The Hidden Balance Sheet Impact: How Tariffs Are Reshaping Financial Reporting
Published on by Matt Rosen, Lane Zedrick, in Manufacturing
When President Trump signed Executive Orders on February 1, 2025, imposing new tariffs on imports from Canada, Mexico, and China, most business leaders were quick to understand the operational implications. What many didn’t anticipate was the maze of complex financial reporting challenges that would soon consume their accounting departments.
The scale and scope of tariff-related financial reporting implications have proven more extensive than anything seen in recent decades. And while the basic principle that tariffs affect inventory costs remains straightforward, the current environment introduces unique challenges:
- The speed of implementation
- Constantly changing rates
- Ongoing legal challenges
- The sheer magnitude of costs
Combined, these factors have transformed simple accounting exercises into complicated applications that require careful judgement and nuanced legal interpretations – and increase the burden on finance, operations, and legal teams across industries.
Understanding tariffs as inventory costs
At its core, the accounting treatment is grounded in a basic principle: tariffs are part of the cost of acquiring inventory, not a separate expense to be immediately recognized on the income statement. FASB Accounting Standards Codification 330-10-30-1 defines inventory cost as “the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location.”
This means tariff costs associated with the acquisition of inventory are recorded on the balance sheet, flowing through to cost of goods sold only when the related inventory is actually sold. In an environment where tariff costs can represent 25% to 55% or more of product costs, this timing difference matters considerably.
Abnormal cost classification is problematic
As tariffs have escalated, some companies have attempted to classify them as “abnormal costs” that should be expensed immediately, or as general administrative expenses. Both approaches are problematic. While the current tariffs may have been unanticipated, they represent routine supply chain costs once implemented.
Leading accounting firms have been clear: tariffs do not represent abnormal costs, but rather increased costs of acquisition for otherwise routine purchases. They must be capitalized, regardless of their magnitude.
The net realizable value challenge
Once tariff costs are embedded in your inventory balance, you face a critical question: is that inventory worth what you paid for it? Accounting standards require inventory to be measured at the lower of cost or net realizable value—the estimated selling price minus reasonably predictable costs to complete, dispose of, and transport the inventory.
Data from the Federal Reserve Bank of Boston shows that during 2025, businesses expected to pass on only about half of their cost increases to customers. For companies dealing with tariffs ranging from 10% to 55% or more, that level of margin compression creates significant exposure to net realizable value write-downs.
Here’s where things get particularly frustrating: once inventory has been written down below its cost, the reduced amount becomes the new cost basis that should not subsequently be marked up if it’s later determined that the costs were recoverable.
Operational complexity in capturing tariff costs
Tariffs don’t arrive in a single, uniform way. Depending on your supply chain structure, you might encounter them through multiple channels: directly assessed when you’re the importer of record, passed-through by freight carriers or logistics providers, embedded in supplier price increases, or subject to separate negotiations with suppliers. Each requires different processes and controls, and for companies sourcing from multiple countries with different tariff rates, the data management challenge can become enormous.
While accounting guidance requires tariffs to be capitalized into inventory cost, it doesn’t dictate exactly how. Three general approaches are often utilized: part-specific tracking where tariff costs are embedded in individual item costs (most precise but most complex), treating tariffs as purchase price variances subject to capitalization in a standard costing system, or capturing them as overhead costs reflected in overhead capitalization rates. The choice depends on your systems, the magnitude of exposure, and resources available for implementation.
The legal uncertainty factor
The U.S. Court of Appeals for the Federal Circuit has ruled that certain tariffs exceeded available legal powers. By some estimates, the affected “IEEPA’” tariffs comprise between 50% and 80% of all tariffs being assessed. While they have remained enforceable during the Administration’s appeal, the Supreme Court has yet to publish their ruling, which could happen at any time. If lower court decisions are upheld, businesses could potentially receive refunds.
Questions arise on whether a receivable can be recognized for tariffs paid subject to the ongoing legal challenges. The accounting guidance establishes a high bar for recognizing potential recoveries. The prevailing practice requires that a claim for recovery be recognized only when probable, and there’s a presumption that recovery is not probable when subject to litigation. Until there’s a final legal determination, recognizing a receivable for potential refunds would be difficult to support for most companies.
Revenue recognition complications
Many companies found that their existing contracts don’t provide clear rights to pass-through tariff costs. Even when customers are generally receptive, actually getting an agreement in place takes time. The natural inclination is to recognize the expected recovery in revenue, but confidence in recovery alone isn’t sufficient under the revenue recognition standard.
When contracts include tariff recovery provisions, the recovery generally represents variable consideration that must be estimated and included in the transaction price, but only to the extent it’s probable that a significant reversal won’t occur.
When contracts don’t include such provisions, contract modifications are required. The critical issue is that modifications must create legally enforceable rights and obligations in order to be recognized.
The modifications’ impact are recognized on a cumulative catch-up basis on the date the modifications are made – not when you might expect, and that can create unanticipated timing mismatches: compressed margins in the period when goods are delivered, followed by windfall margins in a later period when the modifications are finalized – even though economically, you’re just recovering costs.
Practical action steps
While the focus for many business leaders has been on managing the tariffs’ economic impacts whether by assessing alternative sourcing or strategizing how to get reimbursed by customers through pricing increases, the financial reporting implications also need to be considered.
The tariff environment has exposed challenges to many companies’ systems and processes where the volatility and constantly changing dynamic has not allowed companies to settle into a ‘new norm’ and institute new, and stable, processes.
However, with reporting season upon us for many companies, there is no longer time to settle in. The combination of technical accounting requirements, lack of systematic processes, the judgements requirement, and the magnitude of the impacts requires careful planning and cross-functional coordination to navigate.
