For decades, many American companies have relied on the global economy to provide them with the supplies, components, and talent they need to achieve their business goals. The recent introduction of new tariffs disrupts this balance, creating considerations that businesses must factor into their operations.
Tariffs involve adding a tax on imported goods paid to the government. In some cases, the institution of tariffs on imports from one country may lead other countries to place tariffs in retaliation, creating what is commonly called a “trade war.”
Although the existence and extent of tariffs that the U.S. government places on imports has been changing rapidly in recent weeks, many businesses must prepare for the effects. Tariffs on materials or finished goods can increase costs, lower profit margins, or force companies to reconsider their global trade strategies. These changes also affect how businesses disclose information about the impact of tariffs on their bottom lines. By following a tariff compliance checklist or reading the information below, business owners and other stakeholders can determine how best to comply with regulations and how to handle financial reporting for tariffs.
Understanding Tariffs: A Brief Overview
Tariffs come in different forms. Ad valorem tariffs tax a percentage of the value of the item imported, while a specific or fixed tariff applies an exact charge. For example, a company might have to pay a 10% tariff rate on the value of a material imported from a country with that tariff. If they must use imported energy to meet production goals, they may pay a fixed tariff amount for each unit of energy they consume. In some cases, compound tariffs set both a percentage and a fixed value for the duty that importers must pay.
When businesses observe a change in tariffs that affect operation and production costs, they must determine how to handle the change. Key stakeholders should evaluate the extent of the changes and plan ahead. Some companies decide to pass on the increased costs to their customers to preserve their profit margins, while others may choose to keep pricing competitive as a way of preserving their customer base. Depending on the tariff costs and the extent to which company expenses change, organizations may need to pivot quickly to reconfigure expense planning and sales estimates. In certain circumstances, businesses may need to file additional disclosures to notify investors of these changes, outside of the normal financial statements.
Cost of Goods Sold (COGS) Implications
The introduction of tariffs may prompt companies to perform a digital transformation in accounting, re-evaluating the value of their inventory as well as their short-term cost assumptions. Broad, sweeping tariffs can do more than increase the cost of goods. They may also raise the cost of services related to the imports or create interruptions to the supply chain. Businesses should be aware of the following potential impacts:
- Direct increase in the cost of raw materials or components produced
- Changes to supplier contracts
- The need to search for new suppliers with fewer tariff impacts
- Updates to accounting systems to factor in new costs of inventory or overhead
Evaluating options quickly and thoroughly can be challenging, particularly in a political climate that frequently changes. Some companies may choose to look for trade partners and suppliers that are closer to their operations home, in nearby countries if not domestically. While this approach, known as “nearshoring,” often yields benefits in terms of reduced transportation costs and time, the existence of tariffs on the country of origin dictates whether it is a practical way to reduce the burden of the tariff rate.
Margin & Profitability Impact
Which financial aspects are most impacted by tariffs depends on the industry and the tariffs in question. For example, some businesses may see a growing disparity between operating income and net income. While a company with strong profit margins and multiple options for sourcing materials might have to adjust its accounting strategy in response, businesses with thinner profit margins might see their entire pricing strategy upended by tariffs.
Companies typically set prices strategically, so they neither leave too much money on the table nor lose market share to the competition. Tariffs can disrupt the paradigm, forcing organizations to decide whether to risk losing customers by raising prices, cut into their own profits by keeping prices the same, or some combination therein. Market volatility may call for some fluidity in financial planning, so companies can determine how to change prices and handle accounting for tariff charges.
Financial Reporting & Disclosures for Tariffs
In the Management’s Discussion and Analysis section of SEC filings, companies have the responsibility to detail important aspects of the company’s financial performance, risk factors, future prospects, and overall condition. A significant change to the organization’s operating costs, overhead, revenue, or margins (as a result of tariffs) should be included in this section. Although accounting standards for tariffs in Form 10-K and Form 10-Q reports may not require specific line items, companies should aim to be as specific as possible about tariff impacts. Common disclosures in financial statements may include:
- Outlines of changes to supply chain or material costs
- New risk factor calculations to accommodate tariffs
- Changes to revenue recognition, particularly for companies that cannot pass along the increased costs
The type of disclosures that companies must make regarding tariffs depends on the impact the organization expects. For many businesses that rely on imports, a sudden change in tariffs affecting imports or exports may require reporting of a material non-adjusting subsequent event. These disclosures indicate that the tariffs have a significant impact on the company’s supply chain, margins, and revenue. This type of disclosure comes in advance of the company’s regular reporting interval. Some organizations may even choose to release a Form 8-K filing to give a current update of the business’s financial situation.
Tax & Transfer Pricing Considerations
Minimizing tax burden is a common reason for companies to look at the global economy as a resource for cheaper materials, and tariffs can complicate this situation. Renegotiating the supply chain, or adapting to higher prices, may change a business’s tax liability and approaches to the following:
- Global Tax Strategies: Companies that relied on international suppliers or fulfillment may need to reconsider where they produce components or route shipments, to reduce the overall tax burden.
- Transfer Pricing: Businesses that use transfer pricing to account for services between departments or subsidiaries should evaluate how they apply these expenses from a taxation and compliance standpoint.
- Compliance: Companies changing the location of sourcing materials or production may need to file additional documentation to avoid the appearance of collusion.
Corporations should carefully evaluate changes to the supply chain or production plans, as moving to new locations may lower tariffs but add other taxes or regulations.
Managing Uncertainty & Scenario Planning
Companies that rely on scenario-based planning may discover that this approach is better for planning around the existing uncertainty tied to tariff costs. Scenario analysis might involve the running of various possible outcomes, including different tariff hikes or policy changes. These simulations can help businesses determine whether it makes sense to change suppliers or look for ways to produce domestically. The details provided in a scenario analysis can also assist organizations in hedging their strategies, to minimize long-term tariff impact while shoring up volatility in the short term.
Of the many trends in financial reporting, transparency remains key. Companies may feel reticent to reveal that tariffs will negatively affect their operations, but accurate estimation and reporting are required to maintain SEC compliance. Remaining compliant is the best way to avoid additional scrutiny and possible penalties from a failure to disclose.
Streamlining Tariff Compliance & Disclosures
While tariffs may create several questions for companies to answer in terms of general operations, they also create additional considerations for financial reporting. Staying on top of the latest tariffs and financial reporting requirements, in addition to using tariff accounting software, can help businesses navigate market volatility and avoid compliance failures. DFIN specializes in assisting companies with their financial reporting, including:
- Regulatory Filings: Our financial reporting software simplifies the process of filing a 10-K, 10-Q, or other forms with detail about impacts from tariffs.
- Virtual Data Rooms: Our virtual data room solutions allow businesses to collect and process data efficiently in a secure environment, ideal for supply chain adjustments or changes to M&A plans.
- Advisory and Tech Solutions: Outside of SEC filings, tools such as ActiveDisclosure help companies communicate consistent information about tariffs’ effects on costs or risk factors.
Browse our solutions to discover how DFIN can improve your financial reporting and compliance.
