Inventory Management in Times of a Pandemic
One of the consequences of the COVID-19 pandemic outbreak is a considerable change in consumer habits. As a result, companies may experience a sizable decrease or increase in demand. Managing the supply chain in this unprecedented environment will likely become a challenge. While the responsibility for adapting and responding to these challenges will span well beyond the accountant’s office, there are several important accounting considerations in this area specifically related to inventory management.
Decrease in Demand
Economic uncertainty caused by COVID-19 will likely lead to a decline in demand and sales within certain industries (i.e., for clothing items or other similar retail goods during the stay-at-home orders). For organizations in industries that normally hold a large amount of inventory, management should evaluate whether there needs to be an adjustment to the stock’s carrying value. This includes both on-hand as well as firm commitment on future purchase of these items. Various seasonal supplies and products with a short shelf life are at a higher risk level of loss.
Under US Generally Accepted Accounting Principles (GAAP), the decline in the carrying value of inventory should be recognized as an expense in the period it occurs following two primary methods:
- Direct write-off, where the valuation of impacted inventory will be decreased with a corresponding expense.
- Allowance, which uses a contra-asset account (such as inventory reserve) along with an expense account until such a time that the stock is disposed when both inventory and inventory reserve (or similar account) will decrease.
Increase in Demand
Certain organizations and industries will see an increase in demand for their products during economic downturns (i.e., a surge for cleaning supplies and disinfectants during the COVID-19 pandemic). As a result of this, it would be expected that the costs of materials/ components used in manufacturing may also escalate if additional suppliers are needed or if a premium price is required to source materials on short notice. This may require review of the inventory costing assumptions and models. Specifically, the company will need to consider whether the treatment of the significant variances (from the standard costing) should follow the standard or adjusted process.
Another consideration would be triggered if there is a decrease in the production line output caused by a shortage of raw materials. For example, fixed overhead allocation per unit will likely increase with any unplanned work stoppages or delays. Management will need to apply a level of judgement in determining how production is performing versus normal capacity. Under the accounting rules, costs outside of the “normal range” should be expensed in the period incurred.
Outside of the significant changes in demand, companies will also need to consider implications from a broader range of impacts caused by COVID-19:
- Interruptions within the logistics network, which can cause an inability or delay in delivering goods to customers or receiving raw materials required for manufacturing.
- Pre-buys of raw materials, and as a result, potential modifications to supply contracts.
- Inability to effectively perform inventory counts (for example, cycle counts may not be performed or delayed due to social distancing measures and restrictions).
- Impairment considerations related to the facilities owned and/ or leased by companies as a result of a decline or slowdown in production or usage of the assets.
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