjusting pricing strategies or considering disclosure requirements, the details matter. Missteps can lead to misstated financials, compliance issues, or unexpected hits to profitability. By keeping a close eye on tariff-related costs and working with finance and tax professionals, businesses can make informed decisions and stay ahead of potential challenges.