Financial Statement Concerns for Manufacturing Companies

Feb 16, 2021Accounting, Manufacturing, Nonprofit

Good accounting practices are an important tool for managing a manufacturing business. Given the industry’s uncertainty, it is crucial to fine-tune financial statements for users of them to review reliable information. We have provided a guide below highlighting common financial statement concerns for manufacturing companies.

manufacturing industry financial statements

INVENTORY

  • Pricing & Obsolescence 
    • Many manufacturing companies are experiencing volatility with prices for raw materials and other inputs in the current environment. Based on the method used to cost inventory, companies may need to consider reviewing their pricing model for accuracy and compare it to current prices.
    • For example, suppose a company uses an average price costing method and typically pays near the same price per unit over an extended period. The system may never have cared about FIFO or average cost; now, swings might matter more with more volatile prices. Additionally, changes in the supply chain, demand for products, and workforce issues could lead to a decrease in the net realizable value of inventory, or in extreme cases, make a specific inventory item obsolete. Manufacturing companies should assess their inventory’s carrying value and verify if cost or net realizable value is a more accurate value.
  • Production Levels Below Normal
    • According to ASC Topic 330, Inventory, when a company’s production levels fall below normal, they must expense a portion of their fixed overhead rather than capitalizing them into inventory. When at normal capacity levels, fixed overhead costs are typically capitalized on a per-unit basis into the cost of inventory. If all fixed overhead were to be capitalized during low production, it might give an inaccurate depiction of the inventory’s actual cost.

COVID-19

  • PPP Loan Forgiveness
    • Based on when your manufacturing company receives/received forgiveness on their PPP loan, there are different options for treating the accounting for the PPP loan. If forgiveness was received before year-end, the forgiveness can be recorded as either operating revenue or non-operating revenue based on management’s decision. If forgiveness has not yet been received or received after year-end, there are a couple of options:
      • The PPP loan can remain on the balance sheet as a long-term debt, with a footnote explaining the deficit is likely to be forgiven in full.
      • Alternatively, there is the option to consider the loan an advanced payment on a federal grant with conditions, as those conditions were met by spending the funds on allowable expenses, income can be recorded.
  • Subsequent Events
    • With the unknowns of the length of time and the future impacts the pandemic will have on your manufacturing business, a subsequent event disclosure should be considered. This would be viewed as a non-recognized subsequent event. The footnote could be used to explain subsequent impacts such as government-mandated restrictions, reductions in employees, additional government relief received, or other effects.
  • Accounting Estimates & Asset Impairment
    • The information used to support specific accounting estimates may be affected by the consequences of COVID-19. For instance, if customers delay making payments or experiencing financial hardship, management may need to consider increasing or setting up an allowance for doubtful receivables. Along similar lines, all assets should be reviewed for potential impairment. This could include setting up an allowance for doubtful receivables, a reserve for inventory, reviewing property and equipment and intangible assets, and deferred tax assets.

LEASES

  • New Leases Accounting Standard
    • If your manufacturing business has a large number of leases or a long-term lease, you should consider discussing the impacts the new leases accounting standard will have on your balance sheet with your bankers. Under FASB ASC 842, Leases (effective for years ending December 31, 2022), companies are required to move all long-term leases to their balance sheet as both a lease asset and lease obligation liability. The addition of a lease obligation liability may impact your debt to equity ratio. Working capital and current ratios are negatively affected by the current portion of the lease obligation liability, and additional, more complex disclosures will be required for leases. Discuss these items with your banker and the impact they may have on loan covenants. For additional details on the new lease accounting rules or to learn more about how we can help, please contact a Smith Schafer professional.
  • Rent Forgiveness
    • A lessor or lessee may decide to modify the terms of a lease agreement due to the effects of COVID-19. For instance, some companies were given periods of free rent as a result of the pandemic. Management needs to make sure to fully understand the consequences of the changes made to the lease. In some cases, the months of free rent may have been added to the end of the lease. In this case, a liability would need to be accrued for the rent. In cases where the rent was forgiven and will not be paid at a future date, income for rent forgiveness should be recorded along with the related rent expense.

QUESTIONS?

Industry knowledge and close collaboration are instrumental in providing our manufacturing clients with the insight and awareness to make the best business decisions and seize growth opportunities. Smith Schafer is a recognized leader in providing accounting and consulting services to the industry since 1971. We have a team of experts focused on working with the manufacturing industry and committed to helping our clients succeed. For additional information, click here to contact a Smith Schafer CPA expert. We look forward to speaking with you soon.

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