By Philip Blakely, CPA, Manager at Blue & Co.

Inventory Valuation and Impacts of Idle Capacity

The beverage industry is navigating through challenging times, with increased aging barrels in the market, potential international tariff concerns, and a temporary dip in the demand and price for distillate—especially newly produced American whiskey. These factors have created uncertainties, particularly for distilleries that depend on contract distillation to generate cash flow while aging barrels for their own brands. As a result, some distilleries are making strategic decisions about whether to maintain full production capacity or adjust to meet current demand.

At Blue & Co., we understand the pressures and uncertainties these times bring. While the market is cyclical and tends to recover over time, slower production is expected to continue in the short term. Preparing proactively can help your business adapt and emerge stronger. Here’s what to keep in mind from an accounting perspective.

What Are Inventory Costs?

Inventory costs encompass all expenses incurred during the production, storage, maintenance, and maturation process to ready goods for sale. These include:

• Direct materials: Costs of materials like barrels, grain, water, and enzymes used to create the distillate.
• Fixed overhead: Costs that remain constant regardless of inventory levels, such as rent/lease payments, insurance, salaries, and depreciation.
• Variable overhead: Costs that fluctuate with production levels, including utilities, stillage removal, and wages for variable staff.

Additional carrying costs, like storage, insurance, and taxes, are incurred over time as the distillate ages. These expenses should be capitalized into inventory costs when they arise.

Impact of Idle Capacity or Reduced Production 

If your distillery plans to temporarily reduce production or shut down, it’s vital to understand how this impacts financial statements. While slowing production saves cash in the short term, it also changes how overhead costs are allocated to inventory.

Direct material and variable overhead costs are still applied to inventory, but fixed overhead costs must be reassessed. Accounting guidelines require that fixed overhead be allocated based on the “normal capacity” of the distillery. If operations run below normal capacity, fixed overhead costs per barrel/proof gallon should not increase to compensate for idle capacity. Instead, any abnormal amounts of overhead should be expensed in the current period.

This adjustment ensures that inventory is valued accurately and reflects actual production levels. Determining “normal capacity” often requires judgment and should consider maintenance periods necessary for ongoing operations.

Example/Illustration

Consider a distillery operating at normal capacity, producing 10,000 barrels a month at $500 per barrel. This cost includes $400 of direct materials, $50 of variable overhead, and $50 of fixed overhead. If production is reduced to 6,000 barrels per month due to lower demand, direct material and variable costs remain unchanged, but $200,000 in excess fixed overhead ($50 x 4,000 barrels) would need to be expensed during the period rather than applied to inventory.

Blue Beverage Services Is Here to Help

Navigating these accounting complexities can feel overwhelming, but you don’t have to do it alone. Blue & Co. is here to support you every step of the way, helping you reassess capacity, allocate costs appropriately, and prepare for market recovery. Contact us today to ensure your financial practices remain robust and aligned with industry standards.