Ind AS accounting impacts of tariffs

Tariffs are not new to the global economic landscape. A country can impose tariffs on goods being imported into its jurisdiction for reasons such as protection to domestic industries, encouraging foreign investment and local production of goods or services, to increase government revenue, tariff retaliation and/ or geopolitical and policy issues. In recent months, prominence and impact of tariffs have grown significantly for reasons such as new tariffs, including reciprocal tariffs, imposed by the US and, in response, a number of affected countries have responded with retaliatory tariffs

Considering changes in tariff policies, entities are likely to face complex operational and compliance challenges such as supply chain disruptions, increased costs, price fluctuations and shifts in market demand. It is evident that senior management of impacted entities will focus on mitigating supply chain disruptions and operational hurdles. However, in doing so, one should not ignore financial reporting consequences of tariffs since introduction or modification of import taxes can lead to significant accounting and financial reporting implications. This article highlights certain key accounting and reporting considerations related to the tariffs. It may be noted that these considerations are not all-inclusive and entities need to use judgment based on their specific facts and circumstances. Further, since tariff policies are constantly evolving, entities need to monitor legislative and regulatory developments for potential accounting and reporting implications

Key considerations

Asset impairment

Ind AS 36 Impairment of Assets deals with impairment of assets e.g., property, plant and equipment, goodwill, rightof use assets and intangible assets. Among other matters, Ind AS 36 requires goodwill and indefinite-lived intangible assets (such as trade names) to be tested for impairment at least annually or more frequently if there is an indicator of impairment. It also requires other assets to be tested for impairment when there is an indicator of impairment.

Indicators of impairment can include significant changes with an adverse effect on the entity that will take place in the near future in the market to which an asset is dedicated, as well as situations when the carrying amounts of the net assets of the entity are more than its market capitalization. Given the substantially higher tariffs imposed on some countries and volatility in the stock market, entities will need to carefully monitor if any impairment indicator exists. For example, tariff increases the cost of assets/ inventory that are imported and if the entity is unable to pass these rising costs on to customers, it may indicate that carrying amount of the noncurrent assets is not recoverable. Consider one more example which may indicate impairment. Contract with the customer requires the entity to bear any tariffs imposed in customers’ jurisdiction and there are additional tariffs imposed.

If there are indicators, entities will need to test assets for impairment. While testing impairment either due to indicators and/ or due to annual impairment testing requirements, entities will need to consider whether assumptions used to calculate recoverable amount are up to date and related disclosures are clear and meaningful. Value-in-use calculations should consider multiple scenarios and higher discount rates to reflect the greater uncertainty in cash flows due to tariffs. When the recoverable amount of the assets/ cash generating unit (CGU) is lower than the carrying amount of the asset/ CGU tested, an impairment loss will need to be accounted for.

Inventory

Ind AS 2 Inventories requires entities to account for inventories at the lower of cost and net realizable value. Tariffs may result in increase in cost of inventory and/ or reduction in net realizable value. Entities should ensure that assumptions related to tariffs, as well as the effect of those assumptions, are included in determination of net realizable value. If there is insufficient margin in the entity’s ultimate selling prices to absorb the tariff and the entity does not believe it will be able to increase its ultimate selling prices sufficiently, there will be a need to write down that item of inventory to the lower of its cost or net realizable value. If net realizable value increases in a subsequent period, the entity would reverse these write downs. However, the amount of gains recorded by an entity should not exceed the original cost. If supply-chain disruptions affect an entity’s ability to operate its manufacturing facilities at normal capacity, entities will need to reconsider fixed overhead costs which can be included in cost of inventory. For example, certain entities may be forced to operate their manufacturing facilities at abnormally low level which will require them to expense abnormal overhead costs as incurred

Revenue

Tariffs are generally levied on and paid by the importer/ purchaser of the goods. This indicates that there may not be a direct accounting implication for a seller of goods subject to a tariff. However, this may not hold true in many cases. It is possible that the seller of goods needs to bear the impact of tariff levied on purchaser, either due to explicit requirements of the contract with the customer or the customer may renegotiate terms in response to the imposition of the tariff. Also, where the entity is the importer of the goods which have been subjected to tariff, it may strive to recover those tariffs from customers either in accordance with terms of previously agreed contract or through modification of the contract. Also, tariff imposition on the imports of the entity may increase the overall cost of completing the contract

Entities must consider whether changes in pricing of existing customer contracts due to tariffs need to be accounted for as variable consideration or a contract modification. If an existing contract contains legally enforceable terms that allow an entity to pass the increased costs of tariffs to their customers automatically, any change in the transaction price would be accounted for as a change in the estimate of variable consideration and, generally, allocated to the performance obligations on the same basis as their initial allocation at contract inception. If a price change resulting from tariffs needs to be separately negotiated and agreed with the customer, the contract modification requirements in Ind AS 115 Revenue from Contracts with Customers are applied once the modification is enforceable. Based on the facts and circumstances, the contract modification would be accounted for either as a separate contract, a termination of the existing contract and creation of a new contract, or as a part of the existing contract

Tariffs might affect the measure of progress for over-time performance obligations under which a cost-to-cost input method (i.e., costs incurred relative to total expected costs) is applied to measure an entity’s progress toward satisfaction of the performance obligation to recognize revenue.

Entities need to understand the purpose of each tariff and what triggers an obligation to pay a tariff to determine whether they are incurring the tariff expense itself (i.e., the entity is liable) or they are paying the tariff on behalf of the customer. This will impact whether the tariff is presented as expense or netted off from revenue recognized during the period

Tariffs may also impair the customer’s ability to pay amounts due under the contract. In respect of amount previously recognized as revenue, this will affect measurement of the expected credit losses on trade receivables. In respect of further revenue recognition, entities may need to reconsider their conclusion on existence of contract in view of the customer’s inability to pay. If the entity concludes that the contract with the customer does not exist, further revenue recognition may be precluded

Depending on the uncertainties involved, entities may also need to revisit disclosures required under Ind AS 115. Particularly, disclosures requiring specific attention include significant judgments and changes in judgments, revenue recognized in the current period for performance obligations satisfied (or partially satisfied) in a prior period and methods used to recognize revenue over time.

Financial instruments

Entities with lending activities will need to consider the requirements in Ind AS 109 Financial Instruments when measuring expected credit losses (ECL) on financial instruments as tariffs may adversely impact the ability of borrowers to repay their debts and could trigger impairment losses. Borrowers that are adversely affected by tariffs should consider the impact on their debt covenants. Also, entities need to assess whether the contractual terms of borrowings are modified substantially and apply the appropriate accounting. Tariffs and the related uncertainty may also impact the fair value of financial instruments. Entities should consider whether valuation techniques, judgment and assumptions are appropriate and ensure that the related disclosures are clear

Share-based payment awards

The significant uncertainty in the current environment may prompt entities to amend the terms and/or conditions of share-based payment awards to keep employees and others providing similar services incentivized. An entity must apply modification accounting if amendments change the fair value, vesting conditions or classification of the award. When an award is modified, the entity is required to, as a minimum, recognize the cost of the original award as if it had not been modified unless the award does not vest because of failure to satisfy a vesting condition (other than a market condition) that was specified at grant date. In addition, when the effect of the modification increases the fair value of the award, the incremental fair value is recognized. The incremental fair value is spread over the period from the date of modification until the vesting date of the modified award, which might not be the same as that of the original award

If entities or employees cancel any equity-settled share-based payment awards during the vesting period, the cancellation should be accounted for as an acceleration of vesting and the entities must, therefore, recognize immediately the amount that otherwise would have been recognized for services received over the remainder of the vesting period. However, if a new equity instrument is granted and identified as a replacement of the cancelled award, the entity accounts for the granting of the replacement equity instruments in the same way as a modification of the original grant of equity instruments

Provisions and contingent liabilities

When an entity has a regulatory, legal, or contractual obligation to pay a tariff, the amount and timing of that obligation is usually clear and there is no uncertainty involved. In these cases, liabilities are generally recognized and measured in accordance with Appendix C Levies to Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets. When it is not clear whether an obligating event to pay a tariff has occurred or what amount is required to be paid (e.g., there is ambiguity in the tariff policy), an entity is required to apply the guidance in Ind AS 37 to recognize, measure and disclose any potential tariff liabilities.

If the introduction of tariffs makes a contract loss-making, entities will need to consider whether the contract is onerous. A contract is considered onerous when the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. If an entity has a contract that is onerous, Ind AS 37 requires the entity to recognize and measure the present obligation under the contract as a provision. Ind AS 37 specifies which costs an entity needs to include when assessing whether a contract is onerous or loss-making

Income-tax implications

It may be appropriate for entities to evaluate how imposition of tariffs impact profitability, liquidity and impairment concerns. This may have an impact on income tax accounting in accordance with Ind AS 12 Income Taxes. To illustrate, consider a scenario where imposition of taxes results in significant reduction of the entity’s current year profit or it may even incur losses. This is further accompanied by reduction in future profits or a forecast of future losses. This will obviously require the entity to reassess recognition of deferred tax asset in accordance with Ind AS 12. If deferred tax asset recognition criteria are no longer met, then the entity may need to write off previously recognized deferred tax asset through the Statement of Profit and Loss.

Further, depending on forecast profitability and funding requirements at various group entities level, the entity may need to upstream undistributed earnings of subsidiaries, associates and joint ventures, which was previously not required. This may be accompanied with reduction in dividend paid by the entity to its shareholders. From Ind AS 12 accounting perspective, this will require entities to revisit their previous conclusion related to recognition of deferred tax liability on undistributed earnings of subsidiaries, associates and joint ventures.

Subsequent events

A subsequent event that provides evidence about conditions that did not exist at the balance sheet date (i.e., those that arose after that date) is not recognized in the financial statements. A tariff that is levied or amended after the balance sheet date may be non-adjusting subsequent event in many cases. However, this may not always be true. It is imperative that entities evaluate facts and circumstances existing before the reporting date and leading up to imposition of tariff to determine whether imposition of tariff after the reporting date should be considered as an adjusting or nonadjusting event in accordance with Ind AS 10 Events after the Reporting Period.

Even if the entity concludes that imposition of tariffs after the reporting date is a non-adjusting event, such a non-adjusting subsequent event may need to be disclosed to prevent the financial statements from being misleading. Such disclosure should include both the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made

Discount Rates

With tariff uncertainty, the potential for high inflation and a general economic downturn, entities should revisit whether discount rates used to calculate value-in-use, employee benefit provisions, incremental borrowing rates for leases, provisions and share-based payments are still appropriate.

Going Concern

Management is required to assess an entity’s ability to continue as a going concern, including whether the going concern assumption is appropriate, and provide relevant disclosures for both annual and interim reporting periods. An entity needs to assess whether it has sufficient liquidity to continue to meet its obligations as they fall due. It should also revise budgets and forecasts to take into account the increased uncertainty. Entities need to consider whether their ability to access financing is impacted and the related consequences.

Prospective financial information

Management needs to carefully evaluate the implications of trade policy and tariffs on projections and other assumptions used in preparing the financial statements, including determining how tariffs may affect cash flow projections used in prospective financial information. Entities also need to consider how uncertainty caused by tariffs could affect the discount rate. Projections should be consistently applied (e.g., measurement of fair value, asset impairment tests, realizability of deferred tax assets tests) and should reflect the effects of the current economic environment, including tariffs.

Other accounting and reporting considerations

Entities should assess whether lease assets and liabilities need to be remeasured as a result of reassessing renewals, terminations, or purchase options, e.g., if the entity decides to relocate its facilities in response to tariff

Tariff uncertainties and the associated disruptions to traditional trade routes could lead to restructuring initiatives. Restructuring costs are recognized only when the general recognition criteria in Ind AS 37 are met, i.e., there is a present obligation (legal or constructive) as a result of a past event, in respect of which a reliable estimate of the probable cost can be made.

New government support programs for entities significantly impacted by tariffs may be introduced. Only once introduced and in place would entities begin to account for the associated government grants subject to the requirements of Ind AS 20 Accounting for Government Grants and Disclosure of Government Assistance.

Ind AS 34 Interim Financial Reporting requires a condensed interim set of financial statements to explain events and transactions that are significant to an understanding of the changes in financial position and performance since the previous annual financial statements and to provide an update to the relevant information included in the last annual financial statements. Ind AS 34 sets out a number of required disclosures as well as a non-exhaustive list of events and transactions for which disclosures would be required if they are significant

Financial statement disclosures

Financial statement disclosures will vary based on the magnitude, duration, and nature of the effects of the current economic environment including tariffs on businesses and the availability of information required to make the disclosures. Ind AS 1 Presentation of Financial Statements requires disclosure of information about the assumptions concerning the future, and other major sources of estimation uncertainty at the end of the reporting period, which have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. An entity is also required to disclose the judgments, apart from those involving estimations, that management has made in the process of applying its accounting policies and that have the most significant effect on the amounts recognized in the financial statements

How we see it

Given the current economic environment, including tariffs, entities need to continuously evaluate the related effects on their business and financial reporting, provide disclosures on the material effects, and update the disclosures as circumstances change. Entities should avoid using boilerplate language in their disclosures and instead provide specific, tailored information that allows investors to evaluate the current and anticipated effects of the current economic environment including tariffs from the perspective of management. Entities should determine the financial reporting areas impacted by import tariffs and the measurement and disclosure requirements that apply. They should provide clear and meaningful disclosures about judgments and assumptions made