Accounting and auditing in supply chain crisis

By Laura Hay, CPA, CAE, OSCPA executive vice president

Supply chain challenges bring new business risks and disruptions, highlighting the role of trusted financial advisers to lead through this crisis. Matt Rosen, CPA, director at Barnes Dennig & Co, Ltd., offered the most frequent technical advice CPAs should be aware of during supply chain constraints.

“More than ever, accountants and auditors need to interact with other areas of the business, such as purchasing and operations, to understand how the enterprise’s risk profile is changing and its impact on audit planning, accounting and financial reporting,” Rosen said. “Understanding what business model changes will stick and how that positions the organization for future value delivery is important in providing a high-quality audit and relevant, decision-useful information.”

Some accounting and auditing considerations highlighted by Rosen include:

Inventory valuation and storage

Understanding what purchasing is doing to address the operational impact affects assessments of inventory risks and obsolescence. For example, if more inventory is purchased in advance, or if more inventory is stored in additional locations, this could result in higher risk being assessed in audit planning and could also result in greater obsolescence reserves. New locations can mean new leases that need to be evaluated.

Purchase commitments

To manage against future risks, an organization may enter contracts committing to a certain volume of purchases at a determined price, which exposes the business to market fluctuation risks. Evaluating market risks and disclosing the purchase commitments and unfavorable market pricing may be required.

Inflation and price changes

Rising prices not only create valuation challenges, but also a need to better understand what portion of price increases the entity is able to pass on to customers. Prices that are less than costs could create a need for net realizable value reserves.

Understanding the increasing costs of selling and marketing the product is also important to this evaluation.

“If the selling company is covering shipping costs and paying more to ship products with razor-thin margins, that can be enough to put them in a negative position requiring NRV reserves,” Rosen said.

Likewise, a business interruption with production stoppage or reduction due to supply or labor shortages could result in an overallocation of fixed costs to inventory.

Understanding the true cost of goods and services becomes more complex as future prices and inputs become increasingly unpredictable.

Revenue recognition

Methods of measuring progress toward satisfying a performance obligation may become interrupted with business or supply disruptions. Using the example of the construction industry, if contractors are buying more inventory ahead and holding onto more uninstalled materials in anticipation of supply challenges or price increases, this may require a change from existing accounting processes to identify these materials to avoid the premature recognition of revenue.

On the selling side, as contracts are renegotiated with more variable pricing relationships in place as companies work to manage inflation risks, revenue recognition practices may need to be reexamined.

“CPAs need to walk down the hall and understand what purchasing, sales and distribution are doing,” Rosen said. “In what ways are contracts changing that dictate accounting, reporting and disclosures, as well as how is the business model changing that may advise accounting policy changes for the future? Business decisions are having a more direct impact on financial practices and CPAs need to be the consultants assisting with navigating these changes.”

Risks and uncertainties

Additional disclosures of risks and uncertainties are likely due to disruptions.

Small or specialized business challenges

Smaller businesses with fewer resources assigned to managing supply networks or highly specialized or stressed businesses may face a more significant impact on the ability to deliver products or services, causing cash flow, debt, or ongoing concern disclosure needs. Accurate forecasting to predict future cash flow needs will be more complex.

More information on the accounting, auditing and reporting requirements and other accounting and auditing considerations of supply chain challenges are in the AICPA Center for Plain English Accounting paper, Supply Chain Disruptions: Accounting and Auditing Considerations.

A new Charter for Collaboration from the Institute of Management Accountants, the Association of Chartered Certified Accountants, and the Chartered Institute of Procurement & Supply discusses how accountants and procurement specialists can better work together during supply chain constraints. The report asserts that many organizations don’t fully understand their supply networks. During a period of increasing regulation and pressure to disclose ESG supply chain risks, it is critical that these roles work together more closely.

Technology and transparency are essential tools in improving the understanding of the connectivity and information roll-up throughout the network. Predictive analytics on customer trends, the potential for future supply breakdowns, and other business model shifts such as the move to online work and consumption can help in developing future production and warehousing plans.

The profession’s commitment to ethics makes it the ideal partner to provide this information for users and business decision-makers.

Laura Hay, CPA, CAE, is executive vice president of The Ohio Society of CPAs and staff liaison to the Accounting Auditing and Professional Ethics Committee. She can be reached at Lhay@ohiocpa.com or 614.321.2241.