Effects of tariffs on financial reporting

Financial reporting considerations

Contract modifications and price changes

If a price change to an existing contract is negotiated with a customer, it is evaluated as a contract modification.  When the only change in the contract terms is price, the price change is accounted for either prospectively (if the goods and services are distinct) or on a cumulative catch-up basis (if the remaining goods or services are not distinct).

If a price adjustment is contemplated in the terms of an enforceable contract, a company should assess whether it represents variable consideration or a contract modification. If the price change relates to a future contract, it is simply considered in the accounting for that contract.

KPMG Handbook, Economic disruption

• Section 2.5, Contract modifications 

KPMG Handbook, Revenue recognition

• Chapter 11, Contract modifications

Estimates and judgments

Key estimates and judgments in the revenue recognition process may be affected and therefore may need to be reassessed. Potential effects include::

• Variable consideration, such as price concessions or rebates, which may require revenue to be constrained.
• Allocation of consideration – standalone selling prices may need to be updated.
• Measures of progress could be affected by supply chain or workforce disruptions leading to cost changes or project delays as well as increases to total forecasted costs due to tariffs.

KPMG Handbook, Economic disruption

• Section 2.2, Variable consideration
• Section 2.6, Standalone selling prices 

KPMG Handbook, Revenue recognition 

• Section 3.4, Price concessions
• Section 5.3, Variable consideration
• Section 7.4, Measuring progress toward complete satisfaction of a performance obligation

Collectibility

If, at contract inception, a customer’s creditworthiness is such that the collectibility threshold is not met (i.e. it is not probable that the company will collect substantially all of the consideration to which it expects to be entitled), a contract does not exist and the general revenue model cannot be applied. 

After contract inception, companies need to evaluate whether significant changes in credit risk have occurred and, if so, reevaluate the collectibility criterion for existing contracts. If, on reassessment, it is determined that collectibility is no longer probable, use of the general revenue model should be discontinued. Previously recognized revenue is not reversed and the alternative (deposit) model is applied.

KPMG Handbook, Economic disruption

• Section 2.4, Assessing collectibility, receivables and contract assets

KPMG Handbook, Revenue recognition   

• Section 5.2, Elements of transaction price

Financial reporting considerations 

Capitalization of tariffs

Tariffs are capitalized if incurred in procuring the goods required to bring the inventory to its existing condition and location – e.g. inbound to the manufacturing facility or fulfillment center.

KPMG Handbook, Inventory

• Question 3.2.20, Are tariffs and other import fees included in the cost of inventory? 

KPMG Handbook, Economic disruption

• Section 4.3, Inventoriable costs - Tariffs

Net realizable value (NRV) / impairment assessment

Tariffs and related cost increases can lead to higher inventory costs without corresponding increases in selling prices. If these costs cause the inventory’s carrying amount to exceed its net realizable value, an impairment loss may result. 

For inventories measured at lower of cost or market, determining replacement cost may require additional time, effort and judgment due to supply chain disruptions and price volatility. 

If inventory has been stockpiled to avoid tariffs, it should be monitored for obsolescence or other signs of impairment.

KPMG Handbook, Economic disruption

• Section 4.4, Impairment

Purchase commitments

Companies with firm purchase commitments should assess whether those agreements will result in a loss that needs to be recognized. If there are firm sales contracts for the future inventory, the pricing of those contracts including ability to pass on the cost of tariffs should be considered.

KPMG Handbook, Economic disruption

• Section 4.5, Purchase commitments 

KPMG Handbook, Inventory

• Question 4.6.20, Are losses as a result of firm purchase commitments evaluated similarly to on-hand inventory? 

Normal production levels

If production falls outside the range of normal capacity, companies may need to adjust how costs are allocated to inventory. If production is abnormally high, the fixed overhead allocated to each unit of production is reduced. 

If production is abnormally low, no adjustments are made to the fixed overhead allocations, and unallocated overhead is expensed in the period incurred. 

KPMG Handbook, Economic disruption

• Section 4.3, Inventoriable costs – Normal production levels

KPMG Handbook, Inventory

• Question 3.2.110, How are fixed and variable production overhead costs allocated to inventory?
• Question 3.2.120, Are unallocated fixed overhead and other abnormal costs capitalized in the cost of inventory?  

Financial reporting considerations 

Indicators of Impairment 

The effects of evolving tariffs policies on certain industries or markets may lead to an impairment triggering event. This may occur, for example, due to permanent or temporary curtailment of operations, reduced customer demand or supply chain disruptions. 

Companies should assess whether triggering events indicate that the carrying amount of long-lived assets may not be recoverable or when an event or circumstance indicates that it is more likely than not that goodwill or indefinite-lived intangible assets are impaired.

KPMG Handbook, Economic disruption

• Section 5.2, Triggering events
• Section 6.2.10, Long-lived asset impairment

KPMG Handbook, Impairment of nonfinancial assets

• Section 4.3, Trigger-based testing

Sequence of Impairment Testing

When impairment indicators are present, companies may need to test multiple asset classes. This is done in a specific order:

1. Assets outside the scope of ASC 350/360 (e.g. inventory)
2. Indefinite-lived intangible assets
3. Long-lived assets
4. Goodwill.

KPMG Handbook, Economic disruption

• 6.2.50, Sequence of impairment testing

KPMG Handbook, Impairment of nonfinancial assets

• Question 4.4.10, In what order are assets tested for impairment?
• Question 4.4.20, Does the impairment of goodwill trigger impairment testing for the long-lived assets in that reporting unit?

Projected financial information 

If a quantitative impairment test is required, companies may need to revise key assumptions in their financial projections, including sales growth, supply costs, tariff costs and capital spending. In some cases it may be more appropriate to use probability-weighted cash flow projections given the uncertainty and evolving trade environment. 

As part of the valuation analysis, companies should consider a market participant or investor view in determining which, and to what extent, tariffs and other measures should be reflected in the valuation analysis. 

KPMG Handbook, Impairment of nonfinancial assets

• Question 7.2.30, Are cash flows based on a single best estimate or probability-weighted?
• Question 8.3.210, If an entity expects conditions after the measurement date to change, does it reflect that expectation in measuring fair value?

KPMG newsletter, Tariffs and valuation 

• Three steps to assess rapidly changing policies and environments

KPMG Handbook, Economic disruption

• Section 5.5, Quantitative assessment

Disposals and plans to abandon assets 

In response to evolving regulatory and economic pressures, companies may adopt various strategic measures, including asset disposals or operational shifts. When disposals are part of the strategy, the criteria for classification as held-for-sale are evaluated to determine whether the assets qualify for presentation as discontinued operations.

If a company commits to a plan to abandon a long-lived asset, it accelerates its depreciation or amortization. However, a long-lived asset that is temporarily idled is not considered abandoned and should continue to be depreciated over its remaining useful life.
 

KPMG Handbook, Economic disruption

• Section 6.2.40, Abandoned and idled assets
• Section 10.2, Disposals

KPMG Handbook, Discontinued operations & HFS disposal groups

• Section 4.2, Disposed of by sale (held-for-sale criteria)
• Question 4.3.30, Can a temporary idled long-lived asset be considered abandoned? 

Financial reporting considerations 

Lease modifications and terminations

Relocation or other business considerations may require modifying or terminating existing lease agreements. A lessor and lessee may also agree to other changes to a lease (e.g. shortening the lease term or extending the lease term in return for reduced rent in the near term).  

A lease modification is any change to the terms and conditions of a lease that results in a change in its scope or consideration. The accounting for lease modifications should be approached carefully as their accounting effects can vary widely.

KPMG Handbook, Economic disruption 

• Section 6.3.10, Lessee considerations
• Section 6.3.20, Lessor considerations

KPMG Handbook, Leases

• Section 6.7, Lease modifications (lessee)
• Section 6.8, Lease terminations (lessee)
• Section 7.6, Lease modifications (lessor)

Reassessment of lease terms

Tariff-driven actions may trigger a requirement to reassess the term of the lease or an option to purchase the underlying asset – for example, if the lessee elects not to exercise an option that it had previously determined it was reasonably certain to exercise. 

The expected residual value of an underlying asset may be affected by market disruption, requiring reassessment of the amount it is probable that the lessee will owe under a residual value guarantee.

KPMG Handbook, Economic disruption

• Section 6.3.10, Lessee considerations – Lessee reassessments

KPMG Handbook, Leases

• Section 6.6, Lease reassessments (lessee)

Impairment or abandonment of ROU assets

Refer to the Goodwill and long-lived assets considerations above. 

If a lessee has both the intent and practical ability to sublease the underlying asset, further evaluation should be performed related to reassessment of asset groupings. 

KPMG Handbook, Leases 

• Section 6.5.2, Interaction with Topic 360 when asset will be abandoned or subleas
   

Collectibility 

Lessors should evaluate whether tariffs have adversely affected the financial condition of lessees, potentially affecting the collectibility of lease payments. 

The accounting implications vary depending on the type of lease (i.e. sales-type, direct financing or operating) and whether collectability is assessed as not probable at lease commencement or becomes not probable subsequently.   
 

KPMG Handbook, Economic disruption 

• Section 6.3.20, Lessor considerations – Lessor revenue recognition – collectibility

KPMG Handbook, Leases 

• Section 7.5, Collectibility (lessor)

Financial reporting considerations 

Restructuring

Tariffs and related cost pressures may prompt companies to restructure operations, potentially leading to exit activities such as severance, contract termination costs, and expenses to consolidate or relocate facilities and workforce. 

Companies should evaluate: 

• whether these activities result in recognition of termination benefits; and
• the appropriate timing of recognition and disclosure in the financial statements.

KPMG Handbook, Economic disruption

• Section 8.3.10, Termination benefits

KPMG Handbook, Employee benefits

• Chapter 4, Termination benefits and other nonretirement postemployment benefits

Financial reporting considerations 

Going concern

Companies may face liquidity challenges if they are not able to sufficiently increase selling prices to offset tariffs or due to decreased customer demand. 

Given the uncertainty around the timing and amount of the tariffs, relying on past experience to establish future expectations may not be appropriate. It may also be difficult to establish the probability of a plan’s future success when critical elements of the plan depend on events outside management’s control (e.g. availability of credit lines or obtaining other financing).

KPMG Handbook, Economic disruption

• Section 10.4, Going concern

KPMG Handbook, Going concern 

• Chapter 3, Step 1: Assess whether substantial doubt is raised
• Chapter 3, Step 2: Assess whether substantial doubt exists

Financial reporting considerations 

Loan modifications and credit impairment (lenders)

Changes in the macroeconomic environment may affect borrowers’ ability to meet obligations, leading to an increase in the allowance for expected credit losses. 

Lenders may also need to consider the accounting for loan modifications and whether there are transfers between categories of debt securities.

KPMG Handbook, Economic disruption

• Section 3.2, Credit impairment
• Section 3.3, Loan modifications – lender
• Section 3.4, Transfers between categories of debt securities

KPMG Handbook, Credit impairment

Debt classification and covenant compliance (borrowers)

Borrowers should consider whether tariff-related disruptions affect debt covenant compliance, potentially requiring reclassification of debt from noncurrent to current. 

Borrowers may need to consider the accounting for debt modifications, including whether a debt modification constitutes a troubled debt restructuring (TDR), debt modification or debt extinguishment (debt modification that results in the recognition of a new loan).

KPMG Handbook, Economic disruption 

• Section 7.2.30, Debt covenants
• Section 7.3, Debt modification

KPMG Handbook, Debt and equity financing

• Chapter 4, TDR, debt modifications and extinguishments

Derivatives and hedging

Tariff-related economic disruption may affect whether a financial instrument or other contract is required to be accounted for as a derivative or whether the criteria to qualify for hedge accounting continue to be met. 

KPMG Handbook, Economic disruption

• Section 3.5, Derivatives and hedge accounting 
   

KPMG Handbook, Economic disruption 

• Section 3.6.20 Equity securities without a readily determinable fair value when measurement alternative is elected
  

Financial reporting considerations 

Risks and uncertainties

Companies are required to disclose risks and uncertainties that could significantly affect the amounts reported in the financial statements in the near term or the near-term functioning of the company. Tariffs may represent such a risk and uncertainty, for example, if they affect supply chains, pricing strategies or customer demand. 

KPMG Handbook, Economic disruption 

• Section 10.5, Risks and uncertainties 

KPMG Handbook, Financial statement presentation

• Chapter 7, Risks and uncertainties