Accounting Implications of Tariffs: What Manufacturing and Distribution Organizations Need to Know

The prevalence of tariffs over the past year has increased the complexity of inventory costing and financial reporting for manufacturing and distribution companies. Since the 2025 executive orders imposing tariffs on imports from Canada, Mexico, China, and many other countries, entities have faced a rapidly evolving tariff environment. The tariff landscape has been unpredictable at times, complicating business planning. Understanding the accounting implications of these changes is critical to achieving accurate financial statements and effective risk management.

GAAP Rules and Real-World Complexities of Tariff Costs

Under Generally Accepted Accounting Principles (GAAP) in the United States, specifically FASB ASC 330, tariffs incurred in connection with the procurement of inventory are capitalized as part of inventory cost. The guidance states that the cost of inventory includes all expenditures and charges directly or indirectly incurred in bringing an item to its existing condition and location. This includes tariffs, which are considered normal supply-chain costs even when they are unanticipated or volatile.

Some may question whether tariffs can be treated as “abnormal costs” and thus expensed as incurred. However, the AICPA Center for Plain English Accounting notes that tariffs, while potentially unexpected, do not meet the definition of abnormal costs under ASC 330-10-30-7. Instead, they are part of the inventory acquisition cost and should be capitalized accordingly.

The speed, volatility, and unpredictability of tariff implementation have created significant challenges for companies in updating their processes to capture tariff costs accurately. Tariffs may be incurred in various ways: directly as the importer of record, through freight carriers, or indirectly via supplier price increases or negotiated reimbursements. These complexities can make it difficult to trace tariff costs to specific inventory purchases, especially for entities with high transaction volumes or high volumes of SKUs.

The AICPA Center for Plain English Accounting’s recent publication, Tariffs: Coming to a Balance Sheet Near You, discussed acceptable methods for capturing tariffs in inventory values, including:

• Part-specific tracking within inventory systems
• Capitalizing unfavorable purchase price variances in standard costing systems
• Allocating tariffs as a component of overhead costs

Regardless of the method, it is essential that the chosen approach results in inventory costs that reasonably approximate actual costs at the balance sheet date. In practice, many manufacturers utilize systems that lack the sophistication to absorb tariffs at the SKU level. To comply with the accounting requirements, some companies historically used reasonable estimates to allocate tariffs and related costs into inventory. As the dollar value of these items has increased exponentially in many cases, entities may struggle to identify solutions that provide the necessary precision for capturing the added cost. Companies should revisit their processes and related controls now to mitigate inventory valuation issues at year-end.

Impact on Inventory Valuation

With rising tariff costs, companies must decide whether to absorb these costs or pass them on to customers. If tariff costs are not fully recoverable through price increases, there is an increased risk that inventory will need to be written down to net realizable value under ASC 330-10-35-1B. Determining net realizable value can be particularly challenging in a volatile environment, requiring significant judgment and consideration of subsequent events that may affect selling prices. Once inventory is written down, the reduced amount becomes the new cost basis and cannot be subsequently marked up, even if market conditions improve.

Legal Uncertainty and Refunds

Ongoing legal challenges to the validity of certain tariffs add another layer of uncertainty. If courts ultimately rule that some tariffs were improperly assessed, entities may be entitled to refunds. However, under prevailing accounting guidance (ASC 410-30 and ASC 450), a receivable for tariff recovery should only be recognized when recovery is probable. Given the current legal environment, it is generally difficult to meet this threshold until a final, favorable court ruling is issued. This could result in the recognition of costs from the sale of products, including tariffs, in one period, with an offsetting recovery of the tariff cost in a subsequent period.

Revenue Recognition Considerations and Disclosure Requirements

Organizations may also face changes in revenue recognition considerations due to current business practices regarding tariffs. If contracts provide an enforceable right to reimbursement, tariff recoveries may be treated as variable consideration. The amount recognized should reflect only the portion for which a significant reversal is not probable. If contract modifications are required to recover tariffs, revenue is recognized only when the modification is approved and enforceable, often resulting in a cumulative catch-up adjustment.

Given the uncertainty and potential materiality of tariff impacts, expanded disclosures are often warranted. Companies should consider disclosing:

• The nature and extent of tariff impacts.
• The status of legal challenges and potential recoveries.
• Significant concentration of risk (e.g., reliance on imports from tariff-affected countries).
• The use of estimates in financial statement preparation.

Getting Started with Proactive Risk Management

For manufacturing and distribution entities, tariffs are central considerations in financial reporting as well as the management of business risk. Companies need to be proactive to make sure tariff-related costs are properly captured, significant estimates stemming from potential inventory impairments and revenue recognition judgments are well-supported, and disclosures provide stakeholders with a clear understanding of the risks and uncertainties involved. Pay particular attention to providing management with sufficient, reliable data to manage risks related to the supply chain, pricing strategy, and contractual relationships, now more than ever. Contact us today.