During the past two years, numerous tariffs have been enacted under various legal frameworks. While much discussion has surrounded the business impact and the accounting surrounding recognition, entities are beginning to consider what happens when tariffs are refunded.
Historically, it’s not uncommon for tariffs to be refunded under duty drawback programs and certain tax credits, but the magnitude of entities impacted by tariff refunds has dramatically increased recently following the U.S. Supreme Court’s ruling that certain tariffs enacted under the International Emergency Economic Powers Act were deemed unlawful. This has created the potential for tariff refunds for a wide range of U.S. businesses. Accounting for this activity depends on whether the refund is contingent as well as the initial entries recorded when the tariff was paid.
GAAP Recognition Threshold for Tariff Refunds
The recognition of tariff refunds is not explicitly addressed within accounting principles generally accepted in the United States (U.S. GAAP). Many entities will determine it reasonable to apply gain contingency accounting under Accounting Standards Codification 450, Contingencies, where recognition of a tariff refund should be deferred until the refund is realized or the contingency is substantially resolved. If a claim has been filed but uncertainty exists, those amounts should be disclosed at a measurement date but not recorded. Alternatively, entities could make a case for recognizing the refund under loss recovery accounting which would set a “probable” threshold that the refund will occur in order to be recognized.
Inventory and Cost of Sales Treatment
Under U.S. GAAP, inventory on hand should include any tariffs paid in the capitalized cost. This follows the same treatment of other costs incurred to acquire an asset. When tariffs are reversed on inventory that had been sold, the refund should generally be recorded as a reduction to the cost of sales account used to record the tariff expense. If inventory is still on hand, the carrying value of that inventory should be reduced.
Fixed Asset and Interest Income Treatment
Tariffs incurred in acquiring long-term assets like property, plant and equipment should also be capitalized as part of the cost to place the asset into service. If a refund is received relating to the purchase of these assets, the refund should be applied against the carrying value of the asset and future depreciation or amortization should be adjusted prospectively. If the asset has been sold or is fully depreciated, the refund should be recognized as a gain.
Tariff refunds may also include an interest portion, which should be accounted for under interest income or other income.
Who Can Claim a Refund — and Who Owes Customers a Share
If there’s a determination that a portion of the tariff refund will be passed along to the entity’s customers through their contract or under an implicit obligation, then an amount should be accrued for as a current liability. The amount should be accrued when the refund is recorded as either a receivable or through cash received. If there’s no contract or implicit obligation and a refund is later agreed to between the entity and a customer, then this should be treated as a contract modification.
Since importers pay tariffs, they are generally the entities that could be eligible for refund. Vendors and ultimate customers of these importers would not recognize a tariff receivable unless they have negotiated a contractual right with the importer to share a potential tariff recovery.
IFRS Treatment
Entities following International Financial Reporting Standards (IFRS) should apply a similar accounting treatment under revenue recognition and asset cost value recognition under U.S. GAAP and IFRS since the accounting standards are now largely converged. The recognition of the tariff refund would be more conservative under International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets. Under IFRS, this would be disclosed as a contingent asset and only recorded after realization is virtually certain.
Entities should continue to be mindful of additional new tariffs. For information on the accounting surrounding tariff recognition please see our prior article – Accounting for Tariffs.
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