BDO on Financial Reporting Implications of Tariffs and Questions Audit Committees Should Ask

President Trump’s announcement of a program of new tariffs on imports from many countries have resulted in economic and business uncertainty and securities market volatility.  Tariffs also have accounting, financial reporting, and disclosure implications for public companies.  BDO has published Economic Uncertainty:  Financial Reporting Considerations for Tariffs which discusses these reporting and disclosure issues.  BDO also suggests questions for audit committee consideration concerning the financial statement, disclosure, and audit impacts of tariffs. 

BDO’s paper explores six topics:

1.     Accounting Considerations.  New tariffs may affect revenue recognition, impairment of nonfinancial assets, and income taxes. 

• Revenue recognition. Tariffs may affect revenue recognition in a variety of ways, such as by affecting the collectability of contractual consideration or triggering re-negotiation of the terms of revenue-producing contracts to reflect increased costs incurred because of the tariffs.

• Impairments. Tariffs may affect the recoverability of assets, such as property, plant, and equipment and goodwill. Similarly, inventory may need to be written down if costs exceed net realizable value.

• Income taxes. Effects of tariffs, such as goodwill impairments, may impact income tax accounting. Changes to tariffs may also affect transfer pricing calculations. 

2.     Disclosures.  Companies should consider the impact of new tariffs on financial statement disclosure requirements with respect to subsequent events and risks and uncertainties.

• Subsequent events.  Financial statements should reflect conditions that existed at the balance sheet date; however, certain events and conditions that arose after the balance sheet date may also need to be disclosed to prevent the financial statements from being misleading.  Some tariffs were announced before March 31 (which was the end of a reporting period for many companies), while others were announced on April 2. Companies may therefore need to consider the impact of the subsequent events disclosure requirements (ASC 855) on their financial statements. 

• Risks and uncertainties. The accounting standards (ASC 275) also require disclosure of risks and uncertainties that could significantly affect the amounts reported in the financial statements in the near term. Risks and uncertainties can stem from the nature of an entity’s operations, the use of estimates in preparing the financial statements, or significant concentrations in an entity’s operations. BDO provides this example: “[I]f an entity determines that a change in a tariff that was not known or knowable as of the reporting period end would be a triggering event for a material goodwill impairment in the following period, and that is known or knowable prior to issuing the financial statements, the entity is required to disclose that risk and potential effect.”

3.     SEC Reporting. Tariffs and their consequences for the company’s business may trigger various SEC reporting requirements.

• Regulation S-K.  The imposition of new tariffs and company responses to tariffs may require new or modified disclosure under SEC Regulation S-K disclosure rules in Item 101, Description of Business, Item 105, Risk Factors, Item 303, Management’s Discussion & Analysis, and Item 305, Quantitative and Qualitative Disclosures About Market Risks.  For example, Item 101 disclosure may be required if “[t]ariffs and related market disruptions may cause a registrant to change its overall strategy, operations, customer engagement strategies, or suppliers (such as where it sources its raw materials).”

• Form 8-K.  Companies may need to disclose material information related to tariffs in a Current Report on Form 8-K. For example, entering into or modifying a material definitive arrangement with a supplier or customer not in the ordinary course of business would require a Form 8-K filing.

• Non-GAAP measures. Companies that are considering the presentation of financial information that highlights the effects of tariffs should be aware of the SEC’s rules and guidance on non-GAAP financial measures.  Non-GAAP measures that are based on adjustments for costs that are normal, recurring, cash operating expenses are not allowed. Further, companies are required to explain why a non-GAAP measure is useful to investors and to consider whether the non-GAAP measure is consistent with measures used by management and communicated to the board.  However, BDO points out that the impact of tariffs may be disclosed without running afoul of the non-GAAP rules: “[A] registrant may disclose and quantify the effects of the tariffs in one place and separately list those effects without adjusting its GAAP results. For example, a registrant may include a supplemental table that describes each item and includes dollar amounts. While the non-GAAP rules and SEC staff guidance do not apply to such supplemental information, a registrant that presents such a table should consider explaining how and why this information can help investors analyze the registrant’s results.”

4.     Internal Control Over Financial Reporting.  Management may need to design and implement new or modified controls to address the complexities and risks associated with tariffs. BDO offers this example: “This could involve revising controls over estimation processes, particularly for estimates related to future cash flows. It is critical that entities do not rely excessively on historical information, and only include information that was known or knowable as of the measurement date.”  Material ICFR changes must be disclosed.

5.     Auditing Considerations.  Because of the economic uncertainties arising from the Administration’s tariff program, there may be new risks of material misstatement that the auditor must address. Auditors may also encounter increased difficulty in obtaining sufficient appropriate audit evidence.

• New financial reporting risks.  BDO notes that the auditor needs to understand how tariffs and resulting economic uncertainty may affect the entity and suggests a series of questions that auditors should ask as part of their audit planning.  The auditor also needs to consider “heightened risks of misstatement in specific accounting and disclosure areas, including revenue recognition, valuation of assets, risk disclosures, and subsequent events.”

• Obtaining sufficient appropriate audit evidence. Changes in tariffs and resulting economic uncertainty and new financial reporting risks may require auditors to adjust the nature, timing, and extent of their audit procedures. BDO lists some examples and states that audit procedure adjustments may increase audit effort and cost.

• Effect on the audit report.  The PCAOB’s rules require audit reports to include a discussion of critical audit matters (CAMs).  “The effects of new tariff measures and resulting economic uncertainty on the entity’s financial statements and disclosures may lead auditors to identify new CAMs or revise disclosures related to previously identified CAMs.”

6.     Corporate Governance and Shareholder Considerations.  BDO recommends that boards and audit committees work with management, auditors, and advisors to evaluate tariff-related risks and formulate responses. BDO also suggests that shareholders may be interested in how companies “are managing significant challenges and risks, including those to supply chain management, arising from the tariff measures and resulting economic uncertainty and how executives are contingency planning.”

• Audit committee oversight. Audit committees should consider the following questions as they engage with management and the auditors:

a.     Do the financial statement disclosures reflect changing risk factors, such as changes in supply chains, pricing decisions, loss of significant customers, and disruptions to production?

b.     Do the financial statement disclosures reflect subsequent events that were known or knowable before issuing the financial statements that users of financial statements will find meaningful and reflective of industry-specific considerations?

c.     Are controls over financial reporting adequate to respond to the effects of tariffs or the resulting economic uncertainty, including the risk of fraud?

d.     Will financial statement deadlines be affected by changes to procedures performed by the entity, its specialists, or the auditors?

e.     Is the committee meeting often enough with management and the auditors to address challenges as they arise?

f.      Is the committee keeping the board apprised of significant matters with respect to risk and disclosure?

• Shareholder questions. Boards should expect shareholder questions about such matters as risk assessment and anticipated effects of tariffs; response to tariffs, including changes in product procurement, customer demand, and earnings; financial reporting and disclosures to tariff convey risks; and industry-specific risk mitigation plans, such as contracts, supply chain, and technology.

Audit Committee Takeaways

For many companies, operating and strategy issues associated with the new tariff program and the resulting economic uncertainty are major current challenges.  As companies struggle with these challenges, consideration of the financial reporting and disclosure implications of tariffs may not be top-of-mind.  BDO’s paper provides a comprehensive overview of how tariffs may affect reporting and disclosure.  Audit committees should focus on how financial reporting management is addressing those issues. BDO’s audit committee questions are a good starting point. 

Since tariff policy has the potential to change significantly on a daily basis, audit committees should also ensure that management is monitoring developments and policy changes.  As events unfold and companies respond, the audit committee should make sure that management considers the financial reporting and disclosure implications.