With the current developments in international trade policy and the ongoing trade war, many companies face significant operational and compliance challenges.
These compliance challenges have several aspects. For publicly listed companies, capital market rules for information, guidance, etc., must be handled correctly. Similarly, communication from IR must be carefully considered to help investors and analysts understand and model risks.
From an accounting perspective, increased tariffs can have various consequences for recognition, measurement, and disclosures.
The first step in assessing the potential accounting implications is to identify and evaluate where in the daily operations the company is exposed to the consequences of new and changed tariffs. This includes whether the company sells products and/or services in affected markets and whether the company purchases products and services that are subject to tariffs, directly or indirectly.
This analysis forms the basis for assessing the accounting implications.
In the following, we will review the following accounting aspects:
- Implications on revenue
- Implications on inventory
- Implications on fixed assets
- Other possible accounting implications, including tax, subsequent events, and disclosures in the financial statements
Implications on Revenue from New and Changed Tariffs
When the sale of products and/or services is affected by new and changed tariffs
When the company sells goods and/or services that are subject to tariffs, it will not have a direct effect on the company. However, there will likely be an indirect effect on revenue due to changed demand. Any price adjustments made by the seller to pass the tariff on to customers will also affect revenue.
Price Adjustment of Existing Contracts with Customers under IFRS 15
If price adjustments are made for existing contracts with customers, it is necessary to distinguish between situations where price adjustments are contractually agreed and situations where the price adjustment is negotiated separately.
If it is contractually agreed that prices should be adjusted to account for tariffs, the matter should be treated as variable consideration. Variable consideration must be estimated at the time of contract inception and included as part of the total contract consideration.
If price adjustments are not contractually agreed, but instead negotiated separately, it should be seen as a modification to the original contract. A contract modification should be accounted for either as if the original contract is terminated and a new contract is entered into (prospective basis) or as part of the original contract (cumulative catch-up basis).
If costs are incurred to fulfill a contract that is affected by tariffs, and revenue is recognized over time using a cost-based input method, increased costs due to tariffs will also affect the completion percentage. Therefore, expected completion costs must be adjusted to account for the anticipated increased costs.
Construction Contracts and Services Recognized Using the Percentage of Completion Method under the Danish Financial Statements Act
When recognising revenue from construction contracts and services where the percentage of completion method is used, a cost-based model is often used to determine the percentage of completion, which forms the basis for recognising profit.
In these cases, the same considerations as mentioned above regarding the effect of increased costs on the completion percentage apply.
Implications on Inventory
According to IAS 2, inventory must be measured at cost, alternatively at net realizable value (NRV) if this is lower.
If costs increase due to tariffs, possibly in combination with an inability to increase own sales prices, it may change whether the cost is lower than NRV. If the cost of units in inventory increases to a level above NRV, it will result in a need for impairment.
An impairment need can also arise where completion costs for units in inventory increase due to tariffs.
Implications on Intangible and Tangible Assets
When a company is affected by tariffs, either through the sale of own goods and services or through own purchases, the effects as mentioned earlier can be several:
- Declining revenue due to decreased demand
- Increased costs for purchasing goods
- Generally lower gross margins and EBIT
These factors can individually or collectively be indicators of impairment of individual assets or a cash-generating unit (CGU), which will require the preparation of an actual impairment test. However, the impairment test must always be performed for goodwill and other intangible assets with indefinite useful lives.
When preparing the impairment test, the changed assumptions in the form of increased costs, declining sales volumes, lower margins, etc., must be incorporated, which will likely result in an increased risk that the recoverable amount is lower than the carrying amount of the asset or CGU.
In addition to updating the impairment test itself, disclosure requirements related to key assumptions must be observed. Therefore, it may be relevant to include a description of the assumptions regarding tariffs and their impact on sales volume, etc., that underpin the impairment test.
Other Accounting Implications
In addition to possible accounting effects on revenue recognition and impairment needs, new and changed tariffs can potentially also affect other areas. Below, a number of these are briefly reviewed:
Deferred Tax
Just as there can be an impairment indicator for fixed assets, an expectation of lower revenue, increased costs, and deteriorated earnings can affect the assessment of the ability to utilize tax assets.
Assessment of the Company’s Ability to Continue as a Going Concern
If new and changed tariffs can lead to significant doubt and uncertainty about the company’s ability to continue as a going concern, this must be disclosed in the financial statements.
Subsequent Events
The introduction of new tariffs after the balance sheet date but before the publication of the financial statements can potentially constitute significant non-adjusting subsequent events that must be disclosed in the financial statements.
Disclosures
If new and changed tariffs have a significant impact on the company’s results, financial position, or cash flow, users must have information to understand this context and expectations for the future. If new and changed tariffs are significant to the company’s operations, it is necessary to create transparency around the matter in the financial statements and the management report.
For many, it will be relevant to include a separate section on the matter, where it is reviewed in more detail, as was often the case with Brexit and Covid-19.