The COVID-19 pandemic has had significant impact on businesses and the economy. While the full extent and duration remains unclear, how the pandemic affects the accounting of accounts receivable and inventory needs to be considered.
Collectability of Accounts Receivable
Due to the economic decline, businesses may need to reconsider how the estimate for bad debt is calculated. COVID-19 has brought unprecedented times, therefore, historical estimates may no longer be appropriate. Customers may be faced with cash flow challenges which could impact their ability to make payments. Business owners need to evaluate whether or not receivables can be collected and consider accepting partial payment or extended payment terms. If it is determined that a receivable is not collectible, the loss needs to be recorded.
Offering extended payment terms to new or existing customers may also indicate that the contract includes a significant financing component. When a significant financing component exists, the entity needs to adjust the transaction price considering the effects of time value of money if the timing of payments agreed to by the parties in the contract provides the customer or the entity with a significant financing benefit.
Valuation of Inventory
There are 3 major points to consider regarding the valuation of inventory.
- Lower of Cost or Net Realizable Value
US GAAP requires that most inventory be measured at the lower of its cost or net realizable value. In this volatile economic environment, businesses need to consider if the utility of inventory has been impaired. Businesses may have to reduce the sales price to sell inventory on hand and record the loss when it is expected for the margin to be negative upon sale of inventory. Seasonal inventories, perishable products and products with shorter shelf lives would be most exposed to the risk of loss.
- Excess Inventory
Businesses must assess whether a larger reserve for obsolescence or slow-moving stock may be necessary as a result of a slower sales pace. In addition, an evaluate on project-based inventory is needed if a customer cancels a project. If the result of the cancelled project is excess inventory that cannot be sold to other customers, a loss needs to be recorded to reduce inventory value.
- Manufacturing Cost Calculation
US GAAP states that variable overhead should be allocated to work-in-process and finished goods based on the actual usage of the production facilities. Fixed overhead, however, is allocated to work-in process and finished goods based on the normal production capacity of the enterprise’s production facilities. The overhead rate needs to be recomputed in instances when actual production exceeds the normal capacity. However, situations of unexpected production shutdown can result in an abnormal reduction in production level. Large expenses resulting from idle facilities should be treated as a period cost and should not be allocated to inventory.
If you have any questions or concerns regarding the pandemic effects on your business’ accounting for AR and Inventory, please contact our Assurance Senior Manager, Tomoko Nakao.