How to Account for Recalls in Financial Statements

by Charmayne Smith; Updated September 26, 2017

Product recalls occur when faults are found in products that can result in harm or injury to the users. When products are recalled, the business is generally required to correct or repair the faulty equipment or refund the consumer for the purchase of the recalled product. Product recalls can have substantial impacts on the business revenue. The resulting adjustments to financial statements are dependent upon the methods the business uses to correct the product recalls.

Step 1

Determine the methods the business will use to correct the product recall, along with the expenses and costs involved. Include items such as refunding purchase cost, repairing products, shipping and administrative expenses and additional manpower.

Step 2

Adjust the applicable journal entries to reflect the costs incurred due to recall activities. Update the business’s current balance sheet with the new calculations. Reduce the ending inventory portion of the balance sheet by the amount of raw materials and inventory that can no longer be used or sold due to the product recall. Include the lost raw materials and inventory expenses in the depreciation potion of the balance sheet.

Step 3

Adjust the net sales, cost of goods sold totals, inventory totals and labor costs in the current income statement to reflect the incurred costs, as well as the changes and losses in the inventory. List the recall advertising costs and general expenses incurred in the general and administrative portion of income statement.

Step 4

Update the business’s cash flow statement to show how the business’s funds flow in and out of the company. Adjust all applicable sections of the statement --including the payroll expenses -- to show increases in labor, repairs, maintenance, additions to professional services for legal advice regarding the product recall, as well as bad debt and accounts payable entries.

Step 5

Determine your company’s new inventory turnover ratio now that the figures have been adjusted for the product recall. Take the inventory figure from the updated balance sheet and multiple the total by 365 days. Divide the figure by the total cost of goods sold found on the updated income statement to determine the percentage of inventory turnover.

About the Author

Writing professionally since 2004, Charmayne Smith focuses on corporate materials such as training manuals, business plans, grant applications and technical manuals. Smith's articles have appeared in the "Houston Chronicle" and on various websites, drawing on her extensive experience in corporate management and property/casualty insurance.