Current challenges in the manufacturing industry and the impact on your financial reports

The manufacturing sector continues to feel the after-effects of COVID-19. Many countries have reactivated their economies, moving to a post-COVID ‘new normal.’ However, the challenges that emerged during the pandemic, including staff shortages, remain.

In addition to the above, current geopolitical issues in Europe add further strain to the sector. The Ukraine-Russia conflict has caused rising gas prices and reduced supply. As a result, many European companies are expecting to scale back production.

High inflation in the USA and other large economies is also impacting households. According to the Australian Bureau of Statics, over the twelve months to September 2022, the consumer price index (CPI) in Australia rose 7.3 per cent. This is a stark contrast to the previous five years when it was below 2.9 per cent. This may result in consumers severely cutting back on expenditure and could lead to a recession.

As a result, companies in the manufacturing sector are being impacted by:

•    Labour and staff shortages
•    Significant increase in freights and transport
•    High interest rates
•    High inflation resulting in high energy costs, supplies and salaries to staff
•    Delays and shortage of raw material and electronics

To support the sector, the Australian Government has implemented a manufacturing initiative. It will run over the next 10 years, with an initial commitment of $1.3bn. This government initiative aims to help manufacturers to scale up and create jobs. It will lift manufacturing capability, drive collaboration, and identify new opportunities to access domestic and global supply chains.

From an accounting point of view, the above matters add significant challenges to financial reporting. Entities in the manufacturing sector may struggle to ensure their financial statements accurately reflect their true and fair financial position and  their performance. Below there is a summary of  key applicable accounting matters to consider: 

The trading activities and the financial position of some manufacturing entities have been severely impacted by COVID-19 and as a result of the other events discussed above. Other entities have a reduced ability to access finance. These matters may affect their ability to continue as a going concern.

Going concern

In according with the Australian Accounting Standards (‘AAS’), financial statements should be prepared on the going concern basis unless management has no realistic alternative but to cease trading. However, where significant uncertainty exists, this must be disclosed, together with management’s plan to ensure the business is able to meet its obligations.

Where businesses have been severely affected, the directors may also wish to seek legal advice regarding their obligations relating to insolvent trading.

Cost of inventories

AAB 102 Inventories (‘AASB 102’) states the cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Significant judgment is required to properly allocate systematically fixed and variable production overheads that are incurred in converting materials into finished goods.

Measurement of inventories

Under AASB 102, inventory shall be measured at the lower of cost and net realisable value.

Increases in costs, such as labour, freight, energy and raw material and electronics, can result in the cost initially recognised as being greater than its net realisable value. The amount of any write-down of inventories to net realisable value is to be recognised as an expense in the period the write-down or loss occurs.

Impairment

Under the AAS, where significant changes take place which have an adverse effect on an entity, this should be treated as an indicator of impairment. This includes changes in the economic and market environment in which the entity operates or in the market to which an asset is dedicated.

A similar criteria applies regarding assets use or expected use. Significant changes which negatively impact the extent to which, or manner in which, an asset is used or is expected to be used, represent an indicator of impairment. Examples of these include assets becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite.

Therefore, management should immediately carry out an impairment test, assessing any remaining value in such assets, and either recognise an impairment or write the assets off if appropriate.

Indicators of impairment may still exist even where an entity appears to not be directly impacted by recent and current market conditions in the sector. These indicators may exist for either tangible or intangible assets, as a result of reductions in customer demand or sales activity. If such an indicator of impairment is identified, a full impairment test must be performed over the asset or impacted cash generating units.

Borrowing cost

AASB 123 Borrowing Costs (‘AASB 123’) certain inventories and manufacturing plants may meet the definition of ‘qualifying asset.’ Therefore, borrowing costs directly attributable to the acquisition, construction or production can be capitalised as part of the cost of these assets.

AASB 123 defines a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

It is noted that the capitalisation of borrowing costs is forbidden for inventories that have been acquired ready for their intended use or sale, as well as for inventories manufactured, or otherwise produced, over a short period of time. Instead, these costs are to be recognised in profit or loss as interest expense over the period in which they are incurred.

For more information

If you have concerns about any of the issues raised in this article, please reach out to your local RSM office.

Article source: Manufacturing Monthly