The decline of economic activity due to the coronavirus (COVID-19) pandemic and resulting economic disruptions will certainly require some manufacturing companies to make adjustments under SFAS 151, Inventory Costs, when preparing their 2020 financial statements. Manufacturing companies experiencing an abnormal decline in capacity utilization are more likely to be required to expense all fixed manufacturing costs associated with unused capacity in the current year. These adjustments will impact reported 2020 net operating income and ending inventory amounts.

SFAS 151 [Accounting Standards Codification (ASC) 330-10-30, paras. 1–8], effective for fiscal years ending after June 15, 2005, resulted from the efforts by FASB and the IASB to harmonize accounting standards globally. SFAS 151 changed the wording of Accounting Research Bulletin (ARB) 43 (ch. 4, para. 5). If, in the judgment of financial statement preparers, the annual production level is abnormally low (outside the range of expected variation in production), fixed overhead allocated to production units should not be increased due to fixed expenses related to the abnormally low production, or idle plant. Fixed overhead costs related to excess capacity should be expensed in the period in which they are incurred.

Calculation of Ending Inventory Cost and the Impact of the SFAS 151 Adjustment

Most manufacturers probably set their predetermined fixed manufacturing overhead rates for 2020 based in part on 2019 production levels, which peaked at approximately 78% capacity utilization. Statistics from the Federal Reserve Bank of St. Louis (, indicate that, due to COVID-19 economic disruptions, manufacturing capacity utilization in the second quarter of 2020 fell to just above 60%. That was a lower capacity utilization rate than that experienced at the very bottom of the Great Recession in 2009 (63%).

Quarterly financial reporting information available in the Compustat database ( revealed that several manufacturing industry segments reported less than half of sales and cost of goods sold, on average, in the second quarter of 2020 compared to the second quarter of 2019. In four different four-digit standard industrial classification (SIC) codes, a company with more than $10 million in assets reported sales decreases of more than 70% and cost of goods sold decreases of more than 60% in the second quarter of 2020 (compared to the corresponding quarter of 2019). Manufacturing capacity utilization has risen somewhat since the second quarter of 2020; nevertheless, capacity utilization rates late in 2020 were still well below the level that many manufacturers would have used to calculate their 2020 predetermined overhead application rates.


To illustrate the potential impact on manufacturers’ financial statements, the following example is provided for STEEL Company, a fictional small steel manufacturer. [The sales and cost numbers used in the examples are roughly based on information available from FocusEconomics ( and a report by the Joint Research Center of the European Commission (] Assume fixed manufacturing overhead was approximately 20% of the cost of goods sold reported by the company for 2019. In steel production, the output of tons of steel could serve as the overhead application base. (The same effects would be present for companies that use other bases, such as machine hours or direct labor hours, to apply manufacturing overhead costs.)

For the following calculations, assume STEEL Company’s 2020 predetermined overhead rates were based on 100,000 tons expected production, or 80% capacity, and the company budgeted $10 million of fixed overhead. The fixed manufacturing overhead predetermined rate for STEEL Company for 2020 would equal $10 million ÷ 100,000 tons, or $100 per ton. Assume that 90% and 10% of the units produced in 2020 were sold and included in ending inventory, respectively.

Assume that due to less demand than expected in 2020, actual production was 60,000 tons and that STEEL Company reduced their fixed manufacturing costs somewhat, to a total of $9,500,000. The fixed manufacturing overhead volume variance is calculated as follows:

Fixed manufacturing overhead applied:

Actual production, 60,000 tons × $100 rate per ton = $6,000,000

Less: Actual fixed manufacturing overhead incurred – $9,500,000

Underapplied fixed manufacturing overhead for 2020 = $3,500,000


Under normal capacity utilization, the underapplied overhead would be allocated between cost of goods sold and ending inventory. Assuming 10% of the units produced are in ending inventory, $350,000 (10%) of the $3,500,000 underapplied amount would be added to ending inventory costs and not be expensed.

If 2020 production levels are considered abnormally low, SFAS 151 would require expensing the total underapplied fixed overhead of $3,500,000 in 2020. The SFAS 151 adjustment would be the $350,000 of underapplied fixed manufacturing overhead that otherwise would have been allocated to ending inventories, resulting in a somewhat lower reported 2020 net income and ending inventory in STEEL Company’s financial statements. After the SFAS 151 adjustment, any adjustment necessary to value inventory at the lower of cost or market should be considered.

Many companies have experienced severely reduced sales and cost of goods sold during 2020 that should be considered “abnormal.”

At a price of $600 per ton, if STEEL Company could sell 60,000 tons (50,000 units produced in 2020 and 10,000 units from beginning inventory units), the company’s sales would total $36 million. Therefore, the SFAS 151 adjustment of $350,000 for 2020 would be close to 1% of sales. This adjustment may not significantly affect financially strong companies, and may even position them to achieve much better reported results in 2021.

Even a relatively small adjustment, however, will negatively impact the ratios calculated from financial statements. Some companies may find that the adjustment impacts 2020 financial statements just enough to cause violations of their debt covenants based on financial ratios. When properly disclosed in the notes to financial statements, managers could point to the effect of SFAS 151 to ask for covenant waivers or mitigate unfavorable modifications to their debt terms because of the covenant violations.

Proper Disclosure of the SFAS 151 Adjustment

A previous study examined manufacturing companies’ SFAS 151 disclosures for 2009, which was the lowest point for economic activity during the Great Recession. (See Foster and Baxendale, “Accounting for the Cost of Unused Capacity in an Economic Downturn,” The CPA Journal, May 2013, pp. 20–26.) That study found that only some 40 companies mentioned SFAS 151 adjustments in the notes to their 2009 financial statements, of which only 11 disclosed a dollar amount. Company accountants and auditors should plan disclosures that will provide better information to users than that given with most 2009 financial statements.

An example of adequate disclosure is provided in the fiscal year 2009 10K report for Motorcar Parts of America Inc. ( p. F-6):

Finished goods cost includes the average cost of non-core raw materials and allocations of labor and variable and fixed overhead. The allocations of labor and variable and fixed overhead costs are determined based on the average actual use of the production facilities over the prior twelve months which approximates normal capacity. In addition, the Company excludes certain unallocated overhead such as severance costs, duplicative facility overhead costs, and spoilage from the calculation and expenses them as period costs as required in Financial Accounting Standards Board (“FASB”) Statement No. 151, Inventory Costs, an amendment of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4 (“SFAS No. 151”). For the years ended March 31, 2009 and 2008, costs of approximately $2,019,000 and $1,599,000, respectively, were considered abnormal and thus excluded from the cost calculation and charged directly to cost of sales.


Plan for Disclosure

Many companies have experienced severely reduced sales and cost of goods sold during 2020 that should be considered “abnormal.” Thus, CFOs and auditors of companies that experience large unused capacity costs should plan for the calculation and disclosure of SFAS 151 adjustments. During the Great Recession’s abnormal impact on unused capacity in 2009, very few manufacturing companies disclosed the amount of their adjustments. Better disclosure, including the dollar amount of the adjustment, will help managers explain deteriorating financial results for 2020. Better disclosure will also help potential investors, lenders, and other financial statement users formulate more robust assessments of companies’ current risk, their ability to generate future cash flows, and their potential profitability as the economy and production emerge from pandemic disruptions.

Benjamin P. Foster, CPA, CMA, is a professor of accountancy at college of business, University of Louisville, Louisville, Ky.